What does it take to start a business? When is it appropriate to seek venture capital? Such questions were addressed at "The Inside Story on Venture Capital," one of thirteen educational panels presented at the Management Conference in June.
Nearly 170 conference attendees crowded into a Gleacher Center
classroom to glean advice and insights from four GSB alumni–venture capitalists Kathryn C. Gould, ’78; Robert V. Adams, ’61;
and Richard H. Kimball, ’83; and entrepreneur Robert C. Taylor
Jr., ’90. The session was part of the entrepreneurship track of
the conference, which also included a "back to the classroom"
session with James E. Schrager, clinical professor of entrepreneurship
and strategic management. The track was immensely popular, and
according to Gould, with good reason.
"It's an amazing time for entrepreneurship in this country," she
said. Funding for start-ups is available at unprecedented levels;
$12 billion was invested by venture capitalists in 1998. How does
an entrepreneur tap into this resource? Below is an edited version
of the panelists' discussion. Some of the questions were initiated
by Gould, who moderated the panel; others were asked by the audience.
Should you start a company? What are the most important personal
characteristics of an entrepreneur?
How can you get an unfair advantage? How can you bring proprietary
knowledge and skills to bear?
How should you finance your company?
What should you look for besides money from venture capitalists?
And is there a valuation, a value-added trade-off?
Speaking of “vulture” capitalists, let’s talk about what you should
look out for with venture capitalists. How do you check out venture
capitalists? How do you make sure they’re not “vulture” capitalists?
Are there definite dos and don’ts when approaching venture capitalists?
When approaching venture capitalists, are references what really
matters?
Resources
Should you start a company? What are the most important personal
characteristics of an entrepreneur?
Taylor: When we started Focal, the old adage “necessity is the mother
of invention” really played out. All four of us were in telecommunications
and related fields. My original partner was vice president of
marketing at MFS Communications, and I ran a business unit there.
We kept hearing a need from customers that we couldn’t satisfy
at MFS for various reasons. We eventually thought maybe we could
fill this need. We were lucky enough to be at a company that had
experienced incredible growth and equity appreciation, so when
we stepped out to take the leap, we could afford to do it for
one or two years.
The ability to leave a comfortable job to take a risk is something
one in a thousand do. While we’ve hired a lot of people who say
they wish they would have been with us earlier, the reality is
they never would have been there earlier. You must have a certain
belief–one that I think is unique among entrepreneurs–that whatever
you’re going to do will work.
Gould: You exemplify a couple of the common points I see in start-ups.
One, there’s usually a team of people. Two, having proprietary
insight into a market is really important, because venture capitalists
like to back people who have a lot of experience in their chosen
markets.
Taylor: We also had four founders who were uniquely different. One came
out of NationsBank, where he was a high-yield bond analyst for
the telecommunications industry. He became the CFO and had an
inside perspective on what venture capitalists might want to see
from a business planning process. We also had somebody who was
a VP of sales from another telecom company who could go out and
attract a sales force. The other original player and I had both
marketing sales and operational skills. The telephone business
is so big and so complex that one person can’t do it all.
Adams: I started ten companies, and the first thing I looked at was
if the top person or people were compelled to do it. We talk a
lot about the glamour of entrepreneurship, but the uncertainty
gnaws at you so hard that it has to be something you have to do.
You can’t be driven by money, because the money will never be
worth it. If you’ve got that passion, if your life isn’t going
to be complete unless you do this, then do it. But if you don’t
feel that way, I’m not sure I’d suggest it.
I also don’t think the top person needs to be the smartest person
in the team, but he or she needs to be a visionary, because you
don’t have money for the strategic planners that you’d find in
a larger organization. The leader must have it in the gut, know
what he wants to do and where he wants to go, or there’s going
to be a lot of trouble managing that small team.
Having said that, I always looked for the absolutely smartest
people
I could find for the CFO, marketing chief, and so forth. The whole
gist of entrepreneurship is that there are no guideposts, no milestones,
no history. Unless you are really smart and can move quickly,
it’s going
to be too late.
People starting a company also have to be good team players because
you can’t spend too much time pointing fingers when something
goes wrong. You all have to jump on it and get it fixed.
Gould: Starting any company is really hard to do, so you can’t be so
smart that it occurs to you that it can’t be done. A lot of people
ultimately conclude that in fact it can’t be done, but it gets
done anyway. It takes that passion to walk through walls. To be
an entrepreneur takes a high tolerance for ambiguity and chaos.
It doesn’t make sense a lot of times, but you just have to keep
going.
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How can you get an unfair advantage? How can you bring proprietary
knowledge and skills to bear?
Gould: A great way to start a company is with a customer, perhaps from
your previous experience. Another thing that works very well is
to have an expert advisory board.
Kimball: The way we look at the world, only one thing matters: Are there
customers? Are there people willing to pay for that solution,
product, or service? Do they have a sugar daddy customer? We think
that gives someone an edge.
Taylor: Surround yourself with competitors, especially if they are monopolists.
One couldn’t design better competitors than the large corporations
Focal is up against. The competitive advantage for a small company
is to make a decision quickly. As simple as that seems, it is
a huge advantage in this marketplace.
Kimball: The reason venture capitalists are in business is that great
things are done by small groups of people. Big companies throwing
three hundred people at a software problem does not offer an advantage
over throwing thirty people at it; in fact, it gives you a big
disadvantage.
Adams: The biggest unfair advantage you can develop is being first,
getting such a momentum going that even more nimble competitors
have a hard time catching up with you.
An example is Documentum, which writes document management software.
We could see applications for that software across a half-dozen
different industries. We also had only about a half-dozen people.
We felt that if we tried to spread ourselves across too wide an
area, we would never get any momentum up and our competitors would
catch up. We stumbled upon one particular application in pharmaceuticals
and decided to focus on that. We found the first early adopters
and drove into that market as far as we could until we had ninety
or so customers before moving on to the next vertical market.
That didn’t allow anyone to catch up with us.
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How should you finance your company?
Gould: These days there are a lot of alternatives. Certainly you can
bootstrap it if you get access to the right customer or small
set of customers first, or have the right uncle, I suppose. There
are more and more angel investors, as well as venture capital.
Taylor: We thought about all of those. One of my partners and I had enough
friends and family members and uncles that we could have raised
enough money to get the business going. But we also knew we would
ultimately need Wall Streettype investments. While you gain one
aspect of control when you have a bunch of “dumb” investors through
friends and families, you lose the institutional value that venture
capital firms bring. This is important if you want to go to the
next stage. If you want to start a doughnut shop, that’s all you
ever want to do and it’s going to be one store, then friends and
family are perfect. But if you think you’re going beyond that,
you may need a venture capital firm. Even though it meant giving
up a substantially larger piece of the business, we felt that
the reward, the insight, and the reputation of those firms would
be paid back to us in spades.
Gould: In situations where you need to move quickly, there’s no better
way to get a fast start than through venture money. Interestingly
enough, my start of Oracle was not venture backed. It was a painful
bootstrap in the early ’80s, in part because at that point in
time, software was something venture capitalists couldn’t really
wrap their minds around as something to invest in. But as I look
back, maybe it was best. Clearly it was best for the founders–we
owned a lot of the company.
Another plus was that we were in a market where moving fast was
not what it was about. We grew organically at the pace that the
market could absorb the new technology. I wonder often if we had
been successful in raising venture money–which we tried, for a
couple years–if we would have been forced to move differently.
A venture firm, I imagine, would have become quite impatient with
us.
Adams: Part of it depends on what your end game is. If you’re looking
to start a business and you don’t care if it’s large, and therefore
you can grow it more slowly, there are probably more economical
ways of getting capital than through venture capital people. They
get a fair sum for what they do because they don’t just give you
money–they give advice. They also put a stamp of approval on you
when you go to investment banks to go public.
I prefer to have names on my venture capital list that the banks
know and that have been successful. To me, it’s worth giving up
more of the ownership. If it works, you’re going to make enough
money that having two percent more isn’t going to make much of
a difference.
Gould: I think you bring up an interesting point. Some companies that
are not destined to be large companies can still be very lucrative.
They are great to own for a few years and not share with venture
capitalists. In fact, some companies that should be proprietorships
mistakenly raise venture money, which leads to some unhappy conclusions.
Venture capitalists invest expecting at some point a liquidity
event and expecting a return. That can force a company to be in
a position where they need to be acquired and that may not be
the desire of the founders. Before taking on venture capital,
you have to consider the obligations.
(Back to top)
What should you look for besides money from venture capitalists?
And is there a valuation, a value-added trade-off?
Taylor: We began by going through a list of venture capital firms and
whittling it down to those who did technology and communications.
Then we crossed off those who were involved with potential competitors
and really got that down to a small list. We picked out two or
three who we thought might be interested, but who we didn’t think
we’d ultimately do business with, and sent them our first draft.
We began to go through the process to see what they liked, what
they didn’t like, what they’d be looking for. We took that information
back into the secret lab and fine-tuned our presentation.
We were looking for people who didn’t need a lot of explanation
about the phone business. The phone business, even when I started
here at the business school, was monopolized, and here we were,
little Focal, trying to compete against companies like AT&T and
Ameritech. We felt that we would have an advantage with those
who had played in competitive wireless or who had played in the
early days of competitive long distance. We spent a lot of time
building a really good business plan that would get their attention.
There are venture capital guys in every business, and the key
was finding the guys who appreciated and understood information
technology. That was our first and foremost focus.
Gould: Clearly, you were looking for industry knowledge. How important
was the venture capitalists’ ability to help bring in board members,
management team members, and so on?
Taylor: It didn’t enter our thinking at first. But eventually we recognized
that to get to the next step, we would need to add outside board
members. The venture capital firms were very helpful in that because
it was their reputation that added credibility to the business
and opened doors on Wall Street. There’s a lot of downstream value
that is impossible to put a dollar figure on. You can certainly
do the friends and family route, but by and large you get all
those downstream benefits from picking the right venture firms.
Kimball: The entrepreneur is at ground level, he’s in the jungle. The
way we look at things, we’re up at 30,000 feet. We’re seeing hundreds
of companies and we’re following lots of different scenarios,
so if the entrepreneur looks like he’s heading for trouble, we
can at least warn him and get him moving in another direction.
In one of my companies where I serve on the board, a software
company, the sales line was going like gangbusters. The only problem
was that we were having tremendous difficulty implementing the
software. Our professional services arm was losing money. I have
no skill set to fix that, but one of my investors is the individual
who built the professional sales arm at PeopleSoft from zero to
a business bringing in hundreds of millions of dollars a year.
So I got him on the board. There were major problems, but at least
I knew I could sit back and say it’s going to get fixed. I didn’t
have to worry about it. And that’s what the entrepreneur felt
as well. The value our firm added was this relationship that we
could have from seeing the big picture.
Gould: I want to talk about Chicago for a second. We only invest up
and down the Pacific time zone because we spend so much time with
the companies we’re working with. I wondered if any of you have
thoughts on the difference in time, space, and money for a company
based here versus a company in California.
Taylor: The number one rule is it’s really expensive to travel. One of
our firms is from Boston. Flying from Chicago to Boston on a full
coach fare, when they call you up and say, “We’d like to see you
tomorrow,” is about $1,200. But you can fly to Newark for $300,
rent a car and drive five hours, and you’re there for a lot less.
We ended up doing that every time we had to go to Boston. It didn’t
dawn on one of the venture capitalists until he asked what time
our flight was. It was noon when he asked and we said, “We have
to leave now, our flight is at seven o’clock.” He said, “But Logan
is five minutes away.” We said, “But Newark is five hours away.”
The next day an offer letter showed up.
Getting to them was something we considered, and we looked with
a greater concentration in Chicago simply because we were here.
We weren’t thinking of whether or not we wanted them here–on the
one hand, it would be great if they were in San Francisco, because
they’d never stop in.
Kimball: We’d love to be doing business in Chicago. We conduct deals all
across the country and have even figured a way to do deals in
Canada. If a venture has to be very people- and time-intensive,
it doesn’t make a lot of sense. But if we can find a relatively
mature company in Chicago, we’d love to do it. For one, it’s a
lot less competitive than the Bay Area, which translates into
lower pricing. Two, there are lots of great people and talent
in Chicago, and the ability to retain those people is probably
greater than in Silicon Valley. There a new start-up might open
down the street and become the hottest thing, and your people
can walk out the door and take the next job with the best stock
options. In that vein, if you bootstrap the company today and
are thinking of getting venture capital, I would tell you two
things. Make sure you’ve got a Big Five auditor and get top legal
advisers who’ve done venture deals. That’s going to make you much
more professional and much more able to deal with “vulture” capitalists.
(Back to top)
Speaking of “vulture” capitalists, let’s talk about what you should
look out for with venture capitalists. How do you check out venture
capitalists? How do you make sure they’re not “vulture” capitalists?
Gould: It’s important to make sure they understand your business, but
it’s also important to check them out. There’s nothing wrong with
asking for references. Or, if you want to be subtle, it’s easy
to find out the boards they sit on. Call up their CEOs and say,
“So tell me about them.”
Taylor: We called around, we looked at what boards they were on, and
we talked to people. We tried to do the same amount of due diligence
on them that they were doing on us. This is a marriage that goes
beyond the IPO, if that’s the route you go. It’s going to be years
before your relationship ends. I could see some of our venture
capitalists being on our board forever.
(Back to top)
Are there definite dos and don’ts when approaching venture capitalists?
Gould: My most important criterion is still a well-thought-through target
customer who has a compelling reason to buy. The absence of that
is a pretty good killer. If the team has that customer, we’re
willing to work with almost any other quirk.
Adams: I won’t invest unless it’s a pretty large market. I don’t really
like niche markets, it’s too hard to stay viable. You might get
started, but sooner or later someone will catch up with you who
is much larger.
Kimball: Big and fast-growing markets make up for a lot of mistakes. In
our portfolio, it’s absolutely clear that the most important thing
is finding the big market. Because if it turns out that we can’t
compete, we still make great money on those investments.
(Back to top)
When approaching venture capitalists, are references what really
matters?
Gould: I love companies who have people we’ve backed before. Work your
networks hard. It amazes me how many people you can come to know
through people you already know. But one thing to be aware of:
Don’t be referred by bozos. Make sure it’s someone I know and
respect.
It’s very much a personal process, and it’s not a rational process.
It’s not that if you don’t know the right people you can’t get
funded. But if you think you don’t know the right people, you
should get networking.
Resources
Gould suggested these sources to find firms that are investing
in companies similar to yours.
National Venture Capital Association
1655 North Fort Myer Drive, Suite 850, Arlington, Virginia 22209
Phone: (703) 524-2549 Fax: (703) 524-3940
VentureOne Corporation
590 Folsom Street, San Francisco, California 94105
Phone: (415) 357-2100 / (800) 677-2082 Fax: (415) 357-2101
Additional resources
Venture Capital Resource Library
Links on the GSB’s Web Site
www.gsb.uchicago.edu/research/entrep/HelpfulLinks.htm
www.gsb.uchicago.edu/gsbcar/vencp_ind.shtml
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Secret of Her Success: More than one thousand people attended the 47th Annual Management Conference in June. Karen Katen, A.B. ’70, M.B.A. ’74, vice president of Pfizer Pharmaceuticals and president, U.S.
Pfizer Pharmaceuticals Group, delivered the keynote address over
lunch at the Sheraton Hotel Chicago, followed by thirteen educational
sessions at Gleacher Center.
Chicago faculty members and industry experts–inclucding eighteen
alumni–offered advice, debated the issues, and took attendees
"back to the classroom" for educational updates. For a list of
sessions and presenters, click here.