Don't Be Hasty: What Entrepreneurs Can Learn from Ents

The ancient character of Treebeard the Ent in J.R.R. Tolkein's "The Lord of the Rings" is constitutionally averse to haste: "Do not be hasty, that is my motto." Much of the popular notion of entrepreneurship, and seemingly that most valued and promulgated by some investors, is one of rush, speed, first-to-market, quick-to-exit.

What percentage of that sort of entrepreneur survives long enough to actually succeed? And by what means is success measured? These are relevant questions for someone who has decided to forego the comforts of relative certainty that seem to be the aim of getting a job. [I demur on this point, as I've little experience in my 44 years of getting or keeping what might be construed as a typical 9-5 job.]

Before rushing headlong into any plan of action, I seek to know: What are my motivations? What is it I seek to accomplish? What is the point of it all? The answers to those questions should help to clarify when and where haste is warranted or to be avoided. If the goal is to produce something lasting and sustainable, to propel true innovation, rather than superficial repackaging, then endurance may often trump haste.

I was recently pushed by a potential investor to provide a quick demo for some capabilities we are developing. I have utmost confidence that we can deliver, but the time scale is likely beyond his expectation. In the next breath, he explained that a partner of his believes he had worked on "the same thing twenty years ago". Really? I thought.

How incongruous that someone could believe that time is of the essence, and yet argue that two decade old failed attempts to develop a technology (that is completely absent from present offerings, but could revolutionize the field) could somehow forestall our efforts.

For now, I'm happy to put the Ent back into entrepreneur.

A Founder's Punctum Saliens?

The punctum saliens is an inflection point, a point of no return. At times, we wish we could turn "no return" into "know return". But then, certainty is not within the realm of an entrepreneur As Thomas Paine wisely reflected in On the Crisis (there's always a crisis, is there not?): "That which we obtain too cheaply, we esteem too lightly."

A few years ago, I attended an event at which the discussion of early-stage funding arose, and I objected to, and clarified the various concepts regarding early stage. I wrote about it here. At times, I have described myself as allergic to investors. But the truth is, I mostly seek to avoid conversations wherein the two parties are speaking mutually incomprehensible languages. It's not that I dislike investors, more that I realize I simply don't speak their language.

When I was an undergrad at Indiana University, I worked a few years on the telefund at the IU Foundation. I was quite good at it, and received several awards. But in the years I worked there, they only once or twice assigned me to fundraising for sports scholarships. It wasn't simply that I raised no money on that first night, but rather a sense that I was better utilized in other domains. I just didn't speak the language needed to carry off raising money to support student athletes.

That was a salient point. It is not so often a question of capability as it is a question of "for what?" In the four years I have led this enterprise, I've done well enough to bring in over $1m in non-dilutive funding, to support R&D efforts that I passionately believe in. I've moved out of my home office, to a building downtown. I've hired and fired. And I've made decisions (and delegated tasks) that I hadn't ever considered before then.

I'm most comfortable leading the technology side of things. I'm good at solving problems, about connecting disparate fields and ideas into a cohesive approach, about uncovering fundamental assumptions that serve as hidden roadblocks to resolution. I'm good at envisioning potential applications. But I'm not quite as adept at researching the market and determining price points, at grasping the strengths and weaknesses of competition, and the holes that provide a key to product success.

A restaurant runs smoothly only when the kitchen staff is skillful, the cleaning crew effective, and the waitstaff courteous and efficient. Running the technology end of my business is akin to being the chef. You must be responsive to the needs of the customers, and able to interpret their desires from the waitstaff. But somehow it's better that the waiters intervene.

Lately, I have come to realize there are limits to my capacity to continue wearing so many hats. The time has come to take a step back and decide just what areas are to remain my purview, and just which I will seek others to take on. Is it time for me to bring on a CEO or a VP for Business Development? I guess that may be the journey that begins around the next bend.

Is VC a Degenerative Disease?

Here's a pithy quote from a recent WSJ Venture Capital Dispatch blog post:

Venture firms have now gone a full decade without collectively returning a dime, causing their investors like pension funds and university endowments to question whether the venture capital model even works.

Is there any reason that an entrepreneur with a cart full of ideas, excitement, passion, and motivation should pause, gesticulate, and faun over VCs to gain their attention and hope for their largess?

For my part, I'll stick to developing the winning ideas, figuring out a way to make it from napkin to market to profits, with or without the suits to back me up.

Innovation vs. Old School Short-Sightedness

Today's Financial Times, includes a news analysis quoting the former U.S. Auto Czar Steven Rattner comparing allowing the auto inustry to fail with "dropping the economic equivalent of an atomic bomb on the Midwest."

Dramatic, huh? The question is... what would constitute "allowing the auto industry to fail." See, to my mind, encouraging transformative technological advances with the potential not only to retain old jobs but create new ones is a viable alternative to injecting good cash into bad businesses.

Try this on for size: rather than propping up the behemoth auto makers, why not create a pool of cash, say $100 million (small change to what they threw at the giants) to finance a handful of awards for projects that would push the envelope, creating, developing, and commercializing innovative automotive technologies, and a whole bunch of jobs with them. It'd be a cross between SBIR and public venture capital.

Why does it have to rest on private initiative, like the Automotive X-Prize to support these sorts of projects? Rather than arguing that allowing some particular old firms to fade is the equivalent of letting the automotive industry fail, perhaps government officials would do better to think outside the box. If we're going to spend taxpayer dollars on supporting business, why not do it in a way that supports society and job creation as well?

Problem is: if you hire people like Steven Rattner, former private equity executive, to run a bail-out scheme, you're likely to get results in line with old school short-sighted thinking. Perhaps it's time to be bold!

Proposed Tax Credit for Investors in SBIR firms

Proposed Tax Credit for Investors via The Pursuit.

Now all we need is some tax incentives for the entrepreneurs and small businesses themselves, to reward bootstraps as much as those who take outside investment:

• Allow the self-employed to fully deduct the cost of health insurance premiums, just like the rest of the employed population.
• Provide all employers (regardless of size) with tax breaks for creating net new jobs. Let's create a level playing field that actually rewards job creation.

Hungry Entrepreneurs Innovate

Startups: Poverty is Underrated. Be Glad That You’re Not Rich (via TechCrunch)

Firestorm against Nydia Velazquez

Small Business California notes the rising firestorm against Nydia Velázquez, current (and hopefully soon-to-be-departing) Chair of the House Small Business Committee, whose loyalties to small business seem to be ever more in question.

Rick Shindell's SBIR Insider posted notice a few days ago of Nydia's latest outrage in the form of the following statement (in her official capacity as chair of the House SBC):

Without the participation of venture-backed companies, the SBIR program has become little more than corporate welfare for marginal companies who are unable to secure external market based funding.

It's quite amazing really that she could be so (willfully) ignorant of the ways innovation and job growth have been spurred in this country for the past quarter century, and the essential role that SBIR and perhaps other similar programs have played in SEEDING innovative small businesses.

Once again, for the record, if there are any VCs out there with even the slightest interest in SEED FUNDING, stand up and be heard. No? Noone! I didn't think so.

SBIR, remade in the image of the puppet masters who control Nydia Velazquez (D-NY) and her companion-in-arms Sam Graves (R-MO), the committee's ranking member, would cease to foster, support, and sustain small business innovation and job growth. Unfortunately, it's not simply their actions, but the general inaction in Washington that most threatens the economy and the prospects for innovative high-tech small businesses to play our leading role.

The offending comment was not a private offhand remark, but passed on March 4 by unanimous consent of the entire House Small Business Committee as part of the committee's Views & Estimates document sent to the Chair of the House Budget Committee. Interestingly, the document was subsequently "corrected" to reword the offending passage, softening the language that calls for exactly the same thing: dismantling of the SBIR focus on seed funding of small businesses.

Read Scott Hauge's firestorm post on Small Business California. And read Rick Shindell's background on the story I describe here, then take action to urge our elected officials to do what's right. I join Fred Patterson in his call to have Velazquez removed as chair of the House Small Business Committee. It's time. Is anyone in the leadership in Washington listening?

Still not quite convinced

Understanding motivation can be key. My friend Fred Patterson, the SBIR Coach, calls it WIIFM: What's in it for me?

Only... we're sold a bill of goods by common assumption, that it's we, the entrepreneurs, the inventors, the scientists, the researchers, who must go as supplicants to the trough of Investors, tripping over ourselves to convince the moneyed that we are worthy of their largess.

I'm still not quite convinced. Turning the tables, I wonder "what's in it for me"? See, I'm a lone researcher, a radical, an oddball, who after several years as supplicant at the trough of Academia, after 150 faculty applications, and a miserable stint of Adjunct Servitude, decided to shirk the bonds I had willingly taken on, and head out on my own.

I stumbled into SBIR. And, now, little more than a year and a half later, my firm is growing from one, to a staff of six (four full-time). We're patent pending, about to start our first Phase II, and our second Phase I with a different agency on a related but distinct project.

I believe in the mission of SBIR to support innovation wherever it lurks. I believe in SBIR as an open competition of ideas, not as earmarks. I believe in the wise use of public funds to spur and stimulate and foster and fertilize the fragile seeds of innovation. What a wonderful idea: small pots of money for outstanding ideas, to support a short path to proof-of-concept.

What's in it for me? I have learned. A spare six months to delve whole heartedly into the realm of my passions, to test the mettle of my ideas, to drive those naked thoughts into evidence. Yes, indeed, this will work, and it will solve your problem. Then, the chance to compete for Phase II funding, to support a full-scale R&D effort for a couple years, creating high-quality jobs along the way. Finally, the chance to make those dreams a reality by commercializing the results of those ideas and that passion, solving real-world problems, paying back the largess of public coffers. That's a win for everyone.

But what's in it for me to (possibly prematurely) sell off parts of my firm to investors, whose interest may more likely begin and end with dollar signs, not passion, or ideas, or public interest? I'm not much for knocking on doors, beating the bushes, and doing a song and dance for investment.

I'm not much for paper entrepreneurship, writing dazzling business plans. Sure, I can project millions in profits like the best of them. Only, it's far more interesting (and difficult) to actually achieve it. Do I need private investment to get there? Will private investment ensure I get there? Will it help?

Those are the important questions. I can't say I know the answer just yet. I'll answer a knock at the door, and listen in earnest to the pitch. But for now, I think I prefer if they work to convince me. I always enjoy a good song and dance.

Tax break on profits again in jeopardy - The Boston Globe

Interesting headline on the front page of today's Boston Globe (Tax break on profits again in jeapordy). What reasonable justification is there for treating the investments by some few in the potential of someone else's ideas to provide a handsome return-on-investment as different and better than the investments of entrepreneurs in their own creations? Why is that tax incentives go to hedge fund managers, and venture capitalists, and angel investors, but not directly to the entrepreneurs themselves who invest not only sweat equity but often stake their own savings and the safety of their families?

What is the motivation behind such tax incentives? The argument in their favor is that "raising taxes on investment" will "weaken the economy". But how? Look at yesterday's post, and the opinion piece by Josh Kosman. Are hedge fund and VC investments really benefiting the economy at large? That's quite a debatable point.

Perhaps we should look at the sustainable and broad benefits of an entrepreneurial economy, about the benefits that accrue from seeding innovation at the earliest stages, and supporting research entrepreneurs in pursuing and maintaining their passions for bettering society. Perhaps by focusing our energies and tax incentives on these individuals themselves instead, we'll more likely strenghten the economy!

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Anyone opposed to increased access to capital?

Landrieu to Introduce Bill Increasing Loan Limits for Small Businesses.
(Thanks to Fred Patterson, the SBIR Coach, for spotting this):

Included in the bill is language to remove the "Small Business Innovation Research/Small Business Technology Transfer (SBIR/STTR) contracting exemption that was included in the Recovery Act." If you haven't been following along, someone (mysteriously, multiple hearings have been unable to unmask the culprit, as noone is taking credit) inserted language into H.R. 1, the American Recovery and Reinvestment Act, that effectively exempted $229 million of stimulus funds from being spent on small high-tech businesses for R&D under the SBIR/STTR funding mechansims (known as R41/R42 and R43/R44).

This action was arguably illegal, certainly unethical, as the language was inserted while the bill was under the authority of a conference committee, after having been passed by both Houses of Congress without it. As per the rules of Congress, the purview of a conference committee is to reconcile differences between House & Senate versions of a bill, not to introduce any substantive changes that were not a part of either bill.

If Landrieu's new bill passes, those $229 million* will be restored as per statutory requirements under the Small Business Act and numerous SBIR/STTR reauthorizations to set aside a small percentage (currently 2.8% total for both programs) of certain federal agencies' extramural R&D budget to provide seed (Phase I) and transition-to-commercialization (Phase II) funding for small business-led efforts. American recovery & reinvestment: it's even in the title of the act.

Access to capital means much more than providing loans to small businesses. And it means more than letting Venture Capital interest and investment serve as a proxy for a business' worth. There is a reason that SBIR/STTR have been so successful in stimulating the creation of new technologies, and getting those technologies to the end users where they will have the greatest effect, more effective than Venture Capital.

I've said it before, but it warrants repeating: it's all about seed funding, and continued support to get those sprouts to market!

* UPDATE * Actually the language of Landrieu's bill, S. 1832, would only restore $150m of the stimulus funds to SBIR/STTR. Apparently, according to Fred Patterson, this may have been a compromise NIH was willing to agree to. Considering Jo Anne Goodnight's current detail, away from her desk as NIH Coordinator for SBIR/STTR, to the Senate's Committee on Small Business & Entrepreneurship, it's not too far fetched that there is close (albeit tight-lipped) coordination between the activities of the SBE and NIH administrative personnel.

Sprouting Seeds

My friend, the SBIR Coach, recently posted reflections from attending the Conference of the National Association of Seed and Venture Funds (NASVF). He mentioned a recent conversation he had with Laurence Briggs, CEO of a private investor network:

What they look for is a proved-out concept for a product or solution addressing a significant market with scalability, and a good coachable team appropriate for their stage of development.

I read those words, and wonder at the first requirement for private investment: a proved-out concept. The image that comes to mind, reasonably enough I presume, is that of a seed, for a seed undoubtedly predates such proof.

Last I checked my botany, a seed by itself is anything but proved-out, especially the seed of a new hybrid or an untested variety. But what a wonderful package it is! All potential and for explosive growth at that. A seed is quite resilient, enduring a great many torments, even years of neglect. But a seed needs a few things to realize that potential.

1. A seed needs warmth and moisture to sprout, which provides proof of its viability.
2. But a viable seed may still die without the proper nurturing. Once we've obtained proof of viability, the seed needs the suitable conditions to root and leaf and grow. This is the testing stage, where a viable seed is coaxed into a relatively mature specimen, a prototype if you will of the field or forest it might become. Now we have a plant, but what sort of fruits will it produce?
3. If a mature specimen warrants our further interest, we need to attend to the task of reproducing it, distributing it, continuing to examine and study it to discover the ideal conditions and create them in field or farm or greenhouse.

You may notice something in the image: It mirrors the process of seed capital as represented by SBIR.

1. Phase I is the seed-sprouting stage, where we take an unproven concept and prove it out.
2. Phase II is the stage where a viable seed is taken to prototype.
3. Phase III is the stage where a prototype is brought to commercialization in a broader market.

It would seem then that Phase I, the true seed stage, is the untouchable part to private investors. The greatest value of SBIR is its ability to leverage public funding, through a highly competitive process to identify the most promising kernels of ideas, along with the appropriate team to take it from unproven concept, through proof, prototype, then commercialization.

If SBIR is transformed--as many in the House Small Business & Science Committees are intending and entrenched to do--to preference the later stages of business development and growth (the stages preferred by Angels and VCs), then what source would remain for the true seed stage of innovation?

Some might argue that seeds are in too great abundance to be sorted by non-experts. Surely, it is the risk factor involved that stays many Angels and VCs from entering the fray at this early stage. Yet innovative science and technology take time, sustained effort, and commitment: often more of these three than most realize or would care to support.

This is perhaps the genius of SBIR: it allows Program Managers to define high priorities for their particular programs, to solicit proposals that address those specific priorities, have these proposals evaluated by experts, if not experts in the fields of research at least expert in the problems that need resolution. It permits federal agencies that spend billions of taxpayer dollars to reserve a small portion of those funds for work by small businesses, to serve the greater good, to stimulate innovations that might otherwise sprout and die on the sidewalks of neglect and indirection, ones which large corporations and universities have not or could not achieve.

It focuses the minds of innovative researchers to solve realworld problems, fertilizing the growth of the entrepreneurs who will create and lead new industries built on new technologies that remain unimaginable today. Innovation by definition has no peers. Again, I ask, if SBIR will no longer support this earliest stage, then who or what will?

Nota Bene: we judge small businesses differently

First, a disclaimer: my firm currently has an SBIR Phase I proposal under review at the NSF, submitted in early June, for which, if selected, the author of this post would serve as PI. That said, I respect the integrity of the process and trust that my comments here should have little to no bearing on the merit review of the proposal, either positively or negatively.

The NSF website prominently notes:

Consideration of proposals usually requires up to six months.

From the viewpoint of a small business seeking support for R&D, I would welcome the passage into law of §204 (3) (B) of H.R. 2965 EAS :

...a final decision on each proposal shall be rendered not later than 90 days after the date on which the solicitation closes unless the Administrator determines, on a case by case basis, that a decision may be extended from 90 days to 180 days

That's old news (though we still await the final version of the SBIR/STTR Reauthorization Act)! What caught my eye today however was a passage on the NSF website, from their instructions to the Phase I Technical/Commercial Peer Review Panel. Here it is verbatim [emphasis theirs]:

(N.B.,SBIR/STTR INTERPRETS THE NSF CRITERIA SLIGHTLY DIFFERENTLY THAN THE REST OF THE FOUNDATION BECAUSE WE ARE LOOKING AT RESEARCH THAT IS CLOSE TO PRODUCING A MARKETABLE PRODUCT (i.e., "Advanced Applied Research,") NOT BASIC RESEARCH. The science/engineering entailed in the project may be well understood; the novelty may lie in the application.)

Interesting use of the word may there. What if... let's be radical here... what if the science and engineering were cutting edge, rather than "well understood" despite its origin in a small business, rather than a university? What if the novelty lay not merely in the application, but in the approach itself? Let's just say it does. Let's just posit the possibility that a small business enterprise might be truly innovative. What then?

I'd like to think that my firm fits that latter description, because frankly it doesn't well fit the former. The science and engineering is not well understood (at least not outside my company), because it's novel. I have argued on this blog rather passionately for seed-stage funding through SBIR and perhaps other mechanisms. I admit this passion is in part self-interest. Seed funding is hard to come by.

VCs and others are aligned to invest in businesses "close to a marketable product," but not, as it turns out, in potentially transformative but yet unproven ideas. Why should NSF SBIR fill that same niche, when true seed funding is remarkably scarce? Does the cited guidance to NSF technical reviewers hint at a presumption that small businesses are not capable of scientific innovation?

The requirement is well established that SBIR applicants must justify their proposals with a strategy toward commercialization (which already distinguishes SBIR from other NSF programs). It is a requirement that we in the small business community embrace. The guidance seems to go beyond that however. It is not merely asking for commercializability, but in essence preferencing later stage efforts over early-stage R&D, but doing so merely for small businesses, asking us to compete not to a higher bar, but on another track.

How different from the stance of the DoD :

Our appropriated funds are designated for research and development. By law, we cannot spend them for anything else.

What leads to such disparity by different agencies both authorized to fund innovative research by small businesses? Let us only hope in the end that innovation leads, not guidance.

A Matter of Stage

The terms seed stage, early stage, and startup are bantied about as if their definitions were self-evident (or more likely as if their use were intended to evoke an emotional response without regard to the precision of their meaning). But the meaning of these terms in context is crucial to understanding the availability of funding for innovation, and just why SBIR and similar resources are so critical to the well-being of our economy.

The following definitions come from PriceWaterhouseCooper's MoneyTree™ report:

Seed/Start-Up Stage: The initial stage. The company has a concept or product under development, but is probably not fully operational. Usually in existence less than 18 months.

Early Stage: The company has a product or service in testing or pilot production. In some cases, the product may be commercially available. May or may not be generating revenues. Usually in business less than three years.

Expansion Stage: Product or service is in production and commercially available. The company demonstrates significant revenue growth, but may or may not be showing a profit. Usually in business more than three years.

I attended a luncheon yesterday ostensibly addressing "The State of Angel Investing." Oddly, the speaker, Joe Kremer, director of the Wisconsin Angel Network, insisted against all evidence to the contrary (and providing none of his own) that "Venture Capital is entering into more and more earlier stage deals."

Um... what? He provided a chart of the "Financing Continuum" (which to his credit is a very clear and useful resource -- a larger version of the chart can be found on p. 4 of the Wisconsin Technology Council's report "Wisconsin Portfolio"). If you look at Kremer's version, you'll note a line running through the middle of "Product Development" and toward the end of "Start-Up Funding". To the left of that line is what Kremer called "early stage". Venture Capital is almost entirely above that line.

"Do you mean that VCs are funding more deals below that line, because my understanding and experience say that VCs have no interest, 0% in funding pre-prototype R&D." Uh... well, I consider prototype a pretty early stage event, was his reply.

Down at the earliest level of funding is SBIR/STTR. It rivals only the Four Fs. In other words, without SBIR for seed stage funding, only the wealthy can afford to enter the realm of innovation. Anyone can have a great idea, regardless of their present financial status.

If founders, family, and friends are simply not able to provide the seed capital to develop that idea into a proof-of-concept then a prototype, and no other source of funding is available, that idea will die. Period!

SBIR provides a means for open competition of ideas to gain such funding that is simply not otherwise available: no where, no how.

It's all about seed capital!

Claiming stakes

Worthy of note:

Growthology reports on an NVCA study that

"claims that VC-backed companies accounted for ten percent of employment in 2006 and some large share of recent job growth. Yet when you scroll down to the data tables, you see that they take year 2000 employment of a company that once received venture capital (e.g. Intel), then year 2006 employment in that company, and attribute the change to the fact that company once received venture capital. Voila! Are you telling me that the VC investors in Intel played a role in the company's job growth between 2000 and 2006".

NVCA has a penchant for staking claims on all the good that has ever been done by anyone once affiliated with a company that at some point in its life cycle had permitted itself to take some funding from an organization that at least had some association with a relative of someone who once walked in front of a building that was in part owned by a future or former venture capitalist.

Look! Let's make this clear: good ideas become innovations. Good businesses are built on the foundation of those innovations. Researchers and entrepreneurs provide the ideas that become those foundations. At best, venture capitalists provide some funding, insight, marketing, and business sense to contribute to the success of a venture based on the good ideas that emanate from a researcher or entrepreneur. It is possible for a symbiotic relationship to accrue, whereby a mutual respect permits innovators and VCs to collaborate on building great businesses. But it is in no way a foregone conclusion that a good idea requires VC funding to become a great business, nor is it in any way assured that the receipt of VC funding will positively impact such a company's potential success.

Period! Full stop!

The Color of Money

DefenseSolutions.gov is a relatively new website described as "The U.S. Department of Defense New Idea Portal". Thanks to the SBIR Coach, where I first read about this resource. This morning, I received an email notification of their latest update, removing some fulfilled requirements, and adding a few others.

Of note was the following statement regarding why some worthy endeavors were not funded:

... because DefenseSolutions.gov is a research-oriented endeavor, we could not fund some good ideas because they required little or no research to complete the associated development. This is a legal, "color" of money restraint. Our appropriated funds are designated for research and development. By law, we cannot spend them for anything else.

Whatever legal restraints exist on their funding ought naturally to be part of SBIR as well. Small Business... Innovation... Research. The argument I have been making all along is that SBIR represents a pot of funds for early stage research. Without a funding source for independent researchers, innovation suffers, simply because established researchers affiliated with established institutions, have established expectations and established assumptions, regarding established practice.

If SBIR fades as a resource for seed funding, what alternatives exist for independent researchers, entrepreneurs, and small businesses to pursue early stage R&D? Will organizations like the National Association of Seed and Venture Funds step up to the plate? Will agencies, like the DoD continue to provide alternative sources, like DefenseSolutions.gov? What other resources are out there?

Where's the bootstrap?

There's an old principle that if you don't come to the table knowing what you want, someone is sure to sell you a bill of goods and convince you it's just what you need. The circle is self-perpetuating: If I've been sold that bill of goods, I just may come to believe it is indeed what I always wanted; and I'll go on to persuade others as well.

What I'm familiar with just seems right: sauerkraut on hot dogs; corned beef on rye; the home team, because they're mine, not because it makes any objective sense. If I'm told over and over that raising investment capital is how you build a business, it seems backed by generations of experience. I may be inclined to believe it.

But then, innovation requires challenging underlying assumptions, finding alternate routes to the same destination. The goal is to build a successful company. What is needed to get there? Sure, capital: you need money to purchase equipment; to pay for an office; to hire and retain staff. But as they say "it all pays the same".

Interestingly, however, it doesn't all cost the same. What is the trade-off for any given source of capital? SBIR provides funds in exchange for the sponsoring agency's royalty-free access to the resultant technology; Banks provide loans (well, mythically at least) in exchange for a percentage of interest to be paid on top of the principal; Angels & VCs offer funding in exchange for a percentage of ownership. Each has its place. Which makes most sense for your business needs, and most especially your long-term plans?

Matt Storms at AlphaTech Counsel has penned an article about a study on how companies with various sources of startup capital fare at their Initial Public Offering (IPO). Among the pithy bits that he relates [emphasis is mine]:

The average size IPO for venture capital backed companies was smaller than any other group of companies. The highest average size IPO came from companies that were neither angel investor nor venture capital backed; in fact, the average size IPO of this group of companies was more than 2.5 times that of venture backed firms.

VC & Angel backed enterprises were quicker to go public (and likely quicker to be sold off or shutter their doors as well--they do call it an "exit strategy" after all). So, if you want quick and small rewards, VC funding is the best bet. But, if you're planning for the long haul, accomplishing something lasting, and garnering the greatest gains, perhaps a bootstrap is for you. And do bear in mind: even a bootstrap may someday come to seek outside investors. While conventional wisdom advises to seek capital before you need it, the longer you delay (assuming you remain successful and viable), the more valuable your company will be, when you do eventually seek it, reducing the cost of that capital in terms of ownership.

A bunch of fools

SBIR reauthorization has moved into high-gear negotiations between the principals of the Senate Committee on Small Business & Entrepreneurship, the House Large Venture Capital Small Business Committee, the House Only-Universities-Do Science & Technology Commitee. The aim is to reconcile the disparate legislation represented by H.R. 2965 and S. 1233.

Apparently, both sides are "negotiating in good faith." Though, from this blogger's perspective, the proof will be in the pudding. Compromise is the only game we have to play at this point. Rather, it's the only game we have to observe from the sidelines, rooting, cheering, and booing as we see fit.

Looking ahead, the issue remains: how can we as a nation, as a people, best support and sustain innovation? I worry at a closed system that sets up unnecessary and counterproductive hurdles to new ideas, shutting out the outsider rather than establishing a meritocracy of ideas. There is a dangerous set of assumptions out there that: the best (indeed the only quality) science is conducted at universities and guided by peer-review; and that investment from large Venture Capital firms can serve as a meaningful proxy for the value of innovative ideas. Both assumptions are verifiably and patently false!

Let me illustrate from the world of science:

• If you want to go into research, you need to get into the best school as an undergraduate, serving under the best adviser.
• If you fail at that--when you're eighteen and fresh out of high school--you'll have greater difficulty getting accepted at a top ranked graduate school to serve under a big-name researcher in the field.
• If you fail at that, you'll be hard pressed to obtain a high-quality post-doc.
• Without a high-profile post-doctoral appointment, you'll have trouble getting a respectable research appointment... etc. etc.

Every step of the way, it is easier to move further from the goal. And funny that, because the goal is not (or at least ought not to be) getting into the right school, or serving under the right person, but rather conducting high-quality research, to achieve a breakthrough.

The Wright brothers weren't established ornithologists. They didn't study under the biggest names in aeronautics. They made and repaired bicycles! But they had a dream, and a vision, and the dedication to see it through. Innovation comes from great ideas, being pursued to their logical extremes, often against all odds, and subject to an enormous amount of persistence and perseverance on the part of the innovators.

It does not spring miraculously from following all the rules, fitting in, standing in line! "Innovation has no peers--by definition!" Which leads us to the question: how best can we stimulate and sustain innovation?

A year and a half ago, I attended a workshop at the University of Wisconsin-Madison on starting a high-tech business. It was there that I first learned about SBIR. But it was also there that I first heard a description of the "four Fs" of startup investing:

• Founders
• Family
• Friends
• and Fools

This, coming from an Angel Investor who was lead instructor. Fools? There's that aphorism: A fool and his money are easily parted.

Perhaps the biggest hurdle faced by research entrepreneurs is the view that early-stage investment in the form of seed-capital is a fool's errand. Indeed, the three decades of SBIR success, the tens of thousands of patents, the hundreds of thousands of jobs created, the thousands of companies that got their start from SBIR alone, all attest to the wisdom of seed-stage investing (when done well, which SBIR does).

The question is: if we weaken the ability of SBIR to provide seed capital to sprout a field of ideas (Phase I), remove the wilted seedlings and prune back the weaker branches (Phase II), then transition to harvest (Phase III), what will replace the resource? Will those large venture capital firms that have spent millions of dollars lobbying for nearly unfettered access to ownership and control of SBIR-eligible firms step up to the plate and prove the wisdom of folly? And if they did, would that be the best resource for research entrepreneurs?

It's funny that the argument most popular among those Representatives railroading through a change in eligibility rules has it that the proposed change is intended to make it easier for small businesses to obtain funding, and to allow small businesses rather than Washington bureaucrats to make decisions regarding the source of their funding, whereas the opposite is the likely result. Reality is, if the changes pass into law--furthering the trend toward later stage growth businesses, rather than continuing to support early-stage ideas--fewer high-tech small businesses will have any chance whatsoever, and those that do will more often be forced to take venture capital investment (which has been described as the most expensive money you will ever take, because of the hefty equity stake VCs require for their investments).

What a pity that would be!

Baseball Bats & Tennis Courts

Yesterday, my friend and colleague Fred Patterson, "the SBIR Coach" sent out an email with article links regarding SBIR reauthorization. The odd and infuriating thing about those articles was that nearly every one of them plied disinformation. Some were bizarre in their reporting, making free with the details. It's as if an historian talked about Ben Franklin being caught at a red light on his way to the airport. Some were honest mistakes. Others were intentional, like the repeated argument that changes were intended to "modernize" SBIR to make it easier for small companies to raise capital.

Here again is the link to the floor discussion on the "structured rule" of H.R. 2965. You can read many of the political arguments there. Bear in mind however that the voices heard represent only those which were allowed by the two chairs presiding: Jared Polis and Virginia Foxx. Moderate voices like Ed Markey's were not heard. We heard opposition mostly or entirely from Republicans, making it seem like a partisan tussle. Unfortunately, some of those Republicans used their spare minutes to bash the Democrats, rather than address the issues, reinforcing that false impression. Representative Donald Manzullo from Illinois was a refreshing exception, making clear that reasoned opposition came from members of both parties, singling out proposed amendments by Democrat Ed Markey and Republican John Gingrey.

But I want to clarify the issue here:

This is not about protecting the little guy!
This is about preserving SBIR as a source for seed-capital!

Imagine this: Barry Bonds meets Serena Williams at Wimbledon. Barry represents VCs; Serena stands in for innovative small businesses. Barry brings a bat. What's the deal?

Some will see a big bully with an unfair advantage. But the issue is certainly not that Serena Williams couldn't take Barry in a tennis match. The problem is that he's brought a baseball bat on a tennis court! There's no question whether Barry could knock that little yellow ball out of the ballpark. It's not that VCs are big and burly, that they're unfair competition. It's that they're playing a different game!

GET OFF THE TENNIS COURT WITH YOUR BAT, YOU MORON!

SBIR was created to provide seed capital for promising early-stage ideas. That's Phase I. Bring us an idea that hasn't yet been tried, to solve some problem in the world that wants resolution. We'll give you a small pot of cash to fund one or two researchers for 6 months to a year, to test the feasibility of that idea. And while you're at it, give us a commercialization plan: what's your market? Don't worry, it doesn't have to be big, it just has to be realistic, large enough to get you independent of federal dollars in a couple years.

If your idea proves feasible, we'll give you a medium-sized pot of cash for a couple years to fund the development of your idea into a prototype. That's Phase II. If your prototype delivers on what it promises we'll help you along to get your prototype in the hands of end-users who need it. We'll acquire it if we need it, and we'll encourage you to find strategic partners and investors to make it commercially viable. That's Phase III. It's a system that has worked for three decades.

You see the pattern here? SBIR is for seeding ideas, proving out their feasibility, developing prototype solutions, and culminating in commercialization. That's not new. That's the way it's been. Many of the changes proposed by H.R. 2965 are not modernization, they are destroying a valuable resource. VCs follow another model, say the rules of baseball vs. the rules of tennis. They're both worthy sports. It's just baseball doesn't belong on a tennis court.

VCs want big markets, rapid growth, and a clear and short-fused exit strategy. If your idea will save 200 lives a year, and garner $3m in annual sales, no VC or large corporation will touch it. That's why we need small businesses as well. That's why we need seed-capital. VCs invest in companies; SBIR invests in ideas (at least it had before H.R. 2965). That's the issue!

Here's the fact: A higher percentage of independently-held SBIR firms commercialize their SBIR-sponsored products than VC-held firms do. [Venture Funding and the NIH SBIR Program, National Research Council of the National Academies of Science, June 2009: Figure 6-1, p. 49.]

If SBIR is transformed in the way that H.R. 2965 intends, the last vestige of reliable seed-funding for promising ideas in the United States will have dried up. Mark my words: if this becomes law, the U.S. will lose a great many research entrepreneurs to foreign countries that are more amenable to innovative ideas, and fewer foreign innovators will be migrating to America, choosing more welcoming destinations.

Paul Ryan statement on H.R. 2965

Rep. Paul Ryan (WI-1) has issued a statement following the passing of the flawed H.R. 2965, including the following remark:

I was troubled by the Majority’s rejection of a commonsense improvement that would have gone further in support of small businesses. Legitimate concerns were raised on the impact on venture capital ownership restrictions, and I was eager to support an amendment to address this issue introduced by Representative Ed Markey, my Democratic colleague from Massachusetts. Unfortunately, the Speaker did not allow a vote on this provision.

Huff and puff and...

The great strength and value of the Small Business Innovation Research program (SBIR) has always been its ability to seed promising ideas that otherwise might never get off the ground. The innovations that have resulted from SBIR seed funding have saved lives, have saved money, and have provided the federal government and the economy at large with an enormous and incomparable return on investment. This return has taken the form of high-quality and enduring jobs, and transformative innovations that have reached the marketplace where they can benefit the general public as well as the sponsoring agencies.

The overwhelming majority of these innovations have been achieved by independently held small businesses with little to no venture investment. If you don't believe it, the Small Business Technology Council and Anne Eskesen's Innovation Development Institute have compiled extensive statistics on the matter.

The argument that venture capital involvement can be used as a proxy for validity of a small company's viability is a false one. VC investment strongly favors only those companies that are poised for rapid and significant growth. Both the tortoise and the hare finish the race, sometimes in ways you might not expect. Growth and expansion are not the best measures of innovation or value to society.

How many Boston Markets, Circuit Cities, and Starbucks have we seen over-expand and grow too rapidly, resulting not in benefit to society but in the rapid loss of millions of jobs, despite a few shareholders making millions. Winning the lottery provides rapid and significant ROI as well, but its beneficiaries are few, and their largess often smaller. If the principal focus is on short-term financial gain, innovation often suffers. According to the prominent Venture Capitalist Marc Andreesen: "When companies are acquired quickly, innovation slows down."

The greatest threat posed by H.R. 2965 is not its weakening of the eligibility rules, to remove all restrictions to VC participation. If their participation in the end supports the aim of stimulating innovation, creating jobs, and benefiting society, there should be little to complain of. But that's a big "if". The greatest threat is that the proven effective three-tiered system (Phase I: feasibility; Phase II: development; Phase III: commercialization) will be dismantled and discarded.

H.R. 2965 does far more than alter eligibility requirements (perhaps the least of its vices). It raises the caps for funding far beyond what can be justified by inflation (are wages really 250% higher today than a decade ago?), without increasing the pool of funds (by means of raising the allocation percentage of existing expenditures). $10 million can be 100 awards at $100k or five at $2 million each. The math is pretty simple. The net effect of this change will be an immediate and lasting reduction in the number of awards issued (meaning fewer promising ideas will get the chance to move ahead).

But it's worse than that: H.R. 2965 mealy-mouths a requirement for Phase I, opening the door for "justifications" to bypass the crucial feasibility phase, and the bill explicitly authorizes concurrent Phase I/Phase II awards, as well as perpetual consecutive Phase II awards. This means discarding the requirement to prove feasibility before garnering larger awards (as proposed to be on the order of $2 million), and removing any oversight that might enforce that the ideas funded hold commercial viability beyond perpetual government subsidy.

This is not about protecting small businesses from the Big Bad Wolf. Entrepreneurs can hold our own. It's about safeguarding that American taxpayer dollars will be well spent, that the investments made to stimulate innovation will be sufficiently diversified to ensure that in the end the American taxpayer is the greatest beneficiary. What a refreshing change from recent policy that would be!