Tax Comments on Startup Boards



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I write books not to be the authority on an issue but to lay a foundation for an informed conversation. Below are the welcome additions to Startup Boards from David Thomas, a partner at WSGR in Palo Alto. These comments will join an errata when it becomes necessary.

You suggest that the idea of an executive session is useful for board discussion because it’s an attorney / client privileged discussion.  But you don’t explain until later that the presence of the lawyer at the meeting is what makes it privileged.  You clearly know this, but could be people who don’t.

The discussion of 280G isn’t as clear as it could be.  A few comments on that:

  • I’d drop a footnote that any payments in connection with a change in control could be parachute payments, not just carveouts (e.g., if acceleration is approved)
  • I’ve never heard the term “280G election”.  It’s always referred to a “280G vote” or a “280G cleansing vote”.  From a pattern recognition perspective, you’re on your side of the votes much more than I am, so it could be phrasing that board types use.
  • This one I’d strongly urge you to make—you say that 75% of shareholders not affected by the vote get to vote.  This implies that the common holders who are the shareholders most affected are not counted in your 75%, which is absolutely not true.  You meant to say 75% of shareholders not benefiting from the carveout.

Following are some nits around the Section 409A discussion:

  • “Artificially low” implies that it has to be really discounted to be a problem, when in actuality 1 cent low and 1 dollar low have the same effect once the IRS audit starts.
  • I’d also point out that serial acquirers are likely a bigger risk than the IRS. Google, Cisco, and Oracle look at this stuff closely.
  • This and the next one are personal nits, IRS didn’t establish Section 409A, that was Congress.
  • It actually happened October 4, 2004 “a day that will live in infamy” not in 2005

 


Startups Think Outside the Silicon Valley Box – Marketplace Tech



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Today on Marketplace Tech, another blooming startup community was given a great write up. The article, Startups Think Outside the Silicon Valley Box, walks through some reasons how and why Salt Lake City, Utah is a fast up-and-comer in the startup scene. It might be because of the engineering research coming out of the University of Utah. It might be because of the low cost of living (making wages that startups can afford to  pay top talent). It might be because of the foundation of a strong work ethic and perseverance due to the Mormon faith. Either way, entrepreneurs are choosing to build companies in Salt Lake City and venture capital is flowing in.

Read or listen to the full piece here at Marketplace Tech.


Scaling Up Start-up Communities: Engage Risk as Your Friend, not a Foe



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Guest Post By Tom NastasScaling Up Innovation – (VC, Mentor, Blogger)

How Impact the DNA of Investors11 Scaling Up Start up Communities: Engage Risk as Your Friend, not a Foe

 

The most frequent complaint I hear from entrepreneurs in the emerging markets is the lack of risk capital in their country; investors willing to finance start-ups and early stage companies.  Many founders travel to America seeking money and connections in the US venture ecosystem.  While a few are able to raise cash, most don’t—and return home empty handed—to face an unknown future.

With trillions of dollars invested in food & beverage, fast moving consumer goods, retailing, wholesaling and construction to name just a few, plenty of money exists in the developing world—from Beijing to Buenos Aires to Bangalore—and from Moscow to Manila to Mexico City.  So if there is so much capital seeking opportunitieswhy is it such a struggle to get local investors to open their pocketbooks and finance technology, 1st time entrepreneurs and early stage SMEs? And what actions can entrepreneurs implement to ‘shape’ their business models to the risk attitudes and behaviors of investors + learn to ‘sell risk, then opportunity’—to raise $ for their ventures?

I spoke on these subjects to entrepreneurs, investors and government officials from East Europe as the invited guest of US Ambassador to Croatia, Mr. Kenneth Merten and his economic section chief Thomas Johnston at the Brown Forum. This event commemorates former US Secretary of Commerce Ron Brown’s (Clinton Administration) efforts over 20 years ago to initiate trade between states of the former Yugoslavia—after years of war and conflict—and the United States.  The theme of 2013’s event was ‘Entrepreneurship & Venture Capital in South East Europe.’

Topics in my 16 minute video talk include:

  1. Investor behavior is driven by the cultures of risk:  What it is, how it differs in the emerging markets vs. Silicon Valley and actions to make risk your friend—not your foe
  2. Debunking myths—what investors (do/will) finance in emerging markets. Risks ‘bought’ by investors in the developing world & risks which scare them (beginning with slide #39)
  3. Business models which unlock capital—& those that don’t

What I ask of you

With a deeper understanding and insight into the risk behavior of capital, entrepreneurs can create and ‘shape’ business models to unlock the wallets of customers and investors. So please write me with the solutions and strategies you used to overcome the cultures of risk and raise $ for your venture.


Tom Nastas Scaling Up Innovation 300x289 Scaling Up Start up Communities: Engage Risk as Your Friend, not a FoeAn entrepreneur myself, I created Innovative Ventures Inc., (www.IVIpe.com) in 1986 to invest venture capital (VC) into university
technology from Michigan State University and the University of Michigan.

Then I Did Entrepreneurship and Venture Capital in International Countries

In 1990 with a few coins and lots of energy I led IVI’s international expansion into Canada & Europe, then Africa, later into Kazakhstan and Russia, created new venture funds and grant program to finance technology and entrepreneurs across these continents and countries through equity, debt, grants & royalty structures: $300+ million committed from Governments and development banks like the US Government, the European Bank for Reconstruction & Development, the World Bank and its investment arm the International Finance Corporation, Canadian Development Bank, European Commission, the Government of Kazakhstan and institutional investors.

I’ve lived, worked and invested in Canada, Europe, Africa, Kazakhstan and Russia (in Moscow for 10 years). Over the last 20 years I’ve acquired a deep understanding of investing in tech and non-tech companies/entrepreneurs (with domestic investors and Governments) in these regions, what works & does not (& why) in countries with different economic environments, cultural practices and legal regimes that require new protocols of doing business to balance the interests of all stakeholders to achieve success. Now I split my time in Michigan, Russia & Kazakhstan, and other places where contributions are needed.

 Scaling Up Start up Communities: Engage Risk as Your Friend, not a Foe

What Should Your Startup Board Package Look Like?



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Guest Post By Mahendra RamsinghaniThe Business of Venture Capital – (Author, Investor, Mentor) 
boardroom2 300x248 What Should Your Startup Board Package Look Like?

Preparing your board package is a bit of an art and a science. The sample slide deck below offers a framework for consideration (please see “Notes” section of slides as well). The primary goal for the CEO is to communicate with the board, in adequate detail. Your board needs to hear about your progress (or lack thereof).

Here are some points to consider:

a) Progress metrics: Each startup has different metrics and at the very heart of it, you as CEO / founder need to prioritize these over the next 12 months. These metrics could include adoption, revenues or simply, customer discovery / development milestones. The art form lies in picking the metrics that matter – quite simply, ask yourself – what is the one development that would help the company to be seen as a leader in this space? Can this development help raise the next round of capital at increased valuation? This is not about pandering to investors but knowing what constitutes value creation.

b) Significant developments / changes: Board members need to know of any significant shifts. Fired your CTO? Pivoted to a new market?  Increased burn rate by a factor of two? All of these are important enough that your board needs to know – ideally before the board meeting. At the meeting, these topics are the ones that yield a robust discussion. Remember, a board meeting is not a one-way brain-dump from CEO to board. It is a two-way street and if you do not pause, ask questions or breathe – it will ultimately lead to frustrations. The board is there to help but you have to let them help you.

c) Financials: No matter how cool the product feature set may be, make sure you include financial statements in your board package. These are ideally prepared by your part-time CFO and include your income statement, balance sheet and cash flow statements. For very early stage companies, its best to offer a simple snapshot of

(i) Cash at hand (ii) burn rate and (iii) months before we need additional capital.

Ultimately, remember that a board package is nothing but a prop for communication and discussion. Your goal is to ensure that (a) your board gives you a thoughtful input / feedback on the company’ progress (b) knows where you need help and (c) is able to help you along the way.

You can download the original PowerPoint Slideshow Here.

 


Mahendra Photo What Should Your Startup Board Package Look Like?

Mahendra Ramsinghani

I manage and lead all investment activities for Invest-Detroit’s First Step Fund, a micro-finance fund that is focused on seed and early stage investments in the region. Since its launch, the Fund has invested in 40+ companies across technology, healthcare and energy sectors.

In 2011, I finished a labor of love – a book titled “The Business of Venture Capital: Insights from Leading Practitioners on the Art of Raising a Fund, Deal Structuring, Value Creation, and Exit Strategies (Wiley Finance). See: http://amzn.com/0470874449

As Mentor-in-Residence at University of Michigan’s Office of Tech Transfer , I helped spin-out a Life Science tools start-up, 3D Biomatrix. In 2012, this company was recognized by Wall Street Journal Technology Innovation Awards (chosen among 536 entries).

At the MEDC, I led the efforts for development of two Fund-of-Funds programs that was signed into a legislation and currently deploys $200 million in VC Funds. I serve on the investment committee of two seed funds and on the Board of University of Michigan Social Venture Fund.

 What Should Your Startup Board Package Look Like?

Everyone At Cheezburger Reports To Another Employee Of Cheezburger — Except For Me. I Work For The Board Of Directors



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Guest Post By Ben HuhCheezburger – (CEO-Founder)

 Everyone At Cheezburger Reports To Another Employee Of Cheezburger    Except For Me. I Work For The Board Of DirectorsWe have 5 Board of Directors. Their names are:

What does a Board do?
The Board is another tool of business. You can use it wisely, or it can use you. Legally, as a corporation, we are required to do certain things according to the legal documents we all signed (this gets really complex and there are a million ways to do it) but the role of the Board, regardless of who is on it and why, is to: look after the best interests of the shareholders/owners of the corporation.

In this case, our Board members have a specialty (not all businesses are the same), they represent the world of high-risk, high-reward Venture Capital investment and invest in startups of a certain, smallish size. (Vs. say, a large publicly-traded company, or a charitable organization.) The Board of Directors are also not the same thing as Board of Advisors. Advisors don’t take on legal responsibility of looking after the company, Board of Directors do. Often, this gets confused, but BoD is the real deal where the rubber meets the road. BoA is a loose collection of advisors.

In human history, we have an illustrious pattern of fucking up the art of representation, oversight and management — over and over again. Mob rule? Meh. Despotism? Sucked ass. Monarchy? High failure rate. Democracy? Not bad. Companies are no exception. The Corporate Board is a method of shareholder representation, oversight and management.

A healthy Board should be independent, thoughtful, supportive, and aligned. This is the art of corporate governance that’s a real thing and a seldom visible and seldom credited KEY CONTRIBUTOR to the success and failure of many companies. Corporate governance is fascinating to a business nerd like me, and again, like all things in business, deceptively simple, yet virtually impossible to master. (Major BoD failures make the news, but successes don’t. Hello, Enron!)

There are many duties (legal, ethical, and quasi) of a board. Here are some examples:

  • Hire/fire the CEO (Shareholders vote — based proportionally on the number of shares each one controls and the Charter of the company– to elect the Board of Directors, who in turn hires/fires the CEO. My legal and ethical obligation as CEO is to the Board and by extension the shareholders of Cheezburger.)
  • Review and approve executive hires
  • Review and approve the official plan
  • Review and approve the financial controls and accounting
  • Review and approve mergers and acquisitions
  • Etc.

If the Board members are smart, well-connected, and helpful, FANTASTIC! But there is actually no law that requires each company to have smart, well-connected, and helpful Board members.

I’ve been exposed to a fair number of board interactions through my friends who are CEOs of their own companies. I also sit on the Board of one other company, Circa (a way to be on the other side of the table) where I try to not be a shitty Board member.

What’s it like working for your meta-self and the Board?
We have excellent Board members. (I’m not just saying that because Brad gets these blog posts emailed to him.) Because we were profitable, we were able to reject about a dozen different interested VCs before we took money from this group — because I couldn’t tell if they were good or bad until Greg and Brad came along. Our investors were heads and shoulders above the rest.

The key to what makes them great is that:

  1. They believe that the best way to create a great return on their investor is to support the CEO.
  2. They believe in WORKING HARD to do it, and they love doing it. As Rich told me once “it’s a great gig, if you can get it.”

That’s all I ask of them. Really. That’s it.

I’ve met a lot of VCs who do not work hard to help their companies. They come to a meeting every few months, don’t read up on the business, dish out irrelevant advice, and then leave. Bad Board members waste the time of the company — this is the cardinal sin of Board members.

I can list many examples of our Board members busting ass at all hours, on and off vacation because I asked for help. They take me at face value and while they are not afraid to challenge my thoughts and assumptions and whip me out of a funk, they trust me and defer the decisions to me — no matter how much or how little stock a CEO owns, it’s their company until it’s not.

And in return, I don’t hold back, and I don’t put up a wall. They see me at my best, and also at my worst.

I talk to them quite often. Before the days of the Internet, the Board operated on a far slower, monthly, or quarterly schedule. You’d spend hours in meetings reviewing reports and financial data. Now, we send them information as soon as we have it, which keeps them and us more connected, productive, and allows us to use our valuable Board Meetings to discuss opportunities and issues, not reports.

Side-note: How does the business of a Venture Capital investor work?

Greg, Brad, and Rich all have to look out for the best interests of THEIR investors (called Limited Partners, or LPs for short) who gave their companies (venture capital firms, VC for short) money (capital) to invest in companies like ours through a financial instrument and a legal entity called a “fund” (a VC firm usually operates several separate funds at any given time since a fund’s lifecycle runs only for several years).

It’s the job of venture capitalists (usually called “partners” in a VC firm) to invest the money of their LPs from a particular fund and spread the risk out over many investments. And in about 5-15 years, if things work out, they send the LPs a bigger box of money (return on investment). If the VCs are good at this, they get to raise new funds, and do it over again.

Their jobs depend on our success too.

Problems always have answers:
A bad CEO comes in just as many flavors as bad Board members. One of the things I have gotten better since that day was not just presenting the problem, but also showing what we’re doing to fix, mitigate, not-repeat it. If it’s my legal duty to be honest with the board, and if it’s my ethical duty to tell them as quickly as possible, it was all my learning as CEO to present the best possible solutions with the problem.

Good Board members won’t tell you how to solve the problem. Like good teachers, they show you the direction, they prod, they support, they suggest, but the solution is mine to own, and I am accountable and responsible for the decisions I make. It’s a strange thing, but I can disagree with my Board for weeks, but once I make the decision, they support me 100%. I count myself lucky to have people like this back me. They serve as role models for me as to how to be an employee and manager.

 Everyone At Cheezburger Reports To Another Employee Of Cheezburger    Except For Me. I Work For The Board Of Directors

Part V: Scaling Up Investment—Finance the Startup of Start-up Communities



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Guest Post By Tom Nastas – Scaling up Innovation – (VC, Mentor, Blogger)

Tom Nastas a 25 year VC veteran in US, int’l and emerging markets wrote a series for Startup Rev on the ‘spark’ which sparked the startup of Russia and how the development of start-up communities in emerging markets are shaped much more by the cultures of risk vs. what we investors and entrepreneurs face in the USA.  An interesting read, below are the individual posts and content for each one.

In Part V, subjects discussed:

1.)   For Entrepreneurs—What are You Selling to Investors?
2.)   For Investors—Let’s Be Realistic
3.)   For Governments/Development Finance Institutions—Atypical Leadership Needed
4.)   Concluding Remarks
5.)   My Next Blog Series—Mobilize Local Capital to Finance Your Dreams
6.)   About Me
7.)   Links: Evolution of Runet (Russia Internet) & the Russia Tech Scene

Last time in Part IV, the Quest for Growth, I discussed:

1.)   Clonentrepreneurship or Alternative Paths to the Start-up of Start-up Communities?
2.)   Change the Culture & Amazing Things Happen

Read Part IV here.

The ‘take-away from Part IV.

Clonentrepreneurs sensitize local investors to the rewards of investing in technology since clones match the behavior of local investors to risk. As results are achieved and money is made by all, investors open up to new investment opportunities a bit more adventuresome and innovative—disruptive vs. cloning.

Cloning and Clonentrepreneurship is one strategy to impact the DNA of local investors in emerging countries to spark the startup of start-up communities, but of course others exist.

What are the other actions which each you can take to achieve your objectives and fuel the startup of start-up communities?

For Entrepreneurs—What Are You Selling to Investors?

Entrepreneurs raising money too often attempt to shape investor risk behavior to their investment opportunity. Instead, shape your business model to match the needs of not only your customers but investors too.  Think creatively to find the solution which your customers will pay for—no matter how little the revenue is per customer—to craft your business model to match investors’ DNA to risk.  Design your business model and its execution to systematically attack each of their fears to early stage tech deals.

Risks that Scare Investors + Source Info Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Once you have this business model executed with paying customers, approach investors by ‘selling risk, then opportunity,’ i.e., demonstrate how you’ve eliminated risk in each of the four categories to prove your great investment opportunity. Once you raise money, execute yes but also pay forward in your start-up community; be the role model to other entrepreneurs, teach/mentor them in the solutions which you executed to overcome the fears of local investors in emerging markets.

For Local Investors—Let’s Be Realistic

Rarely will Western clones match the big returns as your investments in telecomm, real estate, construction, food/beverages, fast moving consumer goods, wholesaling and retailing have performed.  Yet as the economy in your country progresses and incomes grow, populations and enterprises open their pocketbooks to products and services which better match changing needs.

In the Chinese online travel industry for example, Ctrip and eLong have millions of registered users. Entrepreneurs seeking money to compete against them is risky and uncertain; however opportunities exist for unorthodox business models. For example, Chinese company Qunar is a travel search engine for online travel services. It aggregates travel information like air tickets, hotels and holiday offerings so Chinese consumers can make better and more informed travel decisions. Qunar serves the evolving needs of consumers and achieves success by approaching the market differently by making competitors—its partners.

Tell entrepreneurs your needs for business models which generate revenues in the immediate term; postpone your demands for immediate profits and cash distributions. Be creative in deal structuring and flexible to valuations since tech business models scale better across customers and geographies to justify higher prices paid vs. investments in brick and mortar.

Structure the investment agreement to align and incentivize entrepreneurs to your attitudes and behaviors to risk.  Oh, how does that work? An example:

American investor financings typically include an equity option plan for founders and employees.  In some emerging countries, legislation permits the issuing of equity options to management of start-ups. When permissible, distribute equity shares based on revenues realized vs. traditional metrics like length of time served in the company or # of users engaged. If legislation does not permit this action, structure the investment agreement as equity earn-ins held in escrow with shares issued when agreed-upon metrics are achieved.

For Governments/Development Finance Institutions—Atypical Leadership Needed

Governments and their finance institutions conceive venture initiatives to catalyze venture funds, to finance the startup of start-up communities.  Frequently these funds are modeled to the program called Yozma, the Israel Government’s fund-of?funds.

Yozma was capitalized with $100 million; $80 million which financed new VC funds with $20 million for direct investment into Israeli tech SMEs.  It invested $8 million into a private VC fund with a minimum of $12 million/fund invested by Israeli and foreign venture capitalists. Yozma financed ten VC funds with a total capitalization exceeding $200 million. These funds went on to finance innovative companies and spur the development of the high tech SME and VC industry in Israel, where one did not exist before. Fast forward 10 years and the 10 funds supported by Yozma were managing over $3+billion with the VC industry in Israel managing $10+billion.

Yozma-type schemes offer economic incentives to induce investment and build learning experiences in seed and early stage tech investing such as:

1.)   Commit up to 49% of the capital to the creation of a new VC fund
2.)   Offer preferential returns to investors
3.)   Take 1st losses on failed investments
4.)   Cap financial returns to the Government so as to boost profits to investors
5.)   Subsidize management fees &/or pay the costs of investment due diligence
6.)   Allow private investors to ‘buy-out’ the Government’s equity, usually within the 1st five years of fund operation, at cost + a bank interest rate of return

Yozma worked exceedingly well in Israel and a few industrial nations.[1]  But results in China, Russia, Chile, and other emerging countries has not been so spectacular; local investors didn’t respond in the #s or volume of investments in the seed and early stage sector as expected and targeted by sponsoring governments.[2]

HmmmmReality sets-in as staffers scramble for new solutions and a chair before the music stops. “Let’s try something different.”

When domestic capital does not change its risk behavior to seed/early stage tech, government staffers work vigorously to create a new class of investor—angels—since their risk behavior better matches the profile of entrepreneurial ventures. While angel investors are welcome in all countries, developing this community takes years to accomplish with multiple false starts and entrepreneurs seeking money now going unfunded.

Hmmmm—let’s rethink what the initiatives should be.”

Plenty of money exists in the pocketbooks of local investors in emerging markets to finance start-ups for a start-up community to emerge.  What’s required is the unlocking and mobilizing of local capital for investment in technology, 1st time entrepreneurs and early stage tech SMEs. Certainly encouraging a cloning strategy in the entrepreneurial community is one solution to unleashing local capital as the successes of Russian clonentrepreneurs proved.

Another solution is to think forward—design venture schemes which better match local investors’ behavior to risk and the mentoring of local investors in early stage tech investment. Include in this mentoring ‘show & tell’ sessions of other financing solutions: royalty based or technology performance financing schemes, i.e., capital invested in technology SMEs with investment returns generated from the cost savings and/or revenue enhancement earned by customers.

What else might you do, say with founders and management teams?

Organize a mentoring program; get them the mentors they need to ‘shape’ early stage tech business models to the risk attitudes & behaviors of local investors + ‘sell risk, then opportunity.’ Until investors can understand and ‘buy’ the risk in start-ups & early stage SMEs in the emerging markets, little capital will flow to them.

But what can you do if you seek to do something more ambitious, i.e., generate knowledge creation to disrupt industries and attract local investors for the needed finance?  Deal flow funds are one solution to attack both needs.

Deal flow funds finance entrepreneurs and SMEs executing to a single technology, product or service platform, technical challenges that require new thinking in science and engineering to accomplish.  What might be an example of technical challenges in need of solutions?  Take a look at these slides which tell this story.

Slide1 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Slide2 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Slide3 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Slide4 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Slide5 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Slide6 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Slide8 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Slide9 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Tech Solutions not Ldt to Russia+source info Part V: Scaling Up Investment—Finance the Startup of Start up Communities

A ‘deal flow’ fund finances technology development and commercialization.  And in Russia for example, development of the Shtokman field is a national priority of the Russian Government, not only because of its wealth potential but also the promise of new economic prosperity to the Russia Far North.  The linking of technology to a country’s national priority helps assure local financiers that innovators deploying the tech have a market and paying customers.  It’s this matching of tech solutions to customers which harmonize the risk behavior of local investors to the risks of start-ups and early stage SMEs.

Concluding Remarks

Emerging markets face huge obstacles in finding talent, capital, knowledge, and yes, the business models which match the risk appetite of local investors.

Spark Points3 Part V: Scaling Up Investment—Finance the Startup of Start up CommunitiesClones are one solution to spark the startup of a start-up community since they generate the revenues which local investors demand as a precondition for investment.  As Clonentrepreneurs achieve success, it encourages others to try entrepreneurship too.  Some are a bit more venturesome and launch improvements to models cloned from the West.  Others do something different and inject their own notions of creativity by innovating new solutions layered on top of Western platforms like Russian beta-stage start-up ClipClock is doing to YouTube or IVI.ru is doing in the Russian video streaming industry.

Start up Nitroo Part V: Scaling Up Investment—Finance the Startup of Start up CommunitiesAnd isn’t that what we want?

More entrepreneurs driving business and economic growth, irrespective of the business model or the platform technology. We all want more investment, more initiative and more conversation with more saying “I can do that” and “I can invest too.” Such actions generate the growth, the economic opportunities for citizens, and the prosperity that all countries, regions, cities and towns desperately seek.

 

 

My next Blog Series: Mobilize Local Capital to Finance Your Dreams

This is one of the topics I mentored 80 entrepreneurs from 36 countries—at Singularity University, located in the heart of Silicon Valley.  These entrepreneurs learned about exponential technologies to solve global challenges, and my job was to work with them—selecting ideas, developing and shaping business models to investors’ behavior to risk.

I was one of approximately 16 or so team project advisors selected from around the world to mentor these entrepreneurs at Singularity University, created by x-Prize Foundationfounder/CEO Peter Diamandis and inventor, entrepreneur and futurist Ray Kurzweil.

Nastas Title Slide Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Till then, be well and be lucky

Question slide Part V: Scaling Up Investment—Finance the Startup of Start up Communities


[1] For explanation why Yozma worked great in Israel and not so well in emerging countries, see ‘The GoForward Plan to Scaling Up Innovation, page 4 (English). For my Russian readers, go to ‘The GoForward Plan to Scaling Up Innovation,’ by Thomas D. Nastas, June/July 2007, Russian edition, Harvard Business Review.  Hungarian readers go to October 2007 ‘Scaling-Up the Innovation Ecosystem,’ Hungarian edition, Harvard Business Review; Sept. 200. Spanish readers go to ‘Innovation for Growth,’ Latin America edition, Harvard Business Review

[2] For explanation, how local investors in emerging market typically behave-invest, when managing Yozma-type schemes, see slides 50-68, ‘Bridging the Valley of Death,’ presentation of Thomas Nastas to staff of the World Bank & IFC, 29 November 2011

 

About Me

IMG 70411 300x200 Part V: Scaling Up Investment—Finance the Startup of Start up CommunitiesI am a venture and private equity investor since 1986, financing university tech in Michigan with liquidity events including Neogen (NEOG: NASDAQ), AISI Inc. (acquired by ESI, ESIO: NASDAQ, USA) & Personal Bibliographic Systems (acquired by Thompson Financial, NYSE: TRI) as examples.  An entrepreneur myself, I left Michigan in 1992, created int’l and emerging market funds in Africa, Canada, Europe, Kazakhstan and Russia, for ROI & economic development, i.e., >$300 million invested to advance entrepreneurship, innovation and growth in int’l and emerging market countries.  I am past/current Independent Director, Board of Directors of eighteen (18) companies over the past 25 years, USA & international enterprises.

I can work with you in four ways.

1. As an investor advising LPs and GPs in your country for emerging market investment, create venture initiatives (+ raise capital). I invested my own capital + established and managed cash flow, venture, private equity and fund-of-funds as shown in the 1st picture below. The 2nd picture shows the deal structures and strategies executed to localize money for investment in each country and to match local investors’ behavior to risk.

Nastas Infographic VC Funds2 300x225 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Nastas Infographic VC by Deal Structures2 300x225 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

2.  As an advisor to Governments & development finance institutions.

  • Design & execute venture initiatives: My clients include Development Bank of Canada, European Commission, European Bank of Reconstruction & Development, IFC/World Bank, Russian Venture Company, Govts of Slovakia, Croatia and the US Govt’s USAID—create, startup, finance & execute:
    • Venture capital funds
    • Venture lending funds
    • Private equity funds
    • Royalty based & cash flow funds
    • Fund-of-funds
  • Design & execute grant schemes—to advance tech dev. thru commercialization:  With six other directors, I manage the $85 million technology commercialization project in Kazakhstan, making grants to finance and advance science from proof-of-concept thru 1stcommercialization.
    • We established the policies/procedures for grant investment, criteria, tender & selection process including all documentation for program execution
    • Selected & committed $22.5 million to 21 development stage SMEs and R&D groups in 2011 & 2012, average grant ?$1MM
    • I lead the creation of 1st technology commercialization office in Kazakhstan, to transfer Kazakhstan tech to market.  I established strategy, programs, key performance metrics, deliverables and all tasks for commercialization & execution-budget is $2.8 million, staffing of four international experts + five Kazaks.
  • Design & execute int’l—cross border tech transfer & commercialization initiatives:  Conceive programs and connect—Russian Corporation of Nanotechnology (Rusnano)—& int’l organizations
    • Created project to establish technology proof-of-concept tech dev. & commercialization program between Rusnano & tech transfer offices of US universities (e.g., Colorado, Utah & Michigan). I established the trust and confidence in the parties to negotiate & secure signed agreements

3.  As an entrepreneur mentoring founders & entrepreneurs as an Independent Director, member of the Board of Directors or member of the Advisory Committee.  I established legal entities, hired & managed staff in Africa, Canada, Europe, Kazakhstan and Russia, all costs of market entry and operation financed by me. Living, working and      investing in these counties—paying the bills too—developed in me the experiences to counsel:

  • Founders of mid-size companies, revenues to $100 million, solutions to integrate their firms into global markets, harmonize products/services & the organization for this global expansion, raise int’l capital and build the 2nd tier layer of management for execution
  • Entrepreneurs of early stage companies, my contributions include conceive/negotiate partnerships for 1st commercialization, raise 2nd round VC financing, ‘shape’ business models to the risk profile and behavior of local money in the country, mentor/counsel management team in growth & development

My other contributions to global entrepreneurship:

Nastas Country Experience 300x225 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

4.  As a thought leader & advocate of VC, entrepreneurship and innovation to solve global challenges, I conceive and deliver keynote talks and Master Classes to engage stakeholders with the ability, interest and resources to finance technology commercialization and early stage venture capital.  View my publictions which spread ideas—solutions to create more investment, innovation and entrepreneurship.

Let’s engage on how to make an impact, make money and have fun. Contact me atTom@IVIpe.com. Learn more at Scaling Up Innovation.

Links: Evolution of Runet (Russia Internet) & the Russia Tech Scene

Top 10 Web Start-up CEOs in Russia, 2011

Top 10 Russian Web Startups of 2011

Top 30 Russian Internet Companies (Forbes, 2011)

Top 10 start-ups of 2009

Top 10 Internet Entrepreneurs, 2009

Top 10 Internet CEOs in Russia

Top 10 Russian Venture Capital Internet Investors 2009

Top 10 Russian Web Startups, 2008

Top 10 Russian Web Apps & Sites, 2007

http://www.eddy.lt/2011/12/10-must-know-facts-about-russian.html#!/2011/12/10-must-know-facts-about-russian.html

http://goaleurope.com/2012/04/21/eastern-europe-weekly-news-from-eastern-europe-baltics-russia-ukraine-and-poland/

http://thenextweb.com/russia/2012/04/19/skolkovo-stimulating-russias-it-industry-by-spending-stupid-money-smartly/

http://thenextweb.com/russia/2012/04/20/already-europes-largest-internet-market-and-still-growing-astoundingly-fast-russia-by-the-numbers/

http://thenextweb.com/russia/

http://www.marchmontnews.com/Archive/News/18636.html

 Part V: Scaling Up Investment—Finance the Startup of Start up Communities

Part II: The Cultures of Risk—Financing the Startup of Start-up Communities



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Guest Post By Tom Nastas – Scaling up Innovation – (VC, Mentor, Blogger)

Tom Nastas a 25 year VC veteran in US, int’l and emerging markets wrote a series for Startup Rev on the ‘spark’ which sparked the startup of Russia and how the development of start-up communities in emerging markets are shaped much more by the cultures of risk vs. what we investors and entrepreneurs face in the USA.  An interesting read, below are the individual posts and content for each one.

Subjects in this post:

1.)   The Cultural Divide:  What Investors ‘Buy’
2.)   What Investors Fear
3.)   The Culture of Venture Capital:  Friend or Foe?

Last time in Part I, I discussed:

1.)   First, Three Definitions
2.)   The Russia Tech Scene
3.)   Growth in Russia
4.)   What Changed for Growth to Emerge
5.)   The Spark that Ignited the Start-up of Russia

Read Part I.

Read the Introduction to the series.

Summary from Part I:  Beginning about 2006, innovation became a priority of the Russian Government to diversify its economy from oil/gas with its multi-billion dollar investments in the Russian Venture Company and the Russian Corporation of Nanotechnology. Even with these investments, the needle of tech investment crept up ever so slowly in venture stage companies.

But everything changed beginning in the 2nd half of 2010; Russian entrepreneurs cloned US business models in Internet e-commerce, social and mobile with 20+ startups attracting more than $400 million in less than eighteen months through 2011.  For 2012 investment in start-ups and venture stage companies is estimated at between $800 million to $1 billion.

The ‘take-away. Russian entrepreneurs demonstrated that cloning established Western Internet business models and localizing them for the domestic market captures growth.  This was what domestic investors needed to open up their pocketbooks and spark the startup of Russia.

Ok, so, uhm—what’s so revolutionary about entrepreneurs cloning the ideas of others and investors financing start-up clones?

To answer this question, I discuss the culture of risk in the developing countries and how it impacts the behavior of local investors and their willingness to finance seed and early stage tech business models.  Then I contrast how their investment behavior differs from investors in the developed countries.

The Cultural Divide:  What Investors ‘Buy’

The Clam and Pearl Part II: The Cultures of Risk—Financing the Startup of Start up CommunitiesAmerican tech and start-up entrepreneurs ‘sell opportunity’ to raise money. This works great in the United States since angel investors and venture capitalists are comfortable with risk, ambiguity and uncertainty, and willingly pay the costs of failure when business models don’t work, founders pivot and start-ups evolve into something different from entrepreneurs’ initial intentions.

Except for the very few, most local investors from Manila to Moscow and from Shanghai to San Paulo approach risk differently. Sure, opportunity is required for the financing of ventures.  But the risks of execution are more importance as the deciding factor since emerging market countries are opaque and with their lack of transparency—invisible risks and obstacles can cause even the most experienced investors to lose their entire investment:  Capital preservation drives financing decisions.

Consequently they buy ‘risk’ by investing in the known and understandable;  businesses and projects with markets and customers a 100% guarantee, where the risks of the investment are in the execution of building a factory or constructing a warehouse, creating a bank, establishing a chain of shops or restaurants as examples. These are the uncertainties they have dealt with as businessmen and investors, and have the experience to help entrepreneurs solve—avoid.

Risks Financed + Source Info Part II: The Cultures of Risk—Financing the Startup of Start up Communities

What Investors Fear

The risks of financing innovative firms, i.e., does a market exist, will customers buy, achieve promised performance—often technology based—are uncertainties too great for domestic investors in emerging markets since they add additional layers of risks to those of execution and involve a different sort of risk assessment—skills and experiences they frequently lack.

Risks that Scare Investors + Source Info Part II: The Cultures of Risk—Financing the Startup of Start up Communities

Clones overcome these fears since many generate revenues immediately, some from day #1, demonstrating that a market exists, the tech works, customers show up and pay.  With these risks behind the venture, the way forward is managing execution—risks that local money in emerging markets ‘buy:’  the tolerance of emerging markets investors for the US model of entrepreneurial experimentation, trial and error and the funding of pivots is zero.

Why is this so?  And how do we use this culture of investor risk-taking as our ally, to make amazing things happen; more entrepreneurship, more innovation and more investment for the start-up of start-up communities not only in Russia but throughout the emerging world from Chile to China, Kazakhstan to Kenya, India to Indonesia?

The Culture of Venture Capital:  Friend or Foe?

To obtain a deeper understanding why entrepreneurs and investors behave as they do in the emerging markets, we must look at an unlikely place to frame this discussion:  Silicon Valley.

“Silicon Valley is the only place on Earth not trying to figure out how to become SiliconValley.”[1]

Silicon Valley Attributes and Attitude to Risk + Source Info Part II: The Cultures of Risk—Financing the Startup of Start up Communities

Silicon Valley’s greatest attribute is not its ability to finance the future and failure, but investors’ attitude to risk which shapes their risk taking, their acceptance of ambiguity and uncertainty to early stage tech deals, thereby attracting entrepreneurs with the wildest (and craziest) ideas.

This behavior to risk is exemplified by the 2-6-2 distribution of returns rule.[2]

For every ten investments made by investors, two fail with all money lost, six return the original investment + a low to modest rate of return, with the remaining two generating breathtaking profits (Facebook, Google, Apple, Cisco, Oracle, Instagram and Microsoft as examples). These ‘superwinners’ as they are called, produce the superior rates of financial return that compensate for losing investments and slightly profitable ones.[3]

Of course one never knows in advance which investments will be superwinners or also-rans. Since Silicon Valley investors know that statistically they’ll invest in their fair share of superwinners, they have the confidence to finance the wild and crazy, a few which become successes. Superwinners breed or attract others to launch start-ups.  As more entrepreneurs enter the market, the number of new companies financed increases with less time required by investors to make the investment decision. More choice is what investors need since for every one investment, 99 are rejected;[4]  to consummate ten investments (the 2-6-2) an investor needs to see 1000 opportunities.  More choice attracts more capital to the start-up community as other investors jump in to finance the next set of superwinners.  The start-up community prospects and perpetuates to a thriving ecosystem.

Many superwinners did not start on the path to greatness, and they only found it after experimenting with different business models until they hit the bulls-eye;  others started down a path only to change direction—pivot—to find what the market and customers would accept.  Silicon Valley investors willingly finance early failures since they know statistically, many pivot to success as Google, Instagram, Facebook, YouTube, PayPal and others did to achieve superwinning status. While it may seem counterintuitive, investors must finance failure since without them they are not taking enough risk.[5]

It’s this willingness to finance ambiguity and uncertainty that makes Silicon Valley—uhm—Silicon Valley.

The National Venture Capital Association (USA) estimates that in 2010 the US venture industry invested the equivalent of $3,945 per person living in the Silicon Valley area vs. $43 per person in the rest of the US, including other start-up communities like Boston and New York. That’s a 91:1 ratio.[6]

Go to my home state of Michigan and the number falls to $15 per person, a ratio of 263:1.[7] So the likelihood of a Detroit startup raising venture capital in Michigan is more difficult vs. Silicon Valley.

In Russia and other emerging market countries the amount of capital invested/population is even less than Michigan;  these regions lack the quality and quantity of deal flow that typifies the Valley and local investors are unwilling to fund experimentation, pivoting, trial and error in business model creation.  Since domestic investors buy the ‘risks’ of execution by investing in the known and understandable—businesses and projects with markets and customers a 100% guarantee (experimentation/pivoting not necessary)—the chances of superwinners being created and financed is remote:  Yet an increasing flow of future ‘superwinners’ is what’s required for local investors to invest in, and for a start-up community to crystalize.

In Russia and other emerging market countries the amount of capital invested/population is even less than Michigan;  these regions lack the quality and quantity of deal flow that typifies the Valley and local investors are unwilling to fund experimentation, pivoting, trial and error in business model creation.  Since domestic investors buy the ‘risks’ of execution by investing in the known and understandable—businesses and projects with markets and customers a 100% guarantee (experimentation/pivoting not necessary)—the chances of superwinners being created and financed is remote:  Yet an increasing flow of future ‘superwinners’ is what’s required for local investors to invest in, and for a start-up community to crystalize.

We have met th enemy and it is us Part II: The Cultures of Risk—Financing the Startup of Start up Communities

That is until an event or series of events breaks this cycle to change the trajectory of the market.  In Russia it was the early and fast liquidity from the Groupon clone that demonstrated the merit of cloning Western business models plus the IPO of Mail.ru that minted the money for clone investment.  With the United States as the engine of start-up creation in the world, it was natural for Russians to copy, localize and paste clones into Russia, to capture the eyeballs and wallets of the Russian consumer. And then—the pocketbooks of investors too.

The chasm between the cultures of risk-taking by local investors in Russia and the risk of start-ups was crossed. Foes became friends. The start-up of Russia began. 

“But this is not the only contribution of clones to the startup of start-up communities.”

For Next Time—Part III:  The Power of Clones

In Part III, I discuss the multiplier effect in start-up creation that clones have in local market.  Clones do more than just build a local network of supply chain partners thereby increasing the # of startups for a startup community to emerge.  Their successes impact the DNA culture of investors to risk as they build new experiences in seed and early stage risk.  And they do so without taking the risks of opportunity that is normally associated with early stage companies since clones[8] demonstrate that a market exists, the tech works, customers ‘get it’ and pay.

Subjects in Part III:

1.)   Drive Growth and Innovation in the Supply Chain
2.)   Sidestep the Obstacles that Impede Scaling Up
3.)   Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start-Up?
4.)   Spread of Clonentrepreneurship

Comments, opinions and questions are welcome here or send directly to me atTom@IVIpe.com.

Be well and be lucky.


[1]Quote from Robert Metcalfe, father of Ethernet, founder of 3Com, author, pundit & conference host

[2] Author’s note:  The 2-6-2 distribution of returns rule is a term to describe the distribution of investment returns in a venture capital or private equity portfolio. The 2-6-2 rule comes from data collected and reported on the industry’s financial performance over a 40 year period from Cambridge Associates, the National Venture Capital Association and the Small Business Administration (which tracks investments made through the Small Business Investment Corporation program of the US Government).

[3] Author’s note:  While the 2-6-2 distribution of returns is an industry average, individual funds will have a different distribution of financial performance, e.g., some might have a result of 4-4-2, others a 1-9-0, others a 0-7-3, etc. Approximately 2% of investments since the 1980s have produced 98% of the financial returns realized in the venture capital industry (USA)

[4] Author’s note:  A rule of thumb in the industry.  Naturally some firms will be in the flow of ‘better’ investment opportunities and able to transact the necessary number of investments with a lessor number of total deals evaluated

[7] Source: Ibid

[8] Certainly all clones are not alike.  Prudent, wisdom and understanding of the local market is required in the selection of which business models to copy, localize and paste into an emerging market

 Part II: The Cultures of Risk—Financing the Startup of Start up Communities

Introduction: The Startup of Start-up Communities; The Power of Clones in Russia—& Beyond



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Tom Nastas a 25 year VC veteran in US, int’l and emerging markets wrote a series for Startup Rev on the ‘spark’ which sparked the startup of Russia and how the development of start-up communities in emerging markets are shaped much more by the cultures of risk vs. what we investors and entrepreneurs face in the USA.  An interesting read, below are the individual posts and content for each one.

What are the elements of a start-up community?  What can you do to startup a start-up community in your city, or help it do more—faster?

Venture investor Brad Feld (Foundry Group, Boulder, Colorado, co-founder of Tech Stars, blogger Feld Thoughts) writes about these subjects in his other blog StartUp Communities with his new book titled ‘Startup Communities: Building an Entrepreneurial Ecosystem in Your City.

If you don’t know Brad, he was and remains the protagonist and instigator that transformed Boulder from a sleepy Rocky Mountain hippie town into one of the most vibrant entrepreneurial tech start-up communities in the United States.  It is his individual contributions to this success that makes Brad’s advice sought by investors, government policy makers and entrepreneurs from around the world.

Recently Brad accepted my offer—I contribute a post on the startup of Russia to StartUp Communities.  As I started writing, one subject led to another, with the result too much for one individual post.  Over the next few weeks I’ll upload the content as a series of posts for you:  the investor, the entrepreneur, the Government policy maker, staff of international development finance institutions.

In this series I answer five questions:

1.)   What is the ‘spark’ that ignited the start-up of Russia?

2.)   How does the ‘start-up’ of startup communities differ—emerging markets vs. developed countries?

3.)   Why is the US entrepreneurial model of experimentation, trial and error and pivoting a death sentence for entrepreneurs in the emerging markets?

4.)   How does the culture of risk and failure in emerging markets impact investor DNA—what they finance and what they won’t?

5.)   What is Clonentrepreneurship, where is it spreading from and to, and why is it a model for more—innovation, startups, and venture investment?

There is much happening in Russian cities like St Petersburg and Novosibirsk as two regional hubs of innovation and entrepreneurship.  Even so, I’m confining my discussion to Moscow since what we are seeing in the Russia capital is being replicated in other cities in the Russia Federation, only to a lesser degree.

Here’s a preview of the topics in each post.

PART I: THE START-UP OF RUSSIA

  • First—Three Definitions
  • The Russia Tech Scene
  • Growth in Russia
  • What Changed for Growth to Emerge
  • The Spark that Ignited the Start-up of Russia

 

PART II: THE CULTURES OF RISK

  • The Cultural Divide:  What Investors ‘Buy’
  • What Investors Fear
  • The Culture of Venture Capital:  Friend or Foe?

 

PART III: THE POWER OF CLONES

  • Growth and Innovation in the Supply Chain
  • Sidestep the Obstacles that Impede Scaling Up
  • The Controversy of Clonentrepreneurship: Cloning the Idea or Hatching a Start Up?
  • The Spread of Clonentrepreneurship

 

PART IV:  THE QUEST FOR GROWTH

  • Clonentrepreneurship or Alternative Paths to the Start-up of Start-up Communities?
  • Change the Culture to Make Amazing Things Happen

 

PART V:  SCALING UP INVESTMENT—FINANCE THE STARTUP OF START-UP COMMUNITIES

In this final post to the series I answer the question:  “What are the small but meaningful steps you can take to impact the culture to change the culture for more investment, entrepreneurship and innovation?”

  • For Entrepreneurs—What are You Selling to Investors?
  • For Investors—Let’s Be Realistic
  • For Governments/Development Finance Institutions—Atypical Leadership Needed
  •   Concluding Remarks
  • My Next Blog Series—Mobilize Local Capital to Finance Your Dreams
  • Links: Evolution of Runet (Russia Internet) & the Russia Tech Scene

 

I hope that these subjects will help you to ‘Scale Up,’ more entrepreneurship, more investment and more tech start-ups in your country, with Russia as one experience to learn from.

How might this happen you ask?

Frequently a mismatch exists in the business models that entrepreneurs launch in the emerging markets and what local investors finance.  Struggling to raise money, entrepreneurs label capital as risk adverse with investors blind to potential, seeking guarantees and sure things.  Investors respond that entrepreneurs of venture stage companies fail to transform potential into paying customers fast enough and in the volumes needed for the business to scale.  Add in their need to generate a rate of financial return required for their own survival, and it’s logical why local investors in the emerging world finance expansion stage companies.

This conflict spills into the public stage with Governments called to action.  They conceive and invest taxpayer money to catalyze an early stage tech venture capital industry to fill market voids.

What happens next is perplexing to the creators of these investment schemes.

These new funds have a mandate to invest in venture stage tech companies, but they behave differently in execution. They invest in tech, but at the growth stage of company development, not at the startup stage.

But what if seed and early stage business models exist with the revenue growth characteristics of expansion-stage companies?  If such business models do exist, what are they? Can they impact the DNA of local investors to risk and catalyze investment at the earliest stages of company formation?  And can they spark the start-up of a startup community? While such business models seem to be an illusion and counterintuitive to the natural evolution of market development, I explain in this series that such models do in fact exist in Russia—& beyond.

Subjects I discuss in Part I:

1.)   First—Three Definitions
2.)   The Russia Tech Scene
3.)   Growth in Russia
4.)   What Changed for Growth to Emerge
5.)   The Spark that Ignited the Start-up of Russia

Reactions & opinions welcome in the comments box or send directly to me atTom@IVIpe.com.

Be well and be lucky.

 Introduction: The Startup of Start up Communities; The Power of Clones in Russia—& Beyond