The Team Turnover Paradox

I recently had the pleasure of attending a presentation by a very successful Wisconsin-based high impact entrepreneur. His talk included some thoughts on the advantages and disadvantages of building a high impact start-up in “between the coasts” locales with limited access to venture capital. One big advantage, he suggested, was lower employee turnover, which led to lower recruiting, training, and administrative expenses.

He is certainly right about the cost savings of lower team turnover, and thus likely right about the overall positive impact of low turnover on his business. In terms of the regional economy, though, I think his conclusion points more to a problem – low levels of high impact entrepreneurship and investing – than any sort of regional advantage.

I’ve always been intrigued by paradoxes, business and otherwise. So, for example, most venture investors favor jurisdictions, like California, that don’t enforce non-compete agreements. At the same time, when they do a deal in a jurisdiction, like Massachusetts, that does enforce non-competes, they are more than happy to employ them.

Team turnover is another business paradox. On the one hand, pretty much everyone agrees that high employee turnover is a bad thing for any particular business. On the other hand, places with the most dynamic high impact entrepreneurial and investing sectors – Silicon Valley being the obvious example – generally “suffer” from very high turnover rates. What’s not so good for any given tree, it seems, can be pretty good for the forest.

Or, at least, forests where new growth is constantly crowding out the old growth. Places where the “creative destruction” that Joseph Schumpeter said was the distinguishing virtue of capitalism, was most active, as a plethora of “next big things” is always nipping at the heels of yesterday’s headliners.

When you look at turnover in places with substantial high impact start-up sectors, what you see is a lot of folks looking for new opportunities to change the world, as opposed to folks looking for some marginally greener grass in the next break room over. Sure, folks at Apple may move over to Facebook or Google for a better salary, but the real allure for hot-shot employees with outsized ambitions to create wealth and change the world is the opportunity to latch on with what just might be the next Apple, or Facebook or Google. It’s about taking big risks for big payoffs, not chasing the marginal dollar.

And so, as I see it, while the high employee turnover in places like Silicon Valley surely poses tactical challenges for individual businesses, be they start-ups or tech titans, it is a clear strategic advantage for the region taken as a whole. The data, in terms of rates of economic growth, wealth creation and innovation, pretty clearly suggest that the costs of higher team turnover, while no doubt real, are more than compensated for by the benefits. That having a workforce always on the lookout for the next big opportunity – and willing to jump at it despite the risks – is the stuff of outsized innovation and economic performance.

And thus the paradox of high employee turnover. It may be bad for you and me, but it can be very good indeed for us.

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Sorry, But Who You Know Still Matters

We live in an age where “democratization” is all the rage in the world of startup investing. An age where rent-seeking gatekeepers such as venture capitalists are going to be put out of business by Crowdfunding, ICOs, and more generally the mass dissemination of information across the world via the internet. Pretty soon, so the narrative reads, everyone will have access to the best deals, and a new entrepreneurial golden age will emerge. The only thing that will matter is what you know, and John and Jane Doe will be driving the Tesla’s previously consigned to the folks on Sand Hill Road.

Baloney.

The problem with the notions that “everyone will have access to the best deals” and “everyone will be empowered to make the best deals” is that neither assertion is true.

On the first score, the people with the best deals will continue to seek out the investors with the best track records and value-add. I mean, if you are really good and have a really good idea, who would you rather have financing your start-up, Sequoia or some guy named Barney and his pals at the country club in Podunk?

As for the second point, evaluating, making, and managing the best deals is about more than having access to them: it is about having the skills, experience, and networks to recognize them and turn opportunity into achievement. Good venture investors are in fact good at something that is very hard to be good at, not something any old Jane Doe could master if only she had access to the same raw material (most if it garbage in any event). Seriously, pick a name out of the phone book and the chances you’ll find a really good high impact venture investing talent is probably about the same as your finding someone who can hit a major league curveball.

I am not arguing that Crowdfunding and ICOs and the internet generally have not changed and will not continue to change the venture capital business. What I am arguing is that those changes will be evolutionary more than revolutionary; that the fundamentals, including the curation of deal flow, will still be very much in play. And that curation will continue to be one of those “guilt by association” situations driven by relationships, not algorithms.

Look at it this way. Most venture investors see far more entrepreneurs and deals than they can possibly give serious attention to, much less invest in. Further, the best venture investors not only see the most deals generally, but the most good deals as well. There is an awful lot of noise in the system. And for pretty much every venture pro out there, the most logical and effective first noise reduction filter is… who that I respect thought this deal was worth my time to look at?

Deals where the answer to that question is “no one,” aka “over the transom” deals, seldom get more than the most cursory review, and as any honest VC with a solid track record will tell you almost never get done.

Will adding more over the transom deal flow – for example via web solicitation or on public Crowdfunding sites – change that? Of course not. An experienced VC will be no more likely to seriously investigate a deal that comes in over a digital transom than a deal that comes in over a traditional transom.

 

None of this means that Crowdfunding and ICOs and the internet generally are not changing the venture business. But the changes are around the margins – more efficient ways to distribute, access and process information. And these changes are lowering transaction costs, which is great for everyone. But as much as there is more noise in the system, the value of getting a curated introduction to a good investor is if anything more, not less, valuable than it was in the past.

And so, discounting the hype and the bad actors in the Crowdfunding and ICO worlds, the large majority of the good deals are mostly being done by professional investors in closed – even if online – syndicates. And by teams that meet their lead investors via an introduction (likely as not a digital one), not the online equivalent of a billboard.

The point, then, is this: if you are serious about getting your start-up funded by investors that know what they are doing, start talking to folks – other entrepreneurs, service providers, other investors – that are known and respected by those folks. Because no matter how much you know, who you know still matters.

Back to the Future in Silicon Valley

Silicon Valley came by its name honestly enough: way back in the 60s, 70s and 80s, it was the place where venture capitalists and entrepreneurs turned silicon into computer chips in high volumes and at low prices that astonished the world. I have a chart on my office wall that shows how hundreds of silicon-based chip companies emerged in the Valley in that period, the vast majority of which could be traced to Shockley Semiconductor Laboratory (founded 1956), and Fairchild not long thereafter – the later spawned so many later chip companies that it fairly earned the moniker “Fairchild University.”

The Big Kahuna of the silicon companies in Silicon Valley was and is, of course, Intel.  The company’s x86 chip architecture, launched in 1978, powered the PC revolution and remains to this day by far the dominant architecture in personal computers, laptops, workstations, and even the cloud computing business. It’s even a big player in the supercomputer segment. Name a big chip company and chances are good a big part of its business is x86-based chips. Much the same as the IBM System/360 architecture has dominated the mainframe business since the 1960s. Yes, there is still a market, albeit not so big as it used to be, for mainframes.

The x86 architecture has been so dominant for so long that for maybe the last two decades or so, the venture capital business – a business that owes its current form largely to its role financing all those chip companies way back when – has pretty much stopped funding chip startups. Until recently, that is.

I was doing a bit of research on the current AI revolution (there have been others: folks of a certain age will remember the “expert systems” AI hype in the late 80s) when I found something pretty interesting – well, to me, at least. Over the last couple of years, VCs have invested hundreds of millions of dollars in more than 20 new chip companies. All of which seem to have one thing in common: they are developing chips optimized for AI applications. Chips with non-x86 architectures.

I said I found this interesting. That’s because it suggests to me that while lots of folks are talking about how various tech-enabled and tech-driven revolutions are on the cusp of changing the world for people who use technology, and how to frame that as an investment opportunity, far fewer folks are talking about how those revolutions might change the world for today’s biggest producers of technology, and how to frame that as an investment opportunity. So, for example, while there are plenty of people talking about how AI might disrupt the smartphone business and the personal transportation space, not so many are talking about how AI might disrupt the businesses that provide the components that power those businesses. Who, that is, will be the next “Intel Inside.”

I’m betting it won’t be Intel – for the same reason IBM didn’t follow its System/360 mainframe architecture with something like an x86 architecture of its own. When you are king of a big mountain, and Intel’s is still sitting at the top of a pretty big one, you tend to think more about defense than offense. Protecting your realm, not cannibalizing it. Just ask Kodak – the folks who invented digital photography.

So here is an investment hypothesis: Assuming (and this is a big assumption) that today’s AI revolution will be even nearly as big as the hype suggests, I’ll bet when the dust settles there is a new sheriff in the silicon part of Silicon Valley. Though if you look at where those chip-hungry VC investors have been spending their money, it just might be an out-of-towner.

gener8tor: The Gift That Keeps on Giving

It’s been a few years now since I wrote my first appreciation for the folks at gener8tor.  Back then, they had just launched, and yours truly was surprised (albeit very pleasantly) that they had gotten not just off the ground but had achieved some sort of seemingly stable orbit.  Which surprised a bunch of people, I think.  I know it surprised me.

Well, here we are in November 2017 and they have flown well beyond Madison and Milwaukee to places as far afield as Minnesota, Illinois and even my own neck of the woods up here in Packerland.  Recently, it was my good fortune that a scheduled speaker for a OpenBETA Lunch program in Oshkosh had a last minute scheduling conflict.  My good fortune in that I was offered an opportunity to substitute as the headliner for the event.

The Oshkosh event was a lot like my first time at gener8tor way back when in Milwaukee.  Quirky space, a roomful (well, ok, maybe a half-dozen plus) of raw but passionate and very early-in-the-process entrepreneurs.  Who asked good questions, and shared some good ideas.

What was most interesting about the event, for me, was in fact how it took me back to those early gener8tor classes, where the entrepreneurs were rawer than raw, and the ideas sketchier than sketchy.  And, in fact, what amazed me about gener8tor then – and caused me to write my initial blog about the program and team – was how over the couple of months after I saw that cohort of newbies the gener8tor folks had somehow worked some magic to turn them into that rarest of commodities hereabouts, fundable high impact entrepreneurs.  (And, yes, they all got funded.)

Since those times, gener8tor’s flagship program has expanded to new places and moved a bit downstream in terms of appealing to less raw, even semi-polished entrepreneurs (often hailing from well beyond Wisconsin).  And I’ll admit, I had (and to a limited extent still have) some doubts about whether they can sustain their success across multiple markets and with later stage entrepreneurs.  But the results continue to speak for themselves, and if we – that is those of us who are serious about growing the high impact entrepreneurship and investing community in our little corner of flyover country – are lucky gener8tor has a lot of fuel left in the tank.

All of that said, what really made my day at the OpenBETA event was seeing gener8tor staying true to its “rawest of the raw” roots, and doing it in the New North.  In Oshkosh even.  (They also have a new gBeta program in Green Bay.)   That means, I think, that it won’t be long until entrepreneurs and investors in Madison and Milwaukee start  realizing there are deals to be done in Wisconsin in places other than Madison (mostly) and Milwaukee.

And so congratulations to all of us in the high impact entrepreneurship and investing community across Wisconsin.  We are the lucky benefactors of the gener8tor program – the gift that keeps on giving.

Stanford Offer is a Good Thing

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Stanford Offer is a Good Thing” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“So the good folks at Stanford University’s business school want to lend a hand to the ‘underserved’ folks in flyover country.

Good for them — and us.

Even way back when I was in school — we are talking late 70s to mid 80s — the attraction of Stanford was, at least in part, that it was ‘there.’ And I was ‘here.’ A ticket to Stanford was generally thought of as a one-way ticket: ‘Go west, young man,’ Horace Greeley advised; and don’t come back, he implied.

As it turns out, I did not go to Stanford, and instead got my MBA and JD closer to home, in Chicago. But my first post-education stop was in Silicon Valley, and it was a great move that I never regretted.

Those Who Do it All… Shouldn’t

Paul Jones, co-chair of Venture Best, the venture capital practice group at Michael Best, has been selected as a regular contributor of OnRamp Labs, a Milwaukee Journal Sentinel blog covering start-ups and other Wisconsin technology news. Paul’s most recently contributed piece, “Those Who Do it All…Shouldn’t” can be found under their Business Tab in the Business Blog section: Click here to view his latest blog.

A short excerpt can be found below:

“In more than thirty years in and around the high impact entrepreneur and investing space, I’ve come to the conclusion that every entrepreneur, even and in fact particularly the most successful, has at least one serious personality flaw.

One of the more common flaws is the “I can do it all” personality: the entrepreneur who insists that they are not only good at, but the best at everything involved with making their business a success.

What really makes the “I can do it all” entrepreneur so frustrating is not so much that they are almost always wrong about their capabilities. Rather it is that even if an entrepreneur really is the best at everything actually doing everything is still a bad idea.”

Click here to read more.

SEC Issues Proposed Rules to Increase Financial Thresholds Applicable to Smaller Reporting Companies

The U.S. Securities and Exchange Commission (SEC) has proposed rules that would amend the definition of a “smaller reporting company” by significantly increasing the applicable financial thresholds. In an effort to promote capital formation and reduce compliance costs for smaller companies while maintaining important investor protections, the proposal to update the definition would expand the number of companies that qualify as smaller reporting companies, thus qualifying for lower levels of required disclosures in prospectuses and periodic filings (such as requiring disclosures for a reduced number of annual periods and the elimination of the need to include risk factor disclosures and certain financial data).

Smaller reporting companies may provide scaled disclosures under the SEC’s rules and regulations. Currently, smaller reporting companies are generally defined as companies that have less than $75 million worth of company shares that are held by the general public (i.e. public float), or companies that have zero public float and annual revenues less than $50 million.

The proposed rules would revise the definition of smaller reporting company to qualify a company with:

  • less than $250 million of public float, or
  • no public float and less than $100 million in annual revenues.

In addition, as in the current rules, once a company exceeds either of the thresholds, it will not qualify as a smaller reporting company again until public float or revenues decrease below a lower threshold. Under the proposed rules, a company would re-qualify as a smaller reporting company again once its public float is less than $200 million (instead of $50 million under the prior rules) or, if it has no public float, once its annual revenues are less than $80 million (instead of $40 million under the prior rules).

However, we should note that the SEC is not proposing to increase the $75 million threshold in the “accelerated filer” definition. Therefore, companies with public float between $75 million and $250 million may qualify as smaller reporting companies, but still be subject to the requirements that apply currently to accelerated filers, including the timing of the filing of periodic reports and the requirement that accelerated filers provide the auditor’s attestation of management’s assessment of internal controls over reporting required by Section 404(b) of the Sarbanes-Oxley Act of 2002 (unless a company is an “emerging growth company” under the JOBS Act).

Many smaller companies are challenged to meet the excessive reporting and compliance costs that come with being a public company, which the SEC has estimated to be about $2.5 million for initial compliance costs in the case of an IPO and $1.5 million annually for ongoing compliance. The proposed rules, however, would offer substantial compliance and regulatory cost savings to an expanded number of companies (for example by reducing certain financial and executive compensation disclosures in periodic reports and proxy statements).

This may lead to mid-size companies who are currently reluctant to go public to more readily consider that option. However, companies may remain reluctant to go public due to continuing concerns of an increased potential for claims made by investors and related liability.

Public comment on the proposed rules should be received by the SEC no later than 60 days after publication in the Federal Register.

For more information, please contact your Michael Best attorney; Michael H. Altman at mhaltman@michaelbest.com or 414.225.4932; or Daniel J. Gawronski at djgawronski@michaelbest.com or 608.283.0124.