University Startups and Spin-Offs: Guide for Entrepreneurs in Academia (2015)
Part I. Strategies for University Startup Entrepreneurs
Chapter 14. Moving Past the Startup Stage
The prospect of having to micromanage their company’s taxes, accounting, payroll, and sales calls and handle all the other unpleasant byproducts of entrepreneurship is often a turnoff for students and researchers. Whether they are good multitaskers is another question. A world-class entrepreneur should not waste time filling out a tax return that an accountant could complete for $100. But to reach the point that you can delegate all the support tasks, you need to understand what it takes. The first stages of entrepreneurship are yours and yours alone. Doing everything in the beginning does not mean things will always be that way. It is important to realize that your venture will graduate from bootstrapping and MVP testing mode at some point. In order to be a business, it must eventually launch a final product and take off.
I have discussed the most important three analytical tools in your startup toolkit: the lean canvas, the financial model, and the one-page proposal. You have learned many approaches that can help you leave the building and get real feedback about your product. You know how to incrementally develop products the market wants, using “build, measure, learn.” And you have become acquainted with several techniques to engage others with next steps and improve communications so they see a benefit in what you offer. Your startup may be in MVP testing mode or may have launched products. You may be bootstrapping, or you may have made sales. In any case, you have taken the first steps and are now an entrepreneur. That’s the most important thing, and I applaud you for following through. You cannot skip the first stages of startup entrepreneurship discussed in this book so far. They lay the foundation for everything that follows.
After being a startup entrepreneur for a while, you understand what it takes. There will be a time when you are ready to pull the trigger and move past the startup stage. Then you can decide if you want to continue running the business yourself. Perhaps you have found your entrepreneurial stride and are fully comfortable managing your company from here forward. This is an exciting endeavor, and when your startup has taken off, the hardest part is often behind you.
Alternatively, you may begin to look for synergies from the outside. Once you have tested various MVPs and confirmed your value and your growth hypotheses, you have armed yourself with enough knowledge to engage a joint venture partner or raise capital from a venture capital firm. If you do, you will no longer be responsible for everything and will integrate an established company in your operations. This is a viable option that could help you tap into a larger network and scale your operations.
The legalities of entering a joint venture deal or signing a term sheet with a venture capital firm are complex, and other sources discuss them at length. This chapter gives you an overview of what to expect when going down either path.
Seeking a Joint Venture
Small and medium enterprises (SMEs) and multinational companies may approach universities for collaborations with research projects. These collaborations are often limited, with a knowledge transfer in favor of the company. Because most universities are far from being startup hubs, companies cannot be blamed for that. Startups that currently launch out of universities have little traction in the market and little conviction about their business models and future direction. Naturally, they cannot make many demands on industrial partners. As a result, they frame discussions with established companies not as being about real joint ventures between startups and industry, but rather as being about sponsored research partnerships.
R&D can be costly for companies, but by sponsoring research teams and tapping the knowledge of a university, they can save millions of dollars. With more and more university startups on the horizon, the focus of such partnerships is beginning to shift. Students and researchers have more strategies available to develop products that satisfy a genuine need in the market. When market testing shows that enough people are willing to pay for their products, university startups are standing on stronger footing. They are viable companies, often with existing revenue and a sizable present value. This opens the gateway to an entirely new value proposition: instead of a collaboration between a company and a university research team, a joint venture is a collaboration between two companies. The expectation is a two-way knowledge exchange where the startup entrepreneurs learn as much about doing business as the joint venture partner learns about technology—a win-win situation for both parties. University startups should begin to lead the discussion in this different light.
Unless someone on your team is a natural born manager, I recommend you look for a joint venture partner around the time when you are ready to launch your final product. There is of course no surefire way to land the joint venture of your dreams. The only certain thing is that the collaboration should benefit both parties. After you have validated your value and growth hypotheses, you will be in a good position to approach potential joint venture partners. You may already be in contact with companies that service the same market as you. Investigate whether they can bring synergies to your venture: scale, better distribution, or access to better manufacturing technology. At the same time, the feedback from your MVP tests, along with your financial model, should make the case that your company is a decent business worth considering as an investment. You may still have no revenue, but if your final product and outlook are a match for them, joint venture partners may want to collaborate with you.
You will rarely convince a joint venture partner with numbers and logic alone. Chemistry and mutual trust are often more important than anything else. Unless your company already makes millions of dollars a year, you should look for a joint venture partner who likes and appreciates your team, your history, and your effort. If you have developed a product with MVP testing and have validated your hypotheses, this entrepreneurial achievement may be the deciding factor that causes a company to partner with your startup instead of another one that is still deliberating how to get started.
SMEs can be very good joint venture partners. The founders of these companies are often still at the helm as CEO, so they may sympathize with young entrepreneurs who have made something out of nothing. Conversely, in a multinational, daily business is dictated by shareholder demands. In such top-down bureaucracies, the human factor is less prevalent; thus it may be more difficult to start a discussion with a partner who is a giant in a market.
Let’s say you identify a few potential joint venture partners. How do you approach them and open the discussion? As you may have guessed, you apply the same communication tools you used to get your startup off the ground. The world has not changed much in the meantime. Third parties still want to see the benefits of your product; they want to know how those benefits relate to solving their current challenges, and you must engage them with actionable next steps.
Show them the test results from your MVP testing and your incremental product development. Introduce the final product that you determined is desired by the market. Your lean canvas should summarize how this relates to the potential joint venture partner. The assumptions behind your financial model will open the discussion about pricing and cost structure. Then move the discussion along with one-page proposals. This involves several steps, with the ultimate goal of selling shares of your startup to the joint venture partner and becoming part of their network.
A joint venture is simply an offer to another businessperson that they see as valuable. You should already have learned how to do that several times over in this book. The exact structure and terms of your joint venture is outside the scope of what we are discussing here. When you reach the point that negotiations and legal agreements enter the picture, I recommend you work with your lawyer.
Raising Venture Capital
I have previously talked about venture capitalists and how they can help your startup with capital and expertise. Although I said that early venture funding may be a disadvantage for a first-time entrepreneur, it can make sense when a company has developed far enough to launch a final product. This product should have solid, confirmed market demand. Revenues are therefore on the horizon. With this value proposition, your startup becomes interesting for a venture capital firm as an investment.
Before you sign the investment agreement with a VC, you should have a clear idea of what raising venture capital entails. Other books sufficiently explore the legal side of this. I will simply present an overview of the process of entering into business with an investment firm in case your startup chooses to go down that road. Note that this is a different proposition than passively meeting venture capitalists who approach your university. You will see later in this chapter that your active participation is paramount to identify the right venture capital firm.
Before reaching out to investors, develop a clear idea of what your company needs; only then can you scan the venture capital landscape and pick a firm that matches your vision. Do your own due diligence on these firms. There is a great variety out there, each with a distinct focus and track record. Study all the information you can find, and think about whether this firm can bring you value other than money alone. Firms that randomly approach your university most likely will not make that shortlist.
Venture capitalists Brad Feld and Jason Mendelson give a good outline of the process of raising venture capital from the perspective of startup entrepreneurs.1 Their recommendations include some the points explained in the rest of this chapter.
Determine the Amount of Capital You Need
The amount of capital you need tells you which venture capital firms to approach. VCs specialize in terms of the stage they fund. A firm focused on later-stage funding will hardly consider a startup that incorporated yesterday, just as an early-stage fund will not invest in a company that aims to raise funds pre-IPO. A smaller firm or angel investor may seed amounts up to $500,000. If your startup is raising $10 million, then a larger VC firm will be a better partner.
Have a clear idea of the number you are aiming for. Never offer a range of, say, $4 million to $6 million. You must know whether you need $4 million or $6 million. Instead of letting the other party figure out what is best for you, work it out for yourself, and then confidently ask for it.
Have Your Fundraising Materials Ready
The materials you need include the following:
· Executive summary, compiled with the saying “less is more” in mind. Fit as much information as you possibly can on one page. Avoid any fluff. Fancy design is unnecessary.
· PowerPoint presentation in 10/20/30 format.
· Elevator pitch with your micro-scripts.
· Lean canvas. You may have several, according to different scenarios.
· Financial model. As I said before, more important than impressive numbers are the underlying assumptions of your financial model. Be able to explain how you arrived at the numbers in your model.
· Demo or prototype. This may be more important than all the other documents together. Even if it is still in early development, a demo shows the VC what you are working on. If you already have your final product, then bring that. If it is too big, bring a video, or invite the VC to your lab. Having a prototype available shows that you are serious with your startup and ready to move to the next stage.
· Due-diligence materials. When a venture capital firm is ready to sign a term sheet with you, it will ask for capitalization tables (how the shares of your company are distributed), contracts and material agreements, employment agreements, licensing agreements, board meeting minutes, and so on. You do not need them in the first meeting with a VC. Regardless, make it a point to assemble these materials early so you can easily access them when needed. You should never hide anything unpleasant, such as a current dispute or similar issues. It is better to bring those up right away and be clear in the future.
Despite what anyone else may advise, forget about writing a business plan. Most VCs have not read one in years. The same goes for what is called a private placement memorandum (PPC). This is necessary only when your negotiations have progressed significantly. Bringing one with you to the first meeting is overkill and will only raise red flags. A venture capitalist will most likely ask you to e-mail something first, so make sure your documents are light enough to be attachments.
Finding the Right VC
Hopefully by now you have a sizable network of fellow entrepreneurs in your city and beyond. Ask them about their experiences with VCs and which ones they recommend. It is much more powerful to be introduced by another entrepreneur who already knows the venture capital firm than to cold-call them. A good VC firm receives thousands of submissions per year. You need to cut through the clutter any way you can, and personal introductions go a long way.
Research the different firms on the Internet. Carefully study which other companies they have invested in. Examine their track record. Google whether there are any lawsuits against this venture capital firm or any of its partners. Just as VCs investigate your startup, you have the right to know what they are doing. Ask for a list of entrepreneurs the VC has worked with and startups it has funded. Call some of those startups and ask what their relationship with the venture firm was like. The best VCs will give you this list. If not, feel free to ask. If a firm balks at providing references, then ask yourself whether you want to work with an nontransparent partner.
As mentioned before, most VC firms will not sign an NDA with you. This is less alarming than it may seem. Reputable venture capitalists are busy and have no time to steal your ideas. You should have weeded out untrustworthy firms long ago with your own due diligence.
Of course, a meeting with a venture capital firm is no guarantee that it will invest in you. Even after prolonged due diligence, the firm may pass on the deal. This can happen directly or indirectly, when the VC simply stops returning your e-mails. If a firm turns you down, you should try to find out what happened and why it chose not to invest. This information is important for your path ahead. Persistently probe until you find out.
If everything goes well and both the VC and you feel that working together is in your mutual interest, a deal will come to pass. This stage is often split into two separate activities. Part one is signing the so-called term sheet, a document that outlines the final deal structure. As Feld and Mendelson explain, the most important aspects of the term sheet are economics and control. Economics relates to how the venture capital firm will share in profits, through either a sale of the company or an initial public offering (IPO). Control refers to how the VC can influence the direction of the company either directly or by vetoing certain decisions of the CEO.
Without going into more detail about joint ventures or raising venture capital, your startup is well on its way when you have reached this stage. Serious contact with established companies or investors will seldom take place early in the life of your startup. As you have seen, you must have validated assumptions about your product and your market before you can move on. You should have a clear picture of your business model and what your startup can provide to others. And, most important, you must have explored whether entrepreneurship is for you. As much as you may want to, these steps cannot be skipped. They are necessary to build a strong foundation for your startup.
1Brad Feld and Jason Mendelson, Venture Deals: Be Smarter Than Your lawyer and Venture Capitalist (Hoboken, NJ: John Wiley & Sons, 2011).