Hot Off the Virtual Press! The 2013 edition of "KU Finance" Special edition on KC's entrepreneurial finance scene

One of my pleasant duties is serving as faculty editor of "KU Finance." The current issue is out, and it focuses on the role played by KU alumni in Kansas City's vibrant startup community.  Kansas City has a long tradition of entrepreneurship illustrated by Marion Labs and Cerner. More recently, the growth of entities like ThinkBig Partners and the Pipeline Innovator program have added to the virtuous cycle. This publication is a bit KU-centric to be sure, but it captures what is going on. Check it out here:  KU Finance

Early-Stage Investing - the Video

The Kansas City entrepreneurial scene has been catching a wave.  This panel discussion with some leading regional entrepreneurs and investors brings to the fore some of the issues that arise when opportunity, energy and money mix. What does it take for entrepreneurs to be noticed by investors? Are there successful local entrepreneurs who can invest wisely and keep the virtuous cycle going? And a question you would think would be a yawner - are convertible notes a good thing? - generates lively debate, as well as insight into the roles of entrepreneurs, angels and VC's. Other tidbits: the Series A crunch is really two, one for Web 2.0 a sign of too much seed funding, and one for life sciences, a legacy of bad returns, long cycles and a dysfunctional exit ecology.  Plus some new thoughts on making early-stage investing more scientific and evidence-based, and much, much more. Enjoy!

My thanks go to Kauffman Foundation for its generous support and the panelists for their engagement. 

The video and list of presenters comes from the University of Kansas, School of Business web site (link below).  Also available here: http://www.youtube.com/watch?v=3NF4uviQ_xc

Early-Stage Investing

April 5, 2013, 8 am – 3:30 pm

Kauffman Foundation, 4801 Rockhill Road, Kansas City

Organized by George Bittlingmayer, University of Kansas

Supported by the Kauffman Foundation

7:30 am - Breakfast

8:00 - Panel on Current Trends

• Peter Brown, Grassmere Partners
• Dr. Nicholas Franano, MD, Novita Therapeutics
• Herb Sih, ThinkBig Partners
• Robert Wiltbank, Willamette University 

Moderator: Fred Coulson, Five Elms Capital

9:00 - 12:00 - Recent Research I

Robert Wiltbank, Willamette University, “The Role of Prediction in New Venture Investing,” (co-authored with Richard Sudek) Discussant: Joel Wiggins, Mid-America Angels Investments and Enterprise Center of Johnson County

9:50 - 10:10 - Break

Manuel Adelino, Duke University, "House Prices, Collateral and Self-Employment," (co-authored with Antoinette Schoar and Felipe Severino) Discussant: Robert W. Fairle, UC-Santa Cruz

Ann Kovner, Federal Reserve Bank of New York, "Doing Well by Doing Good? Community Development Venture Capital"? (co-authored with Josh Lerner) Discussant: Julia Sass Rubin,Rutgers University

Noon - 1 p.m. - Lunch

Vladimir Mukharlyamov, Harvard University, “The Cost of Friendship,” (co-authored with Paul Gompers and Yuhai Xuan) Discussant: Chris Rider, Emory University

Laura Lindsey, Arizona State University,"Economic Ties in Co-Investment Networks: Evidence from Venture Capital," (co-authored with Yael V. Hochberg and Mark M. Westerfield). Discussant: Anne Marie Knott, Washington University, St. Louis

https://businessdev.drupal.ku.edu/early-stage-investing

Leading KC Entrepreneurs Pitch to KU Class

Fun & Enlightenment! Three Pipeline Innovators visited my "Entrepreneurial Finance Class" earlier this month and pitched their startups.  I am lifting the story from KU's School of Business blogspot. Thanks to Joe Viviano for excellent reporting.http://kubschool.blogspot.com/2012/10/leading-kc-entrepreneurs-pitch-to-ku.html++++++++++++++++++++++++++++++Wednesday, October 17, 2012

Leading KC Entrepreneurs Pitch to KU Class

What does it take to sell an idea to an investor? Students in Professor George Bittlingmayer’s Entrepreneurial Finance class at KU’s Edwards Campus recently found out. The founders of three of Kansas City’s most innovative startups demonstrated their “pitches,” fielded questions, and explained the appeal of entrepreneurship in early October.

Left to right: KU students Robert Van Trump and Hong Bing Zhou; 

Pipeline Innovators Kyle Johnson, Xandra Sifuentes and Jeff

 Blackwood, and KU students Sarah Schmidt, and Darren Campbell

The three entrepreneurs, Jeff Blackwood, Kyle Johnson and Xandra Sifuentes, all have the distinction of having been chosen for the elite Pipeline program. Founded in 2006, Pipeline is a selective startup accelerator that connects the Midwest’s most promising entrepreneurs with a network of supporters, peers, and advisers.  Each year approximately 10-12 new members are invited to join and participate in a rigorous, yearlong business leadership development program.  Mr. Blackwood and Mr. Johnson were members of the 2011 PIPELINE class and Ms. Sifuentes was invited to join in 2012.                 

An entrepreneur’s pitch to potential investors states the problem, outlines the entrepreneurs solution and marketing strategy, and offers estimates of the potential market size and company projections. The best pitches are polished, focused and attract financing from angel investors and venture capitalists. 

Xandra Sifuentes is currently the President of Metactive Medical, LLC, a subsidiary of medical device company Novita Therapeutics.  Prior to her position at Metactive Medical, she earned her MBA from the University of Missouri-Columbia and co-founded two medical device start-up companies.    Leveraging an experienced team of professionals, Metactive plans to introduce a ball stent that will repair cerebral aneurysms by 2016.  “We are looking to have half the cost of our competitors.  Our product only requires one ball stent and comes in variable sizes,” Ms. Sifuentes explained. Metactive plans to enter European markets before launching the product in the US due to less stringent regulations and a quicker adoption rate of medical technology.

Jeff Blackwood is the CEO and President of AB Pathfinder, a start-up company that develops technology tools to aid children with autism, Asperger’s, and other brain development disorders. The company has partnered with Microsoft to develop a web-based application that fosters communication between therapists and educators, allowing them to focus more on the children than on administrative tasks. “We didn’t build this software in a vacuum. We had a solid team of business and scientific advisors behind us including medical researchers at University of Kansas,” Mr. Blackwood said. 

KU graduate Kyle Johnson is the CEO and founder of music streaming service AudioAnywhere, and won the January 2012 pitch contest for his 2012 Pipeline cohort. Before establishing AudioAnywhere, Johnson worked for more than six years in management consulting. His vision is to enhance the business model of online music streaming services by more closely tailoring advertising with consumer preferences and thus improving advertising revenue per song played.  “We can make more money than Pandora on a per-user basis,” Mr. Johnson predicted.

Perhaps the most memorable takeaway of the evening was the relentless drive and ambition that characterizes the most successful entrepreneurs.  “The presenters really believed in their product…and really made you believe their product and ideas were going to be successful,” said Darren Campbell, an engineer and current MBA student.

Jared Sinclair, also in the MBA program and in health care, came away with an appreciation of the work and effort that goes into raising money. Despite differences in style, “each one knows how to get people interested in what they had to say.”

In response to questions about the lessons of entrepreneurship, Kyle Johnson summed up his experience. “You live and learn.  Raising money is the hardest thing.  Knowing how not to waste it is the second hardest thing.”

Xandra Sifuentes acknowledged the risks of the entrepreneurial path, but said she finds value and fulfillment in her work.  “I love the creative process in bringing an idea to life that will help save lives.”             

Academics meets practice: A VC conference

The conference on "Early Stage Venture Investing" that I've been fretting over finally took place March 31. The schedule appears below.

Why I do this.  This was yet another of my attempts to bring academics and practitioners together. I caught the bug on this in the early 1990s, when Stanford hosted a conference on "corporate control," a topic that gained prominence with the rise of takeovers, private equity and leveraged buyouts. All the big names were there: top academics, the chief judge of Delaware's Court of Chancery, the CFO of Merck, and George Roberts of KKR (Kohlberg Kravis Roberts).  The chemistry was great, and I got material and inspiration that served me well for many years.

I tried to imitate this model in 1997 with a UC-Davis conference marking the tenth anniversary of the October 1987 stock market crash. At KU I organized a few more conferences along the same lines on various themes: the tumult after 9/11, venture capital and private equity, corporate control in the wake of Enron and WorldCom, and investing in China. In each case I learned a lot, first in picking speakers and topics (harder than you think), and then in the serendipity that comes from smart people exchanging facts and ideas. Worldly wisdom is not going to come knocking on my door. I have to go out and find it, and there's still no substitute for face-to-face interaction.

The Stage. The pieces were in place for my recent event. The Kauffman Foundation provided financial support, including a top-notch venue. We had regional, even national, practitioners on the program, including the head of Angel Capital Association, the founder of Five Elms (a midwest PE/VC firm), and a general partner at MPM Capital (a bioscience venture firm with a national footprint). We were also fortunate to have investment executives from Kauffman's Endowment, which has made substantial investments in private equity/venture capital. And we had the academics, including a clinical professor at Colorado involved both in teaching and ecosystem development.

My Angst. Still, even as a old hound, I had some trepidation.  More than just about any area of finance, the gap between what academics know and are interested in, on the one hand, and what practitioners care about seems huge. At that early 1990s conference on private equity in Stanford, there was a revealing and slightly awkward moment when George Roberts gave the after-dinner speech. What role did he see for academics in the private equity revolution?  Help to publicize what private equity really is, and explain how it operates and what its effects are.  What went missing from that lukewarm endorsement was any thought that the assembled PhD's could ever tell him something he and his very clever associates and advisors didn't know. We were there to throw light and bestow credibility on private equity, perhaps to serve as foot soldiers in public policy and legal battles. But you wouldn't want us doing the deals, not even advising.

What holds for private equity holds for spades in venture capital.  The magic sauce in venture capital is the expertise of the venture capitalist. Good venture capitalists know the technology and markets that they are investing in, and they have been in exactly the same spot as the founders of their portfolio companies.  What's the role for academics? Not much it would seem. When I first read Venture Deals: Be Smarter than your Lawyer and Venture Capitalist, by Feld and Mendelson, VC's at the Foundry Group in Boulder, I thought, "Why can't professors write like this?" It's compact, to-the-point, and every sentence oozes worldly experience. A thousand years spent poring over the (highly imperfect) data on venture investing is no substitute for a few decades of sweating over deals.

I am sounding pessimistic.  There is in fact a role for academics and research. It comes through in the textbook I used in my course  (alongside Feld and Mendelson's book): Metrick and Yasuda's Venture Capital and the Finance of Innovation. While it can't match Feld and Mendelson with hands-on-wisdom, its strengths lie in providing a data-based, big picture overview of terms, trends and players in venture capital.  Certainly for the limited partner side (say prospective money managers at pension funds, endowments and family offices), there's value here that a venture capitalist cannot provide. (Now there's also a downside to the academic's insistence on rigor, consistency and a tight disciplinary lens, but that's a topic for later.)

Much to my relief, the role of academics also came through at our recent conference, to which I now turn.

Light Emitted from an Imploding Law Firm. For my taste, the academic paper that threw the most light on the conference theme of early stage investing was "Does Angel Participation Matter? An Analysis of Early Venture Financing", presented by Gerard Hoberg and written with three of his colleagues at the University of Maryland.  The short version: a big-name law firm (Brobeck Phleger Harrison) goes bust, and its records are turned into a research archive, allowing Hoberg and his colleagues to look at how both venture capital and angels participate in early stage investments.  This is almost never ever possible because while there are commercial databases that do a so-so job of tracking venture investments, angel investments are tracked by no one, despite the fact that angel investments account for a large proportion, perhaps more than half of early stage funding. Whatever pops up in this rare database will be news. It turns out that most of the first rounds in the sample had mixed VC-angel funding. (Who knew? Perhaps very experienced investors, but not this professor.)  Much has been written about VC-angel conflict in startups, which sets the stage for the paper's most intriguing result: exit outcomes are worse not if a company has both VC's and angels investing, but rather if the board is split between the two investor types. Now that's something worth pondering. 

The Venture Capital Model Is Broken.  One theme I should have known was going to bubble up, but didn't figure largely in my expectations was the refrain, "the venture capital model is broken".  The   symptom is well known: essentially zero net return to limited partners for over a decade. The possible causes are not, at least when I speak from the standpoint of the stylized facts and received wisdom on the academic side.  One force that receives some attention, and that was highlighted by Kauffman's Harold Bradley, is too much money flowing in, annual flows still well in excess of what came in during the early 1990s.  I think academics have a hard time with this because it relies on the notion of "dumb money" and thus irrational or poorly informed investors.  The other force is incentives, and the emphasis on misalignment of incentives was something new for me. I have certainly seen enough academic and industry coverage to know that the 2-and-20 rule (2% management fee plus 20% "carried interest" or share of upside going to the venture capital firm) is often revered as a stroke of genius that "aligns incentives".  (The standard academic criticism is that it encourages VC risk taking, based on the similarity of the payoff profile to a long call option.) Yet, that formula came in for some hard knocks, as did the sketchy transparency offered by some venture firms to limited partners.  (I say "some" because practice no doubt varies.) At the risk of imputing even more complacency to others than I was guilty of, I think scales fell from some eyes. Thanks go to Harold and his colleagues Diane Mulcahy and Thom Ruhe for ending the day on an important and thought-provoking note.

Early Stage Venture Investing: Sources, Terms and Trends Friday, March 30, 2012 Kauffman Foundation, Kansas City, Missouri

Organized by George Bittlingmayer, School of Business, University of Kansas, and made possible with the support of the Kauffman Foundation

7:30 – 8:00 am – Breakfast 8:00 – 9:30 am –  Panel Presentations and Discussion

o Fred Coulson, Five Elms Capital 

o Steven St. Peter, MPM Capital 

o Marianne Hudson, Angel Capital Association 

o Brad Bernthal, Silicon Flatirons Center

Moderator: Matthew McClorey, Bioscience and Technology Business Center 

9:30 – 9:50 Break

9:50 am – 11:50 am - Research Presentations 

o Ola Bengtsson, University of Illinois, “Different Problem, Same Solution:

Contract-Specialization in Venture Capital” Discussant: Jide Wintoki,

University of Kansas 

o Susan Chaplinsky, University of Virginia, “Exit Returns and Venture

Capital Investment Opportunities” Discussant: Felix Meschke, University of

Kansas 

o Thomas Chemmanur, Boston College & MIT, "Venture Capitalists versus

Angels: The Dynamics of Private Firm Financing Contracts" 12:00 – 1:00 pm - Luncheon Presentation – “Teaching Early Stage Investing,” Brad Bernthal, Silicon Flatirons Center

1:00 – 3:00 pm – Research Presentations 

o Gerard Hoberg, University of Maryland, “Does Angel Participation Matter? An Analysis of Early Venture Financing” Discussant: Brad Bernthal 

o Brian Broughman, Indiana University, “Do VC’s Use Inside Rounds to

Dilute Founders? Some Evidence from Silicon Valley” Discussant: Na Dai,

SUNY Albany 

o Harold Bradley, Diane Mulcahy and Thom Ruhe, Kauffman Foundation,

“A Discussion: The Breakdown in Alignment Between Entrepreneurs, Investors and General Partners in Private Finance"

The wisdom of VC boards: Trite until you've lived it.

What I love about the world of venture capital: it forces essential truths to the surface very quickly and compellingly. Venture capital is like the rest of business, even like much of the rest of life, only more so.

This evening, in this class on "entrepreneurial finance" that I am teaching for the very first time, we covered a classic treatment of boards of directors for high tech firms, what they do right, what they do wrong, what takes them up, and what brings them down. The article is Jaffe & Levensohn's "After the Term Sheet: How Venture Boards Influence the Success or Failure of Technology Companies." bit.ly/zf0ifB

When you read it, say reading it in a hurry to prepare for class, it seems dry, unsurprising. Take this list of ten common pitfalls of venture boards:

1. Complacency
2. Inability to confront difficult issues
3. Distraction and over-commitment
4. Misalignment of interests between Board Members and investors
5. Divisiveness on the Board
6. Paralysis over liability issues
7. Board Member role confusion
8. Leadership vacuum
9. Loss of trust in the CEO
10. Resolution to fail

The list seems trite and obvious, if you breeze over it.

In tonight's presentation, though, one comment highlighted by the two presenters, Sean and Jeff, struck me: "The quality of the interpersonal relationships between VCs, other Board Members and upper management is the key to enterprise success."

Of course that's true. It struck me because in the least satisfactory parts of my professional life, the interpersonal relationships are decidedly low quality. And in the parts that are humming, the interpersonal relationships shine. And yes, the causation goes from the quality of interpersonal relationships to success and satisfaction, and not the other way around.

Jeff and Sean summed it up nicely, the key to success in business, to success in life is...relationships.

I rushed back to find the URL for the Jaffe & Levensohn article and ran across this 2005 post by Brad Feld, Foundry Group VC and author of one of my texts: http://bit.ly/cupiRN

Feld's take: "This is one of the best articles I've ever seen of the issues and dynamics surrounding the board of a venture backed company."

The lesson for me: what's important is trite, until you've lived it, and then its wisdom.

Feedback on business education

My report from the west coast. What does a smart observer think of business education?

My source: a thirty-something immigrant who came to the US in his late teens. I had the pleasure to meet and talk with him on my recent trip. He's smart and resourceful, and by no means cynical. His accomplishments include a degree in computer science, four years of experience supporting risk analysis and equity trading at a major Wall Street firm, and a job as a product manager at a Silicon Valley firm known to one and all.

He also completed an "executive MBA" with a major university. I had to ask: What was it like? What did you learn?

The feedback: the executive MBA was largely a waste of time. The major benefit was learning the highly imperfect models and associated default terminology that everyone uses in business practice, "the lowest common denominator". Oh, and there's networking, in this case getting to know people in one's own company. Finance was a major disappointment, which was galling to this finance professor, especially since my source had ample Wall Street experience.

The one bright spot he reported was the course on entrepreneurship, which was taught by a well-known star in the field, someone I have seen in action and called "the smartest sociologist I know."

So, there's a challenge for the B-school business. Get the respect of the best and brightest.

Being called to venture capital

My Journey into the VC World

There were a number of signs from my Higher Power that VC was my calling. Shortly after I moved from California to Kansas in 2000, I unthinkingly dropped the term "VC" into a conversion with a finance professor who said "What?" Clearly, I had a comparative advantage.

Then three doctoral students - all three of whom were absolute pleasures to work with - chose to write on small business finance or venture capital, despite the fact that I knew nothing, nada y nada, about small business finance or venture capital (though I did know what VC meant). Students were leading the professor on an important dimension: what to study.

Mid-decade, representatives of the Kauffman Foundation came to the University of Kansas and expressed an interest funding an entity - a center or something like that - that would support top-notch research on entrepreneurship. My colleague Joshua Rosenbloom was there. From the KU Department of Economics, he has worked on the economics of innovation and thus was actually credentialed in the topic. We decided we could play the role of economic statesmen -- the mediators between the Kauffman Foundation's targeted support of research entrepreneurship, on the one hand, and local KU talent that could illuminate the topic, on the other.

The resulting entity, CREA or Center for Research for Economic Activity, received funding from the Kauffman Foundation and did in fact support top-notch research by Donna Ginther from KU's economics department and Vladimir Ivanov then at KU's finance group in the business school. We also hosted outside speakers like Scott Stern, now at MIT, and Toby Stuart, now at Berkeley.

I confess to a devilish "Nixon-goes-to-China" pleasure in having hosted Stuart. I am an economist by training, often pigeonholed. Stuart got his degree in sociology, he has served as an editor of the American Journal of Sociology, and his official bio has words like "organization" and "strategy," mushy girly stuff in the view of so many economists and finance professors. He is one very smart dude interested in stuff that matters, and I am glad I was able to introduce him to my colleagues at KU.

At about the same time, my son studied and then started working in computer science, the field par excellence in which entrepreneurship is not just endemic, but where it matters and has changed our lives forever in big, big ways. If I was interested in my son's work, and I was, I had to be interested in the world of start-ups, entrepreneurship and "liquidity events". One of the signs that you are aging gracefully is that you can learn from young people and share their enthusiasms and interests.

Some of the irony is not lost on me. My son has worked at three corporations, all publicly traded. I have worked at none, always at universities and government supported think tanks. But I teach finance.

Then, the very last and decisive Sign from Above that venture capital was my calling was a request to teach Entrepreneurial Finance, a course I had never taught. Yes, yes, yes, a thousand times yes. I will do it.

My line on this has been: Lloyd Blankfein famously said he was "doing God's work" at Goldman Sachs. No, no, no. Helping an engineer start his own business, that's God's work.

Well, I haven't taught the course yet, but it's been fun getting ready. Details on what I am learning will follow. For now, I like this gig for several reasons.

1) The practitioners want to talk to you and help. This includes angel investors, venture capitalists, entrepreneurs, or "eco devo" (economic development) types. I attribute some of this to the strong influence of the computer scientists, who for the most part like openness. Another reason for openness comes from the collaborative, networking nature of the early and middle stages of a start up's life. In any event, the relatively free flow of information has been a welcome change from other parts of finance, where important stuff is going on, but nobody will talk to you. (Try, just try to find out what what goes on at Renaissance Technologies, one of the largest and most successful quant hedge funds.) One more bit of evidence: when I ran into a KU graduate and angel investor in California, he invited me to spend the better part of a day with him in Sunnyvale going over the dynamics of the industry and the economics of some of his current deals.

2) The people who write on venture capital are great. You discover Paul Graham. (Quick, check out paulgraham.com if you have never seen it). You find books like the recently published Venture Deals: Be Smarter than Your Lawyer and Venture Capitalist, by Brad Feld and Jason Mendelson, both with the Foundry Group. As I read the book, I had these admiring and envious thoughts: These guys really know their stuff. And why don't professors write like this?

3) Actual venture capital practice routinely integrates the finance with the underlying economics and technology. There are no silos. It's a generalist's dream-come-true. To illustrate, I went to two "pitch events" in San Francisco at which mostly twenty-something entrepreneurs made tightly scripted pitches to a panel of venture capitalists (including a Zynga founder) and then fielded questions from the panel. It is also true later, when serious VC money needs to be raised. Unlike other areas of finance, the connection between the financing and what the firm does is pretty tight.

My journey continues. I'll welcome tips on books, websites, events, and whatever else is relevant for this topic. Email: bittlingmayer@ku.edu.

George