Emerging Enterprise Center Blog - Commentary and Analysis For Entrepreneurs and Startups

I like Don Dodge’s predictions for 2010, it seems as if we are about to enter the brave new world of mobile everything (commerce, computing, internet whatever), but I have been trying to figure out what bugs me about the predictions. I finally got it. Here is the answer. I was recently reminded of the scene in Star Wars when R2D2 plugs into the Death Star and turns off the trash compactor. In the brave new world of the future interoperability will be seamless. Think about all the devices we have (and shortly will have: the Android, the new Apple "pad" is that is what it will be, mp3 players etc.). Think about all the services (Pandora, Twitter, GPS directions etc.). My prediction is that 2010 will be another year of technology chaos demonstrating that we are still in the infancy of the technological age.

Once again the year end numbers are out and the ritual wringing of hands has started. As is often the case, Fred Wilson has a clear point in his post The Venture Diet is Working. His basic point, which many others have also made, is that there is too much money floating around the venture industry and that this excessive amount of money drives down industry returns. If there is less money invested in any given period, presumably it will go to the better deals (generally speaking) and will ultimately provide better returns. You can’t argue with that proposition. It is economics 101.

However, Fred is looking at the supply side of the equation (i.e. the supply of money). I am not an economist (in fact I am an attorney with a graduate degree in English literature), but if you look at the demand side of the equation (entrepreneurs seeking money) you might conclude that underlying Fred’s and others’ analysis is an assumption that the rate of change along the demand curve is more or less constant. For every dollar that you take out of the venture market a somewhat consistent corresponding amount of demand increases (or to put it another way – the value of the investment dollar gets bid up in a somewhat consistent way).

I keep saying "somewhat" because I think the demand curve may be more (and sometimes less) steep at various points along the supply curve. Here is the part that I cannot "prove" or demonstrate, but I believe that the ecosystem needs a certain amount of investment activity to remain viable. In order to motivate people to pursue their entrepreneurial dreams, they have to have some hope of getting funded and, ultimately, of a cool exit. If the investment supply becomes too small, that hope may disappear and the ecosystem may not support entrepreneurial life at all. If you take enough oxygen out of the pond, the fish will die.

So, the system needs to be smaller to permit good returns to investors (or they will go away), and the system needs to be large enough to provide incentive (hope of funding), even to those who might fail. Those two points define the space of viability for the venture capital/tech entrepreneur ecosystem. The question that needs to be answered is whether that space exists at all. A second question is, if it does exist, where is it?

To me this issue also raises larger questions about the so-called venture model. From my vantage point, I see VCs investing in well conceived tight investment thesis tech companies with the plan of an M&A exit (mostly). One way to think of this (and not a particularly original way) is to observe that the buyers (Microsoft, Google, et al) are outsourcing new product development risk. That is why VC investments seem to be focused on tight investment thesis companies with a seeming clear path to an acquisition. (I can just feel the VC community pounding me with the "we want to create great companies speech," but look at what they actually do not what they say they want to do.) In part this model is driven by the ten year fund cycle. Recently, I have run across VC investments (I have two in my client portfolio), that are not driving to an exit so much as towards developing larger sustainable businesses.

While it may be that the VC diet works, it also may be that it doesn’t and something new must emerge. Either way, it is a critical issue. We need tech entrepreneurs to grow wealth and we need a way to value them and provide a handsome return to people who invest in them. If we don’t we will end up having to compete with Brazil to make Nike sneakers.

  Eric Belsley from our office had this to add on the subject of accruing but non-cumulative dividends.  More concise and to the point than my post of Wednesday.

This is a relatively unusual provision. However, it would mean that although dividends accrue daily (and thus are computed when payable on a number of days in the year to date basis), the amount of such dividends is reset to $0 at the beginning of each year.

An interesting issue is the effect of this provision on payments made in liquidation and redemption. If the liquidation and redemption sections expressly refer only to "accrued and unpaid dividends" in addition to the principal amount, the company would have an argument that the non-cumulative nature of the dividend reduces the payout attributable to the accruing dividend in these events. This argument is much weaker if the liquidation and redemption sections expressly refer to the amount defined in the accruing dividend section, without referring to it as a "dividend."

First, don’t put too much store in sales advice from a lawyer. Second, here is something I have observed more than a few times, so it seems to me that it merits mention. Every now and then I run across what seems to me to be a very compelling story. The entrepreneur has identified a pain point in the market. They have a service or a product that seems to address it elegantly. The business thesis hangs together in a very coherent and compelling way. The company has talented, energetic and committed officers and employees. Investors buy into the thesis and invest. But, somehow, for some reason after several years of trying the business is just not developing. 

I am just the lawyer. I don’t know what the problem is, but I have seen the situation before and I recognize the symptoms. Everyone involved is engaged in a collective delusion. They are all ignoring (perhaps they really don’t see it) an important fact. The emperor has no clothes. 

If you find yourself doing the same thing over and over again and getting the same results and you continue to be convinced that your strategy and tactics are destined to succeed – you just can’t explain why they haven’t, consider whether or not you and your team have not fallen into a collective delusion. You need to find reality in order to address it effectively. 

Your widget is perfect. It is the best thing on the market. The competition, while well established, is lumbering and slow and expensive. But no one is buying. You need to go back over each of the facts and examine each one. Somewhere you are missing something. Here is my bet. The most basic premise is where you have gone wrong. In this widget example, I began with “your widget is perfect.” I am willing to bet that it isn’t. If there is some premise that can’t be examined, that is truly an article of faith. If the CEO keeps saying our widget is faster, and no one ever challenges that assumption, it is almost certain that that is where the problem lies. 

It may be that the problem can’t be fixed, but you might as well know it. If it can’t be fixed and the problem is fatal, at least you can move on. If it can be fixed, then you at least have a shot at it if you can identify the problem. The real world gives you feedback. What you think is nice, but it better not fly in the face of what is actually happening or you may find that you are parading down the street with no clothes.

I once sat in on a meeting between a public company client and an investment banker, from whom the client wanted an underwritten offering. At one point in the conversation the CEO of my client said something like, “We intend to structure our business in accordance with the requirements of Wall Street.” Nobody twitched. But this is not going to be a post on the absurdity of taking unsound actions to appease Wall Street, it is a post about being realistic about how you cater to your financing sources. 

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