New Venture Creation has always pushed to inspire entrepreneurs to “think big.” There are countless small business owners who, like a dairy farmer, are enslaved by their business. This usually includes ex- tremely long work weeks, with even 100 hours a week not unusual, with little to no vacation time. These hardworking owners rarely build equity in their core business. A significant difference between the growth- and equity-minded entrepreneur and this traditional small business owner is that the entrepre- neur thinks bigger.
Patricia Cloherty , a venture capitalist, past presi- dent of Patricot & Company, and the first female president of the National Venture Capital Associa- tion, puts it this way: “It is critical to think big enough. If you want to start and build a company, you are going to end up exhausted. So you might as well think about creating a big company. At least you will end up exhausted and rich , not just exhausted!”
Transforming Caterpillars into Butterflies
This chapter is dedicated to making the tough naviga- tion from opportunity to big company more efficient by focusing a zoom lens on the opportunity. It shares the road maps and benchmarks used by successful entrepreneurs, venture capitalists, angels, and other private equity investors in their quest to transform the raw, caterpillar-like nature of an idea into a butterfly.
Only about 5 percent of entrepreneurs create ven- tures that emerge from the pack to grow into big companies. These ventures reveal a highly dynamic pattern that can be recognized rather than a product
of a formula or the execution of a checklist. This highly organic and situational character of the entre- preneurial process underscores the criticality of determining fit and balancing risk and reward .
New Venture Realities
1. Most new ventures are works in process and works of art; where you start does not have a lot of correlation with where you finish. 2. Business plans are obsolete the minute they
are finished. Onset Venture Partners found that 91 percent of portfolio companies that rigidly followed their business plans failed! 3. The key to succeeding is failing quickly. 4. Success is highly situational and requires a
substantial amount of “luck.”
5. The best entrepreneurs specialize in making “new mistakes” only.
6. Plan for the worst when starting a company and avoid large solo projects.
The Circle of Ecstasy and the Food Chain for Ventures
The “circle of venture capital ecstasy” ( Exhibit 5.1 ) and the “food chain for entrepreneurial ventures” ( Exhibit 5.2) show the entrepreneur how the com- pany building–investing–harvesting cycle works. Un- derstanding this cycle and the appetites of different suppliers in the capital markets food chain enables you to answer these questions: For what reason does this venture exist and for whom? Understanding the who and what has profound implications for fund- raising, team building, growing, and harvesting the company.
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130 Part II The Opportunity
space,” which creates the attraction for the “best management team.” Speed and agility attract the “best venture capitalists, board members, and other mentors and advisers” who can add value to the venture.
Exhibit 5.2 captures the food chain concept, which will be discussed in greater detail in Chapter 13. Dif- ferent players in the food chain have very different capacities and preferences for the kind of venture in which they want to invest. The vast majority of start- up entrepreneurs spend inordinate amounts of time chasing the wrong sources with the wrong venture. One goal in this chapter is to provide a clear picture of what the criteria are and to help you grasp what “think big enough” means to the players in the food chain. This is a critical early step to avoid wasting time chasing venture capitalists, angels, and others when there is not a match between the venture the entrepreneur is pursuing and the interests or capaci- ties of the investor.
When Is an Idea an Opportunity?
The Essence: Five Anchors It is important to know the difference between idea and opportunity; and from an opportunity to understand what is an interesting feature, a good product or service, and
EXHIBIT 5.1
Circle of Venture Capital Ecstasy
Highest market capitalization
Top decile internal rate of return
Best technology and market space
Best management teams Best speed of attack Best venture capitalists, board, brain trust advisors
Best underwriters
EXHIBIT 5.2
The Capital Markets Food Chain for Entrepreneurial Ventures
Stage of Venture R&D Seed Launch High Growth
Company enterprise Less than $1 million $1 million–$5 million . $1–$50 1 million More than $100 million
value at stage
Sources Founders FFF* Venture capital series IPOs
High net worth Angel funds A, B, C . . . † Strategic acquirers
individuals Seed funds Strategic partners Private equity
FFF* SBIR Very high net worth
SBIR** individuals
Private equity
Amount of capital invested Up to $200,000 $10,000–$500,000 $500,000–$20 million $10–$50 1 million
% company owned at IPO 10%–25% 5%–15% 40%–60% by prior 15%–25% by public
investors
Share price and number ‡ $.01–$.50 $.50–$1.00 $1.00–$8.00 1 / 2 $12–$18 1
1–5 million 1–3 million 5–10 million 3–5 million
* Friends, families, and fools.
† Venture capital series A, B, C . . . (average size of round)
A @ $5.1 million— startup
Round B @ $8.1 million—product development (Q4 2004) C 1 @ $11.3 million—shipping product Valuations vary markedly by industry (e.g., 2x s ).
Valuations vary by region and VC cycle.
‡ At post–IPO.
**Small Business Innovation Research, a N&F Program. The SBA provides a number of financial assistance programs for small businesses, including 7(a) loan guarantees, 504 long-term finance loans, and disaster assistance loans.
Exhibit 5.1 shows that the key to creating a com- pany with the highest value begins with identifying an opportunity in the “best technology and market
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what is a good business. Real business opportunities have the following anchors:
1. They create or add significant value to a cus- tomer or end user.
2. They fix a real problem in the market, some- thing that is truly a market pain.
3. The need for the product or service is pervasive, the customer wants urgently to fix it, and the customer is willing to pay to fix it.
4. They have robust market, margin, and profit- ability characteristics that the entrepreneur can prove.
5. The founders and management team have collective domain experience that matches the opportunity.
A strong management team recognizes these op- portunities and takes advantage of them when the “window of opportunity” 1 is available. A strong team
recognizes these fleeting moments and develops competitive advantage to give the business additional leverage to exploit the market opportunity.
To summarize: A superior opportunity has the market qualities of customers that are pervasive, have a high sense of urgency, and are willing to pay for the product or service. This product or service creates significant value for the customer by addressing a se- rious problem. 2 The most successful entrepreneurs,
management teams, venture capitalists, and private investors are opportunity-focused; that is, they start with what customers and the marketplace want and develop their competitive advantage in response to the market opportunity.
Spawners and Drivers of Opportunities
In a free enterprise system, changing circumstances, chaos, confusion, inconsistencies, lags or leads, knowl- edge and information gaps, and a variety of other vacu- ums in an industry or market spawn opportunities. Opportunities are situational. Some conditions un- der which opportunities are spawned are idiosyn- cratic, while others can be generalized and applied to other industries, products, or services. In this way, cross-association can trigger in the entrepreneurial mind the crude recognition of existing or impending opportunities. It is often assumed that a marketplace dominated by large, multibillion-dollar players is im- penetrable by smaller, entrepreneurial companies,
and that it is impossible to compete with these en- trenched, resource-rich, established corporations. The opposite can be true for several reasons. A num- ber of research projects have shown that it can take years or more for a large company to change its strat- egy and even longer to implement a new one. It can in fact take up to 10 years for a larger company to ef- fectively change its culture or update its operational systems. When Cellular One was launched in Boston, giant NYNEX was the sole competitor. It is estimated NYNEX built twice as many towers (at $400,000 each), spent two to three times as much on advertis- ing and marketing, and had a larger head count. Yet Cellular One grew from scratch to $100 million in sales in five years and won three customers for every one that NYNEX won. What made this substantial difference? Cellular One’s entrepreneurial manage- ment team.
Many of today’s most exciting opportunities have grown from technological innovation. The perfor- mance of smaller firms in technological innovation is remarkable—95 percent of the radical innovations since World War II have come from new and small firms. A National Science Foundation study found that smaller firms generated 24 times as many inno- vations per research and development dollar as did firms with 10,000 or more employees. 3
Technology and regulatory changes have pro- foundly altered the way we conceive of opportunities. Cable television with its hundreds of channels came of age in the 1990s and brought with it new opportu- nities for small companies to achieve cost-effective and substantial reach in the sale and distribution of goods through infomercials and pay-per-view. New opportunities in sales have recently arisen: For exam- ple, Red Box movies and Netflix allow people afford- able and convenient ways to get the entertainment they want and have put movie rental stores out of business. The Internet has created even more diverse and cost-effective methods of customer reach as demonstrated by Amazon.com, Priceline , eBay , You- Tube , and emerging social networks led by Facebook and Twitter. Consider the following examples that illustrate the phenomenon of vacuums in which op- portunities are spawned:
Deregulation of telecommunications and the airlines led to the formation of tens of thou- sands of new firms in the 1980s, including Cellular One (now Cingular ) and Federal Express.
1 The window of opportunity is defined as the period of revenue growth in the life cycle of the target industry when the slope of the revenue curve is increasing.
The window of opportunity begins to close as that revenue curve levels off.
2 See J. A. Timmons, New Business Opportunities (Acton, MA: Brick House, 1989).
3 Leifer, McDermott, O’Connor, Peters, Rice, and Veryzer, Radical Innovation: How Mature Companies Can Outsmart Upstarts (Boston: Harvard Business
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132 Part II The Opportunity
Microcomputer hardware in the early 1980s far outpaced software development. The industry was highly dependent on the development of software, leading to aggressive efforts by IBM, Apple, and others to encourage software entrepreneurs to close this gap.
Fragmented, traditional industries that have a craft or mom-and-pop character may have little appreciation or know-how in marketing and finance. This is demonstrated by nationwide chains that have emerged in residential real estate, funeral homes, dry cleaners, and lawn maintenance corporations.
In our service-dominated economy (70 percent of businesses are service businesses, versus 30 percent just 30 years ago), customer service, rather than the product itself, can be the critical success factor. One study by the Forum Corporation in Boston showed that 70 percent of customers leave because of poor service and only 15 percent because of price or product quality. The tremendous shift to offshore manufacturing in India, China, and Mexico of labor- and transportation-intensive products has dramatically altered the nature of selling manufactured goods in the United States. Exhibit 5.3 summarizes the major types of dis- continuities, asymmetries, and changes that can result in high-potential opportunities. Creating such changes through technical innovation (PCs, wireless
telecommunications, Internet servers, software), in- fluencing and creating the new rules of the game (airlines, telecommunications, financial services and banking, medical products, music and video), and anticipating how the associated industries respond are central to recognizing opportunities.
Search for Sea Changes
Arthur Rock, a lead investor in Apple Computer and a famed venture capitalist, stated, “We look for ideas that will change the way people live or work.” The best place to start in seeking to identify such ideas in a macro sense is to identify significant sea changes that will occur. Think of the profound impact that personal computing, biotechnology, and the Internet have had on industries. Exhibit 5.4 summarizes some categories for thinking about such changes. Moore’s law (the computing power of a chip doubles every 18 months) has been a gigantic driver of much of our technological revolution over the past 30 years. Breakthroughs in gene mapping and cloning, bio- technology, nanotechnology, and changes brought about by the Internet will continue to create huge opportunities for the next generation. Beyond the macro view of sea changes, how can one think about opportunities in a more practical, less abstract sense? What are some parameters of business and revenue models that increase the odds of thinking big enough and therefore appeal to the food chain?
EXHIBIT 5.3
Summary of Opportunity Spawners and Drivers
Root of Change/Chaos/Discontinuity Opportunity Creation
Regulatory changes Cellular, airlines, insurance, telecommunications, medical, pension
fund management, financial services, banking, tax and SEC laws, new societal and/or environmental standards and expectations
10-fold change in 10 years or less Moore’s law—computer chips double productivity every 18 months:
financial services, private equity, consulting, Internet, biotech, information age, publishing
Reconstruction of value chain and channels of distribution Superstores—Staples, Home Depot; all publishing; autos; Internet
sales and distribution of all services
Proprietary or contractual advantage Technological innovation: patent, license, contract, franchise,
copyrights, distributorship
Existing management/investors burned out/ undermanaged Turnaround, new capital structure, new breakeven, new free cash
flow, new team, new strategy; owners’ desires for liquidity, exit; telecom, waste management service, retail businesses
Entrepreneurial leadership New vision and strategy, new team equals secret weapon;
organization thinks, acts like owners
Market leaders are customer obsessed or customer blind New, small customers are low priority or ignored: hard disk drives,
paper, chemicals, mainframe computers, centralized data processing, desktop computers, corporate venturing, office superstores, automobiles, software, most services
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