These days I am spending a lot of time trying to make sure that I understand what we have done right/ wrong at Kickstart in order to ensure that we are learning and improving as we move forward and try and scale up our efforts.  I had a few LPs also ask me if I could share lessons learned — hopefully these are helpful to entrepreneurs and investors alike.  Here is an early draft of some of these lessons learned – I would love to hear your thoughts and feedback as well.  Should be a number of follow-on posts about the topic as well.

Our involvement actually seems to matter.  3-5 years from now when most of the results for Kickstart I are obvious we are going to do a bit of regression analysis to really understand what factors made a difference or didn’t in the outcome of various companies.  One variable that clearly seems to stand out already is: deals that we have a significant investment in and are active with seem to be vastly out-performing those that we have a small, passive investment in.  This is consistent with Kauffman studies on the subject as well — showing that active involvement has a statistically significant impact on returns.  As basic as this sounds, I think this is an important insight for us.  I have always felt like investing at the seed-stage in UT is fundamentally different than the Bay Area etc…  One of the key differences (illustrated by the above) is that you can’t just take for granted that a company will have active, value-add board members.  In a way, I think a passive strategy can work well in more “dense” markets because you are essentially able to “free-ride” on the mentoring that other people will give your companies.  In UT and surrounding states we need to own that responsibility and give our companies they help that they need. One of the reasons that we all enjoy this type of investing so much is that our input really makes a difference at the seed stage.  Send me an email if you would like to be involved with mentoring startups. (more…)

Well, I hope this finds everyone well.  Not a lot of great material to draw on from the sports world right now, so how about a bit of historical note.  Recently I read an extensive history of World Ward II called the Rise and Fall of the Third Reich.  One of the most striking human insights from the book and its detailed coverage of the war is the willingness of the Western European and other powers to pursue a policy of appeasement toward Adolf Hitler.  Chamberlin’s and other world leader’s gestures to avoid war in Europe at all cost, allowed Hitler to gain strength, rebuild the military industrial machine of Germany and solidify his political position.  His incursions to re-occupy the Rhineland, the take-over of Austria through a campaign of terror, and finally his bloodless take-over of Czechoslovakia (despite guaranties of protection by France) were scarcely even met with reproving words.  In retrospect, the menace of Hitler’s Germany seems obvious (similar events had unfolded a few decades before).  But the war weary Allies were more focused on the reality they wanted to see, than the reality that was starring them in the face and thereby were manipulated by the Nazi regime’s lies and clever political maneuvering.

The analogy for our work with startups is the clear challenge that we face in making difficult, challenging decisions that dramatically alter the status quo of the companies that we work with respect to people, markets, and strategy (to be clear I am not suggesting that any of our companies or their executives are in any way Nazis).  One merely needs to open the WSJ to see dozens of examples of large companies ignoring and explaining obvious sources of alarm e.g. Borders, Blockbuster, Nokia, Microsoft, the Financial Crisis etc…  Similar to large companies, startups also suffer from tunnel vision or inability to confront reality, but unlike large companies, the punishment for startups thinking this way is almost always a death sentence.  There have been times when I have looked back on a company that I have worked with or observed for some time after making a difficult decision like replacing a key executive, reducing expenses, or shifting the strategy of the company and thought to myself… “that was obvious for some time why didn’t I do that sooner.”  Knowing when and how to act I believe is a real test of judgment, character and courage.  So how do we avoid this type of thinking on the boards and companies in our portfolio?  Following are a few thoughts on combating these dynamics:

• Governance.  Our companies must have engaged, challenging boards of directors and also seek for having multiple management perspectives (not just the CEO) on the progress and status of the company.  Tactically this means asking good questions and testing the assumptions of the team.

• Investor objectivity. Escalation of commitment is a real issue in investing and it impairs judgment and rationale thinking.  No one is immune from this behavior.  At Kickstart the way we combat this is with an investment committee that behaves as discussed above.  The way we structured our decisions (majority instead of unanimous) means that we have a culture where dissent is ok.  Finally, we have tried to structure our investment pacing to keep a rational approach.  We have an initial investment followed by small reserves after which all follow-on investments are competitive between companies.  This underlines the scarcity of capital and frames follow-on as a reward not a right.

Personally, my spirits are feeling buoyed by signs of an improving economy and a world with one less mass-murderer thanks to Seal Team Six (with some props [this was truly an accidental pun] to the new stealth helicopter if the media is to be believed).  Also encouraging to me is seeing some of our Kickstart companies really hitting their stride. I am hopeful that, having been funded and molded in the fulcrum of the Great Recession, these companies will maintain a strong advantage in their respective markets now that the economic headwinds are slowing (could we be headed for a tail wind?).  Through the Kickstart portfolio we have exposure to a wide variety of industries from hospitals to online travel, from event management to online security and payments and local advertising.  Over the last quarter or so we are seeing sales cycle shorten a bit and the willingness of consumers and businesses to make incremental investment increase.  A few more observations from the field:

Never a dull moment. No startup I have been involved with (even the successful ones) has succeeded without having at least a few “near-death” experiences.  As good as many of our companies look now, our portfolio has been no exception.  The variety of the ways that these come include 1) founder/ team strife 2) product that doesn’t work or that is completely off schedule 3) sales that just are not happening  4) lack of transparency + any or all of the above 5)  market factors like the Great Recession that make equity and debt capital very difficult to get.  One of the ideas that I try to share with Angel investors that are just beginning to invest in these type of companies and is that seed stage investments are almost always going to be a bit wild even when they work well.  We invest significantly in due diligence up front, we negotiate attractive valuations and reserve follow-on capital because it is so much easier to solve problems before you put money into a company.

Investor Archetypes: The Believer v. The Banker. I have been doing some thinking about the pros and cons of various heuristics that venture capitalists and Angel Investors bring to the table.   For illustration, lets take two extreme examples: the Believer and the Banker. The Believer.  The dogmatic Believer has a vision of the future – nanotechnology or mobile gaming etc… and invests behind building this field of dreams in specific and pro forma ways.  (This also can be called the Genius’s guide to investing)  At the most extreme this investor seeks out only data confirming the faith and derides and attacks all disbelievers as would religious zealots would cast out a heretic.  The conviction of the Believer allows him/ her to make bold investment moves, avoid herd mentality, and allows them to incredibly patient with companies as they struggle to get her early traction and validation.  These investors’ can lead them to verbally burn a non-believer at the stake for doubting the Truth through ad-hominen attacks, slander, bravado whatever it takes. Due diligence is of dubious importance because what can possibly stand up again the Vision, many basic questions are not asked or explored.  Ultimately this type of investor doesn’t seek out entrepreneurs but acolytes and clerics to the Grand Vision and ultimately that Great Oz-like Ego behind the curtain.  As a board member, the Believer is engaged and highly supportive and sympathetic to the management team – endlessly optimistic in assessing the team’s performance and their ability to achieve the Goal.  Often the type of entrepreneurs drawn to this type of investor are highly qualified employees (but not entrepreneurs) often from big companies who want the form but not the substance of entrepreneurship who see the customer as the Investor-Believer and his Grand Vision.  Successful Believers tend to attract a “cult of personality” or a number of hangers-on.

The Banker. The Banker is an ex-investment banker or management consultant, financially-trained, an MBA, who fundamentally approaches most interactions in a legalistic – adversarial way and is driven by the opinions of peer consensus.  Investment strategy is a largely a function of what has been getting financial results lately.  Many investments are “me-too” investments seeking to take advantage of hot sectors or fads.  Social proof is the ultimate decision-maker.  “Who” is investing is more important that “what” they are investing in.  Where the entrepreneurs went to school overrides nearly all other important management screening criteria.  Due diligence efforts are intense but often in areas that don’t have a lot of data to offer.    For example, the financial model gets all kinds of scrutiny in a seed-stage or early-stage startup.  He negotiates as hard as possible for as much control as possible.  This is the type of investor that drops a $50K legal bill on a seed financing for investor counsel.  Board room manners are consistently adversarial, Founders are quickly discarded off and replaced with more reliable board members.  Board discussions center around protocol, financials, and fundamentally this investor sees his role as keeping the CEO honest.  Conversations about the product, market, and employees are barely tolerated.  If he isn’t taking up 50%+ of the air time in a board meeting something is wrong.  This investor’s tone from the get-go is shrill and angry.  This investor has little regard for the human side of venture investment and regards employees as cogs in a machine.  Trust quickly breaks down on the board, and between the management and the board because it is clear that this investor has only his own firm’s interest in mind even on fairly innocuous decisions.  This investor treats other investors with some respect as well prominent members of the industry, everyone else is regarded with a mix of condescension and disdain.

Neither stereotype offers a very sympathetic portrait – the reputation or our industry speaks to the fact that this is not all fiction either.  In this industry, it is impossible to be liked by everyone.  With Kickstart, we have striven to be a high-integrity fund known for quality work, professionalism, and approachability.  I am doing my best to avoid investing with these types of personalities or becoming one of them myself.  Ultimately I believe that the tragic flaw in both of these caricatures is Ego.  Ego is blinding for an investor (or anyone) because it colors and distorts the world through its insatiable appetite for praise and veneration.  One of the things that I love about the investment committee of Kickstart is the lack of Ego.  It is an open forum where people say what they think in a very candid way without personal attacks or other ulterior motives.  It has been a terrific environment that has allowed us to make good, rationale decisions to date.

Moneyball and Kickstart

I am still digesting the concepts of Michael Lewis’s Moneyball and how they apply to what we are doing at Kickstart Seed Fund but a couple of thoughts occur to me.  (Apparently, I am not the only one, and far from the first) — there is a very active dialogue in the blogosphere about Moneyball and startup investing.

In Moneyball: The Art of Winning an Unfair Game, Michael Lewis writes about the Oakland Athletics and its general manager Billy Beane.  The book examines the team’s modernized sabermetric approach to assembling a competitive baseball team, despite Oakland’s disadvantaged revenue situation.  Given that the A’s could not afford superstars, Mr. Beane knew that he needed to think differently in terms of recruiting, developing, and letting go of talent.  He understood that that a player’s most expensive attributes are not necessarily his most valuable. So, he employed statistical analysis to assess and score the key attributes of a player’s skill-set.  For example, traditional scoring of errors may mean nothing when it comes to a team’s record, however the ability to get on base (even in the case of a bean-ball) is a valuable asset.

The overall message of the story is that innovating in any industry is risky and controversial but may yield impressive results.  In Moneyball, the A’s recognize that they can’t win in the national auction for free-agent players based on standard baseball metrics like RBIs and Batting Average – how do you compete with the Yankees money?  The A’s decide to lean on statistical analysis to identify and focus on players that are incredibly efficient – productive and low cost.  They end up focusing on drafting college players that might be less athletic but they are smart, consistent, they wear out pitchers, and they know how to get on base.  This strategy worked incredibly well for the A’s over the last decade, so could it apply to us?

Our industry has historical institutions analogous to the Yankees and the Red Sox – the powerful traditional venture funds such as KP and Sequoia.  These firms have big money, great reputations, and a deep farm system for turning up the best athletes.  They have been incredibly successful over the years with a certain approach to the business of venture investing.  As macro variables have changed making room for innovation, it is interesting to note that a lot of innovation happening in VC is coming from outside of Silicon Valley e.g. Foundry Group where groups are not as closely linked to the traditional way of doing things (groups not unlike ours).  Our goal is not to be beat these guys or really to even compete with them, but to find our Oakland-style niche were we can create significant investor returns.

So where is the Oakland A’s opportunity for us?  The world is getting flatter and so is the United States.  India and China are catching up to the US and economies within the US, like Utah, are also gaining ground on more established states.  Utah has the youngest population in the US by an average 4 years.  The workforce has demonstrated itself to be bright, hard-working and very entrepreneurial. What has changed in the last 10 years is sophistication. Entrepreneurs are increasingly accessing high-quality mentors and have better access to capital and resources.  We have a state government that is thoughtful and pragmatic.  Though they have advantages, the money centers no longer have monopolies on talent or innovation.  Look what the University of Utah is doing to change the game from the commercialization perspective.  Look at the rise of the quality of the professional schools at BYU.  The diseconomies and overhead of states like California that take entrepreneurship for granted and are starting to drive human capital and business from the state.  We think there is a tremendous opportunity for Utah.

The internet is serving as a great leveling force in the barriers to entry for startup creation.  Infrastructure investments and location do not dominate the way they have in a world of cloud computing resources and mobile applications.  Increasingly the idea that entrepreneurs are born is getting widely debunked.  Data is driving more and more decision-making.  Thoughtful, younger, cost-conscious entrepreneurs with an analytic approach to building companies are beginning to challenge the old “grey-haired management” mantras of the professional venture capital.  Outlier success is a function of unusual opportunity meeting hard work and excellent execution.  A host of mentoring groups like Tech Stars, Ycombinator, and others have been founded on the premise that entrepreneurship can be taught and optimized with experience and process.  VCs increasingly are needing to act like entrepreneurs to be successful – scrappy, cost-conscious, and opportunistic.

The landscape is changing, we are working to position KSF and the startups that we serve as well as possible to face the new realities.