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.

Advertisements

Is Your VC a Chicken or a Pig? Part I: What a “Lead” Investor is, Why You Need One, and How to Find One

One of my favorite clichés involves chickens and pigs. More specifically, it observes that as interested as chickens may be in breakfast, it’s the pigs that are really committed.

That’s a good way for startup entrepreneurs to think about courting venture capital investors. Collecting a flock of very interested venture investors – chickens – is fine and dandy, but you won’t make much progress towards getting a deal done until you’ve got a pig at the table. So don’t waste a lot of time chasing chickens around until you have a pig corralled. You know you have got a pig in hand when you have a solid term sheet with a “lead” investor inked.

Truth be told, most VCs think of themselves, or at least present themselves, as lead investors. I suppose most probably do lead a deal now and again. That said, though, in any given deal, there is generally only one lead investor. (Co-leads are fairly common, but even in those cases one of the co-leads in fact plays the role of the lead.) That is, one investor who not only wants “in” the deal but wants to “own” the deal.

The first big role of the lead in a deal is to let the relevant chickens know that someone has pig-like interest in the deal. That someone likes the deal enough to put up a big bunch of capital (usually the biggest chunk) and to do most of the heavy-lifting of getting the deal done (which, as we’ll see, is no small thing). That resource commitment, coupled with the signal to the market that a credible (well, hopefully) investor is that serious about the deal, is typically the inflection point when the chickens start getting serious about actually committing some eggs to getting the deal done.

If getting a lead investor lined up is the sine quo non of getting a venture financing done, how do you go about it? Simple. Qualify potential investors as leads before you spend too much time with them. Limit your initial investor solicitations to folks you think are possible leads and folks you think might be sources of referrals to possible leads. When you get a meeting with an investor, if there is any potential interest at the end of the meeting be certain to ask if yours is a deal the investor would consider leading (and if not, can they refer you to any investors who might be).

Step two is to avoid wasting time with investors who are not qualified leads until you have a signature (or handshake) on a term sheet with a lead investor; a term sheet that outlines all of the material terms of the investment. Depending on who the lead is (their reputation in the market), and how big a piece of the deal that the lead is taking (how many other investors with how much more money will it take to fill out the syndicate), agreement on a solid term sheet is the point where most interesting investment opportunities become likely deals.

Next time, we’ll talk about what roles lead investors play after the term sheet is signed.

 

Raising Capital for Your Startup: It’s About More Than Money

Most of the time for most entrepreneurs, raising money for a startup is not a lot of fun. Absent some combination of a hot deal and a hot market, fundraising is a real chore, too often full of demoralizing turndowns and even more demoralizing walls of silence. Still, as bad as it can be, the process almost always includes some important opportunities that good entrepreneurs will seize and use to their advantage.

The first opportunity the capital chasing process offers is self-reflection. Asking other folks for risk capital forces you (at least if you expect any success) to think about your business objectively, from the perspective of an outsider. And not just any outsider, but a jaded professional investor. Vision and passion are certainly appreciated by most of these folks, but as table stakes, not closing arguments. To seal a deal, you will need to get back to the cold hard realities of your value proposition, your business model, your evolving competition, your financing plan, and your exit strategy. Mission critical stuff that can get lost in the fire drill of day-to-day startup life.

Another opportunity worth grabbing on to in the fundraising process is the learning opportunity. If you have been at all careful about qualifying your investors, you will be talking to folks who very likely know a lot about the environment – technology, competitive, financing, exit, etc. – your startup is living in. If you listen carefully, and ask good questions (you should, in all events, be vetting potential investors as much as they are vetting you), you will almost certainly learn a lot of valuable information from the fundraising process, as much or even more so from investors who turn you down.

Finally, the fundraising process will give you valuable feedback on your teams’ capabilities, collectively and independently, in an area – raising capital – that will only become more important as your capital needs grow on the road to your exit. Raising capital is a skill in its own right – indeed as mission critical a skill as there is. Getting a periodic handle on where your team measures up in that regard may not be worth the trouble in and of itself, but when you need the money you might as well get as much besides money as you can out of the process.

Approaching the fundraising process as a learning opportunity, as well as a way to generate needed capital, may not make the effort any more fun. But it can make it a lot more rewarding.

Building Your Startup Team: Complementarity and Chemistry

Most professional venture investors believe the best predictor of startup success is the quality of the team. Good teams can and do fail, but as team quality drops below “awesome,” the chances for success drop very fast. Thus the cliché that most investors will gravitate to an “A” team with a “B” opportunity over a “B” team with an “A” opportunity.

There are a lot of reasons team quality is so critical to startup success. The incredibly stressful startup environment is the biggest. Startup teams need to accomplish difficult goals with minimal resources in terms of time, capital, and people. Additional stress accrues as outside forces – competitors, markets, technologies, etc. – evolve and force teams to make significant adjustments, often including basic “pivots” (business model, for example) on the fly.

If the extraordinary stresses of the startup environment explain the importance of getting the team right, they also offer a clue to what makes a superior startup team. At the foundational level, what separates the superior startup team from the merely good startup team is complementarity and chemistry.

Complementarity is pretty straightforward in concept, if not always in execution. Within the confines of available resources (financial) and the constraints of team chemistry (more later), you need to make sure the team includes top-tier players at the mission critical startup tasks (i.e. the tasks that need accomplishing in the current round of funding), as well as the flexibility to successfully “wing it” with respect to important ancillary functions.

The trick to building a complimentary team lies in recognition of, and dealing with, the well-established HR principle that when people get to choose who they work with – or who works for them – they tend to choose people like themselves. Now, if you are a founder, and thus most likely very confident of your own near-perfection, that might not seem like a problem. If you’ve got perfection, why not clone it if you can?

Consider if Apple had been founded not by Jobs and Woz, but by Jobs and … Jobs. If you know the Apple story, you know what a catastrophe a Jobs/Jobs founding Apple team would likely have been.

The bottom line is that however perfectly suited you may be for leading your startup to fame and fortune, building a team of clones is seldom the best way to go about it. Instead, look for people with different skill sets. And as much or even more so, different personalities and perspectives on business, technology, and life. The most successful startups – even those like Apple in the years after Jobs returned from exile that were dominated by a leading personality – build leadership teams with diverse skills, experiences, perspectives, and personalities. Just ask Tim Cook.

And that leads to the second, and harder to execute, aspect of assembling a superior startup team: chemistry.

It’s not enough to assemble a team that “covers the waterfront” in terms of skills, experience and personality. You need to make sure those folks can also form very strong bonds with each other (thus the “chemistry” analogy). Because in the constantly changing world of the startup, relationships between key players on the team are going to be under almost constant stress as company circumstances evolve and people have to adjust to changing opportunities and challenges. As anyone who studies morale in the military will tell you, folks in foxholes are motivated more by their loyalty to the folks around them than to “the cause” as such.

On that last point, one of my favorite quotes from an entrepreneur came when he was asked what he would tell his team at the beginning of his next startup journey. He replied: “Folks, we are going on a very long and difficult journey. On this journey, we will carry our wounded – and shoot the deserters.”

The quality of the team has long been the most important factor for most venture capital investors, for good reasons. As you think about assembling your team, particularly in the early days, don’t make the mistake of hiring folks because they look like you, or because they are a perfect skills fit. Look more for folks who compliment your skills and personality – and that look like the kind of people you want on your side when the going gets very tough. Because it almost certainly will, likely many times.

Back to the Future? Venture Investing in Flyover Country

The term “Venture Capital” covers a lot of ground, even when confined to the traditional institutional funds at the heart of the industry. Funds come in many flavors based on factors including stage of investment, industry focus, geography, and propensity to lead or follow in deals.

I’d like to suggest another basis for classifying venture investors, one that I think is absolutely critical when considering the unique opportunities – and challenges – of investing in places outside of the major established centers of venture capital investing. Places like where I grew up, and after twenty years in Silicon Valley and North Carolina, returned to some years back: Wisconsin.

My classification is based on two alternative paradigms for investing capital and managing investments: Nurturing and Managing.

The Manager Venture Investing Paradigm

The Manager paradigm dominates the venture business today (certainly in terms of capital deployed and public mindshare). It is characterized by large funds, many in the billions of dollars (see Softbank’s $100 Billion fund for the current outer limits of the industry) with multiple levels of investment professionals, many of which do not have early stage operating experience or even STEM educational credentials. The “value add” Manager investors provide is largely in terms of the later stages of expansion and exit planning and execution.

The Manager paradigm is ideally-suited to the contemporary Silicon Valley venture capital scene and in terms of number of deals and capital deployed the large majority of Manager paradigm investing occurs in Silicon Valley and a handful of other major venture capital hubs. Today’s large funds simply can’t efficiently make and manage smaller deals. Even those that operate affiliated “seed” funds typically make larger initial investments than their traditional seed fund peers, and limit those investments to deals that they perceive as having mega deal potential (and capital needs) going forward. As a result, the Manager paradigm funds are much less likely to invest in raw entrepreneurs who need a lot of hand-holding on basic operational blocking and tackling. Their deep pockets also make them more likely to focus on capital intensive growth/brand-driven exit metrics than profitability.

Now, the Manager paradigm may get all the headlines, and skew the statistics such that Silicon Valley round deal sizes and valuations or as much as an order of magnitude or even more than the comparable figures in flyover country markets, but it is not the only venture investing paradigm. In fact, it was preceded by a very different and still important, if no longer as publicly prominent, paradigm.

The Nurture Venture Investing Paradigm

The modern venture capital era began in the late 1940s and hit its stride in the 1970s.  Throughout that period, and into the 1980s, even the largest venture capital funds seldom exceeded $100 million and most were only a fraction of that. The prototypical Nurture VC was someone with industry operating experience as well as a STEM education. Further, these smaller funds had minimal junior staff compared to the layers of analysts, directors, junior partners, etc. that make up the bulk of the investment professionals at today’s larger venture funds.

The early decades of the venture business were characterized by something else, besides smaller funds: less experienced entrepreneurial teams. With the industry’s small size, and even with fairly rapid growth in the 1970s, it took awhile for the “serial” entrepreneur to emerge as a regular part of the deal flow. It was probably not until well into the 1990s that most venture-backed Silicon Valley startups included founders and senior managers well-versed in the art of building a high impact company from experience at prior venture backed emerging companies.

When you put all of these factors into a pot and stirred them up, you came up with the Nurture venture investing paradigm. An investment model based on VCs focusing on startups where they could add a lot of value to the deal in terms of the basic nuts and bolts of defining and building the business. Indeed it was a time where the venture investor was often involved – as for example Brook Byers and Genentech – in the actual conception of the business, recruitment of the founding team and formulation of the business plan. Sometimes well before it was even clear there would be any resulting investable deal.

The industry’s structure during the ascendancy of the Nurture paradigm had other implications, among the most prominent of which was the emphasis on profitability as an exit metric. This was not because Nurture investors were any smarter than today’s Manager investors, who by comparison are far less concerned with early profitability. Profitability was part of the Nurture paradigm simply because the typical Nurture fund – even when factoring in syndication of investments – simply did not have sufficient capital to support a portfolio company burning tens or hundreds of millions (or as per Uber recently billions) of dollars of capital a quarter.

The Nurture paradigm led to venture capital’s first golden age in the 1980s. It also sowed the seeds of the Manager paradigm which arrived on the scene in the later half of that decade. The Manager paradigm was launched, ironically enough, when some of the great Nurture firms started raising the first wave of mega funds with hundreds of millions of dollars and, before long, even billions of dollars to deploy.

Implications for Flyover Country Venture Investing

If there is still a meaningful role for Nurture funds in Silicon Valley, there is very little room – today – for Manager-modeled funds outside of Silicon Valley and a handful of other of the larger venture investing centers. And that is something that too many folks in flyover country just don’t understand. And something that is making it even more challenging than it needs to be to foster the emergence of a meaningful high impact entrepreneurship and investing sector in still nascent and emerging flyover markets.

I saw the problem in North Carolina circa 1990, and I see the problem in Wisconsin, today. Regional folks who want to foster a vibrant high impact entrepreneurship and investing community look to Silicon Valley and, seeing how the Manager venture investing model dominates the headlines, conclude that we should be doing the same thing here. That we should invest as if our entrepreneurs had the same kind of “been there, done that” startup experience and networks that their Silicon Valley counterparts enjoy.

Well, they don’t. The opportunities and challenges of venture investing in Wisconsin in 2017 are indeed comparable to the opportunities and challenges of venture investing in Silicon Valley. But Silicon Valley circa 1975, not 2017.

What places like Wisconsin need, in terms of venture investors, is Nurture VCs, not Manager VCs. We need small funds, run by hands-on partners who bring their own “been there, done that” high impact startup operating and investing experience to the game. People who are willing to get down in the trenches with entrepreneurs to help shape raw talent and ideas into fundable deals; and who are willing and able to start doing that even before making an investment. Venture investors who can proactively help their portfolio entrepreneurs achieve profitable operations supporting attractive exit opportunities with lifetime risk capital needs that don’t exceed even the average A round in today’s Silicon Valley.

Unfortunately, instead of Nurture funds led by experienced startup entrepreneurs and hands-on investing professionals helping raw entrepreneurs with good ideas build modest companies that offer solid investment returns with limited capital, what I’ve seen here in Wisconsin is mostly investors with little or no venture backed startup operational or seed/early stage risk capital investing experience casting about for the kind of startup teams and capital-ready deals that fit the Manager venture investing paradigm.  Teams and deals that we just don’t yet have enough of in Wisconsin to support a sustainable high impact venture-driven startup community.

Don’t get me wrong. I think – know – that Wisconsin and places like it have the raw entrepreneurial talent and capital to become small but important and sustainable centers of high impact entrepreneurship and investing. But getting there is not going to happen unless and until the folks who want that to happen understand that right now we need Nurture venture investors, the kind that built Silicon Valley, not Manager venture investors in the mold of those who get the headlines in Silicon Valley today.

Montana’s Robust Startup Scene

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, “Montana’s Robust Startup Scene” 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:

“Folks at the Kauffman Foundation – one of the more credible of the various organizations that track entrepreneurship activities across America – recently ranked the various states in terms of the strength of their entrepreneurial sectors. As gener8tor’s Joe Kirgues wryly noted, “at least Wisconsin finished in the top 50.” Which is to say, 50th.

I must say I am not a huge fan of these kinds of rankings. Frankly any ranking of this sort that doesn’t have Northern California at the top of the list is more than a little suspect. Still, by chance I happened to be in Missoula Montana last week, working with several startups at Montana Technology Enterprise Center, or MonTEC, the University of Montana’s technology accelerator. That Montana. The Montana that Kauffman put at the top of its list of states ranked by the strength of their entrepreneurial sectors.

In a lot of ways, Montana is a lot like Wisconsin, only more so. It is hard to get to. The climate is challenging. Not a lot of people live there. And there are no big cities (in fact, there are no cities as “big” as Green Bay). There is just one institutional venture capital investor. It’s fair to say, I think, that Montana’s challenges, in terms of building a high impact entrepreneurship sector, are even more formidable than those facing Wisconsin.”

Click here to read more.

Top Legal Mistakes Entrepreneurs Make When Launching Startups

Print

Melissa Turczyn, co-chair of Venture Best, the venture capital practice group at Michael Best, recently contributed a blog post to Xconomy, titled “Top Legal Mistakes Entrepreneurs Make When Launching Startups.” The post can be found under the “Xconomist Forum – Expert Insight & Opinion” section on the Xconomy website.

Click here to view the blog post.