Can Entrepreneurship Be Taught?

I attended the annual LP meeting for a venture capital firm this week and got into a discussion about the above question. Seems like a good question to ponder given that I spend several hours each week as a professor of Entrepreneurship.

At a high level, I definitely agree that being an entrepreneur and being in school don't necessarily mix. Most of us know of Exhibits 1 (Bill Gates) and 2 (Mark Zuckerberg) from Harvard, but I have met dozens of other successful entrepreneurs who felt a greater need to get going on an opportunity than to wait around to complete a degree.

However, for most of the rest of us, the analytical skills honed in college or grad school, along with the opportunity to network and explore different fields prove invaluable later. With that in mind, I created a new course at San Jose State last year, the Entrepreneurship Lab (E-Lab). The seminar course combined an internship at a start-up or venture firm with classroom learning and sharing of experiences. There was an application and interview process to be admitted to the class so I was able to have a diverse group of students with varied educational and work backgrounds. Business, Engineering, Computer Science, and Design were all represented.

I'm teaching the class again this coming semester and held an information session for prospective students this week. I had several of the students from E-Lab I come to share their experience with those interested in applying for E-Lab II (went with the Super Bowl numbering scheme to see if I can convince the powers that be to make this a permanent part of the curriculum). I was blown away by some of the testimonials of how the course was a career and life altering experience for the students. I realized that opportunities like this are so rare and students don't get enough of this type of experiential education.

Here are a couple of quotes from the students:

"The internship provoked by thinking and challenged me to pursue my interests with more drive and determination. The opportunity provided by the [E-Lab] has been truly inspiring. And now I know exactly where I want to spend my time"

"This internship truly provide me an entry point into the private equity world. I am still not certain about exactly what I would like to do for the next 30 years, but I am certain that it will have something to do with funding/valuing/investing in start-up companies."

I think something else they liked was that there was no final exam, since in the real world, you are judged by the market and investors rather than on a grading curve...Instead, we spent the designated exam time with a final debriefing of the semester at Gordon Biersch brewpub (see below)


Special shout-out to Dan Gordon, founder of Gordon Biersch, who has been a great supporter of our entrepreneurship program at SJSU and is hosting my Entrepreneurial Finance class at the brewery next week.

If you are interested in getting involved in the E-Lab, there are a few opportunities. If you are an SJSU student, the priority application deadline is December 10 and you can find more information and an application here. If you are interested in hosting an intern, we will be accepting employer applications in December and January for internships beginning in February. If you are interested in sponsoring the course, would love to hear from you as being part of a state institution in California provides its own special challenges.

Now back to the question at hand. Entrepreneurship can be taught, but the jury is out on whether you can teach someone to be an entrepreneur. However, I've seen a number of students not find their entrepreneurial DNA until exposed to the content and guest speakers in the entrepreneurial program. That's enough to keep me teaching!

Watch Out for the Red W(h)ine

I have been following the rallying cry of entrepreneurs with some amusement over the past couple of weeks in response to a blog post by Jason Calacanis, "Why Start-ups Shouldn't have to pay to pitch angel investors." In fact, I was cornered by a member of this camp at our recent Sand Hill Angels annual social event at the Wine Room in Palo Alto (great place, by the way). I was afraid if I didn't answer the question of whether Sand Hill charges entrepreneurs to pitch properly, I might be wearing a very nice pinot.

I've written about the practice of charging entrepreneurs in earlier blog posts and it is not something we would ever do at SHA. However, the individual above was adamant that we should have a PR campaign to let the entrepreneurial community know that we don't participate or support this practice. I laughed and said that our web site made this clear and we may have even put a brief posting to this effect on our twitter feed. I'm also a strong believer that your track record and reputation are your most valuable assets in the venture community. This is not something that can happen overnight by putting a press release on the wire.

However, this is a great question to ask at the front of the process. I have put together a list of questions to ask your angel investor group contact:

• Do you charge any fees to present or during the due diligence process?
• How many investments have you made this year? Last year? Average size?
• How many of those investments are initial investments? Follow-on?
• In how many of those were you a lead investor?
  
• How many do you have a board seat?
  
• What percentage of your members have made an investment in the past 12 months?
• What percentage of your members are not active angel investors (i.e. service providers)?
• Do you invest as a fund, single purpose entity or as individuals?
  

This is not a comprehensive list of questions, but certainly a good start? At Sand Hill, we are very active and often lead investor and Series A board representative. We made 12 investments last year (5 new and 7 follow-on) and are on the same pace in 2009.

For those who do charge, should you avoid them like the plague or burn at the stake? I wouldn't go that far, but certainly fair to determine what you are getting for your limited amount of cash. Here is a list of questions I'd ask:

• How much is the fee?
• When are we obligated to pay?
• What do we get?
• Are you a broker-dealer? (Note: Finders fees are illegal in California for non broker-dealers, not sure about other states)
• Do you have any service provider members? Do you charge them a fee?
• If you do charge, why are you you charging me for the privilege of being added to a telemarketing list? Shouldn't you be paying me?
• How many companies have paid fees in the last year?
• How many of these have received investment for your group?
  

I don't think it's time to hang all angel investors in effigy, but remember that due diligence goes two ways...

Survey says VC's invest on Gut Instinct

Nope, the above quote isn't from Richard Dawson on Family Feud, but similar to a headline that caught my attention on the front page of the business section of the San Jose Mercury News this morning. Not that it was surprising, but that it would be news worthy of this placement. Once I got past the headline, I realized, that Scott Harris had the same reaction to the survey that I did.

He was citing a survey done by John Paglia at Pepperdine University. Harris writes "'Gut Feelings were cited by 67 percent of 185 venture capitalists surveyed, while [discounted] cash flow analysis was cited by 43 percent" as techniques used in analyzing potential investments. It struck me that the 43 percent number for DCF was really high, but if a sizable chunk of the VC's surveyed are late stage, would make more sense. Or perhaps, that is just my west coast bias to
think nobody pays attention to DCF.


I decided to go grab the survey to see if there was more. I pulled the report and buried in table 28 on page 35 is the data cited in the article. The data makes a lot more sense if you look at the entire table. I'd break down into two separate pieces - financial analysis and business/market analysis. On the financial analysis end, you have multiples far and away the most common valuation method over DCF, Simulation and Option analysis. I've never heard of a VC running Monte Carlo simulations on possible outcomes. Either the company is going to be successful, wildly successful or will fail....I always focus on the business model and assumptions, but there are too many unknowns to put much faith in the future cash flow projections.

On the other side, you have Market Analysis (96%) followed by gut (67%). This brings up the age old question on whether you are investing in markets or teams. If you've got a large growing market, solid team, strong competitive position and compelling solution, you'll move forward with diligence, which can range from going with your gut to doing detailed projections, numerous reference calls and deep market analysis.

Let's get back to the topic of gut investing. I was a limited partner in Angel Investors, LP, Ron Conway's fund in the late 1990's. They clearly went on gut and were often accused of drive-by investing, but that has to be the only way to invest in 200 companies over a 3-year period. Luckily, Ron's gut told him to get as much money as he could in to Google, which saved the fund.

I just finished reading Malcolm Gladwell's Blink.






Blink starts with the anecdote of the Getty Museum's $10 million acquisition of a rare Greek statue dating from the 6th century BC. They spent 14 months researching the authenticity. A geologist spent two days examining the statue with a high-resolution stereomicroscope and removed a sample and "analyzed it using an electron microscope, electron microprobe, mass spectometry, X-ray diffraction, and X-ray fluorescence." The conclusion was that it was indeed old.

However, when several experts in Greek sculpture viewed the sculpture, they were all able to see immediately that that it didn't seem right, but couldn't necessarily articulate why. Turns out they were right and the statue was fake. Whether this was gut, natural intuition, or some other subconscious analysis from years in the field, it doesn't matter. The point is their opinions weren't clouded by any vested interest or lengthy analysis.

Certainly, a corollary to VC's who have seen hundreds or thousands of start-ups and can often tell within the first 2 minutes or 2 seconds whether an investment is even a possibility.


Back to the survey. One other chart worth noting is the the expected returns from various private capital providers (Banks, Asset based lenders, Mezzanine, Private Equity and VC). From the chart to the left, you can see that the 42% expected return of VC is clearly an outlier on the graph.

Of course, if you look at the Cambridge Associates data ( graph at the bottom left) comparing venture capital returns of top quartile vs. median funds, you'll see that over the past three decades, the median fund has never returned over 40% and that the returns have been 0% over the past ten years. In looking at that data, if I'm a VC and promising LP's a 42% return, my "gut" might be telling me to to find another job when the fund is done.

Burn Rate

The burn rates of my portfolio companies is certainly top of mind right now, but that's not what this post is about. Not yet anyway...Things may change by the end.

Ever wonder what your ops guy is doing when he's not obsessing over your site's health 7x24. If anyone still carries a beeper these days, it's him. Well, our VP Operations at Fliqz, Daniel Marcus, dabbles in creating writing and music when not managing our data center.

His specialty is short fiction of the sci-fi variety, but has also authored numerous papers in the areas of applied math and computational physics, if that's your thing. Since I'm not a fan of any of those genres, I have been looking forward to the release of his latest work, Burn Rate.



A quick synopsis from the book jacket blurb:

Ross and Lori Williamson are living the Boomer version of the American Dream. Ross is a Silicon Valley entrepreneur, battered but still standing after the Internet collapse. Lori has quit her upscale corporate law job to make pottery, study martial arts, and start a family. Unable to conceive, they hire Annie Day as a surrogate to bear their fertilized egg to term. Annie has a few skeletons in her closet, including an ex-boyfriend desperate for cash and on the run from the Italian and Russian mobs.

It is hard to tell the bigger villain - Microsoft (aka evil empire), the vulture capitalists (aka Sand Hill Road) or the Jewish kid from Brooklyn who after some problems with gambling (what kind of nut bets on the Knicks?) and drug dealing (to pay off the stupid bet) takes up kidnapping and murder. Once you get past the stereotypes (of the first two anyway), this is a very funny and entertaining read and a great page turner to take to the beach or pool on one of these hot summer days.

While there are certainly better books that chronicle the highs and lows of starting a company, Burn Rate does raise some interesting issues on the personal side of entrepreneurship. The protagonist, Ross Williamson, is struggling to finance his company and hang on to his team during the process. His angel investors are tapped out and the VC's aren't biting. He convinces his wife to let him take a second mortgage on their home to give Tesseract a few more months of runway.

While credit cards, second mortgages, and personal guarantees are all common methods of early stage funding, they can certainly put a strain on marriages and personal relationships. When he receives a lowball acquisition offer, he must decide between protecting his hide and leaving his team hanging or rejecting the offer and rolling the dice on a better outcome.

I won't spoil the end of the story, but wouldn't bet against the good guys....Now back to hunkering down and figuring out how to deal with the burn rates in the portfolio.

Can you start a company on $10K?

Nope, not another post on boostrapping, although certainly a big part of this question. We held our annual business plan competition at San Jose State this month and first prize was $10,000. While difficult to do a lot with, there are a number of non-pecuniary benefits in addition to the cash.

First prize went to one of my students, Ryan Guerrettaz (giving the winning pitch below), for his college notes sharing service, Rate-the-Test. I think it's a great idea, although one of colleagues starting calling it Cheating.com and StealtheTest.com. One way to look at it is to level the playing field for those students not in fraternities where old (and probably sometimes current) exams are in the filing cabinet.

This is a much bigger idea than that and is really about helping students succeed. Particularly at a school like SJSU, where a large percentage of students are working part or full-time while taking a partial or full load of classes, time is a precious commodity. As a professor, I would also be very open to loading my materials to a site like this both to help students and to share with entrepreneurship faculty at other universities.

Ryan was actually working on another business plan for my class when he came to discuss this concept with me a few weeks before the business plan competition. He was concerned that he wouldn't have enough time to do a good job on the business plan in such a short time and asked me to advise him on whether to proceed. As a part-time academic, I had to pontificate and give him the scholarly answer, which was "Why the Hell Not??". He worked over 50 hours the final three days, saw his girlfriend once in three weeks and blew off other activities, but beat the midnight deadline by a few minutes.

Rate-the-Test was selected for the semi-finals, which gave him a couple of days to prepare a pitch deck. He did an adequate job presenting and barely made it to the final round. However, this gave him a full week (or 30% of the time already spent) to focus on the presentation and feedback from the semi-final judges. By the morning of the finals, he was ready, gave an excellent presentation, and responded to the judges questions with well thought answers.

Back to the question at hand. Certainly, starting a company on $10K is not easy, but it can provide a great start and the motivation to move ahead. In addition to the first prize, he was also given office space at the Plug and Play incubator for the summer and get to spend his days with other entrepreneurs and investors.

However, it will be under a different name as it may be hard to get profs to cooperate with a site called Rate-the-Test and the service will offer much more than previous exams. I look forward to seeing my students using this service in the fall semester. Also, if it turns out he neglected his girlfriend too much while starting up the company, he'll certainly have the opportunity to meet plenty of co-eds as he hands out flyers for the site on campus. With $10K, certainly can't have a marketing budget to do anything but guerrilla marketing.

Bootstrapping 101

I moderated a panel discussion last night on one of my favorite topics, bootstrapping, as part of our Silicon Valley Center for Entrepreneurship Eminent Speaker Series at San Jose State. One of my colleagues, Joel West, beat me to the punch with a summary of the program.

We had a good mix of experts on the subject:

• Jon Fisher, serial entrepreneur, blogger and author of Strategic Entrepreneurism
• Gustavo Alberelli, director of Kennet Venture Partners that specializes in investing in bootstrap companies
• Ilya Ronin, a former software engineer and SJSU alumnus who is one of the three executives of bootstrapping Marpo Kinetics (an exercise machine company)

Gus shared the strategy of Kennet, which is a unique breed of venture firm, sitting in between early stage Sand Hill Road VC's and late stage/private equity players. They have a standard presentation on bootstrapping, which they present around the country. Kennet has a white paper on that summarizes why bootstrapped businesses are the best. Another interesting related point that he made was that only in Silicon Valley does this message seem to fall on deaf ears, although maybe not now! In other parts of the country, this is business as usual:

1. Identify a customer need
   
2. Build a product
3. Sell the product

In the valley, the knee jerk reaction is to start with the powerpoint deck and look for the venture capital drug....

Jon Fisher purposely avoided raising venture capital in his ventures. His latest venture, Bharosa, was sold to Oracle for a 6X multiple in 3 years to his angel investors, a sweet close to triple digit IRR. His goal in building the company was to spend 3 years building value and find a good home for the engineers and product. In this case, a win-win for everyone, except perhaps the VCs who didn't get the opportunity to participate. Certainly not to say they couldn't have raised more cash and built this in to a bigger company, but was nice to have the option of going either way and doing what was right for the founders and employees.

Finally, Ilya Ronin, shared the Marpo Kinetics story, a true bootstrapped garage start-up. The three founders shared a vision, built the exercise machines in the garage, and knocked on doors at health clubs, attended trade shows, and worked the phone to get initial sales. We don't know the end of the story, but they have built a real business with hundres of machines sold to gyms all over the world along with government contracts for military purchases.

In this economy, all entrepreneurs are going to hear a lot of "no's", but time spent going after customers rather than investors should provide a higher return on investment. Of course, assuming you are successful in the first, the latter will certainly be an option in the future.

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.