Lecture Notes

Dr. Robert Epstein

2006-04-21T16:51:00.000-07:00

Dr. Robert Epstein, guest speaker in MGT 222: Innovation and Creativity class.
Psyched on Sirius, Skinner, Psychology Today, Scientific American Mind, ...

Skinner and Creativity. Operant conditioning and incentives. Shaping, not used in business, but should be. Get organism to do something new.
Clinical psychologists don't often benefit from their own work. Freud's superstition and neurosis?

So many creative options that one can't act on them.

Failure is valuable for creativity because it causes ideas to compete.

Teams often inhibit creativity mostly due to socialization. Work in groups for short time, then break out: 2 to 1 output.

Feeling confused: multiple stimuli, novel stimuli causing conflict response.

Four competencies essential for creativity: capturing, challenging, broadening, surrounding.

Set open-ended goals rather than fixed result?

Two-part anonymous suggestion system is enormously beneficial.

Capturing a daydream.

Exit Strategies - One VC's Perspective

2006-03-18T23:49:00.000-08:00

Bill Stensrud - EPVC
Entrepreneur turned VC.

~ "worst thing you can do starting new job is to do your old job" - Peter Drucker

VCs are private equity "day traders"

buy low, sell high
business building is 2nd order consideration
have a plan
understand the landscape

"The plan is nothing; planning is everything" - Dwight D. Eisenhower

Two ways to get an exit: IPO (very small fraction) or Acquisition

Plan for the exit from Day 1

set up multiple options

competition drives prices
look for alternatives

invest in businesses with standalone potential
invest in businesses not products or features
Determine up front who are potential acquirers

make sure there are several

tie up strategic partners early

don't tie your hands

Thinking about acquisitions

Comapnies are bought, not sold
building a standalone business is only getting harder
consolidation reduces number of acquirers in maturing industry
price will be very low without leverage
increase value by building multiple relationships
increase value by having unique competitive value
auctions increase value

The Acquirer

experienced acquirers have it down to science
they move early => buy low
targeting entrepreneur with life-changing offer
they focus on minimizing cost, maximizing earn out, minimize payout, maximize handcuffs for employees
they don't give a sh*t about the venture guys
they completely ignore preference and capital structure

pref struct is just used to divide remaining spoils
series votes often used to change allocation of prefs

theay demand large escrows
the only solution is to secure signifincant leverage

Entrepreneur accepting funds from investors has shareholders and therefore fiduciary duty

The Also-Rans

VCs look for homeruns

ex: fund with 80% of historic returns that come from 25 portfolio companies out of a totlal of 1500

most comapnies in portfolio don't hit 'em
thoughtful mgmt can result in exits rather than shutdown
firms are now developing a "cleaner" function to help mange low value exits

Scarcest resource of VC is time, not money.
Want to spend most time on the potential homeruns.
At height of bubble 4-10x more VCs that market can support.
Also, much more money was in than could be sustained.

The race to critical mass

key success criteria is time to critical mass
more merger transactions among/involving early stage companies
occasionally good reverse IPO opportunities
early/mid-stage consolidation is key for VC to manage and create exits

On IPOs

very difficult now
cost is very high (SOX is big factor) : many deals moving to foreign exchanges
market timing is very difficult
no good market since 2000
always good stalking horse because creates valuation metric

sometimes good to file if in M&A discussions

destroys preference structure: preferred converts to common stock
Lockup creates issues

when to distribute?
impact on proce?
insider issues of VC stays on board

IPO process

post bubble has changed alot
prediction: banks to get disintermediated in process (google ipo auction)

Decision Making

In + situation: mgmt has all the cards
entrepreneur psyche has changed

Summary

exit is as important as the investment
undermanged in most cases
exits are now more dificult than ever
sign of maturity of industry
successful firms focus intensely on managing the exit

Venture Investments

2006-02-25T11:11:00.000-08:00

Lecture at the UCSD Rady School of Management from prominent San Diego bioscience Venture capitalist

Venture Investment and Marriage

You are in it to death, IPO, or M&A do you part
Do you really want this deal
No amount of structural tinkerings can make up for bad investment decision!

Planning for Success

Most investors focus on what can go wrong and what happens if it does
Investors obsess over the negative because failure is probable
Make money on successful deals, but spend most time on the troubled deals
~18 months to wind up a company
basics are more important than protective provisions
how can on investor in Series A get a better deal than another? common stock issues in addition to preferred
common stock can incentivize investor in similar manner as entrepreneur

On Valuation

VC market is efficient (sort of)
VCs collude and know going rate for certain deals
Hotness is determined by people not tech
If its your first time, don't expect good valuation
rigorous financial models are rarely used: "we pull 'em out of our ass"
tweak the models to support the decision already made
best thing to do is show the VCs you know the market, get good comparables

Today's Typical Structure

never seen redemption rights used, but still don't take it out of the deal

Plain vanilla financing

convertible preferred
weigthed average anti-dilution
1x participating preference cap typical, have seen 10x
board representation

Common Toppings

milestones and tranching
pay or play provisions: investors get penalized if not investing in future rounds pro rata. Conversion to common is often used
"drag alongs", protective voting provisions: if majority or super majority of preferred share holders want IPO, other investors have to go along

Protecting the downside

antidilution, participating preferred, cummulative dividends, series voting rigths
Why do we never see harshest versions used? If you ask for full ratchet antidilution, investors in next round will also want it. The provisions don't actually work anyway!

Bridge Loans

designed to get company to next financing event
convertiable debt that is pre-payment for equity in future rounds
modest interest rate
substantial warrant coverage 25-100%
repayment premiums of 1x-3x or more

Does bridge telegraph information?

event on horizon, but could be wishful thinking
often "bridge to nowhere"
blood in the water?
looks like company may be having a tough time getting finance
how much of bridge is unburned?

When things so South

the golden rule: "he who has the gold, rules"
"wash-out" financings: bridge holders often get free haircut
preferred s/h take a bath: preferred becomes common
managment (remaining) get new preferences

IPO vs. Acquisition: The Venture perspective

IPO

liquidity or financing event?
loss of preferences: immediate wealth transfer to mgmt
diminshed control: board dilution, loss of rights, etc

Acquisition

fair mkt value?
liquidity: often cash or highly liquid payment

Class Warfare

Spamogen example
conflict between managment and board members
can board members really represent all shareholders? schizophrenia

Why are managers like convertible debt holders?

salary: stream of inflation adjusted payments
option value of equity holdings
common has value as an option on the value of the firm over and above preferences and debt

Fund lifecycle considerations

investors are likely at different stages in their life cycles
tired investors: opportunity cost, embarassment: want to do ipo to get rid of others preferences
lack of reserves for follow-on
how does inability to play influence board? interst in IPOs goes up
those who can't play get diluted: want IPO to get rid of other's prefs
does it matter if its above or under water?
carried interest has value only as an option.
underwater may seek more speculative path
most VCs are interested in the limited partners. VCs try to show limited that they are getting best result

Conclusions

look before you leap
money is made on winners
deal structure matters most when things go wrong
conflicts emerge
terms encourage good behavior
motivations can be different for different investor classes
on exits the money is in the details
tapped out investors behave very differently
fund specifics matter
mgmt may have different incentives than investors
good VCs won't screw management: does not mean mgmt won't always be happy

Supply Chain Management

2005-11-12T08:30:00.000-08:00

Chris Gopal, president EAS.

Defining the supply chain: management, suppliers, outsources/contract manufacturers, Logistics/Fulfillment, Order management, Matching demand and supply, contracts managment, IP protection, BOM/recipe management, metrics.

Anecdote: 50% startups lose there IP in first year of venture.

Key supply chain tenets: outsource, use someone elses assets, emphasize demand/supply matching, focus on cash and stay fixed on BM for RIOC, zero latency, ...

Manufacturing companies need to nail supply:demand matching

Liquidity, profitability, growth -> capabilty, flexibility

Cash Conversion Cycle (CCC) DSI+DSO-DPO=CCC
Inventory(DSI), Accounts Rec(DSO), Accounts payable(DPO)

Massively distributed routers venture - OEMs require 5% reduction per HY, 10% after 2 yrs., RoHS (reg of haz subs) always required, etc

ipc.org for industry directory for outspurcing leads.

Can't outsource slaes, infrastructure, managing customer...

If an item costs $1, then holding it costs 1-2%/month -> 12-25%/year

Major things venture to look at: see what to outsource, then manage ROIC and match supply:demand, manage IP

Mike Harris

2005-10-28T16:44:00.000-07:00

Vanderbilt MBA. Founder Harris Group, Ex-VP entrata? network storage. Lots of marketing experience. Philips, ... Early product connecting storage area networks to overcome the 10km fibre channel limitation. Pragmatic Marketing gives courses in Market requirements document (MRD) and product requirements document (PRD).
Peer check advocate. Eng/R&D, Sales, Ops, Controller, Customer Service
Value Proposition: WIIFM: What's in it for me.
PRS: PRoduct Release Schedule. Toll gates: supplier, customer, item.
Lots of discussion.

Derry Connelly - Hurler on the Ditch

2005-10-28T15:12:00.000-07:00

From Ireland, CalTech educated, IBM and Kodak 13 years, now at UCSD. In 13 years nothing he worked on was commercialized. At IBM worked on optical storage. No shortage of ideas, shortage of leadership... especially in San Diego. MS had more than enough smarts to beat Google, but they missed the opportunity. Competence, technical expertise, capacity, but lack of vision.

Very difficult ot change culture and business model. Qualcomm was smart enough to sell off infra and handset biz before they were worthless. Left Ericsson and Kyocera holding the bag. IBM and Kodak were obsessed about quality, the manufactured every single component of their products. Big companies get used to big margins. IBM and Kodak had trouble adapting to smaller margins, higher volume biz. On quality, remember the statement: "It just needs to be good enough." Sam comments that at IBM, they tested the hell out of os/2, but they got the scenarios wrong, like 6 clicks to setup printers. Tons of money was spent on electric car, but it took Toyota to look at it differently to introduce hybrib.

UCSD CCAD - Center for the Commercial Adoption of Technology. Working w/ ~20 startups around the country.
Most interesting in CCAD from Von Leibig. A technology for electronically controlling zoom and focus through micro-fluidics. Ideal for cellphones. Prof had no ability to commercialize, but hooked up with a business guy through Von Leibig. The VCs are throwing money at them, they recently turned down $10m term sheet.

Lessons: Leadership is Key, Keep up on business models, day of arrogant ceo is gone. AirSys is CCAD funding company. Wireless asset tracking. Founded by a techie guy, who found a SDSU MBA grad with a software company and arranged to be acquired. Marriage made in heaven.

WD40, San Diego company, outsources nearly everything. They did not start that way though. Biggest challenge is how to build brand. Often have to change business model. Leaders need to be personable, caring, adaptable, coachable. Need chemistry. The only thing worse than a partnership is a sinking ship -guy in cork. Pick people who are complementary. Need both visionaries and executers.