We write frequently 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.
The company was acquired by HP for triple digits 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 the strategic vision, direction and execution of The Venture Company. 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 but to my pleasant surprise, they responded with open ears. I incubated the management team, refocused the company on a single product and led the company 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 this “fathers” proclamation of his role.
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 large 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 6 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 simply not the investors expertise to run companies, directly or indirectly. So, do not raise the money that relinquishes control to investors.
SoftKinetic raised too little money.
SoftKinetic, a company that developed 3D gestural recognition software, contacted us in 2006 (from Belgium) to build an US business and raise money in the Valley. Within 6 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, only to kill the deal because of growing conflicts with one of the original board members (who has since been removed).
I moved on and the company emerged one year later with a new CEO and a licensing strategy that, in our view, is 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 deployed on PCs first to test their viability, the premium gaming experience by SoftKinetic could have provided a much better immersive experience than the Wii – immediately – 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 Angels) who can’t see the forest through the trees sucks the gusto out of disruptive business strategies.
Now, the company is forced to tip-toe into the market and adopt a licensing strategy similar to GestureTek and shuttered Reactrix and yield to 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 certain 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 slide.
It is for reasons like these that entrepreneurs partner with experienced venture catalysts (like us) 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 right terms and with the real passion to support disruptive innovation.
Both parties, the entrepreneur and the investor will benefit from our game-changing attitude.
Entrepreneurs will retain more equity and investors are exposed to deals that actually have the potential to single-handedly impact fund performance.