“10% of something is better than 100% of nothing,” I was once advised by the Managing Director of a major Wall Street Bank. His comment was the result from his observation of what type of manager was needed to be included in the management team that needed to raise several hundred million dollars. The company had to add him/her to the management team at some cost including equity. This candidate had to know the industry and must have handled an enterprise with the sizeable financing needed. Otherwise, the company might not be able the raise the capital. Everyone has seen this thought process when companies such as eBay add a seasoned executive prior to the IPO. But this Wall Street banker’s comment applies to any entrepreneurial business seeking financing from “smart” money. Based on the volume of companies reviewed, a smart investor might come to some conclusion as to the weakness in a management team and I always advise any startup to heed such advice. Or it might never get the financing. Hence, the 100% of nothing rule.
Now this 100% rule came recently to mind with a Californian company I recently met. The management team consists exclusively of doctors, lawyers, and marketing/sales people. It has several patents. The product has “legs”. But not one member on that team has ever worked in a successful startup company that has raised financing consistently. Not one member of that team has had corporate financial experience. Not one has put together a financial spreadsheet to extrapolate projections or a private placement memorandum.
For some strange reason, the management team, replete with many degrees except MBAs, feels that there is no incentive to have someone with business startup experience to share with the equity with the founders. Half of the Executive Summary describes the expertise of its service industry pundits — doctors and lawyers. However, the company cannot put together a well drafted business plan, and, as a consequence, an executive summary directed to smart investors. Of course, they are proud to have several patents. But patents, per se, do not generate sales. Patents can be circumvented. Patents can be eclipsed by better technologies.
The most important strategy that a company must follow with the patented technology is to generate profitable sales as soon as possible and seize the quickest lead in the marketplace. To achieve those objectives, you have to include someone within the management team who knows something about milestones, margins, and projections. Most doctors and lawyers have the least credentials to achieve those goals, although there are notable exceptions, for example, Dr. Hammer.
While with Pegasus Ventures, I was the interim-President of a data storage company in Maryland. The founder was an IT scientist with a patent for a Pedabyte storage system. To me, a scientist falls into the same bucket as doctors and lawyers. My primary concern as a senior manager was to identify ways to generate revenue quickly. After some due diligence, I concluded that the Pedabyte system would cost hundreds of millions of dollars and over a year and a half to build. That long dry spell would be difficult to swallow as a startup.
I also thought about the need to show results quickly to investors with the storage device company, after a CEO of a publicly traded Virginian company commented to me that his investors shut down his company when he couldn’t be profitable within 2 years, even though his business plan indicated that road to profitability could only be reached after 3 years. His observation underscored the fact that investors may seek quick returns and can grow very impatient when the stock market heads south, regardless of what the business plan states. After that observation, I concluded that an average startup must generate profitability and/or cash flow within a year or two, at worst (unless it is a biotech company!).
In my attempt to achieve cash flow with the same patented storage technology within a year, I then asked the data storage scientist whether I can reduce the size to TeraBytes with the same technology and sell to the corporate community. This quick changeup in strategy could generate cash flow within a year. He confirmed the strategy and, as a consequence, the exit strategy was achieved in less than a year after taking that route. But then, this Maryland company acknowledged that it needed an experience manager to lead it, for without that type of executive it never would have gotten off the ground.
As a litmus test to confirm the weakness in its business plans, I suggested to the CEO of that Californian company to send his Executive Summary to a VC fund, to see if it would respond. I myself reviewed its Executive Summary and found lacking many elements needed. I just needed some confirmation. The company does have some money to pay someone to write a decent business plan, but feels that this use of its capital wasn’t wise. They feel that they have been successful as long as they have minor chunks of capital from friends and family. They are now seeking that next round of capital for about $2 million. Anyway, the VC fund didn’t respond, as I had predicted. This situation suggests another appropriate aphorism – “Pennies wise, pounds foolish.”
Since the company needs a few million to begin to market its product, I doubt that it will continue to do so while the business plan and its executive summary don’t meet the standards demanded by the investment community. As a former colleague once told me, he attended a monthly investment meeting with startups and noted the irony that some mediocre companies were more capable of raising smart money with well documented and prepared presentations over companies with great products but bad presentations. How true!
So as long as this Californian company persists in exhausting its limited capital to seek smart money without investing in its presentations and business plans by putting someone on its team with the right experience, it will continue to falter even with all its patents. The company needs to bite the “bullet” – share its equity with such personnel. Of course, many things are possible. They might get that smart investment, but the odds against it are considerable.