At Flywheel Ventures, we invest in entrepreneurs with solutions to the world’s greatest challenges in information technology and urban systems. We often refer to our strategy for finding those entrepreneurs as “fishing where everyone else isn’t.” While looking in non-traditional geographies is a component of that strategy, it also refers to our search in markets and technology sectors that other venture capital investors rarely pay attention to. Very frequently, this strategy finds success in cities across the American West with vibrant creative cultures and strong university, corporation, or national laboratory R&D organizations. Nearly all of Flywheel’s 40+ portfolio company investments have been made in such contexts, with over 2/3 of our investments specifically having origins in R&D organizations, and about 1/3 having explicit technology licensing agreements or equity ownership arrangements with those initial R&D development organizations where intellectual property (IP) was created. Illustrative of our commitment to this investing formula are our recent investments in Tribogenics (a licensee and spin-out of UCLA), Lotus Leaf (a licensee and spin-out of the University of New Mexico), and TerraEchos (a spin-out of a predecessor entity’s R&D work funded by S&K Technologies).
Given our focus and experience in technology spin-out investments at Flywheel, then, the title of this post may seem odd. Certainly, it is intentionally provocative. However, it synthesizes a key lesson I have learned in this deep experience of entrepreneurs building companies at the intersection of global markets and technology commercialization. That lesson is, quite simply, that technology commercialization is both misleadingly-named and vastly-overrated as a strategy for entrepreneurial success. Instead, I believe that “people transfer,” not “technology transfer,” is a much more accurate descriptor for a successful approach. Great companies are built by great entrepreneurs - period, full stop.
Now, it is certainly true that there are segments in which the “technology transfer” or “technology commercialization” strategy has merit, i.e. biotechnology or advanced materials science. If someone in an R&D organization somewhere has truly developed a new pharmaceutical molecule that cures a specific form of cancer, a successful company can likely be built based on the exclusive license to that molecule, regardless of the entrepreneur strengths of the team. Since Flywheel does not invest in life sciences-based companies or entrepreneurs, my expertise in that specific arena is limited.
However, in the areas of IT and urban systems where Flywheel does invest, I am generally in the camp of believing that IP is vastly overrated in general. In the information technology arena, IP is not only useless but, in my view, actually detrimental. There is a movement to eliminate patents on software completely and I am supportive of that movement: http://en.swpat.org/wiki/Software_patents_wiki:_home_page
None of this is to suggest that relationships with R&D organizations aren’t valuable to Flywheel or other VC investors. Specifically with Flywheel, over 2/3 of our investments have had origins inside of R&D organizations. Less than half of those, however, involved any sort of IP license agreement. The more important value from our relationships with R&D organizations – from the Flywheel perspective – is getting to know the _people_ inside the technology R&D organizations. While most will, by definition, not be commercially-viable entrepreneurs, there are always a handful who discover after some time in the non-commercial R&D world that the commercial world is where they passionately belong.
This is also not to suggest that those technologists who decide to leave the safety and comfort of a non-commercial R&D setting to test the entrepreneurial waters will necessarily be the right CEO or other founding executive. Often, they take a founding Chief Scientist, Chief Technology Officer, VP Engineering, or similar technical role, and hire more experienced entrepreneurial business managers for the CEO and other executive positions. Also not infrequently, they may only take an entrepreneurial leave of absence for a year or two, working with the company in a technical advisory capacity to assist the transition from laboratory setting to commercial production. All of these roles are quite legitimate and appropriate.
In the end, however, great companies are built by great entrepreneurial teams. As I have articulated in other posts, the quality of the entrepreneurial team is the most important criteria in my investment decision - and outweighs all other criteria put together.
As a result, then, in the IT and urban systems sectors where Flywheel invests, “technology transfer” or “technology commercialization” is at best an initial, baby step. The initial technology or IP can serve as a useful organizing “seed crystal” around which a world-class entrepreneurial team self-organizes or is formed (often with our assistance). However, any investment is ultimately going to be primarily based on the quality of that team, regardless of the initial technology. Too often, the organizations charged with “technology commercialization” fail to realize this - or, more often, they are not provided the resources or scope of mission to implement this - and they are left wondering why their impressive collection of patent filings and IP assets seems to sit on proverbial shelves, gathering dust. If, instead, they viewed (or were provided the resources and scope of mission to view) technology commercialization as only the first step in a broader “entrepreneurial team formation” process - and measured their success in these broader terms - I believe a lot more R&D would end up in the commercial marketplace.
So, while I purposely titled this post to be thought-provoking and controversial, by all means, there is tremendous value in investigating, protecting, and publicizing the technology and IP assets inside of R&D organizations. That does provide a useful service, but it is only a starting point. The “commercialization” process is not done until a world-class entrepreneurial team has been formed - and, in most cases, it doesn’t even really start until the team formation. Until the “people transfer” process is complete, the “technology transfer” or “technology commercialization process” will remain useless.
“The only decisions an entrepreneur makes that truly matter in the long run are those that involve deciding who to trust."
Every other week or so, I am introduced to an entrepreneur who immediately sends me a non-disclosure agreement and asks me to sign the NDA before we talk further. Among other signals, this indicates that the entrepreneur has failed do almost any homework on the process of raising venture capital investment, as the blogosphere is full of well-articulated posts about the process in general and about NDAs specifically. In short, venture capitalists never sign NDAs.
My well-known VC industry colleague and prolific industry blogger Brad Feld summarizes this industry norm as follows:
“Asking the venture capitalist to sign a nondisclosure agreement, or NDA… is a stupid idea perpetuated by lawyers. Most venture capitalists will not sign an NDA, so all you’re doing is putting up a barrier to get their attention and demonstrating your naivety.”
Despite the excellent treatment elsewhere in the VC blogosphere, many of the entrepreneurs that Flywheel encounters have not been exposed to these norms. As a result, I occasionally find it useful to re-articulate the rationale here, so today I thought I would do so again. Of course, this post does not constitute legal advice.
In recent months and weeks, a number of reports and pundits have opined on the poor financial performance of venture capital funds over the last decade. In general, their analysis is correct, although often lost in the media coverage has been the silver lining of the research, showing that smaller funds have continued to outperform larger funds.
To summarize the theme: the VC industry exploded in the late 1990’s, enabling a record amount of capital and number of funds to be raised in 2000-2001. Since most VC funds are structured for 10 years, that record amount of capital was deployed over the past decade. And as anyone could have predicted, the oversupply of capital led to diminished returns. That is Economics 101.
The main problem with the various analyses is a tendency to project the next 10 years based on the past 10 years. Trends continue right up until they don’t. The best returns in any investment asset class are typically made by those who invest precisely when everyone else has given up. Capitulation is a buy signal. Or as Baron Rothschild said more vividly in the 1800’s, “The time to buy is when there’s blood in the streets.”
The last 4 years have witnessed a record consolidation in the number of VC firms, and we are now entering the 5th year in which VC investments into companies have exceeded limited partner commitments of capital to VC funds. As Herb Simon famously said, “Things that can’t go on forever, don’t.” The financial market for VC investment is self-correcting, just like any other asset class; the challenge is that the long-term nature of VC funds (which, of course, is what gives the asset class its unique advantages) also acts as a damper on the VC industry’s cyclicality. In many ways, we are just now seeing the disastrous impact on the VC industry of the dot-com and telecom bubble implosion from a decade ago. The chickens are coming home to roost, so to speak.
In that context, as a contrarian-minded VC investor, I have tended to believe that the VC funds raised in this period will likely end up being historically strong performers. The consumer Internet revolution, the mobile phone and tablet explosion, and the natural demographic rise of a new generation - with several billion more participants in the free market system - all portend enormous transformation and market opportunity. Record amounts of angel investment and new providers of seed funding like Y Combinator and Techstars, coupled with lower-than-ever costs to start companies, have launched record numbers of new start-ups. Eventually, the successful winners of the start-up tournament will move into the later bracket stages, where they will need traditional venture capital to scale. The reduced availability of that capital will allow the remaining VCs to be more selective and rational in funding only the very best tournament finalists.
Recently Mark Suster wrote a similar blog post with the title “It’s Morning in Venture Capital” that more eloquently echoed my opinion:
Contrary to some press reporting, the boom in startups, the creation of accelerators and seed funds as well as the deserved popularity of AngelList do not signal doom for our industry. They are, in fact, great news for traditional venture capitalists. The most successful of these businesses will still need venture capital to scale their businesses. They need a combination of capital and experience to separate from the rest of the pack – the low cost of starting a business means it is even more vital to become the market leader more quickly.”
I highly recommend reading Mark’s lengthy but excellent post here.
Indeed, it is morning in venture capital investing.