Having raised some $14M in venture capital, here are some lessons I have learned. Both companies were acquired, demonstrating my ability to find, build, and shape winners.
We frequently write about sub-prime investors who delay and suppress the risk associated with technology investments, which in-turn only attract entrepreneurs that are willing to submit themselves to those sub-prime tactics.
Today sub-prime investments occur primarily because of underfunding, but the opposite – overfunding – happened in the bubble days. Here are two real-world examples of how both types of investments deflate returns for entrepreneurs (and indirectly, all parties involved):
OuterBay Technologies raised too much money
HP acquired the company for triple digit-millions in 2006, but the deal was not as good for the entrepreneurs as it appeared to be for the investors, as we predicted back then.
In the words of its then CTO; OuterBay Technologies would not have existed without our strategic vision, direction, and execution. We tell our story here for the first time:
During Christmas in 1999, I ran, through a friend, into four developers from OuterBay Technologies with a horrible business plan. I gave them the bad news, and they retreated looking for other helpers. Two weeks later they came back and asked me why I was so expensive. I drove the founder to lunch in my convertible BMW and told him; look, if you want the ultimate driving experience you have to pay for it. Do you think BMW cares if you do not have $80K to spend? He got the message.
I incubated the management team, refocused the company on a single product and led the company from inception, to launch, and initial market traction. We secured many early-stage customers at around $160K a pop to which no self-respecting investor could say no. Even though many analysts still did, we unwaveringly continued to break new ground.
Success has many fathers, and I smirked after reading the proclamations of OuterBay Technologies’ many “fathers.” When it comes to the pretense of reputation, people are opportunistic scumbags. None of those fathers were around when the going with OuterBay Technologies was tough.
The worst was my former boss at Oracle who after he fired me, for not submitting to his antics and the wrong people he hired, vouched I would never find a job in this valley again, only to beg me for a role with the company years later. Silicon Valley has genuinely turned Hollywood, casting couch and all. But I digress.
Because of the early success we created as a team, and swayed by the ample amount of money available to startups in the late 90s, early 2000s, OuterBay Technologies raised an $11M Series A in 2001. About $6M too much in my humble opinion. As a board member, I approved the deal (I did not want to hold the founders’ dream hostage), but not before warning them of the consequences of such a large round (at double-digit pre-money), selling my founder shares (at a discount) back to the company and relinquishing my board seat.
The net of this story is that with more than $48M in, and such a sizable series A the company was quickly being “run” by the investors who put in a CEO we would not have picked, and expected revenue run rates way above the organic growth of the enterprise space that this invention relied on. As a result, and after almost six years of hard work, the entrepreneurs did not walk away with the life-changing money they deserved. They should have continued to listen to my advice, and they would have walked away with more.
No company should be majority-owned by non-founding investors. It is just not the investor’s expertise to run companies, directly or indirectly. So, do not raise the money that relinquishes control to investors. Ever.
SoftKinetic raised too little money
SoftKinetic, a company that developed 3D gestural recognition software, contacted us in 2006 (from Belgium) to build a US business and raise money in the Valley. Within six months, I validated the proposition against the laboratory developments at Sony, Microsoft, HP, and others and assessed its technological leadership – before Nintendo launched the Wii.
I invited 20 well-known VCs one-by-one over to downtown Palo Alto, demonstrated Quake driven by marker-less full-body movement, still leaving the majority of investors clueless about how the “input device” in the gaming industry fundamentally changes the adoption to the platform. Nintendo sure proved them wrong only a few months later.
I lined up two angels (including many other friends who wanted to participate in any financial way possible) ready to wire a double-digit pre-money $2.5M pre-revenue round, for me to kill the deal because of growing conflicts with one of the original Belgian board members (who has since been removed), more than six red flags indicated his deplorable and questionable performance.
I moved on, and the company emerged one year later with a new CEO and a licensing strategy that, in our view, was the wrong business model for the company. As the new CEO explained it, “at this point, we are not able to raise more money to deploy a different strategy.”
The real solution to the success of SoftKinetic may have faded, but I believe the company could have deployed a premium game station PC platform strategy (not unlike Voodoo, with one of the independent PC OEMs and part of the 40% of the fragmentation in that market) and deployed a growing number of existing 3D enabled games on that platform initially. Since the majority of new games are used on PCs first to test their viability, the premium gaming experience by SoftKinetic could have provided a much better immersive experience than the Wii. And as 3D cameras further commoditize, the software that drives the experience would amplify the core competency of SoftKinetic and be deployed at very low-cost, with hundreds of game titles.
But the latter strategy requires big thinkers at both the company (the board) and the investor side. Years of complacent investing by VCs (thank God for some very wealthy Angels) who can’t see the forest through the trees sucks the enthusiasm out of disruptive business strategies.
Now, the company was forced to tip-toe into the market and adopt a licensing strategy similar to GestureTek and shuttered Reactrix and yield to the suboptimal traction that can be expected from niche game-play and home entertainment interaction. That is a pity for the entrepreneurs and me (as I am still a shareholder of the company).
So, raising too little money is forcing many companies to phase-in disruption, and presents many new obstacles at a higher overall cost to gain significant market share, and at the immediate expense of its founders.
The point I am making with these two examples is that entrepreneurs who model their business after the direction of the investors are almost guaranteed to lose out, spiritually and financially on the level of disruption they aimed to ignite. These examples are representative of an alarming Silicon Valley trend, one we wish we did not need to counter. But we care too much about groundbreaking innovation to let it these symptoms go unnoticed.
It is for reasons like these that entrepreneurs partner with experienced board members who raise the disruptive bar on both sides, put the investor’s feet to the fire and raise the right amount of money at the proper terms combined with the real passion for supporting disruptive innovation with a propensity to change the world for the better.
Both parties, the entrepreneur, and the investor will benefit from a game-changing attitude, with the deployment of a unique and unprecedented vision from which the proper deployment of venture capital can reap generous rewards.
Entrepreneurs will retain more equity and change the world, and investors are exposed to deals that have the potential to improve fund performance single-handedly. What is not to like about that?