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Thursday, May 17, 2012
Department: April 2006
The Tech Trajectory
How to build a startup and make a successful exit
Story by Jack Crawford Jr.
If a colleague of mine — a former Intel executive — is to be believed, Sacramento is changing from a “cow town” to a “tech town.” Its economy is clearly diversifying beyond real estate and government into technology — all kinds of technology.
Look at the wireless and semiconductor innovations spinning out of Intel; the video technology coming from Thomson’s Grass Valley brand; Sacramento State’s business software; the medical devices and biotechnology coming out of the University of California, Davis — our area is even home to a growing clean-technology initiative. That’s a wider range of technologies than you’ll see most anywhere outside Silicon Valley. How are these companies being built and financed?
Most technology companies start with a smart engineer who develops a solution to a recurring problem. Where most people see inconvenience — “This just isn’t fast enough; it’s too expensive; it shouldn’t be this difficult” — entrepreneurs sense opportunity.
Unique insight and access to information about a problem facing a large number of customers provides an opportunity to build a company that facilitates a solution for the market. Quickly evaluating the idea, the marketplace and the competition, as well as securing initial resources, becomes critical.
After “fully baking” the idea, the next steps are researching the market and raising initial capital. Key research questions include: Is the market big enough? Has this been done before? What competitors will I face upon entering the market? What competitive advantages could be created to strategically differentiate my company from other companies? How much capital do I need to establish initial proof points for my solution? Initial capital sources at the idea stage are almost always the entrepreneurs themselves and their friends and family members. The range of investments or loans for these startups is typically from $50,000 to $500,000.
Once initial capital is secured, is it time to buy the Ferrari? Sorry — the initial capital needs to be invested in market research, financial modeling, recruiting fees, attorney fees, corporate branding, rent and staff salaries. There is nothing left for a Ferrari, and many times, not even for salaries for the founders, whose compensation is often the pile of equity they have been allocated in the new company.
With freshly printed business cards, some market research and a best-guess business model, entrepreneurs can climb to the next link of the financing food chain: angel investors and seed-stage venture funds.
Initial capital sources at the idea stage
are almost always the entrepreneurs
themselves.
Although angels fund the bulk of seed-stage deals (Venture One, a leading venture capital research firm, states that only 4 percent of total venture capital investments are at the seed stage), they often work with VC firms to identify interesting deals, perform due diligence on investment opportunities, and put together an investor syndicate. They help build companies and act as financial partners for entrepreneurs.
Some angels, often tech-savvy executives or those who belong to angel groups, invest directly, but many others, often real estate and corporate executives, take comfort in following the lead of venture firms because those firms understand the market, the technology, the due-diligence process and the investment terms for deals at this stage. This round of funding is typically between $500,000 and $1 million and usually comes in the form of preferred stock or convertible debt, a loan that typically converts to equity in the company at the close of a round of financing.
Both angel and VC partners regularly take board seats to provide hands-on interaction and advice for young companies. Along with growing the company by adding to the team, working on product development and identifying beta customers, management teams will work with their boards on strategy as well as the investor-communication tools required for the next wave of financing: a company overview (usually a 10- to 15-page PowerPoint document), a one- to two-page executive summary, a financial model, an ownership schedule including allocation of stock options for future hires, industry research, reports validating the opportunity, and detailed biographical information on the team.
It’s becoming apparent that full business plans simply don’t make sense for companies that are required to be nimble. From my conversations with other investors, a full business plan is no longer a prerequisite for meeting with most VC firms or local angels, although it is expected by the time the round of financing is closed and funded.
Early-stage venture firms are the next link in the financing food chain, and they have identified Sacramento as one of the more compelling emerging
markets in the country. Although they will occasionally invest earlier, these investors are typically focused on larger rounds of funding.
A full business plan is no longer a prerequisite for meeting with most venture capital firms.
According to Venture One, approximately 53 percent of all deals completed by VC firms are at the $5 million to $10 million stage. In 2004, approximately 1,100 companies were funded in the U.S. at this stage, with average financing of $6.9 million. The stringent requirements for meeting with early-stage investors over the last few years have typically included a complete management team and significant customer traction.
More and more early-stage investors are working with locally focused venture funds and angels to identify hot prospects. They are searching for the next Level One, which was acquired by Intel for more than $2 billion, or OSI, which was acquired by Agilent for more than $600 million. Locally focused venture funds and angels can often help provide a valuable bridge to customers, talent and additional capital from the Silicon Valley since they know the local deal flow intimately.
With a successful exit — an acquisition or initial public offering — entrepreneurs are rewarded with liquidity for their investments of capital and/or time. For many entrepreneurs, an exit includes a U-turn right back into the world of company-building: After taking a well-earned vacation, most entrepreneurs I know immediately begin working on their next big idea or dive in to help a friend work on his or hers.
Hopefully, the next great companies built in Sacramento will skip the cowbells and go straight to the opening bell at the New York Stock Exchange.
Jack Crawford Jr. (jack@velocityvc.com) is the general partner at Velocity Venture Capital, the seed-stage and early-stage venture fund exclusively focused on the Sacramento region.
