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Rules Of Engagement
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
May 25th, 2001


By Brent Holliday
Greenstone Venture Partners

"Through the storm we reach the shore,
You give it all but I want more,
And I'm waiting for you "
U2, With Or Without You

If one assumes that people learn effectively and etch things in their long term memory through repetition, then I will be forgiven for hammering a couple of points home that I have referred to a few times before. I think it warrants an entire column to really help you understand what we, as venture capitalists going through hundreds of business plans, are seeing in Vancouver and how we can make things better. This is important stuff, people, so listen up.

We have two problems that need fixing in our BC technology entrepreneurial ranks: 1) we need entrepreneurs/founders of tech companies with years of explicit customer knowledge only gained from working at or with global companies and 2) we need every entrepreneur/founder to understand the game of financing of early stage companies.

For the sake of argument, I am talking here about start-up companies that want to be billion dollar public companies some day or be bought for hundreds of millions along the way. Big ideas.

Let's start with the management issue. It's now a VC cliché to say "the three most important things in a start-up are management, management, management." When asked about the number one issue holding back BC's technology industry, every VC in town will tell you, "inexperienced senior management". We have now created an inferiority complex among the ranks of the technologists and businesspeople involved in the industry. I'm not going to disagree completely with the generalizations about senior management. What I will do is get more specific because, in fact, we have seasoned start-up people that understand the chaos and uncertainty in growing early stage companies. We also have senior managers that are smart and savvy in business that can effectively manage a growing operation. What we are missing is explicit domain knowledge about the markets that the start-up is headed towards. Far too often we see start-ups with a great idea but a CEO that knows very little about the market and the customers.

Nothing is guaranteed in starting a company. The most well-known entrepreneurs in town, having successfully created their companies and generated huge value in the process, cannot step up to the plate with a new start-up and be guaranteed success again. There are just too many variables to control. But the biggest, largest, most accurate factor in predicting a successful outcome is this: How well the entrepreneurs and founders know their potential customer base. Put it another way. What I am saying is that any of the successful founders of companies like Pivotal, HotHaus, Creo etc. have as much a chance of repeating their success from the start, as someone that has worked for many years in a senior product marketing, or engineering role in a big/rapidly growing tech company. I'm talking about anyone that knows the market, the conditions of it, the competition in it and the dynamics of it and has built successful products selling in that market. Typically these people also have great contacts into decision-making positions at many of the potential customers for the new venture. These are the specific qualities that make a "best bet" for starting a world-beating company.

Look at some recent successes locally for some examples of which I speak:

· Abatis Systems - founded by two guys with years of senior experience at Newbridge working with ATM and IP. Result: Celtic House lathered them with VC money and they built a product that the biggest carriers and CLECs wanted. The big carrier contacts? Theirs and the senior management and VCs that they brought on board after the successful launch of the company.

· Inkra Networks - founded by one product marketing person from Nortel, another senior engineer from Motorola Wireless Data and a third, an entrepreneur who sold his last company to a large network access equipment company. Result: Vancouver and Silicon Valley VCs pour money into the company and it is able to set up a customer advisory board of CTOs and CEOs of its target market companies through the relationships and contacts of the founders and the VCs. This is before they even have an alpha product.

In Ottawa, this phenomenon is endemic. All of the well-funded start-ups in the last two years have begun with senior, experienced managers and executives from Nortel, Newbridge, Mitel, MOSAID and JDS Uniphase. They are world-class start-ups, attracting foreign capital as well as Canadian VC money. They are building products that the customers have identified as "need to have" or "must have". Why? Because they knew these customers inside out and could see, very clearly, where the market was headed.

So it should come to no surprise to you that the Silicon Valley has known this little secret, has had this immense edge because of its world-class technology company density and has become the mecca of technology. The average business plan arriving on the desk of the top performing VC funds in the Valley have founders or early stage executive with resumes that say years of experience at Intel, HP, Sun, Cisco, Oracle, etc. etc. When these entrepreneurs make their presentations to VCs for money, they confidently explain exactly what they are building, why the biggest customers in the world will buy it, how they will sell it to them and who they know that can help them get it done.

Remember my caveat. The best laid plans inevitably go awry due to all of the variables at play. Look at Pivotal and Creo as examples of local companies that started out in completely different markets than they are currently in, stumbled badly, almost ran out of money, came up with a new idea for a new market and became successful. That was due to the brilliance of the founders at a) recognizing the mistake b) hiring new management with the explicit domain knowledge for the new market and c) executing the new plan. In other words, explicit customer and market knowledge doesn't guarantee success. But it sure will get you the credibility, which leads to financing to allow you to try.

Vancouver is very, very close to the critical mass of large companies with experienced people that will start the next big companies. As VCs we don't see as many start-ups with superstar credentials as Ottawa or the Silicon Valley. But it is starting to happen. I am quite optimistic about the future talent base. If you are looking to start something big, have this experience on the team with you.

Moving on to bone of contention number 2. If I told you that there was a company that had a world-class team with deep customer knowledge and experience in building globally successful products existing today and then I said that no VC anywhere has funded them yet, you would be puzzled, non? You would say, "Brent, I thought you just said that if they had the goods, the VCs would love to support them." Alas, this mystery company, which does in fact want VC, never understood the early stage financing game and it may cost them a considerable amount of value.

If your intention is to be a world-class company, then you have to set yourself up from the very beginning to be one. There can be no funny deals. And this is a town renowned for "funny" deals. Plain vanilla equity structures need to be in place by going to a lawyer and an accountant from day one that has done venture-backed companies before. Like any other service or product, you get what you pay for. If you get Al's Accounting and your mother's friend's divorce lawyer to set up your initial company structure, you are done. Dinner. Top firms in town know what to do. Even better, they know the VCs and many angels and can get you the introductions.

If you have an idea and want to leave your company to try it out, but you have never started a company before, your first instinct will be to ask your friends and family for advice. And advice from one source always needs to be validated by who it is and what they have done. This may seem rather obvious, but if you are getting advice on how to start your technology company from a mining, forestry or retail executive, you are getting nearly useless information. Sure, they are successful businesspeople. They have networks. They know good people. But the person you need to talk to is in the technology industry. No one in mining knows how to finance a technology company. And if you ever think that a VC, from here or the US, is in your plans for financing, you need to avoid taking the "funny" deal for debt or equity or large fees or promises. Those deals will be possible deal killers for any institutional source of money. This happens WAY too often around here.

Here's a brief primer on what NOT to do when setting up your company:

· Take money without a shareholder's agreement and a subscription agreement (Investment agreement) defining responsibilities and representations on both parties. A hand-scrawled one page deal will be a deal killer from institutional investors later.
· Take on 20 or more investors who each give you small amounts of money (too hard to manage down the road when you need investor approvals, etc.)
· Do a deal that says that the investor gets their money back and gets a significant chunk of equity. That is complete crap. Equity investors only get their money back when the shares are sold. I have seen these deals done many times before and it stinks. It means that the investor has their cake and gets to eat it too. It's either debt for no equity (or a very small amount of warrants) or equity, not both.
· Put four founders and your lawyer on the board of directors and no one from outside the company from the tech industry. A board needs to be objective and create accountability, not be an excuse for a management meeting.
· Issue stock options or warrants or founder's shares to every Tom, Dick and Harry that gave you advice early on. If they are no longer helping the company on an active basis, then you would find it hard to justify to the employee working their skin to the bone that they get less options that vest over 4 years than the "advisor" that helped your company for all of 30 minutes over a coffee at Starbucks.
· Do a complicated deal period. Plain vanilla. Common Stock for money. When you are a very early stage company, fresh out of the gate, don't create "hair" that later investors will get queasy about.

A sign of maturity of a technology cluster is the sophistication of the entrepreneurs and the infrastructure. Vancouver does not lack for exciting technologies or interesting opportunities. It is often hurt by plain bad advice and judgment. Everyone, and I mean everyone, that works or supports the industry here needs to constantly look to how things get done efficiently elsewhere and strive to adopt the formulas that work by learning and listening. There is a machine for financing companies that works in the major US tech centers and very recently in Ottawa. There is an understanding between financier and entrepreneur about the process of making a deal that has been learned by trial and error. And VC is the financing path for growth in nearly every single technology company in the US. The system works. Well. We need to listen and learn.

We will get there, Vancouver. We have the experienced people with deep customer knowledge percolating in our major tech companies. We have more and more people learning the financing game. For me, it can't happen fast enough.

Random Thoughts –

- So Long And Thanks For All The Laughs - A few people (OK, very few... and my mother doesn't count) have asked where I derived my writing style. I would have to say that Stephen King inspired me to use music lyrics in a kind of pop culture meets dry written material fusion thing. And Rick Reilly of Sports Illustrated is easily the best improvisational metaphor writer ever born (To wit: from a column he wrote deriding Canada after the US anthem was booed at Vancouver and Edmonton NHL games - "You've only got six teams left out of the 30 in the league, and those six are lookin' paler than a Saskatoon stripper. None of 'em have a snowball's chance this year, and most are broker than Braniff.") Where does he come up with these lines?

So it is with a heavy heart, that I acknowledge my third writing inspiration upon his untimely death. Douglas Adams passed away in Santa Barbara, California two weeks ago at age 49, leaving us without the funniest science fiction writer ever known. He is most famous for his trilogy of four books based on the Hitch Hiker's Guide To The Galaxy, which was originally a radio script for the BBC. Each of his sidesplittingly funny books was about 40 pages of plot and 260 pages of tangents that left you laughing out loud in public. He was a true genius of creativity and wit. And I devoured everything he wrote and everything he produced including a fabulous "Myst" like video game called Starship Titanic, which I'm sure only sold well in England and parts of Canada where we "get" his type of humour.

His legacy lives on with a website, funded and run by the BBC, at http://www.h2g2.com This is the true Hitchhiker's Guide that was his original vision. It is researched by anyone that wants to add their story of their corner of the universe. Another reason I liked Douglas and take inspiration from his writing is summed up in this quote from him: "I love deadlines. I love the whooshing noise they make as they go by."

- Glenayre is Gone - thirty-five years ago, a few guys from Coquitlam started a pioneering company in our industry in BC. They named the company after a street that one of them lived on. This company went on to become a large player in the wireless messaging industry before wireless was an industry. In the mid-90's all of the management disappeared to North Carolina as a larger company bought them, but kept the Glenayre name. Some 250 people continued to work for Glenayre here in Vancouver until yesterday. In a major restructuring, the company pulled out of its pager business altogether. This product line, which competed with the RIM Blackberry, got absolutely smoked in the market by RIM and Motorola and sales were 70% less than expected. While it is sad to lose a pioneer, the good news is that there are some very talented people looking for a home in our wireless industry now.

 

What Do You Think? Talk Back To Brent Holliday

 



Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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