The Seed, The Early And The Ugly

The possible outcomes of a founder CEO replacement

As a follow up to my previous posting, here are all the possible outcomes of a founding CEO replacement. Imagine you have three coins you can flip. The first coin has "stays/leaves" on its sides, the second "keeps old title/gets new title", and the third coin "friendly/unfriendly". Toss all three coins, and look at the results.

1 - Stays/keeps old title/friendly
This is what the founder AND the investors really want, but as you know, sometimes the founder CEO really has to be replaced.

2 - Stays/keeps old title/unfriendly

Now nobody, but nobody, wants this! Somehow the board is stuck in the mud, the company prospects are pretty dim.

3 - Stays/gets new title/friendly

This is what the investors dream about. The founders usually cringe at this, few of them have the fortitude to go through this for the good of the company, and frankly for their own good (the founder is usually the single biggest shareholder). Jerry Yang (from Yahoo) is a good example, he has been through the CEO cycle twice!

4 - Stays/gets new title/unfriendly

A very common degradation from outcome 3 over time: first, the founder as a good soldier accepts a new role. But slowly (or not so slowly), he/she really balks at the new direction (you guys are killing the company!).

5 - Leaves//friendly

Also known as "graceful ride into the sunset". If 3 cannot be achieved, this is the next best outcome. The founder leaves the company, but keeps the goodwill of everybody involved, and usually keeps helping the company.

6 - Leaves//unfriendly

Alas, more common occurrence that anybody would wish for! Acrimonious email exchanges usually climax in a pouring out of pent-up resentments from all sides. The best then is to get a cool head to settle things down. Rarely does this go in front of a judge, but s.. does happen.

So, brave founder CEO, know that your number might come up one day. Pick your choice ahead of time, or bring three coins to your board meeting....

Why and when do founders get replaced?

I was asked that question yesterday by a serial entrepreneur who is wondering why founders get replaced, what makes the board decide to hire a new CEO.

This is one of the most touchy subject a VC can discuss with an entrepreneur. Now, having been a serial entrepreneur, and now a VC, I can safely ask myself that question and answer myself with candor. Here it goes:

- entrepreneur-me: why do you guys insist so much on hiring a new CEO to replace the founder?

- vc-me: first, let me list all the things that we do NOT intend to do: 1) founder replacement is not our favorite sport; 2) replacing a CEO is always a traumatic event, so we do not like doing it; 3) there is no nefarious take-over-the-company intent - if we wanted to be CEO, we would start companies ourselves.

- e-me: don't you understand that if you take me out, the company will die?

- vc-me: as they say, cemeteries are full of irreplaceable people. That being said, please understand that starting a company is a team sport, nobody can play all positions on the field. As are most founders, you are an extraordinary technical innovator, but all startups get to a point where other skills are as important. If you have the right skills for the next stage of the company, great, this is my favorite case, you keep running the ship. But if you are not the top player for the skills needed at this time, doesn't it make sense to bring in the superstar that we all need?

- e-me: yes, provided you get the superstar. But most of the time, you guys will hire the candidate who interviews well, and who will follow your every whim. And that guy will kill my company!

- vc-me: all right, good point, the hit rate of CEO hiring is actually quite poor. So you'll need to help me pick the right person - but I need to trust you that you are committed to this change and will not just block every candidate that shows up at the door!

And here, dear reader, several endings to the story are possible. We will explore the possible developments in my next postings.

Until then, just keep your job!

It's OK to be a solution looking for a problem, just find a big problem

I just met yesterday with a promising startup that has such a typical problem that you should be aware of it and not run into that trap.

Most entrepreneurs dream up something high on their cool-meter, and if you are a techie (bless your brain), you will discover some really beautiful technology by mere osmosis with your work and play environments. And now what?

This is where most people start to look for a problem to solve. And most of the time, the success of an idea is really not (just) the technology discovery but much more importantly the problem that the technology will solve. Budding entrepreneurs usually trip and fall here. Some samples of what VCs hear most of the time:

1. It is so great that success is obvious (yeah right)
2. You're not smart enough to understand the technology so how can you understand the g-normous problem that it solves (yawn) 
3. This technology can be applied everywhere (sure, just scrape it off the walls and take it with you on the way out) 
4. Look at all those markets this can be applied to! We will win everywhere! [insert here sweeping hand gestures that drop the coffee cup on your new carpet] 
5. We will start with this small market and then I am sure we will find something that we just cannot imagine right now (I call this the Barney Market - from the purple dinosaur in the (in)famous children series, said purple creature always encouraging kids to use their imagination)
6. We will dominated this $100M market (translation: my revenues will tightly hug the few $M line and will never get over $10M)

VCs are looking for a credible scenario for you to get to $100M revenues, because that level triggers all kinds of goodies like an IPO (remember those?), or a nice juicy M&A. This means that you have to find a $1B problem, and then state with utmost confidence that you will get 10% of the market.

So, just like you need two electrons to make a covalent bond, you need a groundbreaking technology coupled to a $1B problem to make a startup that has a chance of getting funded.

The Corporation Giveth, But It Also Taketh Away...

This week has brought two examples of the agony of defeat for entrepreneurs. Both cases involve a round of financing lead by a corporate VC.

In the first drama, this technology startup is inking a scrumptious deal with an industrial partner that, in exchange for a technology license, will invest a significant amount in the startup at an equally significant valuation. After months of agonizing fund raising, you can only imagine the relief of the management team. With the company offices suffused with this new sense of optimism, the team - not without some guilty pleasure of giving back some of their frustration to the VCs - promptly rejected a VC lead term sheet that was promising a fair but clearly lower valuation. Alas, a few weeks after their peremptory refusal of the VC term sheet, their industrial partner has a sudden change of heart, and now the startup is back to square -1.

The second drama follows the same familiar scenario. Our Cinderella startup, after years of toiling in the technology kitchen, is about to reap the reward of a good round of financing lead by a corporate VC. Good plans were drawn, good people were prepped and ready, with visions of twinkling treasures lifting people's hearts. Alas, right before the GPS satellite signals the local midnight, the corporate prince declared that cash is now King, and since the startup cannot promptly produce any ounce of royaltiness, the investment was summarily cancelled, and our Cinderella is back to living from specks of largesse from our Small Business Administration.

This two tales highlight a simple truth: corporate VCs are just too unpredictable, because they have too many cooks in the kitchen. Remember that when cook #1 (the person you are discussing the investment with) acquiesces to a deal, several other cooks can at any time override the whole thing (including that Big Enchilada CEO sweating over his bonus). Yes, VCs sans corporate may not give you the highest price, but they are much more dependable to close a deal, and to support you in the long term.

Until next time, happy chasing!

The Distance Between Failure And Greatness

As an entrepreneur, I am sure this sounds familiar: I have this great idea, but those (*##@#) VCs just don't get it! You are almost correct on both counts.

First, the great idea: the right way to state it would be "I am close to the great idea". Your instincts are good, you are really close, but your foot has not stepped on the Big Idea yet. For example, the startup I alluded to a few posts ago has developed this really incredible nano-sized nonvolatile switch that is completely CMOS compatible. OK, they are close to a great idea, but nobody invests in a technology by itself. What is the breakthrough product that will enable them to dominate a large market?

After some gnashing of neurons, it is so clear that the Big Idea is to develop a new type of FPGA that will be very fast, very low power and very low cost. If this works, they will have their fair chance at World Domination.

Now to the second point: yes those VCs do not get it! And not because they do not like your idea, but usually because they cannot connect the small dot of where you are now to the big dot of a $100M revenue company. VCs do have a lot of imagination, but they need some help here.

So in the case of the above-mentioned startup, I helped them connect with a FPGA architect genius, to really draw the Plan to Greatness. Stay tuned for further developments.

In summary, close is not good enough, your foot has to be cleanly stepping on the trigger for the Great Idea, and please help those VCs connect the dots.

Until then, happy chasing!

ZillionTV Emerges Out Of The Seed Cocoon

ZillionTV unveiled a new personalized TV service with on-demand access to content from major studios (Disney-ABC, 20th Century Fox, NBC Universal, Sony Pictures, Warner Bros.) all of this on your TV using a Wii-like remote control. Oh, and no subscription or monthly fees needed (take a look at this coverage on CNBC, and this on Engadget).

ZillionTV was seeded with a small investment in December 2007. The team has done a terrific job in a little more than a year's time, and this is a perfect example of how seed investments can grow and flourish when driven by a determined and focused team.

I am sure you will hear more about ZillionTV in the coming months.

TARP For Dummies

The Troubled Assets Relief Program, while widely (and superficially) covered all over the news, still remains a mystery for most people. What is it for? How is it supposed to work? How can we monitor its progress?

Well, fret no more, here is an illuminating illustration of what the best and brightest in your government are doing to make your life better.

Do you need all the answers before you meet a VC?

Nope.

First, it is always wise to give your future funder a chance to make an insightful remark, that would cause you to answer "that is a great point" with all your facial muscles in the right position.

But really nobody expects you to have all the answers, because you are still a seed/early stage company. However, you must know the range of the possible answers. And you must show how you will get to the answer - usually this is much more revealing of the thought process of an entrepreneur than the simple recitation of a well rehearsed answer.

"What will the LED cost?"

a) "No idea, we will see after we make a few of them"

b) "Between $1 to $3, given the following assumptions for yield profile, wafer cost, process cost,..."

c) "$2.11"

Of course you as an astute reader have selected b) as the best answer.

Top 10 Reasons Why VC Firms Should Be Immediately Nationalized

Why just the banks? Actually the government should focus its attention on VC firms. Here are the top 10 reasons why nationalization must be put in place immediately!

10 - VC returns have been awful for years. 

I can argue that VCs have been in dire straits for longer than the banks.

9 -  VC firms are just too big to fail. 

Remember, 20% of the US jobs are created by VC funded companies, so letting so many VC firms fail is just unconscionable!

8 -  Partners will continue to have life employment just like today.

No worry about long term view, firm culture, ...

7 - The carried interest will be used to fund healthcare.

This should add at least a few $B to healthcare, enough to add aromatherapy as a covered procedure.

6 - The LPs will be the 41 members of the Ways and Means committee, with Charles Rangel as the "lead LP".

(shudder)

5 - Startups will be able to get funding through earmarks.

Who said all earmarks are bad?

4 - GP perks will be severely limited by the GAO.

Now, I can't wait for those reports to come out! (hey why did he get a gold plated toilet seat in his private jet?)

3 - However, lobbyists will more than make up for it.

(sigh of relief)

2 - Tim Geithner will be able to tell the difference between a VC fund and a hedge fund.

Uh, a hedge fund is still private and a VC fund already works for me?

And for the top reason why VC firms should be nationalized...

1 - GP will go back to its original meaning "Government Property".

Seed 2.0, or Core Tech Seed?

A common perception of seed deals is that those are mainly web 2.0 startups, because it takes only a couple of hungry programmers to start the next Google. However, quite a few seed level startups take on core technologies. Now, last time I checked, a semi fab is a few $B, 3 to 4 orders of magnitude more than a seed startup can raise, so, where is the catch?

Well, one of the seed startup I am working with right now has its aim on a new core technology (that shall remain undisclosed, sorry!) that can upend quite a few components in your cell phone. They have raised so far $500K from angels (before the Oct 2008 debacle...), and with that money have done a few prototypes using the Stanford fab. One more $M would enable them to deliver a first product for the cell phone. Wait a second: this is a core tech startup, and they can develop the technology and a first product on $1.5M? The answer is ... maybe, if their plans come to fruition.

They have done it by a) having experienced and smart people who are donating their time because yes, they believe, b) using simulation models and neurons instead of trial-and-error prototypes, c) squatting at the Stanford fab, where for a low fee they can do some prototypes, d) not paying any salary worthy of being called such. 

When you think about it, any core tech seed startup can do a proof of concept that somewhat verifies the core of their technology without having to develop the whole big bang product. That proof of concept, if carefully defined and limited, can be done for pretty much petty cash, when compared to the real funding needed to develop the product.

Word to the wise: only the hungry survive...