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Archive for December, 2007

Incubating Innovation – part 2

Sunday, December 30th, 2007

I am at heart a technologist. I still get excited hearing about new, cool software technology and solutions. All of my past experience, and now at eXeed, my time goes into figuring how to mold new technology so that it solves a real problem for a large set of potential customers. At IBM Research our group used to use the term “Research in the Marketplace”. Continuing that tradition at eXeed, we work pretty much only with startups that have unique technology, so my comments are very much focused on technology based startups.

In my previous post I tried to show why the numbers make it hard for corporations to create “startups” internally. Beyond the numbers, there are two basic truths about technology based startups that make it very difficult to cultivate them in a large corporate environment:
1. Over a short period of time technology-based startup products need to morph (sometimes repeatedly) to meet customer\market needs –experimenting in the marketplace  while leveraging the same basic core technology. Very few technology startups start with the same set of product (ideas) and business model as they exit with – but in most cases the new direction still leverages the same core technology. 

2. Startups start out small, with very little (if any) revenue. One thing to remember is that even an exponential curve starts out slow – and only speeds up as time goes on.

These two “facts” make it hard for a startup to be incubated in a large company – there are just too many barriers to being nimble enough to make point 1 work, and point 2 usually means that the corporation looses interest before success can be shown (especially given the ambiguity associated with point 1, and since there is usually an existing set of products that can generate more short term revenue with the same investment).

I guess the basic point is that the impedance between running an existing business and starting a new one is so great that unless the corporation is willing to experiment with new, unorthodox models, and can commit long-term high-level executive support, it just won’t work. Even then there is still the issue of getting the right people (and giving them a loose enough rein)  – but I will discuss that in another post.

Incubating Innovation

Sunday, December 23rd, 2007

I read an Forbes article this weekend on incubating innovation which is something I have had the opportunity to do as part of an extra large organization, a medium size company, a small startup, and now as an investor.

The thought process of setting up an incubator in a large company is pretty simple – management sees the outsize returns that VCs produce, know they have wealth of worthwhile internal projects that will never make it to market – put one and one together – and come up with some sort of incubation process. They also hope that it will help them break into new markets. According to the Forbes article  “Arthur D. Little found that only 47% of companies believe their new ventures satisfy strategic objectives. Worse, only 24% meet financial objectives.” I am guessing that these numbers were mentioned since they show that incubation doesn’t work well – on the other hand, IMHO, a 24% across the board success ratio for new ventures isn’t too bad (not great, but not bad).

So I thought I try to do a back of the envelope comparison of the success requirements of internal incubation versus VCs. This is of course comparing apples to oranges since VCs look at the market value of the new venture upon exit, while existing companies look at the revenue and profit generated by a new venture. In any case, I thought it would be fun to try and somehow generate a comparison.

Let’s start by looking at early stage VC returns. Fred Wilson’s success ratio is that 35% of his companies do really well – over 5x investment , 45% do OK – 1x to 5x investment, and 20% tank.

A simple way to try and compare the two is to look at much revenue $1 investment would achieve if invested in existing products at the company– that of course depends on lots of things (including the industry), but I think a ROI of 2 would be considered a success. So to beat out a comparable investment in an existing product – a new venture needs to return at least $2 in recurring revenue for every dollar invested. Using another simplified (and conservative) measure, that $1 in revenue generates $5 in company value in the new venture which is equal to a VC obtaining (1×2x5) 10x on their investment. Now I know this is over simplifying things but a 24% success rate under these assumptions would be really, really good.

Another possible model is to assume that a company needs to return its investment in the new venture (via new revenue) within 3 years (so the new venture needs to return 1/3 of its investment each year). So let’s say the new venture generates $5M of revenue a year on average and with a really high growth rate (what the market and companies reward). The market value of a new venture like that would around $50M-$80M – which means that to get a good return – a VC can invest $10M-$14M and get a pretty good return (3x-8x). In this case the company and VCs are equivalent – the company can invest up to $15M in the new venture and also get a pretty good return by their standards (a 3 year ROI through revenue). Even here a 24% success rate isn’t bad…

Now these are just playing with numbers, there are a lot of qualitative differences between incubating new ventures in a company versus starting new ventures using VCs, but I’ll get to those in another post. These are also the kinds of considerations that companies ake into account when trying to decide between organic, and non-organic growth.

Wisdom of Markets

Monday, December 17th, 2007

I was looking at company that wanted to build a generalized market trading mechanism for anything (which seemed to me to be another name for gambling) and decided to look at intrade wondering whether a market mechanism could actually be used to acurately predict future events. I looked at some of the most highly traded intrade political markets (over 100K trades, which I guess doesn’t really mean over 100K different people) to see who will be the future president in 2008. According to intrade (on Dec 17th)  it will come down to Hillary (with VP candidate Bayh or Obama) vs. Giuliani (with VP Huckabee), and it looks like Hillary is a shoe-in.

One interesting thing I noticed is that there seems to be an internal consistency to these markets, even though the participants are (probably) different.

There is a close correlation between the nominee front runner charts and the presidential winners charts (even though they are unlinked as markets). It will be interesting to see how these predictions change as we get closer to the election, and whether they will actually predict the future…

 BTW - according to intrade there is about a 50% chance of a US recession next year (below the sentiment in September, but above the low in October), but only small chance that Israel/US will bomb Iran (way down from September)…

Amazon EC2, S3 – and now SimpleDB

Saturday, December 15th, 2007

I have been playing with Amazon S3 as a remote backup mechanism for my machines. It is well thought out, works well, and is cheap. For many applications it is a “good enough” solution for managed storage.

Now the friendly folks at Amazon have announced their SimpleDB which provides the core functionality of a DB - real-time lookup and simple querying of structured data. Looks like yet another “good enough solution” for many web based businesses.

It seems like Amazon is rolling along, trying to become the “data center for everyone else”. Big enterprise are not going to be able to divest themselves of their data centers anytime soon, but small business can have the support provided by a data center – with only a fraction of the expense.

Now match this up with a tailored IDE and programming framework to make it even easier to use these services – and you’ll have a killer web application platform (better than Force.com since it doesn’t require the use of a proprietary language – just a specific API).

Investor Presentations

Saturday, December 15th, 2007

I have been seeing a lot of presentations from budding entrepreneurs trying to at least get in the door to present their ideas to some source of funding. Of course, there is great variation in the quality of the presentations (both style and content) – but it isn’t the quality of the graphics that matters (though you can spend hours with Powerpoint wasting time on the presentation), but rather the content and your presentation style.

There are quite a few primers on the web on how to create a good presentation for VCs and other potential investors (e.g. 102030 rule, enetrepreneur pitch guidelines) so I don’t feel the need to write yet another one. In general two simple rules that I use are probably good enough:
1. When creating a presentation a good rule of thumb for the order of a presentation is: Tell them what you’re gonna tell them, Tell them, Tell them what you told them (I heard this first from Stephen Boies while I was at IBM Research).
2. Get to the point – quickly. Since we are a technology oriented fund, tell me about the technology, what it does and why it is unique. So you may actually need to tweak the presentation based on the audience. Or maybe just do it without slides (some of the best pitches were from someone just telling me their story – not a fancy Powerpoint presentation).

One pet peeve of mine is the use too many superlatives – you want me to get excited, but don’t tell me this is the best thing since sliced bread – every entrepreneur thinks that about their idea. You need to convince me. Tell me something I didn’t know. Convince me you know your technical domain and business environment (including competitors).

Another pet peeve is “patent pending technology” – important to mention since it shows that you have respect for your IP and protecting it. Beyond that – it doesn’t really say much. Anybody with a “dollar and a dream” can submit a patent, and in many cases even when it is issued – it doesn’t actually mean much about the value of the idea or technology.

More on Increasing Your Chance of Success as an Entrepreneur

Sunday, December 9th, 2007

An interesting study was published yesterday by the Kaufman Foundation on “Returns to Angel Investors in Groups” which did a large scale study on the returns of angel investment groups in seed and early stage investments.  The main conclusions are:
1. Due diligence time: More hours of due diligence positively relates to greater returns.
2. Experience: An angel investor’s expertise in the industry of the venture in which they invest also is related to greater returns.
3. Participation: Angel investors that interacted with their portfolio companies at least a couple of times per month by entoring, coaching, providing leads, and/or monitoring performance.

 Points 2 and 3 are the most relevant to enttrepreneurs (as long as they decide to invest, who cares how long the DD takes - as long as it is reasonable). The charts below summarize the two main points on the value of angel expertise and experience in providing value to both the entrepreneur and their investors:

Impact of Angel Participation

Impact of Industry Expertise

These numbers back up the my previous claims in “Increasing Your Chances as an Entrepreneur” - anything you can do to get experienced professionals willing to take an active role as part of your team - do it, it will greatly enhance your chances at success.