One of the takeaways I want to share with you has to do with allowable costs. First and foremost, I am referring to Federally awarded grants. The Feds provide three separate sets of rules under 2 CFR Parts 220, 225, and 230. These rules cover institutions of higher learning, state/local governments, and non-profits respectively. If you manage any Federal grants or are considering applying for a Federal grant, you need to review the rule set that applies to you. These rules are called cost principles and dictate what costs are allowable cost for grant funds. Get familiar with these cost principles because the better you know them, the easier it will be for you to identify funding opportunities.

When founders or entrepreneurs decide to seek funding, it is vitally important for them to understand their market. VCs and angels cringe when entrepreneurs get excited and proclaim their new product doesn’t have any competitors. Entrepreneurs usually present this as the first-mover advantage. While being a first-mover can be a disruptive approach, often that is not the case. VCs and angels want some type of proof the product’s lack of competition in the market exists truly because the product is a first-mover and not because there is no market which is usually evidenced by established companies not moving into that market.

No entrepreneur wants to hear that there is no market demand for the product they have just spent the last 6 months developing. The truth of the matter is that any product or service requires a certain level of market research before initiating product production. When proper research is conducted, both the funder and founder benefit by making an informed funding decision and avoid throwing away money. Whether you are a funder or founder, examine market research before committing.

Let me make it clear that I do not advocate for entrepreneurs to receive capital carte blanche without any type of security. As you will continually hear from me, both sides of a capital deal need to conduct their respective due diligence. Entrepreneurs should expect to put some “skin” in the game because no wise investor would invest a penny in their venture without it. VCs and angels should not expect entrepreneurs to personally secure most or all the investments into the venture. There are other means for VCs to protect their investments, such as board control and valuations.

The E-Myth Revisited

Tonight I just finished reading The E-Myth Revisited by Michael Gerber. This book was recommended reading for an MBA course I took last spring. Needless to say, I didn’t get around to reading it for class but recently found the time. I haven’t read Gerber’s precursor, The E-Myth, so I do not have that context to draw on.

One of the interesting things about Gerber’s approach in this book is his use of a central story to apply the various themes he draws. Throughout the chapters and in the final chapter, Gerber counsels a small business owner on how to view and operate a small business. I appreciate his discussion of multiple personalities or “people” in each person that decides to go into business for themselves. Gerber explains the source of the confusion and frustration many small business owners encounter. Later on, Gerber discusses the “new view” of business, how the concept of franchising plays in, and specific strategies to follow.

I recommend The E-Myth Revisited for new business owners and those contemplating starting a business. Gerber provides new ideas along with some time-tested material. Those with sales or management experience will find sections of the book more or less review material. Still, there are some ideas Gerber mentions that are worth reading through to find the gems.

Clearly, 55% of PE analysts believe PE deal flow will remain low this year. That is tempered by the 65% of PE analysts that advise their firms expect an increase in deal flow this year. What will it be? I argue for increased PE deal flow this year due to the positive expectations of the majority of PE analysts. There is some reason as to why each of the analysts in the 65% believe their firms will experience increased deal flow. Maybe it is the confidence of the firm’s partners; maybe it is an increase of potential deals in the pipeline. Whatever the reason, there are plenty of analysts that believe deal flow will improve for their firms. Of course, this could turn out to be a bad case of groupthink and we see lower PE deal flow but I hope that is not the case.

Good to Great by Jim Collins

About a week ago, I finally finished up Good to Great by Jim Collins. I had read almost the entire book and then put it aside for a few months. Not one to leave things unfinished, I picked it up and read the last two chapters. First, let me tell you after reading Good to Great, I found myself wanting to read Jim Collins previous book, Built to Last. What I enjoyed about Good to Great is that Collins used empirical data to support his claims. Collins doesn’t launch into a conjecture contrived of the “wisdom of ages” to guide a good company to greatness. Instead, he and his colleagues reviewed the entire data set, not a sample, of the companies that went from good to great.

I took away three concepts from Good to Great. The Hedgehog Concept, Level 5 Leadership, and the Flywheel. In a nutshell, the Hedgehog Concept has one ask, about one’s own company, “What are you deeply passionate about?”, “What can you be the best in the world at?”, and “What drives your economic engine?” The Level 5 Leader builds greatness “through a paradoxical blend of personal humility and professional will.” And, the Flywheel Concept summarized states there is no “miracle moment” in greatness but rather a buildup of greatness through “continued improvement and the delivery of results.”

I recommend Good to Great to any startup employee and management in any ongoing concern. Both entrepreneurs and “old hats” will find at least one nugget of gold, if not more, in this book.

Art of the Start by Guy Kawasaki

I had the pleasure of reading Guy Kawasaki’s, Art of the Start recently. I came across his book when I started developing my LinkedIn profile some time ago and then the book was assigned reading for one of my MBA classes at PSU. Needless to say I did as most full-time employed MBA students do with their required reading, I skimmed it. While I was skimming it for class, I realized that I needed to actually read the entire book because the little bit I got out of skimming was spot on and applicative.

Well, I just finished the Art of the Start this week and thought I would write a brief review on it. What I liked most about Guy’s writing is that it is very easy to follow and has the allure of a good suspense author; I couldn’t put the book down. Guy does an excellent job of telling it like it is from both sides of the table, the entrepreneur and the venture investor. The Art of the Start is a must-read for any start-up, in any type of business. Guy covers everything from how to start your venture on a limited or non-existent budget to branding your product and business. After reading Guy‘s book, an entrepreneur will have the foundation he needs to get his venture rolling, up to the point of asking for funding. I recommend this book for any entrepreneur at any stage in their venture and for MBA students looking to start their own venture or work in venture capital.

Now that you have found the guidance documents, read them thoroughly. As you are applying for the grant in question, you want to know what the guidance document has to say about each and every section of the grant application. This is because if you provide a 3/4-page answer when the guidance calls for only 1/2-page or you do not answer the question completely, your grant application will most likely be tossed aside or at best put at the bottom of the stack. What most people do not understand is that grant writing is more about following directions than being able to write good. Even the best-written grant application will be rejected if the grant writer did not follow the grant guidance.

To sum up, make sure you read all the guidance for any grant applications you intend to submit. Some grant’s guidance may be minimal while others may be very specific. Either way, write your grant application to the guidance specifications and you will stand a much better chance at getting your project funded.

While no direct causal link has been proven, knowledge that a venture firm’s large and connected network will result in a more successful venture firm should not be novel. From the start-up’s perspective, one of the main draws of a venture capital firm, besides capital, is the value-add the venture firm brings to the table. Venture firms do not tend to be passive investors. Instead a venture firm will usually require a board seat and regular meetings with, and reports, from the CEO on the company’s progress. The VC firm does not only require this to protect its investment but also to help the investee company grow. The VC firm is only as successful as the sum of ventures it is invested in.

How does the VC’s network benefit the start-up? First and foremost, VCs know other VCs, and this fact is important when it comes time for another round of funding. VCs tend to trust other VCs when it comes to making investment decisions. Second, VC firms are typically full of various types of wisdom. By this, I mean that you will typically find strategic planning expertise, internationalization expertise, IPO-planning experience, marketing strategists and the like in a reputable VC firm. This experience might be found in one or two LPs or fund managers or, most likely, spread among multiple members of the VC firm and its network. This is experience that normally takes a long time to gain and as such is invaluable to a start-up.

Wrapping this up, while a VC firm with a large, entrenched network is not a guarantee of success, for either the VC firm or the start-up, I would argue it is a prerequisite. There are many factors that contribute to VC firm’s and start-up’s success and utilizing a proven network only catapults a firm or company ahead.

The argument for the shotgun approach, other than “it’s a numbers game” is that fund risk is reduced through diversification. So, theoretically the more venture investments across different industries should yield a less-risky and better return than focusing on a specific industry or sector. Within reason, this is the same approach mutual funds use to reduce risk and produce a decent return. However, I would argue that more research goes into selecting the mutual fund portfolio companies than the venture fund portfolio companies utilizing this approach.

When we look at the targeted rifle approach, research shows that VC participation in the venture increases the venture’s chance of success and a higher exit multiple (Bottazi, 2007).The idea behind this is that the more focused a VC is on selecting the ventures to go into the fund, keeping the total number of ventures lower, the more time for participation will be available. Kannianinen argues that there is an optimal number of ventures for a portfolio, however there is no evidence to support the additional benefit of an additional venture investment at the margin and there is no specific optimal number identified (2002). The research my partner and I conducted, via personal interviews with VCs, indicated the optimal number to be between four and eight venture investments per portfolio or fund (2008).

While there is no definitive evidence that proves one approach superior to the other, it is my belief that the targeted approach is the better approach to take because a VC can not only invest more time per venture but also has the time and ability to work their networks deep to assist in the success of the ventures in the fund. Specifically, if all the ventures in the fund are in the same industry and/or sector, there will be some network overlap but more importantly, there will be more opportunity to cross-network. It is this personal involvement and cross-networking that will ultimately provide the best nourishment for a venture, as opposed to just an injection of capital.

Sources:

Bottazzi, Laura, Marco Da Rin, and Thomas Hellmann. The Importance of Trust for Investment: Evidence from Venture Capital. Finance Working Paper No. 187/2007, European Corporate Governance Institute. Dec­2006 ed. 2006. Social Science Research Network. 27 Sept. 2008 <http://ssrn.com/abstract=997934>.

Guchereau, Pray. “Venture Capital Fund Strategies: an investigation into contributing factors of high returns.” Intern research paper 2008, Portland State University, Portland, OR.

Kannianinen, Vesa, and Christian Keuschnigg. “The Optimal Portfolio of Start­Up Firms in Venture Capital Finance.” Journal of Corporate Finance 9 (2003): 521­34. ScienceDirect. Elsevier. Portland State University, Portland, OR.