Engineered Startups

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A few years ago, as we described our startup formation to one of our investors he made the comment “so you engineer startups”. I thought about the term for a few seconds and realized that it was a great way to describe what we do.

Think about the startups that most angel investors and VC’s see on a regular basis. A startup team comes to them with an established founding management team, a technology, an application for the technology and a valuation. The investor may have some ability to negotiate or influence some of these elements, but for the most part they are making a decision on whether to invest in the whole package.

But why does it have to be that way? Especially with a university technology where the inventors typically lack startup management experience and may select applications of the technology driven by research objectives not investment return objectives.

We turn this all around. We start by presenting our investors with a portfolio of university technologies and focus on the ones that they find most promising. Then we work with the investor to identify the most promising application of the technology and to select a CEO from a list of candidates. And because we are founding the company we control the initial valuation.

So the seed investor has the ability to work with us to “engineer” the startup and help construct each element from the beginning.

Think of it this way.  Imagine you were going to invest in a rental property and you speak with one relator and they tell you they have a limited inventory of houses, but in each case the location, architecture, rental management company, and rental marketing approach for the property is basically established. We come to you and offer you an opportunity to select the location, architecture, design, rental management company and rental marketing strategy all at a lower price (i.e. valuation) than the traditional realtor. The only question is why wouldn’t an investor chose to invest in an “engineered” startup over a “prebuilt startup”?

Students and Faculty as CEOs

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This week I spoke on an investor panel at a small conference. The audience was primarily researchers interested in commercializing their technologies. The panel was asked a common question, “what do you look for in the CEO of a startup?” In my company’s business model, we always hire experienced entrepreneurs (i.e., have previously run a startup, have raised capital) to run startups. As the other panel members addressed the question I realized that I didn’t want to give the researchers a negative message that “I would never invest in you as the CEO because you lack experience.”  I have often acknowledged that despite my strong preference for experience in a CEO the truth is that I’ve seen several student CEOs and faculty CEOs who have been very successful. The other panelist and I then described several characteristics that we have seen in an in-experienced but successful CEO.

The number one characteristic is that they are great communicators. The word “communicator” could apply to many things (e.g., good salesperson, good teacher, inspiring leader) and those are all skills that I’ve seen in successful entrepreneurs. These are people who like communicating. They get energy from interacting with people. They love to explain their ideas to others and are able to perceive what knowledge level the listener has and tailor the conversation to the listeners level (i.e., great teacher). They share a powerful enthusiasm for their idea and covey that to listeners but at the same time perceive that the listener values and coveys how their idea delivers that value (i.e., great salesman). To a customer, they tell how their product meets their needs. To an investor, they tell how their business will bring them a return. One of the challenges in technology commercialization is that many inventors are brilliant scientist and inherently introverts. Some may be great teachers but fewer would meet the definition of a “great communicator”. Of course, some do.

The second point we discussed was being coachable. This is a common phrase used by investors and simply means that the entrepreneur is willing and able to listen to advice, accept it and act on it. Even when it is contrary to their established opinion. A coachable entrepreneur also has a good awareness of what areas they have expertise in, and what areas they don’t. Sometimes scientist, especially very experienced and accomplished scientist have been viewed and treated as intellectual experts for so long, that they have difficulty accepting that they may need fundamental coaching in areas such as marketing and sales and finance.

I added a final point and a caveat to the need to be coachable. Many of the researchers in the audience had been receiving lots of advice from various experts and mentors and were constantly being reminded that they need to accept coaching. But my final comment was that after listening to that advice they had to be willing to make a decision, often in the face of conflicting advice, and commit to that course of action. In-experienced entrepreneurs who get advice from a many well-meaning potential customers, advisors and mentors will find that there is conflicting advice and lack of consensus around some issues. An entrepreneur who never takes action because they can’t get consensus will not succeed. Every successful entrepreneur has to deal will imperfect information and advice, and in the end, make a decision knowing that it may be wrong, and move forward.

So I would argue that students, faculty and scientist without experience as a startup CEO can be successful as an entrepreneur, provided they are willing to develop great communication skills, be coachable and at the end of the day be decisive.

Observations from JPMorgan Week

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The week of January 11th I had the opportunity to attend the Biotech Showcase in San Francisco during what is commonly called “JPMorgan week”. JPMorgan week is a cluster of life science investing conferences held simultaneously in San Francisco each January. It has become a must-attend week for entrepreneurs and investors involved in life science. It was a fascinating week and I saw many exciting companies and met many interesting people. This month I want to share three observations from JPMorgan week.

As you are aware January has been very bad for U.S. stock markets, and the beginning of the month was extremely bad for the Chinese stock market. In San Francisco I was prepared to have investors tell me that they were going to wait till the markets stabilized before they made more investments. I had several meetings scheduled with Chinese investors and anticipated even greater caution from them. But in fact none of the investors I met with were concerned with the condition of the markets. It gave me confidence that while there may be issues with slowing global growth, the drops in the markets we are seeing in January are not signs of a fundamental problem like back in 2007.

My second observation was that many of the life science startups have some connection to university research. While a number of the companies are actually university spinouts (which we track in Startup.Directory) many other startups which are not technically universities spinouts have some affiliation with one or more U.S. universities. These startups work with universities in a variety of ways including conducting contract research and clinical trials. I think this is a testament to the strength and depth of the U.S. university research community and I’m not sure if university research staff gets sufficient credit for the role they play in supporting startup company innovation.

Finally I was generally impressed by the breadth of innovation represented by the 300 or so companies presenting at Biotech Showcase. Furthermore hundreds of other companies were presenting at other conferences that week and I met executives from even more startups who were attending but not presenting. As I flip through the abstracts it seems like there are multiple companies with diagnostics, devices and therapeutics addressing virtually every major disease and many low occurrence (orphan) diseases and illnesses. Probably the majority of these companies will not succeed, but even if a small percentage of them do deliver a product to market they will, in total, enable dramatic improvements in human health care. So the next time you read an article lamenting the lack of innovation or progress in healthcare or other technology sectors, don’t despair. My time spent at JPMorgan week reassured me that innovation and entrepreneurship in healthcare is alive and well.

A Unicorn or a Double

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One of the hot words in the startup press today is “Unicorns”. Unicorns are private companies with a value of more than $1 billion such as Uber, Snapchat and Dropbox. Many recent news articles are somewhat critical of the growing list of unicorns, many of which are unprofitable. Some articles raise concerns with the potential of a bubble in the valuation of these unicorns. Regardless if there is in fact a bubble, the existence of so many unicorns can lead to institutional investors getting overly focused on investing in baby unicorns.

A friend of mine recently gave me an update on a startup that he has been mentoring. It’s a neat little startup with a young management team, a cool consumer product a nice track record of initial sales. But for the moment it is a one product company, and that product has some unique features but it is not highly protectable, despite one or two patent filings. I could see the company hitting $5 million in sales, and maybe generating $2 million a year in profits without needing a large investment. If the founders ran it for 5 years with continued growth in sales and then sold it for 3 or 4 times EBITA, they would be in a great position to pursue their next idea. I would call that a solid “double”, as in a moderate but not huge success.

But, that’s not the path they are on. They got involved with a Silicon Valley incubator type program. Kudos to them for getting accepted (although there are some strings attached). But now my friend tells me that they have been introduced to VCs out there who are telling them that they have to show how this can become a $1 billion company – a unicorn. That worries me. These young guys are getting caught up in the legitimately exciting atmosphere of the Valley. And I really don’t think they have a baby unicorn. But with enough prompting they may come up with the billion dollar story, start believing it themselves and get an investment from a VC who has cash to burn and is desperate to find a unicorn.

Then maybe they prove me wrong. But if they do become a billion dollar private company, I hope they are profitable, unlike so many unicorns. But what I’m afraid will happen is they will get $20 million or $30 million in investment and then in a few years fail to show adequate growth and the investors won’t allow a modest exit. Rather, they will force them to keep burning through cash until they finally go bankrupt. Now these young entrepreneurs will have received a hard education and come good contacts, but have little else to show for the years of stress. I makes me wonder. Wouldn’t a good clean double be better than chasing a unicorn?

How to Tell a Ten from a Two

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Making a quick judgement about the potential of a startup company is often very challenging. Regardless of if you are considering investing in, partnering with or acquiring a startup it is important to quickly make an assessment of how likely the company is to succeed in the long run. University startups can be more challenging than others because the technology is often very complex and the management teams mixed.

The first and most obvious factor is the management team. It can be pretty easy to make an assessment if you meet the entire management team in a private meeting, but more difficult if you are just watching one member pitch or you meet just one member in a casual setting. Obviously we all want to see leadership on the management team that has significant startup experience. When someone with those apparent credentials is on the team it is important to evaluate the true depth of their experience.

I’ve seen CEOs who state they have decades of business experience, but when you dig deeper it is clear that they have had success in large corporations but not yet in a startups. There is a big difference. You also need to discern who is really making the day to day business decisions. Some startups will engage an experienced entrepreneur with a title of Chairman or co-founder when in fact they are just serving as an advisor and have limited say in the daily operations.

A second question I ask myself is “is this a problem looking for a solution or a solution to a problem”. University startups can be particularly guilty of taking a “cool” technical solution, starting a company and then trying to find someone who actually has a problem that needs that solution. Maybe they will find that market, but life is too short to risk capital or time on that approach.

To make this assessment I like to simply ask a startup “who will use your product”. A promising startup will have a focused answer that states the value. For example “Cardiologist love this product because it reduces post-operative infections by 43% in Atherectomy procedures increasing hospital reimbursement rates”. After that response I’ll ask them how big that market is and if there are other applications.

The response I don’t like to hear is a rambling list of unrelated markets with no real prioritization. That suggests that they have developed a solution and want to shotgun it to lots of markets and then hope for success.

Most investors probably have a series of other factors and questions that they use but the ones I described here can be particularly useful in evaluating university based startups. I’ll discuss some additional ideas in future blogs.

Investing in a University Spinout with a Faculty CEO

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I recently touched base with a university asking if they had any good technology candidates for our startup foundry program. They responded that university faculty were starting businesses on all of their best technologies. I found that disappointing. We don’t build startups where the faculty is the CEO. But a lot of universities push the faculty CEO method now. And admittedly there have been some very successful startups run by faculty. But the odds of a faculty CEO with no business experience building a strong company are probably rather low.

How can you tell if a faculty CEO is investable? We advise investors to consider the “three Cs”; competence, commitment and coachability.

Competence: The first thing we consider is the faculty members’ business competence. Some faculty have had significant experience in a corporate business environment or even with a startup. Some have built and exited from pervious startups and clearly have the ability to serve as CEO for some period of time. But many do not have any experience and naively believe they can develop the necessary skills overnight. I like to ask potential faculty CEOs about their understanding of equity dilution as something of a test question. Often they respond that they don’t know the term, which tells me they probably don’t even have the basic knowledge and skills.

Commitment: Faculty are used to juggling many commitments and projects, including teaching multiple classes, mentoring doctoral students, managing research projects and writing papers. Many believe they can add running a startup as another part-time activity. While that may work if the startup is a just providing consulting project, or securing government grants for research projects it is not appropriate for a startup that is ready to receive equity capital. A simple question to ask a faculty CEO is “are you willing to leave your faculty position and lead the startup full-time if I invest?”

Coachability: Most faculty are high achievers. Over time this can result in a certain level of arrogance, and in turn an unwillingness to listen to others who are not clearly superior in their field. I’ve heard many investors state that coachability is the most important trait in an entrepreneur, and some faculty fall grossly short in that area. I typically find this issue is greater the longer the faculty has been in an academic environment. Young faculty are often very open minded, but may lack commercial sector experience and the willingness to take try entrepreneurial risks.

While I don’t want to argue that all faculty run startups are doomed to failure, I do think investors need to take a critical look at faculty serving as CEOs. In another article, we’ll take a look at the issues around persuading a faculty member to give up the CEO position and majority control of the startup.

Universities Dive Deeper Into Venture Funds for Their Startups

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Universities in the United States produce more than 800 startups per year according to the Association of University Technology Managers (AUTM). But outside of a few major metropolitan areas such as San Francisco, New York and Boston, startups in many university cities struggle to locate angel investors or venture capital funding. Furthermore, many of these startups are run by inexperienced academics and are commercializing complex technologies that are difficult for investors to understand.

The Washington Post recently ran an article “Universities are venturing into new territory:  Funding start-up businesses” describing some of the efforts by universities to create venture capital funds focused on supporting university affiliated startups.

Last year the University of California system announced the formation of a $250 million venture fund focused on university spinouts. The money comes from the $90 billion pension fund and endowment that the University system holds. Like many pension funds and endowments, the University of California invest a small portion in high risk venture capital funds.

The University of North Carolina at Chapel Hill recently announced the $10 million Carolina Research Venture Fund which will commercialize technology developed at the university. This year Virginia Tech announced formation of the Virginia Tech Investors Network (VTIN). This angel investor network, not a fund, will look at investing in startups out of Virginia Tech as well as startups affiliated with Virginia Tech alumni.

Time will tell how well the recently formed venture funds perform. The Washington Post article states that venture funds have yielded, on average just under 10% over the past 10 years but that the successes were produced by a small number of venture funds. The primary challenge for the university affiliated funds is to become one of the minority of funds that produce positive returns.

The university affiliated startups provide some advantages. The technologies they are based are typically based on years of research, truly innovative and have some degree of patent protection. Those features can provide a solid barrier to entry and provide a higher valuation when the company is sold. On the other hand, the majority of the university spinouts are run by faculty with little business experience or young students. The new university affiliated funds may have difficulty producing positive returns unless they can ensure that the startups address the common management experience problem.