VC perspectives – a journey from innovation to IPO

On November 15, 2017, China America Innovation Network (CHAIN) organized its very first VC Talks Event, and invited Steve Hoffman and David Lane to cover the startup journey from innovation to exit.  This article is written based on the talks by Steve and David and the Q&A session.

Steve is Captain and CEO of Founders Space, author of the book Make Elephants Fly: The Process of Radical Innovation, an angel investor, and series entrepreneur.

Founders Space is a world’s leading Global Incubator and Accelerator with 50 partners in 22 countries. David Lane is Founding Managing Director of Diamondhead Ventures.  For the past 30+ years, David has created, built and financed information and health care technology companies.  During the past 20 years, he has directly managed venture capital funds totaling in excess of $2 Billion.  Some of David’s prior venture capital investments include: Harmonic, Inc. (IPO), TriQuint Semiconductor (IPO), NexGen (IPO), Viewlogic Systems (IPO) and Harbridge Merchant Services (acquired by First Data Corporation).

US vs China

As the number one and number two economies in the world, one can’t escape from comparing US with China.  Steve shared an anecdote when he planned to publish his book Make Elephants Fly.
He contacted the publishers in China and US at the same time.  The US publishers’ answer was that it would take them one year to publish the book, and on the stark contrast the Chinese publishers said they would do so in a few months including translation.  As a result, the Chinese version was published in March 2017 and became a bestseller, while the US version just came out in November.  Although only one illustration, this (speed) can be representative in China.  For example, the VC cycle is typically shorter in China, which can be 5, 7 years (plus 1 year), compared to 10 years, which is typical in the US.  This makes the venture capital in China hungrier and more demanding, and wants to see returns sooner.  

Though relatively new (founded 7 years ago), Founders Space has been very aggressive expanding internationally.  In China alone, just in the last 2 years it has opened new offices in Shanghai, Beijing, and Wuhan, and other cities are lined up.  Steve has been traveling to China extensively forming partnerships and advising startups.  When asked about the differences of entrepreneurs between China and US, Steve asserted that they are very similar, and as a matter of fact entrepreneurs are alike everywhere.  They are innovative, hard-working, and have strong passion about what they do.  However due to the cultural differences, the Chinese entrepreneurs tend to jump on things quickly if they see an opportunity, while US entrepreneurs tend to be more individual and chase their dreams or vision, while moving themselves and the startup in a more steady pace.

Silicon Valley is famous for its innovation, and as such in recent years more Chinese money has been pouring to the valley and US on startups, through investment or M&A.  This has driven up the valuation of the startups, and the good ones have easier access to capital.  Both David and Steve point out, this (excess of capital) can be toxic when the startup is still small and requires to stay small in order to move fast on product development, market validation, etc.

How VC’s pick the right startups

Having seen startups going through the tunnel and exiting, David keeps bringing up VC’s Risk & Reward mindset.  Just like a startup, VC’s need to make many decisions dealing with the investment on startups: which company to invest, when to invest, whether to hire a new CEO, when to exit and through which channel (IPO or acquisition).  

At early stage, both Steve and David agree they bet on people to find big opportunities.  The teams with alums from Stanford, MIT and/or Facebook, Google would certainly attract VC’s attention.  More importantly, the CEO’s ability to attract A+ people when there is no or very little funding is a strong signal of the startup strength.  At its very early days, Larry Page and Sergey Brin interviewed all of the employees before hired.  The team should also have industry insights and be able to go to multiple customers.  David emphasizes he looks for discontinuity that the startup is trying to bring to the game.  The first customer can be significant – David gives an example of one of his portfolio companies, who has salesforce as the first customer.  This is a big plus when seeking funding, because it demonstrates the startup’s credibility.


In the late stage, the financials become critical.  Startups raise capital to expand market reach.  For the VC’s, breakeven, profitability, gross margin, and returns become key metrics in their investment.

While it’s important for a VC to know the startup’s domain, it’s equally vital for a startup to do their homework before reaching a VC for funding.  David once received a pitch deck from a biotech startup, but that’s not his area of investment (even though he invests in healthcare), an indication how reckless the founder(s) is when seeking the right VC.

Steve’s “Small” list

Needless to say, startups should have big ideas, chase the big opportunity, and think deeply.  According to Steve, they should also think Small and have Small teams, Small scope, Small budget, and Small time.

Steve further explains that while startups should always keep their eyes wide-open for the long-term vision, to start off they should focus on something much smaller, the one thing that the customer wants.  YouTube failed as a video dating site, however it became viral when someone uploaded a video of a party and shared the link with their friends.  Instagram realized that the filter feature and sharing (on Facebook) are the two key features people really are using.  They then stripped out all other features and focused on these two, which led to their success.

Jeff Bezos’ “two-pizza rule” applies to scenarios of running a productive meeting as well as maintaining a relevant team size.  Keeping a small team, all egalitarian and without hierarchy, is essential to a startup – the longer you stay small, the better.  AngelList and Craig’s list were able to keep a team size of 15 or smaller for a long time, which allows them to focus on the most important tasks and solve the most critical problems quickly.

 

Many startups are struggling to get funding, however does it really help if a startup has too much funding?  In some cases, startups have too much money and have to hire people and find work for them.  This kills the very essence of a startup, speed.  Having just enough funds may be a better choice, so that the startup can focus on other important things and move fast.  This is aligned with fast iteration and be able to figure out a solution to an unmet need and be the first to capture the market.

How to stimulate innovation

In a large corporation, each role has its own defined responsibilities. In a startup, wearing multiple hats is the norm.  Everyone should be engaged and innovating in everything including product, coding, sales, whatever required.

One of the excitements of being part of a startup is to challenge the status quo of a product or service.  To innovate, one can write down the normal beliefs, go through the list, and challenge each and every belief – Can this be changed?  Can it be done differently?

Steve Jobs is arguably one of the best product managers of all time.  He didn’t believe in customer survey or focus groups.  However he had the unique ability to uncover customer needs and create a product to meet the needs.  For a startup to identify a customer need, Steve Hoffman suggests talking to the customers, understand their pain points, observe what they do and how and why they frustrate, and learn what the customers value.  A startup’s job is not to create demand, but to figure out where the demand is and be able to create an exponentially better product for the demand.  Steve emphasizes that incremental improvement from a failed startup idea won’t work.  Period.

Good CEO, Bad CEO

No doubt, CEO is the most important figure in a startup.  According to Steve Blank’s recent Medium article, in the last decade the dynamics between investors and a startup CEO have shifted from board control to founder control.  Startup CEOs have more power and control of the company.  

Regardless, the relationship between a startup and investors is a delicate one.  Understanding startups are really hard, David voices his empathy for founders.  A good VC would lend a hand when the startup is not doing well.  VC should not be just a fund provider, but a provider of resources and network and a sounding board of the CEO, and help identify and hire senior management as needed.

Though he didn’t go in-depth, David alluded that there are dramas in the board room and with Startup CEOs, which destroy value.  How to handle the demotion or exit of a CEO is really a tough job a VC can have.   

Go IPO or Be Acquired

As ironic as it sounds, it’s hard to say whether it’s a good or bad thing when a startup is at a position to choose between an IPO and acquisition.  20 years ago, revenues of 10’s of millions of dollars would qualify for an IPO.  In recent years, the bar has been raised, and it’s normal that it requires a company to reach revenues in the range of 100’s of millions before considered for an IPO.  As a result, if there is little chance a company can reach this threshold, it will likely consider an acquisition.  

In some cases such as when the venture capital is maturing soon, the VC may have pressure (and obligation) to exit earlier, whether it be acquisition or IPO.  In many cases, a dialogue between the CEO and the investors is guaranteed, and often the CEO can have a higher decision power.

 

Author: Zhiyong Zhao  CHAIN President

zhiyong.zhao@innovationchain.org

Currently, with PayPal leading global strategic partnerships, Zhiyong is a business leader with 15+ years of experience in product development, business development, strategic planning, and sales and marketing.  Previously an account manager for a global IT services company and have taken the management role in numerous startups.

Zhiyong is passionate about entrepreneurship and innovation. He was an entrepreneur consultant when attending Ross School of Business, servicing the University of Michigan community. He is also a winner of 12 Small Business Innovation Research (SBIR) awards granted by the US government.

Zhiyong holds a Ph.D. in Electrical Engineering from the University of South Florida and an MBA from the University of Michigan.