Experimenting on Someone Else's Dime

Lets face it, losing your angel investor or venture capitalist's money is painful. It's even more painful to lose money from your friends and family. Running your startup experiment using their dollars is incredibly hazardous. So how to fulfill your startup dreams? Run your experiments on someone else's money.

When I was first starting out as an entrepreneur, we were trying to do an agricultural biotech business and had great science and a cool technology, but knew little to nothing about the industry (we had a great team of advisors who saved us from many mistakes). So that meant that we spent an incredible amount of time and energy figuring out all kinds of aspects of our business model that other people pointed out to us over and over again that we really should have already known. We were re-inventing the wheel at almost every turn.

I see the same thing often happening with my students and their startups in my class now. I pair them up with well-matched industry mentors and this helps to some extent. Much like having a cofounder team with some younger and naive entrepreneurs who are willing to experiment and try new things as well as older, experienced entrepreneurs who know everything that's been tried in the industry over the past 30 years.

This video advocates accelerating your learning through strategically gaining work experience. It also relates to at least three of the papers I've written with coauthors. The first talks about the entrepreneurs who have come out of MIT over the past several decades. We again find that while the average age of the entrepreneur has been shrinking, most get some industry experience first.

The second looks at serial entrepreneurs. Here we find that when the industry or technology are completely new, the first time entrepreneur has a much better chance at success. However, when the experienced entrepreneur is using a similar technology and is in the same industry/market as the previous startup, it's hard to beat the benefits of that prior experience and the experiments that he or she already learned from. The third piece of research this is based on is a study of the roles on founding teams. We found that when a team is using a high innovation strategy and will partner with large firms for marketing and distribution, then having an engineering focused team is best. However, when competing in the product market with incumbents or using an imitation strategy, the team needs cofounders who have a variety of skills and roles to cover marketing, sales, and so on. So the area where you need to experiment depends on your business model.

Reid Hoffman at Stanford

While we're waiting for the course videos I thought I'd share this great talk from this Weds. at Stanford's ETL lecture series by Reid Hoffman.

Google OpenID

We'll be using Google OpenID for authentication for the quizzes. http://code.google.com/apis/accounts/docs/OpenID.html

Also considering posting the course videos and quiz links to a Facebook group as well if we can.

Class today with Fergus Hurley, CEO/Founder of Focal Labs

VC Returns in Silicon Valley versus the rest of the US

I received an interesting question today from an entrepreneur friend who I met a while back at the wedding in NYC of one of my doctoral classmates from MIT Sloan.

He is working on an early stage startup and said that at a Board meeting, they were discussing venture capital and geography and the question was whether there was a higher or lower return on venture capital investments in Silicon Valley compared with other regions?

So he wrote to ask me whether the data back this up. 

This is a very interesting question because it could very well be that due to all the competition for hot deals (startups) in Silicon Valley, this drives up the valuations and thus drives down the venture returns for the VCs. If talent was fairly equally spread geographically,  it could feasibly be a better strategy to look for the less hyped deals that others are not fighting over. Besides the data that coauthors and I have collected from MIT and Stanford alumni, two other papers came to mind. One by a colleague at Stanford:

Robert Hall and Susan Woodward have written one of the most thorough recent examinations of the returns to venture capital and VC-backed entrepreneurs. http://www.nber.org/papers/w13056.pdf

However, it did not address this issue of geography.

The other is coauthored by one of the HBS faculty who I learned from, Josh Lerner and it does address geography directly.

They find that defining success as the proportion of portfolio companies that go public (IPO), VCs in Silicon Valley, NY, and Boston have greater performance and their VC-backed companies in those locations also have higher performance. However, the outperformance of these VC firms comes more from selecting better investments when they invest outside of SV, Boston and NYC! If you think about it, this makes sense. If you are a top entrepreneur outside of one of these startup hubs and a major Silicon Valley VC as well as a local VC both give you term sheets, it's going to be very tempting to take the Silicon Valley VC's termsheet.

However, this still did not answer the direct question of whether Silicon Valley firms outperform those in say Boston, MA or New York City. It also only looks at IPO rates rather than at revenues or employees as alternative performance measures.

For this, I looked at the data from the Stanford Alumni Survey. These are preliminary results, but I do find that when you look at revenues or employees, the Silicon Valley firms (defined as those located 60 miles or less from Stanford) have statistically significantly higher revenues and employees relative to those not in Silicon Valley. [$128M in mean revenues vs. $62M, p<0.05]

Yet, when you compare Silicon Valley firms against those in Boston or New York, there are no significant differences in revenues or employees. It is worth noting that the Silicon Valley firms are bigger on average (the distributions are highly skewed), yet this difference is not statistically significant. [$128M vs. $29M, p<0.17 and 307 employees vs. 51 on average, p<0.27]. Since these distributions are so skewed, the median is perhaps more informative [$300,000 vs. $150,000].

Finally, I looked at the current status of the firms.

For Silicon Valley firms, the breakdown looks like this:
Private firm: 55%
Acquired: 23%
Out of business: 18.4%
IPO: 4.2%

For MA and NYC:
Private firm: 67%
Acquired: 15.5%
Out of business: 16.5%
IPO: 2%

References:

Robert E. Hall, Susan E. Woodward. 2007. The Incentives to Start New Companies: Evidence from Venture Capital. NBER Working Paper No. 13056.

Henry Chen, Paul Gompers, Anna Kovner, Josh Lerner. 2010. Buy local? The geography of venture capital. Journal of Urban Economics.

Abstract:

We document geographic concentration by both venture capital firms and venture capital-financed companies in three metropolitan areas: San Francisco, Boston, and New York. We find that venture capital firms locate in regions with high success rates of venture capital-backed investments. Geography is also significantly related to outcomes. Venture capital firms based in locales that are venture capital centers outperform, regardless of the stage of the investment. This outperformance arises from outsized performance outside of the venture capital firms’ office locations, including in peripheral locations. If the goal of state and local policy makers is to encourage venture capital investment, outperformance of non-local investments suggests that policy makers might want to mitigate costs associated with established venture capitalists investing in their geographies rather than encouraging the establishment of new venture

capital firms.

Team Formation

One of the students had a great suggestion. While we're waiting for the class to get kicked off, you all should use the comments and discussion forum here to begin forming teams. Teams should consist of 3-4 people each.

You can start by introducing yourself briefly, where you're located (it's better if teams for in nearby geographical areas) and your idea or the industry sector that you'd like to work on. If you already have a couple of teammates, specify the skills you're looking to bring in on the team. If you can't find a team that's co-located in the same city, you could potentially use Google+ or Skype video conferencing for team meetings.

You can also use the Facebook group to form teams.