Spent a couple days last week at the Southeast Venture Conference, held this year at Tyson’s Corner outside of Washington, DC.  Saw many interesting companies pitch and met some great people.  Here are some interesting notes and comments from the event:

State of Venture Capital

• Market has stabilized after seeing a loss of capital and funds over the previous three years.  The industry will continue to struggle with growth until some of currently deployed capital realizes returns.  At this point, IPO capacity returns are the only outcome that justifies the time and resources tied up in many of those opportunities.
• Which brings us to the next point… venture will continue to be weak until the IPO market rebounds.  ((On a personal note, the IPO market is absolutely and without a doubt left anemic by over-regulation.  The legislative desire to prohibit big losses like the 2000 dotcom bust has inadvertently limited the ability to realize significant upsides traditionally limited to IPOs.))
• World is flat also applies to venture capital.  Funds can’t ignore that good deals are coming from areas other than traditional hot spots.
• Venture capital is learning that a “no man’s land” exists at between $500 million and $1 billion funds.  Those funds don’t have the capital to play competitively in the correlated footprint and profile.
• While $1 billion + funds are still competitive at raising funds, limited partners are starting to understand that those funds need returns in the $1B plus range to make the fund viable.  Doesn’t take long to do the math and realize that there isn’t room for very many of those funds, given the scarcity of $1 billion + liquidity events.  ((Another personal note, most funds should seek opportunities with exits commensurate with the amount of capital under management.  I.e. a $100 million fund should invest in companies capable of exiting for $100 million)).
• Boutique funds are a better fit for the current limited partner appetite–funds between $100 million and $500 million that have a well defined and compelling value proposition around a specific geographic or industry focus.
• Limited partners are very focused on finding VC’s with a track record of adding and building value in portfolio companies.  Picking winners is no longer enough to satisfy the limited partner.
• The denominator effect for limited partners is exasperated because of mark to market requirements. Creates an artificially high denominator of unrealized value.
• States moving from defined benefit retirement programs to defined contribution is a huge, huge, huge issue for industry over the next two decades; called the most critical issue for the industry as it relates to limited partners.  As more states move pensions from defined benefit to defined contribution, venture capital will see less and less limited partners from this asset class.  Pensions have traditionally been a significant piece of limited partner contributions.
• The lesson for financial markets from the previous twelve years is that venture capital isn’t an asset class that scales.  Smaller and more aggressive funds is a better and more natural fit with the end goals.
• Venture capital struggles with financing usage innovation over core innovation.  ((Personal note–social media, web 2.0, etc are great examples of usage innovation))  Funds seeking the $1 billion exits need to focus on core innovation.  These are long-term, more capital and resource intensive, but capable of huge exits.

Companies Seeking to Raise Venture Capital

• Biggest turn-offs to investors–complex and/or undefined business model, inability to quickly communicate your value proposition, lack of appropriate advisers
• Cost of starting a company significantly less than 5 years ago.. Business models should take that into consideration.  The kinds of teams VCs want to invest in should be able to get to a Series B on $250K of “scaling expenses” ((personal note– I’m thinking scaling expenses are operating expenses less salaries and marketing))
• Be careful about setting price on angel rounds too high.  May feel great at the time, but you’re setting the stage for a down round right out of the gate and/or renegotiating with earlier investors. Also watch for crazy discounts on convertible angel commitments.  VC’s won’t take the discount, so the founders end up eating that dilution also.
• Never, never, never set price in a bubble.  Doesn’t matter how many times you’ve done it.
• Start raising money 6 months before you need it.

M&A Outlook and Strategies

• 2012 looks to be a big year for middle market M&A.  Buyers are motivated by pending tax changes, baby boom demographic retiring and exiting companies, and private investment groups that must deploy capital or surrender management of it.
• Historical top M&A activity drivers are currently sitting with $12 billion of cash assets on balance sheets.
• Wild card issue is repatriation tax issue.  If a tax holiday s given for repatriation of foreign profits, M&A will be the big winner.
• Profitability has become the primary driver of M&A attractiveness, compared to ten years revenue was the driver.  Lots of attention to gross margins.
• Some big players are focusing on talent acquisition, buying early with managerial “buyouts” to keep talent engaged and enjoy value creation.
• Every sector and industry have its own story of valuation, metrics, and drivers.
• Entrepreneurs need to plan sale of company 3-4 years out, showing a balanced strategy around growing and selling the company.
• Have a list of suitors be part of the company’s strategy and a regular topic of conversation at leadership meetings.
• Hot sectors for M&A include: big data, decision-making platforms (both are attractive to IBM, Oracle, SAP, etc), value-oriented mobile applications, cloud infrastructure, vertical software platforms
• Generic multiples– 1x revenue on hardware, 2-4x on software

LP Outlook

• Focus today is on small, boutique funds less than $250 million
• Funds are taking 18 months to close a raise
• Contrary to what some think, first time funds are getting raised consistent with earlier levels, but with stellar teams leaving larger funds.  52 first time funds in 2011.
• Funds showing very disciplined approaches to executing strategy and a track record of execution are getting funded.
• Scrutiny for funds focusing on being a Series B investor.  LPs flooded with interest and need to previous success in the footprint.
• For GPs raising with currently unrealized funds, need to show embedded value in current portfolios.
• GPs shouldn’t worry about over communicating.  LPs never complain about getting touched too frequently by GPs.
• Many institutional LPs are timing their involvement 12-24 months out.
• Most LPs can swallow that 50% of a VC funds portfolio won’t return capital.
• LPs are getting very frustrated with GPs incapable of cutting losses.  LPs don’t want to see walking dead in portfolios.
• LPs want to invest in GPs that have a track record of singles and doubles.  Singles and doubles drive liquidity.

Last, a quote from someone (I think Adrian WIlson of Square 1 Ventures): “My career has seen at least three periods when venture capital was supposed to be dead.  Now is the perfect time to invest (in venture capital) because valuations and terms are great.  It is opportune timing as we turn back from the bottom.”

Our community, state and nation could use some more heroes right now.

Did you ever consider that you could be a hero by starting a business?

You could start a business that generates income for your family; provides a product or service that benefits the community; and employs people, enabling them to feed and house their families.

The success of the business and the compensation paid to employees would generate tax revenue. The profit could be reinvested for expansion, thereby creating more jobs and increasing the company's ability to benefit your community and the broader society.

Out of the fruits of your success, you might choose to give to others who are unable to care for themselves, and your employees might choose to do the same.

As a child, did you ever envision yourself as Superman, Batman, Wonder Woman? Did you picture yourself rescuing a baby from a burning building or storming an enemy base to free hostages? Did you ever imagine a scenario where you were the star athlete, making the winning shot, tackle, kick or run? None of us were born on Krypton. We'll never have the Batmobile parked in our garage or an invisible jet on standby. Most of us won't ever be called upon to risk our own life to save the life of another. Most of us will never be able to dunk a basketball, hit a drive like Tiger Woods, throw a 60-yard pass or hit a grand slam.

You could, however, become a real-world hero by starting a business.

In today's economy, finding a job is good, but we need more job creators. Making a living is necessary, but creating opportunity is better. Earning a paycheck is important, but starting something so compelling that it grows and becomes a creator of solutions, products, services, jobs, and wealth could be vastly more significant.

How many different ways can you measure the impact of Bill Gates (Microsoft), Steve Jobs (Apple), Michael Dell (Dell), Mark Zuckerburg (Facebook), Robert Swanson (Genentech), Jeff Bezos (Amazon), Sam Walton (Walmart) and other well-known entrepreneurs?

From software and 'mass customization' that transformed the computer from specialized research hardware into a ubiquitous tool, to iPods and iPads, to social networking, to man-made insulin for combating diabetes, to delivering bargain-priced products to the masses, these entrepreneurs have created products and services, jobs and wealth on a phenomenal scale. Their companies employ millions of people worldwide, including thousands in Tennessee.

Five of the seven companies — Facebook and Genentech are not publicly traded — have a combined market value of about $900 billion. That's roughly the equivalent of $3,000 of value for every man, woman and child in the United States. All of that value belongs to shareholders, including many employees.

Closer to home, we have examples like Mike Campbell, the one-time grocery store manager who founded Regal Entertainment Group, which today is valued at about $2 billion and is the world's largest movie theater operation. Sandy Beall founded Ruby Tuesday, the international restaurant company that also creates business ownership opportunities through its franchising program. Jim Haslam (Pilot), Jim Clayton (Clayton Homes), Lynn Massingale (Team Health) and too many others to name have made similar impact.

These people aren't bulletproof. They can't fly. They're not going to win the Super Bowl or the World Series. They are taking risks, but they aren't risking their lives. They may not realize it, and they probably don't think about it like this, but they are heroes. They are heroes because of their decisions to become creators of solutions, of opportunity, of value.

Turn a skill into a business. Identify a problem or need, and figure out how to address it. Decide to become a creator and not just a consumer. Be a hero.

Grady Vanderhoofven is the general partner of Meritus Ventures and the Southern Appalachian Fund, which make equity investments in companies located in Appalachia.

For some years now I've struggled to connect these inspirational thinkers with the needs of the entrepreneur and the small company.  How do you discuss company culture when the company is only two people?  What good is leadership in a company of one?  How can you have a strategic vision at a time when you don't even know what products you are going to sell?  On top of it all, there's a million things to learn and to think about during the startup period and perhaps entrepreneurs don't need a million and one.

We have recently enhanced our process with an activity we call Strategy Day which is a 1/2 day strategic planning session aimed at entrepreneurs.  If there was ever a place to introduce strategic vision to entrepreneurs, this was it.  After a dozen or so Strategy Days under the belt I have really been impressed with how entrepreneurs respond to a discussion of strategic vision at such an early stage in their business.  Here is an overview of the process.

Strategic Vision sets out to answer four basic questions:

1. What do we believe?
2. Why do we exist?
3. What do we do?
4. So What?

What do we believe?

Every entrepreneur brings a belief system and a set of core values to the game.  These values will no doubt have an influence on how the company forms and conducts business.  This will happen either directly or indirectly as key decisions are made each day.  It's a good idea to acknowledge this and articulate those key values so you can refer future employees to them.  Core Values will guide the company in troubled times and provide a "moral compass".  A list of three to six key values is ideal.

Why Do We Exist?

A Finance professor once explained that society has a limited set of resources and ultimately, society rewards those who provide value with resources they aquire from those who don't provide value.  In the efficient markets of capitalism, the market makes these decisions on behalf of society.  It's important for a new company to decide how to communicate their value to the market and to remind themselves of this on a regular basis.  A Statement of Purpose is a simple one or two sentences that describes the essential reason why society should allocate it's limited resources to the company.

What Do We Do?

I  really like the way Jim Collins provided a framework to answer this question in his fine book, Good To Great.  The Hedgehog Concept is where Passion and Unique Core Competency come together in a way that makes Money.  If you are really good at something that you really love and it can make a lot of money, that's a Hedgehog Concept.  So when you decide what it is your company does, test it to see if it qualifies as a Hedgehog Concept.

So What?

Again Jim Collins helps us out with a concept called the Big Hairy Audacious Goal or BHAG.  A BHAG is a huge goal so compelling that it captures the imagination and aligns effort.  Yet, it is achievable so people can believe they will get there.  It exemplifies the idea that profound insight lies in simplicity.  The message is so clear that people get it right away.  One of the best BHAG's ever was when President Kennedy declared in 1963 that before the end of the decade, the United States will land a man on the moon and return him safely to Earth.    Having a BHAG is much more ingaging than a boring old mission statement.  Does your company have a BHAG?

Strategic Vision

When you summarize all these statements and concepts into one document, you have one very powerful tool to inspire, focus, guide and challenge you company on its way to greatness.

The timing of the this epiphany came during a "period of transition" in our community as there are now several organizations that support entrepreneurs; all striving for recognition, relevance... and funding.  So many people competing with each other to do good.  So much energy consumed maintaining the status quo.  It's like our collective energy is dissipating toward some state of equilibrium... ENTROPY!  It's a cloud that represents the community with everything in its place, working efficiently, and well measured.  Then something happens to change things and all of the sudden a lot of energy gets spent to achieve the next state of equilibrium. Equilibrium consumes energy.  Or rather, it dissipates it.

This process is painful.  Innovation is sacrificed for efficiency and a well ordered system.  A lot of money is spent on resources to manage the system.  And perhaps most frustrating, attention is poured into efforts not focused on why you're in business in the first place.

If this is truly an example of Entropy, then, at least philosophically, you can't do anything about it.  It's a law of the universe. It is the way of things.  

If this is true, then this reaction is predictable and therefore can be "managed".  Status quo can be the impetus for change.  Change can be embraced as opportunity.  It can be a time for the innovators to get out and make the way for change.  The key then is to learn to recognize the equilibrium in the system and look for way to focus energy on a new and better solution.  

This is the role of the innovator.  He or she is the one that gets out. Ahead of the status quo. Seeing what's next and going to find it.  To be the catalyst for the next upheaval.  To sense a state of equilibrium and realize a lot of energy could be pointed in a different direction to solve a real problem.  But unlike the profit who merely points the way, the innovator hoists the pack, grabs the walking stick and finds the way.  While the entropic crowd worries about maintaining itself, the innovator discovers a way to provide value to a willing customer.  And when this happens, the innovator has become an entrepreneur.

Now the explanation for the pause will take longer than the actual pause but stay with me.  I have been running for most of the years leading up to my certain age; basically since the 6th grade.  I know running.  I live running. Plus, I am (I think) tough.  I know what I know and there's not much I don't know...I am sure of it. But then again, what I know isn't working.  "Ummmm,  yeah," was the phrase that ended the pause.

He immediately emailed a guy that lives two hours away who had a pretty cool website and modestly boasted of a couple Olympic runners he has coached.  His name is Randy and I called him.  I asked him why a guy who coaches Olympians would be interested in coaching a middle aged guy who has nothing to prove but wants to defy age as long as possible. Throughout the conversation he said that he wants to help people who have a desire to improve and he especially likes to work with people who have regular busy lives and want to integrate a running lifestyle.  After about 20 minutes on the phone, we agreed it was a good fit.

So now I keep a daily diary and email it to him on Saturdays.  On Sunday, he emails me a workout schedule for that week.  So what's different and why would I pay for something when there's so much free information on the internet and in other resources?  I'm about 4 weeks into it and the answer is this: it's the access to someone who understands what I am going through and the accountability.  I am running more regularly than I have in many years because I know I have to upload my accomplishments each week.  Plus, when something hurts or I have a question about barefoot running shoes, I can ask him. Even though it's just email and an occasional telephone call, I know I'm not alone...

Entrepreneurship is a lonely endeavor.  It's like hitting a golf ball.  I'm told you have to think about fifty things all at once and one thing affects the other 49 in some way.  One of the things we are emphasizing in the CEG right now is to leverage our personal and professional networks to find mentors for our client companies.  Each company and each entrepreneur is different but everyone needs someone they can bounce ideas off and someone to help remind them which of the fifty things they should think about first.  Jim Collins speaks of the "council".  We call them mentors. But they are really coaches.  Sometimes it's a small group of two or three.  Sometimes you meet formally and sometimes it's over coffee or a telephone call.  It's someone you trust and someone who wants to see you succeed. It may be free or it may cost you something.  There's a guy working with me on a technology opportunity.  He told me "you can't afford me so just buy me a lunch every couple months. I gotta eat."  He has been down the path I'm on.  His advice has been very valuable.  I'm not alone...

Do you need a coach?

One of my assigned technologies was "Nonoxide Fluorescent Nanoparticles"  I still don't really know what that means.  The researcher was very patient with me as he explained free electrons, chemical nanofermentation of metal sulfides and the implications for superparamagnetics and ferrofluids. Perhaps through pity, perhaps through exasperation, he finally explained that the process was just like making beer.  That was my eureka moment.  That was a story I could tell.  A strange thing happened as I spent the next two weeks researching markets and understanding how products from rare earth metals are made.  I began to be absorbed into the world of seven syllable words.  The more familiar I became with the technology, the more I started using the language of the scientist and that found its way into my narrative and my slide deck.  The team got together to review our progress and when it came to me, they stopped me on about the third slide and asked me what the heck I was talking about.  "What do you mean?" I said and proceeded to convince them how cool it was to make heavy metals for quantum dots.  John Morris reminded me of who my audience is and they would relate a lot better to making beer than how to precipitate indium and gallium.  I guess I was proud of my new knowledge or perhaps it was just easier to use scientific language once I understood it.  I went back and based the whole message on how it compared to making beer and rather than listing all the elements that could be made, I used pictures of the products that were made from these materials.  It was a hit as were the other presentations made by the CEG team.

Here are some lessons the old dog had to learn...again:

1. It's really easy to get sucked into the world of complex technology.  The deeper you get, the more you begin to use the foreign language that is "techspeak".  You don't have to have a PhD for this to happen.
2. Practice for others - I recorded myself several times and although I got the "ahhh's" and "um's" out of the story, I completely missed the techspeak.  I must have been impressing myself with how the big words rolled out of my mouth.
3. Pictures ARE worth a thousand words.  I replaced four slides filled with a couple hundred words and about 48 bullets...with one slide that had nothing but pictures of computer hard drives, solar panels and MRI machines.  The people got it and the story was easier to tell.
4. You can't throw it together.  One 15 minute presentation took about two weeks to research, assemble and practice.  I had two of them to do.
5. It's not about you. Your job is to tell a good story to people who don't know who you are or what you are selling.  You have to meet them on their terms, not yours.  They won't be impressed with how casually you can say "superparamagneticism".  If they are, then they are thinking about that and not what a great small business opportunity this is.
6. It's not about the technology.  There...I said it again but now I really believe it.  Technology is cool.  But no one will care unless they can see a pathway to make money with it.  That's your job.

Telling a good story is about communicating an emotion.  It's the listener who gets to judge, not the story teller.  

I hope you enjoy my dog food!  It actually tastes pretty good...

One of those basic realities of entrepreneurship is the fact that you can't get there by yourself.  You will need help and it will likely come in the form of partners.  Manufacturing, sales, marketing, finance, accounting, and the list goes on.  Perhaps a typical scenario goes like this: you have a hot new technology but you need someone to help you make it.  Your intellectual property outlines a basic concept for making the product and your challenge is to figure out how to scale up in a manufacturing environment.  So you meet with a few manufactures who are excited about working with you as you are equally excited about making your stuff. You like one particular company and you sign a Memorandum of Understanding (MOU) or a Letter of Intent (LOI) and start the process of figuring out how to make your stuff.  Through several trial runs, you determine the right mix of materials, the best temperature and pressure and your product turns out to be better than expected.  The question is who owns this new intellectual property?  You? Everybody?  Nobody?

Benjamin K. Riley has written a fine article on the Fortune Blog called Three Legal Lessons For Startups in which he goes into some detail about the importance of legal agreements between business partners and joint ventures.  Different legal agreement types carry different weight when it comes to ownership of intellectual property and it's important to understand these differences and make sure your trade secrets stay a secret.

Partners may not stay partners for ever....

By the way, this article came to me via a great newsletter called Lipper Current Weekly. It's one of the best.

The negotiations process can be taxing on the patience and sometimes, the emotions.  VC's live in a world of contracts and attorneys so they are used to it.  For entrepreneurs, the negotiation process can appear to be a profound lack of trust with a potential partner when everything leading up to this moment has been friendly.  The point here is not to base your opinion of the relationship on the negotiation process.  You are better off talking with others who have successfully survived a negotiation with this partner to find out about the relationship when everything gets back to normal.  Plus, you should do it long before you jump into a negotiation.  A good recommendation from another portfolio company will help you get through the process knowing it gets better at the end.

When checking references, ask questions that get to the "chemistry" of the relationship.  We have seen cases where VC's are very active in the management of the company and others take a passive approach once the deal is done. Neither  of these cases is either good or bad.  You may benefit from expertise and contacts offered by an active investor or you may be better off with them on the sideline.  That is up to you.  The important thing is to find out how they operate post deal so you are not surprised.

Remember, an investor relationship will last the life of your company, or at least through an exit opportunity.  It is easier to get out of a bad relationship with an employee than it will be with your funding partners so enter into the relationship with your eyes wide open.

The fight between founders over the business model and the exit strategy - I have seen companies dissolve over this one.  While Facebook survived, the friendship did not.  Things will change as a company matures and new opportunities are presented so it's not as simple as saying the founders have to agree on everything... they won't.  Someone has to be the one to make the decision and the operating agreement should spell out what happens in the event of a divorce.

Never sign anything you don't read - Term sheets are confusing because attorneys get paid more that way.  Many of them are boiler plate to begin with and sometimes contain stuff no body intended but it's in the template.  Other times, terms are put in that were not agreed to in the verbal part of the negotiation.  This may or may not be deliberate but it definitely happens.  Read everything and question everything and GET YOUR OWN LAWYER!!!!!  You will pay him/her more than you want to but do it anyway.  Just make sure to get one with experience with startups and term sheet negotiations.

Someday you may get to tell customers what they want - but not likely and certainly not when you are starting out.  It's all about what the customer wants.  That is why you need to get your idea into their hands as soon as possible so they can tell you.  If you are lucky enough to be branded as cool, run with it, but figure out how to get paid for being cool.

Be a Level 5 Leader - I leave you to read "Good To Great" for a full explanation of what a Level 5 Leader is but suffice it to say that although getting rich is a powerful motivator, the all consuming focus of the entrepreneur is for the ultimate success of the venture.

Think twice about taxing the rich - OOTG is about entrepreneurship, not politics so worry not... Geoff Robson found a great post by John Tammy on the Forbes Website, "Facebook Exposes Tax and Consumption Myths."  Most rich people earned their wealth and few waste it..which is why they are...rich.  Peter Thiel, the original angel investor in Facebook chose to put $500,000 into a company led by a young Harvard genius rather than plunk it down on a yacht.  That led to a company worth billions and employing hundreds of people who are paid well and many of which will use their wealth to start other companies.

I guess that's 5 Things I learned from "The Social Network"...

So, "there it is..."

In the early 1990's, a group of researchers at the University of Tennessee became interested in "ball lightning" which is atmospheric plasma.  They wondered if the phenomenon could be recreated in a lab environment.  From their efforts came the One Atmosphere Uniform Glow Discharge Plasma technology.  A microbiologist PhD named Kim Witenberg joined the team in the mid 90's to see if the technology could be applied to kill micro-organisms.  

Fast forward to 2008, Ken Wood formed Advanced Plasma Products, licensed the technology from the University of Tennessee Research Foundation and launched a commercialization effort.  The first product has entered the market, The TriClean Pro and is a stand-alone air purification system.

Here is a link to the report: http://www.betterworldproject.net/AUTM2010BWR.pdf