Channelling Bill Shockley

Techstars (an incubator company) and various aerospace companies have announced plans to launch a space incubator in LA. As TechCrunch reported:

Already a major hub for the space and aerospace startup industry, with companies like SpaceX, Relativity Space, Virgin Orbit, Rocket Lab, Phase Four, and others calling Los Angeles home, the new accelerator will provide another booster for LA’s growing startup scene.

The new aerospace program, called the Techstars Starburst Space Accelerator, will be managed by longtime Techstars managing director, Matt Kozlov, who previously helmed Techstars’ efforts at its health-focused accelerator done in partnership with Cedars Sinai.

LA was the country’s major aerospace hub from the 1930s until the end of the Cold War. But with the end of the space race, the downsizing of missile and military aircraft procurement — and the death of Douglas Aircraft and Lockheed’s commercial aircraft division — jobs were cut drastically and others moved to cheaper parts of the country.

The anchor of the new LA space hub is SpaceX, which moved to Hawthorne in 2008. It had been the headquarters of the firm founded by Jack Northrup in 1937, where it built the B-35, F-89 and F-5 military aircraft. (Its B-2 bomber was built at a secret factory in nearby Pico Rivera).

SpaceX is such a tough place to work that it has encouraged its employees to game the Glassdoor employer rating system. Despite this, 1/3 of the 1,109 SpaceX reviews complain about long hours, as with the review that said “There are times I work very long hours including a few times working 60 straight hours”. Last month, SpaceX — celebrating record success in 2018 — rewarded its loyal workforce with a 10% layoff.

Elon Musk has often imagined himself the next Steve Jobs, although Steve Jobs didn’t think so. Musk clearly needs to grow up and at 47 is well past the age when Jobs did so. Jobs was certainly grown up by 1998 (age 43) when his youngest child was born and he took the reins of Apple once again. Jobs also made his money in the commercial marketplace rather than manipulating investors and government procurement.

Instead, I think Musk is the next Bill Shockley. Shockley is known for inventing the field effect and bipolar junction transistors, which won him a share of the Nobel Prize. Late in life, he was known for saying controversial things about political and social issues.

However, (given his Bell Labs colleagues probably would have invented the transistor without him) perhaps his greatest contribution to mankind was creating Silicon Valley. In 1956, he founded Shockley Semiconductor in Mountain View, California.

He was such an asshole as a boss that the next year eight of his leading employees (the “Tratorous Eight”) quit Shockley to form Fairchild Semiconductor — the first of thousands of spinoff companies to be formed in the Bay Area. The eight included Gordon Moore and Robert Noyce — cofounders of Intel — and Eugene Kleiner, cofounder of Kleiner Perkins.

So between his winning personality, stressful working conditions and past/future layoffs, Musk will be making thousands of skilled ex-SpaceX employees available to the LA aerospace labor market. As with Shockley, perhaps Musk’s greatest contribution will be attracting bright engineers to the region, who later take those skills to help get other startup companies off the ground.

Fractalization (and trivialization) of technological innovation

My friend Frank Piller this morning shared a witty story from last week’s New Yorker. The title and subtitle say it all:

“Let’s, Like, Demolish Laundry”
Silicon Valley is in a bubbly race to wash your clothes better, faster, and cooler. This is not a metaphor. Unless, you know, it is.

The story about IT-enabled laundry delivery services focuses on Washio, a LA-based seed-funded startup. The three founders cruise along confident in the brilliance of their idea until they run across three Bay Area rivals (Laundry Locker, Prim, Rinse) — one incubated by Y Combinator — and eventually five more from NYC and two from Chicago.

Author Jessica Pressler makes only a feeble effort to restrain her sarcasm. In commenting why so many other tech entrepreneurs are addressing the same need:

In reality, when people in a privileged society look deep within themselves to find what is missing, a streamlined clothes-cleaning experience comes up a lot. More often than not, the people who come up with ways of lessening this burden on mankind are dudes, or duos of dudes, who have only recently experienced the crushing realization that their laundry is now their own responsibility, forever. Paradoxically, many of these dudes start companies that make laundry the central focus of their lives.

But even in this segment, “new innovations are dying from the day they are born… There’s a term for this. It’s called the hedonic treadmill.”

Some of it has an anthropologist-visits-the-strange-tribe-of-Silicon-Valley feel. Even though their main office is in Santa Monica, Washio has the same (post-Amazon) disrupting of the physical world that brought us Pets.com and Uber. Their goal is to be “the Uber of laundry," and their share a common seed stage investor.

But early on, Pressler raises a more fundamental question:

We are living in a time of Great Change, and also a time of Not-So-Great Change. The tidal wave of innovation that has swept out from Silicon Valley, transforming the way we communicate, read, shop, and travel, has carried along with it an epic shit-ton of digital flotsam. Looking around at the newly minted billionaires behind the enjoyable but wholly unnecessary Facebook and WhatsApp, Uber and Nest, the brightest minds of a generation, the high test-scorers and mathematically inclined, have taken the knowledge acquired at our most august institutions and applied themselves to solving increasingly minor First World problems.

Certainly Amazon and Google and Facebook (mostly) allow us to do things we did before, just more quickly and cheaply and conveniently. Yesterday, my sister-in-law could have mailed pictures of her daughter’s graduation to her friends and relatives, but instead she posted them on Facebook and they were instantly available.

Like Pressler, many of these activities seem trivial when I compare this to other “big” innovations, like trying to get mankind back into space or provide enough food and energy to bring 5 billion of the world’s 7 billion people up to developed world living standards. After changing jobs three years ago, life at my new employer reminds me that the life sciences have many important unsolved problems, whether it be preventing deaths from malaria and tuberculosis in sub-Saharan Africa or finding a cure for cancer.

But on another level, Pressler’s article would come as no surprise to my innovation strategy students of the past eight years (whether at KGI, UCI or SJSU). The pattern is straight out of Dealing with Darwin, the grand unified theory of innovation by Geoff Moore (best known for Crossing the Chasm).

One reason I use the book is that it offers a cogent explanation of the role of innovation in mature industries. He subdivides such innovation into two categories, operational excellence (cheaper) and customer intimacy (better). For the latter, he uses the metaphor of “fractalization”, as illustrated by this diagram from Chapter 6:

As Moore explains (p. 111-112)

Figures 1 through 3 represent the early, middle, and late stages of a growth market. ... As the figures indicate, the driving dynamic at this point is a single-minded attempt to acquire new customers and claim market share.

By the time we hit figure 3, however, the market for the basic offering has become saturated. One can no longer grow simply by adding new customers to the category because the bulk of them have already been added. After virtually every home has a phone, every garage a car, every child a personal sound system, what do you do next?
…
Thus, from the mass-market Model T car, for example, the automotive industry first generated line extensions: a sedan, a station wagon, a truck, a couple, a limousine.
…
Increasingly fine-grained fractalization can and will continue as long as there are discretionary dollars to spend in the system and the category as a whole has not become obsolete.

We do need to recognize the contributions of the laundry app innovators (even if they go the way of the sock puppet). By moving the realm of innovation from the physical world to the digital world, they are enabling new form of experimentation and innovation — as happened in retail, communications, advertising, journalism and other established industries.

Pressler makes clear that the laundry apps still depend heavily on their contract laundry suppliers who do all the work. But if such apps catch on, it would seem obvious that the laundry market will be rapidly consolidated, with the tiny corner dry cleaners replaced by a handful of regional factories. One would expect (as with Web 1.0 and 2.0) the adoption will be most rapid in Silicon Valley, with the shops in Palo Alto or SoMa served by ecofriendly delivery trucks driving from large plants in Morgan Hill or Livermore.

Cold Fusion

This week, I got to revisit the IT world through the efforts of my students. In a class on innovation strategy that I recently completed at UCI, four MBA student teams presented final projects on the current business dilemmas of tech companies.

The most intriguing was that of Fusion-io (FIO), a company that provides faster solid state disc (SSD) systems for server farms — 40x faster than a conventional SSD. The company was founded in 2005 and IPO'd in June 2011.

The story sounds pretty daunting. Although it has plenty of cash, the company has lost money the last two years (on revenues of $432 million and $359 million, respectively). It historically has depended on Apple and Facebook server farms for the majority of its revenue, and has been unable to land another comparable sized customer. It’s also competing with a number of much bigger and more diversified rivals in a segment (like any IT) that is commoditizing.

At a $11.88 close Wednesday, the stock is up 40% from a historic low of $8.32 in January. Still, the company has lost nearly 40% of its market cap since the IPO. Stock coverage is thin and mixed. Pac Crest rates the stock as a outperform with a $14 target. The Street rates it “as a Sell with a ratings score of D.”

Appointed last August, CEO Shane Robison (former Compaq and HP CTO) has brought in Yelp and some other moderately large clients. He’s resisted calls to sell the company: it’s not clear whether he likes being CEO or really thinks he can turn things around.

The students think that a sale is inevitable, and I find their logic persuasive. They suggest three potential buyers: Seagate, EMC and NetApp. They say EMC is best positioned to buy the company, but I think Seagate has the more urgent need to diversify as its core HDD business continues to decline. With 27% of the shares held by large institutional investors, I think the pressure to sell will eventually become irresistible (unless they decide to use the recent runup to bail out).

Either way, it points to a problem that I’ve remarked almost since the first days of this blog: it’s really hard to build a stand-alone tech business nowadays. The complete offering that firms need to provide are complex and diversified, and the incumbents have strong distribution channels and financial positions to keep out any newcomer. Unlike in the early PC era, they are no longer complacent and ignoring new threats and opportunities.

If Facebook kills entrepreneurship, what’s next?

Cross-posted from Engineering Entrepreneurship.

The $19b that Facebook paid to buy WhatsApp is shaking up Silicon Valley, as other Internet startups try to figure out how they can get their own inflated multiple.

But for the rest of the world of tech entrepreneurship — such as life sciences — it could further starve the flow of investment capital they need to get off the ground.

Entrepreneurship guru Steve Blank tweeted Monday

steve blank ‏@sgblank Feb 24
Why Facebook is killing Silicon Valley http://steveblank.com/2012/05/21/why-facebook-is-killing-silicon-valley/ … more relevant today

The earlier article talked about his work teaching entrepreneurship for science-based startups:

The irony is that as good as some of these nascent startups are in material science, sensors, robotics, medical devices, life sciences, etc., more and more frequently VCs whose firms would have looked at these deals or invested in these sectors, are now only interested in whether it runs on a smart phone or tablet. And who can blame them.

Facebook and Social Media
Facebook has adroitly capitalized on market forces on a scale never seen in the history of commerce. For the first time, startups can today think about a Total Available Market in the billions of users (smart phones, tablets, PC’s, etc.) and aim for hundreds of millions of customers. Second, social needs previously done face-to-face, (friends, entertainment, communication, dating, gambling, etc.) are now moving to a computing device. And those customers may be using their devices/apps continuously. This intersection of a customer base of billions of people with applications that are used/needed 24/7 never existed before.

The potential revenue and profits from these users (or advertisers who want to reach them) and the speed of scale of the winning companies can be breathtaking. The Facebook IPO has reinforced the new calculus for investors. In the past, if you were a great VC, you could make $100 million on an investment in 5-7 years. Today, social media startups can return 100’s of millions or even billions in less than 3 years. …

If investors have a choice of investing in a blockbuster cancer drug that will pay them nothing for fifteen years or a social media application that can go big in a few years, which do you think they’re going to pick? If you’re a VC firm, you’re phasing out your life science division. As investors funding clean tech watch the Chinese dump cheap solar cells in the U.S. and put U.S. startups out of business, do you think they’re going to continue to fund solar? And as Clean Tech VC’s have painfully learned, trying to scale Clean Tech past demonstration plants to industrial scale takes capital and time past the resources of venture capital. A new car company? It takes at least a decade and needs at least a billion dollars. Compared to IOS/Android apps, all that other stuff is hard and the returns take forever.

Two years ago — ironically a few weeks before Blank’s blog posting — I started writing my own posting along these same lines. What I wrote (but never posted):

Did software ruin entrepreneurship?
On Friday, I sat between two entrepreneurs at an office party for my old job. One of the entrepreneurs is in clean tech (hardware) while the other is in IT (software). One is in his 30s and one is in his 50s.

The hardware guy was talking about his challenges raising funds. One VC told him (I'm paraphrasing): “I gave Instagram $5 million and got back $200 million. Why should I give you money?” [after their $1 billion acquisition by Facebook].

The remainder of my (incipient) argument was that software promises abnormally low cap short returns, and the amount of money needed to fund a software company is getting smaller by the week, as VC Mark Suster wrote back in 2011.

How will this play out? I see at least four possibilities:

1. During the dot-bomb (dot-con) era we had too much money chasing too few good ideas, and what resulted was what economists call excess entry. Eventually the bubble burst — and it could again.
2. Another possibility is that these other ideas don’t get funded. There are business models that made sense in the 1890s or 1950s that no longer make sense — such as ones that are labor intensive or based on craft work — and new businesses here don’t get launched.
3. Blank points to the genius philosopher-king model — where a really rich guy (it’s almost always a guy) puts his money where is mouth is (again, almost always a big mouth). In a previous century it was Howard Hughes or Richard Branson, while today Blank points to Elon Musk.
4. The final possibility is that politicians play kingmaker, not with their own money but with Other People’s Money, i.e. yours and mine. (They will be egged on by a incantations of “market failure” of a few economists.) While this may make sense for public goods such as public health, we saw how such large scale private intervention worked with firms like Solyndra.

Of course, these are not mutually exclusive. Musk depends on public subsidies to support the business models of Tesla and SolarCity, although — unlike Fisker and Solyndra — he’s at least offering something people want to buy. SpaceX depends on public procurement, but I believe his announced plans that this is just a bootstrap to get the business off the group (so to speak).

Is there a happy ending? Like Blank, I think the Facebook effect is going to get worse before it gets better.

IP, BTE and funding startups

In running the @KeckGrad business plan competition this week, I was struck by how different our students’ life science startups were from the retail or IT startups that are common at other colleges. In most cases, our students needed $5 to $50 million in outside funding to jump through regulatory hoops and generate initial revenues.

It seems like this also reflects a fundamental difference in IP strategy — how a successful startup discourages entry or imitation, and how that ties back both to their funding needs and their IP strategies.

The retail startups have a brand, and locations, and perhaps a little bit of internal process trade secrets. Seed funding is available, but (shy of an IPO or acquisition) any subsequent growth tends to be organic and self-funded. Whether restaurants or clothing, these sorts of startups take years to build up, and the margins are generally thin.

The IT companies rely on copyright and trade secrets to protect their implementations, and hope to build network effects or switching costs to discourage entry. A hot property attracts plenty of money, because the scale is small and (if successful) the TTM and thus the payback time is quick. Still, a well-funded, well-run competitor could catch them. Many startups hope that the differentiator is the vision and positioning: for example, MySpace had years to respond to Facebook, but somehow never did.

Then there’s the life science companies: they need spend (and thus raise) huge amounts before ether generate revenues and — given mandatory regulatory disclosures — give rivals plenty of time to see what they are doing. The only way this works is if you have a patent, that gives investors an ironclad assurance of exclusivity for some period of time.

I'm not exactly sure what the model is for cleantech — but maybe there isn’t one. Certainly renewable energy — such as solar or biofuels — the hope is to leverage economies of scale to attain cost advantages in producing commodity energy. Given the hope of scale as a BTE (or BTI), many companies bulked up quickly, leaving a lot of dead companies strewn along the way. China’s Suntech was once world’s largest solar company — the first to sell 2 gigawatts of solar panels in one year — but is now shrinking and bankrupt.

If we look at older, mature industries, scale is never enough. Scale has reduced (but not eliminated) competition in electronics, steel and autos, but has done nothing to provide barriers to imitation to protect HP, US Steel or GM from subsequent entrants. If anything, the race for scale has led to overcapacity and thus price wars — in steel, DRAM, LCD panels, solar panels.

Dirigisme wins, French entrepreneurs lose

By now, the whole tech world has heard the story first reported Tuesday afternoon in the Wall Street Journal about Yahoo’s failed effort to buy Dailymotion. As the story opened:

Dailymotion was on track to be the first big acquisition for Yahoo Inc. YHOO +2.76% Chief Executive Marissa Mayer, after her company signed a provisional deal to buy control of the online-video website from France Télécom FTE.FR -0.59% SA. Then Ms. Mayer's No. 2 executive met with French Industry Minister Arnaud Montebourg.

At an April 12 meeting in Mr. Montebourg's Paris office, the minister told Yahoo's chief operating officer, Henrique de Castro, and France Télécom's chief financial officer, Gervais Pellissier, that he didn't want 75% of a rare French Internet success story to be sold to an American Web giant, according to people briefed on the meeting.

"I won't let you sell one of France's best startups," Mr. Montebourg told Mr. Pelissier, his voice raised, according to people briefed on the meeting. "You don't know what you're doing."

Facing an uproar, the minister clarified:

“The minister has expressed his desire that a partnership between Yahoo and Orange should be built on an equal base, mutually beneficial to both companies,” his office said in a statement.

It was widely reported that the government was willing to let Yahoo get 49% — or maybe even 50% — but not beyond.

This has so many fascinating implications. First, Yahoo is back to the drawing board in trying to build up its video capabilities.

Second, are the policies of the socialist government — after five years of crypto-Gaullist Sarkozy — going to hurt trade and investment with France. From the New York Times:

The government’s intervention has alarmed entrepreneurs in France, who say it sends a bad message to foreign investors, especially at a time when the country is seeking their money to help jump-start its economy.

“I’m sure France will be downgraded in foreign investors’ eyes because they will think it is too complicated,” said Frédéric Montagnon, co-founder of OverBlog, a blogging platform.
…
The move to block a takeover by Yahoo comes even as France has been stepping up its efforts to attract foreign investment — much needed, analysts say, to pull the country out of a slump in which gross domestic product declined by 0.3 percent in the fourth quarter of last year.

Or, as the headline on the Financial Times proclaimed: “Dirigisme dies hard in France”.

The rebuff to Yahoo comes after Montebourg feuded with other foreign capitalists. From the London Telegraph:

But it is not the first time Mr Montebourg, on the Left flank of President Hollande’s Socialists, has been accused of damaging the country’s business image.

Last year he threatened to nationalise an ArcelorMittal steel plant in Floranges, north-eastern France. More recently he got into a spectacular public spat with American tyre tycoon Maurice Taylor, calling the Titan International CEO “extremist” after he pulled out of talks to buy a Goodyear factory over worker demands.

“The extremists are in your government, who have no idea how to build a business,” Mr Taylor fired back.

But what I think is most important is the message it sends to French entrepreneurs, who know that for the next four years (at least), they can’t build an economically significant firm and sell it to the highest bidder. From Business Week:

“It sends a very bad signal to the outside world, saying that because you aren’t French, we prohibit you from being involved,” says Christophe Chausson, managing partner of Chausson Finance, a Paris-based venture capital group. “To develop startups, you have to do the opposite of what the government has done. Dailymotion needs a lot of capital, hundreds of millions of euros, to develop and buy rights to content.”

The same article noted that the decision hit home for the company’s founders:

Perhaps the most poignant reactions to the collapse of the Yahoo deal came from Dailymotion’s co-founders, Benjamin Bejbaum and Olivier Poitrey, who started the company in Poitrey’s Paris apartment in 2005. “It shouldn’t have been THEIR decision,” Poitrey posted on his Twitter account on April 30. He recently moved to Silicon Valley to head a team that’s developing Dailymotion’s mobile offerings.

Added Bejbaum in a tweet today: “On Monday, there was hope. On Thursday we freaked out. The French economy is not a toy.”

Like Poitrey, some expatriate French are thriving in Silicon Valley. But I see a huge opportunity for French-speaking Switzerland (with access to capital and home of a first-rate technical university) or Belgium (already home of French tax refugees) to create entrepreneurial clusters and attract the best and the brightest minds trapped in President Hollande’s workers’ paradise.

Trying to be the next unicorn

Cross-posted from Engineering Entrepreneurship.

Big company exec-turned-Forbest columnist Steve Faktor posted a funny column Friday that says “Shut Up, You’re Not Apple”.

The introduction is as provocative as the title:

At first, it was funny to hear insurers, IT firms, and startups with no revenues compare themselves to Apple. Since the iPod launched in 2001, I’ve seen hundreds of presentations that liberally use “learnings” from Apple. 1) The word is LESSONS, not “learnings”, my Hillbilly friend. 2) The comparison feels as fresh as that Michael Jackson impression your spouse has been doing since you started dating. 3) Drenching slides (or products) in an iconic brand’s juices won’t transmit innovation, like some benevolent plague. If that were possible, we’d never stop harvesting and packaging Brangelina extract. It’s time for an intervention. Here’s why brands must find their own voice (and scent)…and keep those synthetic Apple fumes from turning into laughing gas.

The ‘why you’re not Apple’ checklist:

I know I’m not alone. We’ve all been to the same Apple-laden meetings…er, orchards. How did those comparisons work out? Did that company become the most valuable in the world? Did that product become iconic and emulated by every company in Korea? Or, did it live and die in its sad PowerPoint tomb.

Using Apple as a model is the business version of ordering jeans after seeing them on Kate Upton. They might not look the same on you. Like Kate, Apple is a unicorn. It defies so many conventions that deconstructing its lessons is silly, unless it’s the last thing between you and a lonely Saturday night at Harvard Business School. To quote my friend and fellow innovator Stephen Shapiro’s book, Best Practices Are Stupid.

It’s not that your company can’t be Apple. It’s that your company absolutely, positively will never be Apple. I’m not discounting your skill or vision. I’m simply acknowledging that Apple’s success is a witch’s brew of leadership, timing, technology, and culture. All those variables can’t be replicated.

He then offers a checklist of factors that it would take to be Apple: a visionary CEO, iconic products, $50b in cash, a million fanboys, and #1 or #2 in most product categories. Yes you can mention Apple in your analysis of the industry landscape, but “as the unicorn in the room.”

As someone who’s studied Apple for almost 30 years, the reality is not just that Apple is one in a 100 million companies: it’s that Apple’s run from 2001 (the first iPod) to 2007 (the iPhone) to 2010 (the first iPad) — will never be repeated in the company’s history. (Or as Faktor put it, “Even Apple won’t be Apple forever.”)

I remember when Neil and I started our company in 1987, we wanted to be the next Hewlett-Packard. Instead, we never got more than 15 employees, a few million in revenues and lasted only 17 1/2 years. Wanting (or posing or emulating) doesn’t bring success: satisfying some need better than anyone else — in a way that’s hard to copy — is what bring success.

When they started in a Los Altos garage in 1975, Steve Jobs and Steve Wozniak didn’t imagine they would have a market cap bigger than IBM. Instead, they were just trying to bring a better PC to market than any of the other hobbyist-hackers out there. Customers didn’t flock to the Apple II, Mac, iPod, iPhone or iPad because Apple wanted to change the world, but because they had a product that no one else had.

Integrity means don't hide behind your lawyers

The private equity investors who flipped Skype (from eBay to Microsoft) have decided to screw some of their employees out of their “vested” stock options.

The issue came up when one Skype employee, Yee Lee, found he forfeited his stock appreciation rights when he left Skype before the acquisition. He summarized his problem on a blog post last month.

Corporate lawyer-turned-law-school-professor (and New York Times pundit) Steven Davidoff summarized the controversy in two postings at NYT DealBook. (Not yet behind the paywall).

In the first article, he noted that PE firm (Silver Lake) could have settled the controversy for less than a million bucks. He attributed the decision to a culture clash between NY financiers and SV venture capitalists. The former is not about reputation or honor, but money.

But in Silicon Valley, the community is not only smaller, the people work together again and again, and so trust and reputation are valued more highly. On his LinkedIn page, Mr. Lee alone lists more than 10 companies where he has worked. When you are going to see and work with the same people repeatedly over many years, $1 million is small change to buy their needed loyalty.

Davidoff argues that while VC has a better reputation, both sides add value equally. Of course, he is a former NY lawyer who advised big companies on their acquisitions.

But the reality is that while VCs do is equally greedy and lucrative, what they do is more rare and economically valuable. Restructuring can be (and has been) done by PE firms, managers who lead a MBO, more traditional corporate acquirers, or even in-house executives with the proper incentives. Best practice in operational efficiency disseminates pretty quickly, so very little about the PE business model (or their value add) is protectable over time.

In a second article, Davidoff concludes that employees are just as likely to be screwed by carefully hidden legal mumbo-jumbo by Google or a raft of other recent startups. (What we don’t know is how each company verbally represented this clause — did they call attention to it or did they bury).

Davidoff’s solution to both cases is that the employee should see a lawyer. (In other words, his philosophy is to create a full employment act for his peers and his students).
In a narrow legalistic sense he's right — that is if Lee were lucky enough to find a lawyer with the right kind of experience. As an entrepreneur, I lost $50,000+ on a business deal that was vetted by my lawyer; my lawyer (of many years) didn’t understand my business well enough to anticipate the scenario that played out, I didn’t volunteer it and he didn’t ask.

However, more seriously, this sort of “ask a lawyer before doing anything” causes an unaffordable drag for startups and their employees. Yes,it might only be $500 for the one consultation that spotted the problem, but it’s also $500 for all those other times where it wasn’t necessary but you paid the lawyer just in case.

There is a non-lawyer solution: we acknowledge that there are fundamentally two types of options: those that actually vest, and those that are only exercisable by current employees.

If the ideas of the incentive stock option is to incentivize employee, then the terms and conditions should be clearly articulated in plain English. If necessary, the state or federal government should require employers to spell it out. (Banning misleading practices is the one place where I believe in aggressive government action.)

I once heard ethicist Michael Josephson say on his radio segment: "Integrity means doing the right thing when nobody’s looking.” (The original author is lost, but similar remarks have been made by quarterback-minister J.C. Watts).

In Davidoff’s world, employers and employees are adversaries using lawyers to duke it out even before conflict arises. In a company with integrity — the only sort I’d put my name to — the terms and restrictions for employee compensation are clearly explained in a way that every employee can understand. As an added benefit, doing the right thing makes sure that the employees and employer have their goals fully aligned (at least until after the end of the lockup period).

Killing startups, killing the economy

One of the arguments that us free market types make is that regulation, bureaucracy, and taxes with high transaction costs disproportionately hurt small businesses. Big established companies have their own bureaucracies to deal with government bureaucracies, but (as I can attest) the new entrepreneur usually struggles to make sense of all the regulation.

Over the past three years, there are fewer new companies creating fewer jobs — and not enough to replace companies that have died — according to a major article Friday in the Wall Street Journal:

Few Businesses Sprout, With Even Fewer Jobs
By Justin Lahart and Mark Whitehouse

Fewer new businesses are getting off the ground in the U.S., available data suggest, a development that could cloud the prospects for job growth and innovation.

The stats were grim. The WSJ charts showed that new firm creation peaked in 2005, but the past three years have had net job losses.

The article quoted the latest econometric research on job creation, which shows that (depending on the phase of the economic cycle) most or all of the net jobs created in the US economy come in the first five years of a company’s life. After that, established businesses (large and small) are a net wash.

Several of these studies have been publicized (and funded) by the Kauffman Foundation. One example was the study by John Haltiwanger, Ron Jarmin and Javier Miranda using data of the U.S. Census Bureau’s Business Dynamics Statistics. They found that from 1980–2005, firms less than five years old accounted for all net job growth in the United States. The WSJ article quoted Haltiwanger as saying the young firm job creation process “isn't working very well now.”

The data get worse: the firms that are being formed are creating less jobs. Some of this is the offshoring that has become common for (“born global”) startups born this century. However, it’s clear that scarcity of capital is impairing growth and particularly job growth.

Last month, I heard Prof. Haltiwanger deliver a keynote at a Kauffmann-founded workshop held at the Federal Reserve Board of Atlanta. (I was there to present my own research on uncertainty and small business success). The picture presented by Haltiwanger and others at the conference was consistent with other anecdotal evidence and the WSJ article: firms are not being created and those that are being created are much more cautious about hiring.

None of the studies yet prove what the root cause is of this weak expansion and job creation: lack of demand, lack of credit, increased costs caused by healthcare reform. But I think the data is relatively congruent: until new firms start being created and grow, there won’t be the jobs needed to get unemployment back down to single digits.

Picking winners, getting losers

One of the key tenets of the interventionist view of governance (whether socialist, fascist or communist) is the idea that the government can manage the economy better than the free market. While extreme views (NB: Cuba, Venezuela, China) make an argument based on naked power — your government will provide for you — the more moderate interventionist arguments are based on the concept of “market failure.”

Of course, the idea that the government can correct for the errors of the market assumes that the government is more intelligent and foresighted than the market, and also is not susceptible to capture, cronyism or other bias. This week provides a classic counter-example.

In between baseball and a clean sweep by Bay Area liberals to the major statewide offices, one of the big Bay Area stories this week was the announcement that one of the biggest solar companies is struggling financially, raising questions about its ability to repay its federal loan.

The latest installment in the company‘s troubles broke Wednesday in the New York Times:

Solyndra, a Silicon Valley solar-panel maker that won half a billion dollars in federal aid to build a state-of-the-art robotic factory, plans to announce on Wednesday that it will shut down an older plant and lay off workers.

Just seven weeks ago, Solyndra opened Fab 2, a $733 million factory in Fremont, Calif., to make its high-tech solar panels. The new plant was supposed to be the first phase of a rapid expansion of the company.

Instead, Solyndra has decided to shutter the old plant and postpone plans to expand Fab 2, which was built with a $535 million federal loan guarantee.

A report by Michael Kanellos of GreenTech Media suggested that the news was held until after the election to avoid embarrassing the administration.

Katie Fehrenbacher of GigaOM was even more skeptical:

Back in May, I raised the question of whether or not Solyndra’s $535 million loan guarantee from the Department of Energy — the DOE’s first and flagship loan guarantee — was a mistake. Despite the fact that Solyndra had raised around a billion dollars of its own private equity, I pointed out the company has one of the highest manufacturing costs of its thin-film solar peers. The economics just didn’t seem to work.

Since I wrote that article, Solyndra ended up ditching its IPO plans, and its founding CEO stepped down. Now this morning, the company announced it will close its first factory and will lay off dozens of workers. Wow. Things could not have turned much worse for the company the DOE held up as an example of a stimulus package that could create green jobs and a good candidate for its long-delayed loan guarantee program.

Fehrenbacher reminds us of the great symbolism of the factory’s 2009 groundbreaking, which attracted the governor, US energy secretary and a video keynote by the vice president. She leaves out that the president himself showed up to tour the factory last May.

Like Fehrenbacher, a GTM analyst quoted by the Oakland Trib thinks the investment was questionable to begin with:

"Solyndra is facing the heat," said Shyam Mehta, an analyst with GTM Research, which tracks alternative-energy markets. "Many higher-cost solar manufacturers are doing well. It's alarming for Solyndra to be cutting back when others are expanding."
…
"The company's problems raise questions about the federal government's wisdom in giving $535 million to a company with an unproven technology," Mehta said.

As with any tech company, the loan was risky — the difference is the magnitude of the risk. It’s rare that a single private investor puts up more than $50 million at once, and only someone who can print money will put up a half billion on a risky investment.

The chances are not looking good for the government — let alone private investors — to be made whole on their investment. As Kanellos concluded:

What happens next? We know what the solar industry thinks. Solyndra will collapse is the general opinion. But it still has a single factory. In some long-shot scenario, something good could, maybe, one day, come out of this.

If the deal fails, the US government owns an unprofitable solar factory and some industrial land in a high-tax state.

It’s clear that the government did inadequate due diligence on a loan guarantee that had a minimal upside and a huge downside. Apparently the assumption was that $1 billion in private money couldn’t be wrong. Has anyone heard of “escalation of commitment”? (Perhaps if they had more MBAs or psych majors they would have.)

What’s the answer? Writing in July, a professor of environmental entrepreneurship argued the answer is avoiding favoring specific individual companies:

The best investments will not come from backing individual companies but come from reshaping the competitive landscape—creating the opportunities for new business models and markets that enable the unique strengths of green technologies to emerge and develop. Consistent regulatory policies and open technology platforms will benefit all ventures and foster collective action to shape emerging market opportunities.

Meanwhile, the Heritage Foundation concludes that all the alternative energy industries are failing despite generous subsidies — and the answer is less, not more subsidies.

Healthcare reform and entrepreneurship

For about 2 hours today, I was scheduled to appear on the local TV news to provide a commentary on the impact of Sunday’s healthcare bill upon local entrepreneurs. So while waiting for my 1 p.m. (later 2 p.m.) interview, I was doing some background reading to be up to speed.

Alas, the interview was cancelled because the reporter had his story changed, when shortly after noon Google announced that Chinese search users would get uncensored results from Google.com.hk. So my mom will have to wait a while longer to see a video of her firstborn being interviewed as an “expert” on TV.

Preparing for the planned interview, I didn’t see a single credible source on the impact of the Senate bill (let alone the planned changes) on small business — nothing equivalent to the November article in Time magazine about the House bill. The most complete factual source I saw was the Tax Foundation timeline published Sunday, but that was bullet points without links to a description of the details.

Obviously, for business, the economy, and the broader society, this massive change brings tremendous uncertainty, particularly during the period between the bill’s enactment and when the major spending is scheduled to begin in 2019. There will be two presidential and five Congressional elections between now and then — not to mention the low probability that either party will actually enact Medicare cuts that are budgeted as the major cost savings.

For California, there is also the uncertainty as to whether the Federal bill will increase or decrease the momentum behind the proposed single-payer monopoly for funding healthcare that has already passed the state Senate. Presume Arnie (and Meg) would veto such a bill, while Jerry would eagerly sign it.

There are also unresolved questions as to how the various mandates will work, and whether they will result in increased availability (and increased costs) of insurance for small and growing businesses. Even without the law of unintended consequences, I don’t think anyone has a clue as to what the net effect will actually be — even if the CBO did have enough time to do their job right.

However, there are two changes where the results are pretty easy to predict:

• Increased taxes on the “rich”. Those making over $200k (family income $250k) will pay 0.9% more on earned income and 3.8% on unearned income (such as investments). This will cause the wealthy to choose not to realize income, which over time will reduce the pool of money available for angel investments. (How much? How soon? Who knows?) As an added benefit, like the AMT this surcharge is not indexed for inflation, so this surcharge will eventually become a middle class tax hike — particularly in high living cost areas like Silicon Valley.
• The 2.3% excise tax on medical device makers. Why those who produce medical innovations should be taxed to pay for increased spending elsewhere is beyond me, but it will shift startups and investments away from this sector.

Both take effect in 2013, presumably to insulate politicians from political consequences until after the 2012 elections.

Anyone who understands economics knows that if you want less of something, then tax it. But then understanding economics is not a pre-requisite for law school, let alone elected office.

Startup Success: the importance of Plan B

A month ago, in my Engineering Entrepreneurship blog, I noted an essential skill that entrepreneurs need: the flexibility to find. Or as I wrote:

Many if not most tech entrepreneurs eventually face a wrenching problem: when do I give up on Plan A and go to Plan B?

As it turns out, a friend of mine, John Mullins has just co-authored a book called Getting to Plan B: Breaking Through to a Better Business Model, released last month.

John is still in London, but his co-author lives here in Silicon Valley and is familiar to both SV denizens and entrepreneurship students alike: Randy Komisar, author of The Monk and the Riddle.

Randy is talking about their new book Tuesday at 7pm in Menlo Park, in an event sponsored by SVASE. It’s an important topic, and I hope some of my readers will be able to make.

Burning up Silicon Valley

My friend and fellow SJSU entrepreneurship prof Steve Bennet is recommending a new Silicon Valley-oriented novel, Burn Rate. The novel is by Daniel Marcus, an operations guy in one of his portfolio companies.

According to Amazon:

Ross and Lori Williamson are living the Boomer version of the American Dream. Ross is a Silicon Valley entrepreneur, battered but still standing after the Internet collapse. Lori has quit her upscale corporate law job to make pottery, study martial arts, and start a family. Unable to conceive, they hire Annie Day as a surrogate to bear their fertilized egg to term. Annie has a few skeletons in her closet, including an ex-boyfriend desperate for cash and on the run from the Italian and Russian mobs.

For those outside the Silicon Valley milieu, “burn rate” refers to the monthly negative cash flow of a startup company. The equation I tell my entrepreneurship students is

working capital ÷ burn rate = time to extinction

For those who have a sense of déjà vu all over again, Burn Rate was also the title of the 1998 memoir by Michael Wolff. As Publisher’s Weekly via Amazon describes it:

After operating a small media company for a number of years in New York City, the author joined the ranks of Internet entrepreneurs in 1994 when he formed Wolff New Media and found himself operating in an industry with few rules, much venture capital money and lots of companies losing that money at a rapid rate. Wolff's own burn rate (the rate at which his company was losing money) was several hundred thousand dollars per month.

In an effort to keep afloat, he and his financial backers met with numerous companies about a variety of business combinations ranging from an outright acquisition of Wolff New Media to a partnership arrangement. Wolff failed to reach agreements with such companies as the Washington Post, Ameritech, Magellan and America Online. He describes his negotiations with these firms in a witty fashion that provides readers a glimpse of the operating style of some of America's best-known companies. Wolff's most entertaining account concerns his dealings with AOL, which he calls the most dysfunctional company in the country.

Although Wolff (Where We Stand) was an early believer in the ability of the Internet to deliver powerful content to a mass audience, by the time he resigned from his own company in 1997, he had come to see the Net as more of a transactional medium. Combining humor with his firsthand experiences, Wolff has produced a book that fledgling Internet entrepreneurs would be wise to read.

The Wolff book was highly engaging, ideal for a course on high-tech entrepreneurship. The one time I evaluated Wolff’s book, I ended up using Charles Ferguson’s High Stakes, No Prisoners, because people at the time had heard of his technology (FrontPage, sold by Ferguson’s Vermeer Technologies to Microsoft).

I haven’t seen the Marcus book in stores yet, but I’ve requested that my local public library buy a copy. I’m guessing that by fictionalizing the Silicon Valley story, Marcus has a freer hand at commentary and humor than the autobiographical stories of greed, love and excess.

On the other hand, it’s hard to see how he could top the dysfunctional big company stories that Wolff and Ferguson tell about AOL Time Warner. After all, this is the failed conglomerate that is the subject of at least three other books, by Alec Klein, Nina Munk and Kara Swisher.

Clearly flawed business model

On Monday night, the airport express security program “Clear” went out of business. As the website FlyClear.com says

Clear Lanes Are No Longer Available.

At 11:00 p.m. PST on June 22, 2009, Clear will cease operations. Clear’s parent company, Verified Identity Pass, Inc. has been unable to negotiate an agreement with its senior creditor to continue operations.

What will happen to my personal information?

Applicant and Member data is currently secured in accordance with the Transportation Security Administration’s Security, Privacy and Compliance Standards. Verified Identity Pass, Inc. will continue to secure such information and will take appropriate steps to delete the information.

Will I receive a refund for membership in Clear?

At the present time, because of its financial condition, Verified Identity Pass, Inc. cannot issue refunds.

Memo to TV airheads: of course they won’t pay refunds, because they’re broke. If they weren’t broke, they’d still be in business.

USA Today reports that the company was started by Court TV founder Steven Brill and attracted strategic investments from Lockheed Martin and GE Security in additional to VC firms. Apparently the company attracted about 250,000 customers before it died.

If I claimed “I hate to say I told you so” I’d be lying. A year ago, I didn’t see the revenue model: not customers willing to pay a large enough premium to solve the travel checkin hassle problem. (It doesn’t help that the most price-insensitive segment of rock stars and athletes never fly commercial.)

As I said back then:

It’s not clear (all pun intended) whether the problem is market size (of people willing to pay anything) or the revenue model (no ala carte pricing). It’s also not clear if (ala Iridium and Globalstar) they have a graceful fallback position short of bankruptcy. But if they can’t find significant paying customers in tech-wealthy Silicon Valley, they are not long for this world.

MIT, Stanford and Silicon Valley

On Sunday, the Merc published a long article claiming that Stanford has for 100 years been the center of entrepreneurship in the Bay Area if not the whole universe. I immediately started writing a rebuttal, but when I was done I decided to post it to my blog on engineering entrepreneurship.

Stanford and the Silicon Valley are unique in the world, and it’s understandable why so many people look here for a model as to how to encourage tech entrepreneurship. However, I think the reporter exaggerated the case for effect’s sake — although local boosters are also prone to exaggerating too.

To boil down my rebuttal arguments, the first point was that there were not a lot of significant Stanford tech spinoffs until the banner year of 1982 (Cypress, EA and Sun). Stanford didn’t even have an entrepreneurship policy until the 1950s, and that was driven by a need to raise money. Yes there was HP, but one company does not a trend make. (I’m grateful to Silicon Valley historian and native Stephen Adams for helping me with the details).

The second point was that there was an acknowledged home for electronics-based entrepreneurship in the US for more than 50 years: it's called MIT (yes, my alma mater). In the early 20th century, MIT created some of the most durable models for industry-university collaboration, as documented by Henry Etzkowitz. MIT also provided the founders for companies from Raytheon and TI to 3Com and Qualcomm, as well as educating some of the key technologists who created Silicon Valley. (OK, now who’s sounding like a booster?)

If you believe the rankings, MIT is still the top electrical engineering program in the country — a position it has held for a century. (This year it’s tied with Stanford and Berkeley in one ranking, which certainly seems plausible given the strength of all three schools).

What’s different is the environment: Massachusetts was a good place for creating tech startups in the 1960s, but it fell dramatically over the succeeding decades. On the Left Coast, there’s no disputing that the transformation of the Peninsula over the past 30 years has made the Valley a much better environment for launching a high-tech business.

So to a large degree, Stanford benefits from what’s in its backyard — the firms and infrastructure created by the industries that grew here in the 1960s-1990s. Some of these firms were by Stanford alums, some were not. In fact, MIT alumni have been taking jobs in the Valley for 30 years, and today I’m among MIT alumni coaching other alumni who want to launch tech startups here.

When did Stanford pass MIT as the top hub of tech entrepreneurship? I’m guessing the evidence would point to sometime in the 1980s, when many successful Silicon Valley firms were created and IPOs demonstrated the advantages of working for a startup.

Since the data is too messy come up with an exact date, any further efforts to nail it down is fodder for a two-beer argument. Anyone want to share a pitcher and come to a definitive answer?

The moral hazard of cleantech hubris

Since last summer, many firms have lined up to get their share of taxpayer subsidies. It is not always clear which firms deserve such subsidies and which ones do not, but as always, it’s predictable that the undeserving firms will do their best to appear deserving.

One of the companies seeking Federal aid is electric car maker Tesla Motors. Tesla has shipped its Roadster to an affluent niche market, but hopes to find a broader (niche) market with its $57,000 Model S sedan. Plans for the Model S have been on again and off again; right now they’re said to be on again.

Tesla is personified by chairman/CEO/founder Elon Musk, a 37-year-old serial entrepreneur who appears to be simultaneously running his 3rd and 4th startups.

My coworker Randy Stross (author of Planet Google) wrote about Tesla in his New York Times column. His Nov. 30 column questioned Tesla’s suitability for Federal bailout dollars:

The Tesla Roadster is an electric car that goes fast, looks sensational and excites envy. The seductive appearance, however, obscures some inconvenient truths: its all-electric technology remains woefully immature and don’t-even-ask expensive. If enough billionaires step forward to inject additional capital to keep the doors of its manufacturer, Tesla Motors, open, I’m happy for all parties.

If investors pass up the opportunity, however, why should taxpayers fork over the capital that Tesla needs? The company is requesting $400 million in low-interest federal loans as part of the $25 billion loan package for the auto industry passed by Congress last year.

The program is intended to encourage automakers to improve fuel efficiency, but should it be used for a purpose like this, as the 2008 Bailout of Very, Very High-Net-Worth Individuals Who Invested in Tesla Motors Act? Can you conceive any way that federal dollars could be put at greater risk — and for no equity in return, keep in mind — to benefit fewer people?

Tesla Motors, a privately held company based in San Carlos, Calif., has spent almost all of the $145 million in capital it has raised to date. It says it will soon receive another round of $40 million from its private investors to sustain operations.

In the start-up ecosystem of Silicon Valley these would be respectably large numbers, but in the automotive world, fully developing an entirely new line of technology can easily run $1 billion. That is what General Motors’ first attempt at an electric vehicle, the EV1, was estimated to have cost to develop in the 1990s.

Stross had two inaccuracies in the original article. First, he confused the $109k Roadster with the “mass market” $59k Sedan (later corrected online).

Secondly, he said Tesla wanted $400m in Federal loans: today, the current estimate is $700m. The money would from the Department of Energy’s loan guarantee program instituted by President Bush. The first $250m would be funded by 2005 legislation to reduce carbon emissions, the second $450m from the 2008 program for drive-train electrification. (The loan guarantees will charge fees to cover the program’s projected default rate, estimated at 25% by the GAO.)

While Stross’ comments were harsh, they don’t seem unusually so. Silicon Valley companies are often called on their wildly optimistic predictions. And in this climate of bailout fatigue, formerly entrepreneurial companies embracing government subsidies should expect some level of public examination and accountability.

Still, this was in November: after four months, all was forgotten, right? Wrong.

In video clips posted Friday to Yahoo Tech Ticker, Musk was interviewed by Sarah Lacy. In one of the video excerpts, Lacy shows one of Tesla’s scarce Model S prototype and asks the question “Should your taxpayer dollars go towards producing it?” She then began her interview with Musk:

Lacy: The New York Times did this piece that everyone in Silicon Valley got very up in arms about…

I don’t think “everyone” in Silicon Valley got upset. Some are too busy trying to keep their own startups alive to worry about Musk’s electric cars. A few tech entrepreneurs (like Paul Allen) were even willing to be politically incorrect and oppose the bailout.

Let’s restart the hard-hitting investigative interview:

Lacy: The New York Times did this piece that everyone in Silicon Valley got very up in arms about, saying that, you know, that the government money going to Tesla, would be this, you know, huge risk of capital that would only benefit the wealthy and venture capital backers who put money in the company, and called the Roadster basically a $109,000 concept car.

What do you say to that article?

Musk: Randy Stross is a huge douchebag! [Both laugh uproariously.] And an idiot!

Wow! I’m impressed! What a command of the English language! What an ability to inspire confidence among taxpayers that their $700m will be well spent! I’m not sure which is the greater need: journalism lessons for the new-media host or PR lessons for the centimillionaire entrepreneur.

After this ad hominem attack, Musk changes the subject:

Musk: First of all, what is he doing picking on electric car company? I mean, why would he pick on the little guy who's trying to do good, when you’ve got egregious wastes of money in the tens of billions occurring in … in … in Detroit? Why?

Hmmm... So wasting nearly a billion dollars on a little car company is OK because it’s not as bad as wasting $10 billion on a big car company? Musk said the money was intended for a “mass market car,” but (since no one owns a car in Manhattan) only in Silicon Valley would $57k be “mass market.”

Musk supposedly has an undergraduate economics degree from Wharton, so I assume this is just posturing rather than a serious answer. Here is how I would explain why that answer would get an “F” in my technology strategy class:

We can look at a wide range of cutting edge technologies in the past — biotech, dot-com, PC makers, disk drive makers and semiconductors — and see that when many companies enter the market, some companies survive while other companies fail. A priori, there was no way to tell the winners from the losers: if there were, investors would not have invested in the losers.

Today, while society may want electric cars, we don’t know which companies will survive and which will fail. If Tesla fails, U.S. taxpayers could lose $0.7 billion.

A VC expects to lose its entire investment anywhere from 10% to 33% of the time. It compensates for that risk by taking equity and getting a 10x return for the big winners. Here, the government would be supplying 80% of Tesla’s invested capital, but will only earn a fixed fee should Tesla have a smash success.

If you and the current investors don’t want to put up that money — but instead want taxpayers to bear most of the risk — perhaps you know something that the public doesn’t about the riskiness of the investment.

Economist Ken Arrow calls that a moral hazard problem due to information asymmetry. Economics tells us we should be suspicious when people who know the most want others to shoulder the risk.

When funding is tight, many tech companies will grow slowly until their positive cash flow will enable further re-investment. However, in this case, Tesla wants to expand its capitalization fivefold to fuel explosive growth, in hopes of grabbing market share before GM, Nissan, Toyota and others bring their electric vehicles (or plug-in hybrids) to market.

However, by taking Federal funding, Tesla would move into the realm of a regulated government-sponsored enterprise, along with all the other companies received bailouts and subsidies. Government money means playing by government rules, however irrational those might be. The best and brightest of Wall Street are fleeing from the TARP-sponsored wards of the state, presumably a lesson that (most) cleantech entrepreneurs will learn someday, as well.

Entrepreneurs are the answer, not bureaucrats

The Wall Street Journal ran a great interview Saturday with the president of the Kauffman Foundation, the organization that funds more research on entrepreneurship than any other organization in the world.

Carl Schramm took over as the head of the foundation in 2002, nine years after the death of Ewing Marion Kauffman — who funded the foundation with the proceeds of selling his drug companies to Merrell Dow.

While I recommend reading the complete interview, here are some key excerpts:

Mr. Schramm, who started his own health-care company and merchant bank, believes that the foundation has a duty to foster an environment hospitable to entrepreneurship. And so, for instance, Mr. Schramm brags that Kauffman has "dragged economists into considering the importance of firm formation to the overall growth of the economy." The foundation has commissioned some 6,000 papers on this and related topics in the past several years.

… Conducted last month, the [Foundation sponsored] survey also showed that instead of the government's stimulus package, two-thirds of respondents would prefer "reducing legal barriers and red tape for new business development" as a way to jump-start the economy. Finally, 89% of respondents said that "capitalism is still the best economic system for our country."

Despite this popular attitude, Mr. Schramm worries that there is a tendency on the part of some citizens to want the government to prevent market chaos. Prior to the financial meltdown this fall, "I think we were in full tide of entrepreneurial capitalism and now there's an introspection, where the vocabulary is all about regulation and the importance of the government to restart the economy," he says. While Mr. Schramm believes that the government has a role to play, he argues that "historically through the last seven recessions it's been entrepreneurs who essentially restarted the economy."

Columnist Naomi Schaefer Riley concludes her column:

Despite the fact that the foundation's endowment has fallen by $722 million since the end of 2007, Mr. Schramm sees this as Kauffman's "moment." While "no one hopes for a recession," it's during economic crises that entrepreneurs "challenge companies that have gotten big and lazy." The downturn, he says, will even challenge Kauffman to "think about how we can do our work better, like every business." In fact, Mr. Schramm adds, "The only people immune from thinking hard in moments like this are in government."

Killing the Golden Goose

Michael (S.) Malone is a Silicon Valley pundit with a multi-faceted success trajectory. He wrote the definitive books analyzing the strategies and culture of two local icons, Apple and HP. (The former was a major source for the history portion of my dissertation).

Malone is a former HP employee who’s been covering the tech industry for nearly 30 years, having worked for the Mercury News, Upside (boy I miss that mag), Forbes ASAP, ABC and even the gray lady herself. He's even a successful Boy Scout leader: talk about all-American.

This week he took aim how the policies that once made such innovative startups possible have been eroded throughout this decade (i.e., under Bush 43 and under both Republican and Democrat legislative control).

As evidence, he cites the recent dearth of IPOs:

Washington Is Killing Silicon Valley
Entrepreneurship was taken for granted. Now we're seeing a lot less of it.
...
From the beginning of this decade, the process of new company creation has been under assault by legislators and regulators. They treat it as if it is a natural phenomenon that can be manipulated and exploited, rather than the fragile creation of several generations of hard work, risk-taking and inventiveness. In the name of "fairness," preventing future Enrons, and increased oversight, Congress, the SEC and the Financial Accounting Standards Board (FASB) have piled burdens onto the economy that put entrepreneurship at risk.

The new laws and regulations have neither prevented frauds nor instituted fairness. But they have managed to kill the creation of new public companies in the U.S., cripple the venture capital business, and damage entrepreneurship. According to the National Venture Capital Association, in all of 2008 there have been just six companies that have gone public. Compare that with 269 IPOs in 1999, 272 in 1996, and 365 in 1986.

Faced with crushing reporting costs if they go public, new companies are instead selling themselves to big, existing corporations. For the last four years it has seemed that every new business plan in Silicon Valley has ended with the statement "And then we sell to Google." The venture capital industry is now underwater, paying out less than it is taking in. Small potential shareholders are denied access to future gains. Power is being ever more centralized in big, established companies.

He then lists the usual suspects of regulation: Sarbanes Oxley, FASB, the SEC, as well as the capital gains tax increase promised by candidate Barrack Obama.

In happier times, his arguments might carry some weight. But after the various GSE and bank frauds that brought the stock market down 40% this year — not to mention Bernie Madoff — efforts to reduce regulation of private companies will fall on deaf ears for several years.

It’s clear that things will get much worse for entrepreneurs before they get better, not only with regulation, but with heavy-handed government intervention that crowds out private investment. There’s no guarantee things will get better any time soon: some impediments to free markets may last for decades. Some even could become permanent, if those who admire Europe’s nanny state succeed in importing it to the US, complete with Eurosclerosis. (Where’s Lady Thatcher when you need her?)

I suspect Malone knows all this: the article in Monday’s Journal is his stake in the ground to say “I told you so.” And perhaps when the President comes back to the Bay Area in 3 years to raise money for his re-election, some of his ardent VC supporters will remind him of these burdens on entrepreneurs and the damage that they do.

Repealing the SOX tax

I’m now back in town after a combined business/personal trip late last week, one without much Internet access. So I’m catching up on some back reading.

One of the articles I missed was printed in Friday’s WSJ, where a commentator noted:

Last quarter marked the first time in 30 years that not a single company backed by venture capital went public in the U.S.

Yes, OK, the market was not very favorable for IPOs, but we’ve had other down markets in the past three decades; the absence seems extraordinary. One obvious implication is that if the traditional exit strategy has been foreclosed, it will be harder to get funding for new startups.

Commentator James Freeman lays the blame at Sarbanes-Oxley, and IMHO (next to the convicted felons from Milberg Weiss), nobody deserves it more:

"A lot of our CEOs are reticent to go through the public process. The [Sarbanes-Oxley] and governance issues are cumbersome, and it means they spend all of their time as administrators versus growing their companies," reports Kate Mitchell of Scale Venture Partners. She adds that chief executives don't want the liability risks of running a public firm and the same goes for candidates to serve as outside board members.

As for Sarbanes-Oxley, or SOX, the hope was that by now firms would have gotten over the hump of learning to comply, and auditors would have stopped obsessing over minute risks. Last year the Securities and Exchange Commission explicitly advised firms to focus only on material threats to the integrity of a firm's financials. "The SEC's heart was in the right place, but the accounting firms' hearts are not," says Mark Heesen of the National Venture Capital Association. He adds that the Big Four accounting firms "continue to feast on SOX audits."

Ms. Mitchell says the "SOX tax" runs up to $3 million per year per company, which can reduce a firm's market value by much more. Mr. Harrick says the costs of being a public company can approach $5 million.

Despite the visibility of this problem, neither presidential candidate plans on eliminating the infamous Section 404. Interestingly, if one kook libertarian (no not that one) somehow had made it to the White House, 404 would be history.

The SEC is trying to improve things but it’s not clear if they’ll be effective. If they don’t succeed before Christmas, it seems unlikely that their reform efforts will survive the next administration.

Freeman identifies another form of innovation drag with Elliot “tripped on my zipper” Spitzer, the former chief persecutor of NY State. Since Spitzer’s onerous policies were not voted for by any national politician, it seems hard to see how they’ll ever be repealed, although some provisions seem ready to expire in another 12 months.

Of course, the history of politicians is to neglect a problem until someone screws up badly, and then overreact. There are other ways that the problems of Enron and WorldCom could have been solved, but those would not have made Sen. Sarbanes and Rep. Oxley household names.

Without IPOs, there’s still the acquisition alternative. Freeman aptly summarizes why this alternative tends to produce less innovation than the other:

Does anyone think that we would be better off if Bill Gates and Michael Dell had sold out to corporate behemoths early in their careers, instead of leading their firms for years as public companies? Would consumers enjoy the same vibrant market in Web services if Yahoo had gobbled up a nascent Google? How powerful would our computers be if Intel had become an IBM subsidiary, instead of going public in 1971?
…
An IPO generally means that the founders can continue to run the companies they have painstakingly built, except with greater resources. An acquisition generally means that the founders move on, see projects they championed get axed, and watch old colleagues get fired.

Built to Last

I was sorting through old newspapers in the pile to read and found a column from the Merc that struck a nerve. Normally, business columnists are either shallow and superficial, or opinionated with conclusions not supported by the evidence presented (let alone reality). This was definitely neither of those cases.

The May column by Chris O'Brien refers to a speech by utility executive Jim Rogers:

Rogers described how he has embraced something called “cathedral thinking” and he was calling on the Valley to join him. I cringed at first mention of the term, worried that he was going to digress into some awkward religious metaphor.

(I’m not sure why O’Brien automatically assumed a religious metaphor would be awkward. Has he not heard of The Cathedral and the Bazaar, a metaphor embraced by as irreligious a bunch of geeks as you’ll ever find?)

Fortunately, O’Brien listened long enough to get the full story.

Rogers talked about a recent visit he’d made to Europe where he visited a number of the great cathedrals. It struck him that the person who often envisioned these great buildings didn’t live to see them built. Instead, they articulated a powerful vision that galvanized people to work on something that took generations to realize.

Rogers is proving the timelessness of two well-understood principles of effective business (or military) strategy. One is a long-term vision of what needs to be done; the second is creating a strategy (or perhaps just a culture or a set of enabling competencies) that will bring that vision to fruition, even if it’s long after the strategist is gone. This latter point is the theme of the Jim Collins bestseller. Bill and Dave certainly had it, Tom Watson Jr. had it, and I suspect (in their own narrow self-interested way) Gene Kleiner and Tom Perkins had it too.

The American political system is seriously broken by the exact opposite thinking Solving a real problem (like homeless people, failed public housing, structural budget deficits, social security) is important for society but too hard for politicians – so they don’t try. Instead, they “kick the can down the road” on these problems and find some symbolic quick victory (like televised hearings) to get re-elected one more time. Duane Delacourt, Doonesbury’s fictional “secretary of symbolism” for President Carter and then Governor Moonbeam, is now no longer exceptional enough to be worth mentioning.

Similarly, today’s CEOs want to string together 10 or 15 quarters of increasing earnings by a penny each time, so they can be handsomely rewarded for sandbagging their objectives before they are sacked. And VCs want to flip a company onto some greater fool before anyone is the wiser.

The occasion of the column and Rogers’ visit was a party commemorating the birthday of a 20-year-old startup, Echelon Corporation. Echelon had an unusually patient management team and board of directors; today its Pyxos embedded control platform appears to be both technologically ripe, and to have found a timely business need —managing industrial, commercial and residential energy usage. The IRR is probably not impressive for the venture investors, but the vision of the CEO and late COO have been validated — and the world is a better place for it.