Unformatted text preview: S P E A K O U T An Engineer’s View of
BY NICK TREDENNICK, wit h BRION SHIMAMOTO
Dynamic Silicon ment versus laissez faire. (Their attitude: “Turn your back on
them and they’ll sit on their hands.” My attitude: “Turn these
particular engineers loose and they’ll work themselves to physical ruin.”) We were in danger of losing good engineers to
morale problems. I suggested to the board that firing all of the
founders, including me, might solve the problem. A new team
might manage more consistently.
The board member from our largest VC firm
invited me to his house in Woodside for a chat
about the morale problems. Acres, opulence,
wealth. We sat in leather chairs on a black
marble floor. Behind him, through the
glass wall, I saw major excavation and
construction work going on up the
hillside. “It’s too bad someone is
building a resort hotel so close to
your house,” I said. “That’s my
new house,” he said. “This
one will be torn down when
that one’s finished.”
We talked about the situation at
the start-up. I outlined my concerns.
I handed him a list of names. “Here’s
contact information for some of the project engineers. The first four will tell you
what I have told you. The fifth will say the
following things….” To his credit, he interviewed the engineers. Also to his credit, he called
to tell me the result. “Everything you said is as you said
it was.” I felt relief. I had struggled with a deteriorating situation for a year and a half.
We agreed on the problem; we agreed on the circumstances—a solution was on the way. They told me: “We think
you should resign.” I left; the problems didn’t. Guide to venture capitalists • Sep tember 2001 The VC connects wealthy investors to nerds. There are few
alternatives. You can self-fund by consulting and by setting
aside money for your venture. That doesn’t work. You could go
to friends and family, but that risks friendships. You could find
“angel” investors, but that only delays going to VCs.
The VC community is a closed one. It caters to a restricted audience. In fact, you don’t get to meet a VC unless
you have a personal introduction. Don’t send them your
business plan unless the VC has personally requested it. I EEE SP E C T R UM DAVID GOLDIN I first encountered venture capitalists (VCs) in 1987.
Despite a bad start, I caught the start-up bug. In the years
since, I have worked with more than 30 start-ups as
founder, advisor, engineer, executive, and board member. It’s a lot more than that if you count all the times I’ve
tried to help “nerd” friends (engineers) connect with the “rich
guys” (VCs). Naturally, I’ve formed opinions along the way.
Many books and articles eulogize VCs. But here I
want to present an engineer’s view of VCs. It may
sound like I’m maligning VCs. That’s not
my intent. And I’m not trying to
change human nature. VCs
know how to deal with engineers, but engineers don’t
know how to deal with
VCs. VCs take advantage
of this situation to maximize the return for the
venture fund’s investors.
Engineers are getting
Fortunately, engineers are trained problemsolvers—I want to harness that power. Engineers,
armed with better information about how VCs operate,
can work for more equitable
solutions. I’m not offering detailed solutions—that would be a book.
Rather, this is a wake-up call for engineers.
My first experience with VCs was as an engineer starting a
microprocessor-design company; VCs were the gods of money.
The other founders and I told the VCs what we thought we
could do and how long it would take. We believed it; they believed
it; we were all naive. I had designed two microprocessors, had
written a textbook on the topic, and had taught at a well-known
university. They thought I knew what I was talking about. We
landed money from premiere firms on Sand Hill Road in Palo
Alto, Calif. We told them a year; it took something like seven
years and it took major changes in strategy to get there.
I wasn’t the CEO; I hired and managed the engineering
teams that eventually reached the goal. I wasn’t there for the
finish. I had a run-in with the other founders, including the
CEO, over how to manage engineers. It was micromanage- 13 I EEE SP E C T R UM • Sep tember 2001 S P E A K O U T 14 • VCs don’t sign nondisclosure agreements. That affords at a big company. Worse for them; worse for us. The industry
them protection if they like your ideas, but they want to fund loses. Progress is delayed.
someone else to do them. At least two of my friends have had
• VCs don’t take risks. VCs have a reputation as the guntheir ideas stolen and funded separately. One case was blatant slinging risk-takers of the electronics frontier. They’re not. VCs
theft—sections of the original business plan were crudely collect money from rich people to build their investment funds.
copied and taped into the VC-sponsored plan. My friend sued Answering to their investors contributes to a sheep mentality. It
and won a moral victory and a little money. The start-up based must be a good idea if a top-tier fund invested in a similar busion the stolen idea went public and made lots of money for that ness. VCs like to invest in pedigrees, not in ideas. They are lookstart-up’s VCs. Most entrepreneurs don’t have the time, the ing for a team or an idea that has made money. Just as Hollywood
means, or the proof to sue. In the second case, venture firm D would rather make a sequel than produce an original movie,
sent its expert several times for additional “due diligence” VCs look for a formula that has brought success. They’re not
regarding the possible investment. My friend got funding building long-lasting businesses; they’re looking to make
elsewhere, but D funded its expert with the same ideas.
many times the original investment after a few years.
When VCs build a venture fund, they charge the fund’s
just as the fashion and toy industries are. The industry is peri- investors a management fee and a “carry.” The carry, which is
odically swept by programming language fads: Forth, C++, typically 20 to 30 percent, is the percent of the investors’ profit
Java, and so on. It’s swept by design fads
such as RISC, VLIW, and network procesVCs take advantage...to maximize
sors. It’s even swept by technical business
the return for the venture fund’s investors.
fads such as the dot-coms. No area is
Engineers are getting short-changed.
immune. If one big-name VC firm funds
reconfigurable electronic blanket weavers,
the others follow. VCs either all fund something or none of them will. If you ride the crest of a fad, you’ve that goes directly to the VC. The VC, who gets a healthy chunk
a good chance of getting funded. If you have an idea that’s too of any venture-fund profits, may have no money in the fund.
Even a small venture fund will be invested across a dozen or so
new and too different, you will struggle for funding.
companies, spreading risk. Also, the VC, as a board member,
the ones with engineering degrees. An engineering degree is will collect stock options from each start-up the fund invests in.
The rich investors take some risk, though their risk is
a starting point. If you design and build things, you can become
an engineer; if you work on your career, you can become an spread across the fund’s investments. The real risk-takers are
executive or a venture capitalist. VCs in Silicon Valley are as the entrepreneurial engineers who invest time and brain
technically sophisticated as VCs come. As you get geographi- power in a single start-up.
cally farther from technical-industry concentration, investors
• Venture funds are big. Too big. If your idea needs a lot of
become more finance-oriented and less technically-oriented. money, say $100 million, then you have a better chance of
Like all people, they dismiss what they don’t understand, getting money than an idea that promises the same rate of
your novel ideas, and they focus on what they know, usually return for $1 million. The VCs running a $1 billion fund
irrelevant marketing terms or growth predictions.
don’t have the time to manage one thousand $1 million
• Experts aren’t very good. The VC will send at least one investments. It won’t even be possible to manage two hun“expert” to evaluate your ideas. Don’t expect the expert to dred $5 million investments. It’s better to have fewer, bigunderstand what you are doing. Suppose your idea imple- ger investments. In such an environment, if you need only
ments a cell phone. The VC will send an expert who may $5 million, your idea will struggle for funding.
know all there is to know about how cell phones have been
• VCs collude. VCs collect in “bake-offs” that are the VC’s
built for the last 10 years. As long as your idea doesn’t take you version of price fixing. They discuss among themselves fundfar from traditional implementations, the expert will under- ing and “pricing” for candidate start-ups. Pricing sets the
stand it. If you step too far from tradition—say, with a novel number of shares and the value of a share, and is typically
approach using programmable logic devices instead of digital expressed in a “term sheet” from the VC to the start-up. VCs
signal processors—the expert will not understand or appreci- optimize locally. It wouldn’t do for several of them to fund, say,
ate your approach.
six companies in an industry wedge. Limiting the options to
One company I worked with had an innovative idea for a two or three limits competition and makes the success of the
firewall: build it with programmable logic and it works at wire few more likely. The downside: limiting competition stifles
speed. Wire speed meant no buffering, no data storage, and innovation and slows progress. As in nature, competitive
therefore no need for a microprocessor or for an IP (Internet environments foster healthier organisms. Innovation is the
Protocol) address. Simple installation, simple management, beneficial gene mutation to the current technology’s DNA.
but so different that experts—even those from programmable
I attended a recent talk by a VC luminary, who gloated over
logic companies—didn’t understand it. To them, proposing a the state of the venture industry, after money for technology
firewall without a microprocessor and an IP address was like start-ups was scarce. Here’s my summary of the VC’s view:
proposing a car without an engine. No funding. Back to work
“A year ago there was too much money available, so there I EEE SP E C T R UM • Sep tember 2001 S P E A K O U T 16 was too much competition to fund good ideas. Valuations for
pre-IPO (initial public offering) start-ups were too high. Startups could get term sheets from several venture firms and
select the most favorable. Too many ideas were getting funded.
With too many rivals, markets might never develop. The current market is much better. Valuations are reasonable and,
with few rivals in each sector, new markets will develop—as
they might not have with many rivals.”
This is nonsense. Look, for example, at hard disks and
floppy disks. In the hard-disk business, there have been as
many as 41 rivals fighting for market share. Only three major
manufacturers competed in floppy disks. The hard disk has
improved much faster technically; the floppy disk is stagnant
by comparison. I’m not talking about market size or market
opportunity (the hard-disk business versus the floppy-disk business); I’m talking about rates of innovation.
• VCs don’t say no. If the VC is interested, you can expect
a call and, eventually, a check. If the VC is not interested, you
won’t get an answer. Saying “no” encourages you to look elsewhere—that’s not good for the VC, who prefers to have you
hanging around rather than going elsewhere for funding.
Fads change; the herd turns; your proposal may look better
next year. In addition, the VC may want more due diligence
from you—to add your ideas to a different start-up’s plan.
If VCs think you have few alternatives, they will string
“I love the deal, but it’ll take time to bring the other partners along.”
“We need more time to get expert opinions.”
“We’re definitely going to fund you, but we’re closing a
$500 million fund, and that’s taking all our time.”
“I’ll call you Monday.”
Once your alternatives are gone, they negotiate their terms.
• VCs have pets. The VC’s version of a pet is the “executive
in residence.” Many venture firms keep a cache of start-up executives on staff at $10 000 to $20 000 per month (a princely sum
to an engineer, but just enough to keep people in these circles
out of the soup kitchens). Start-up executives, loitering for an
opportunity, may collect these fees from more than one venture
firm, since the position entails no more than casual advising.
These executives have “experience” in start-ups. When you show
your start-up to the VCs, they will grill you about the “experience” of your executive team. It won’t be good enough, but not
to worry, the VC supplies the necessary talent. You get a CEO.
The CEO replaces your friends with cronies.
The VCs’ pets are like Hollywood’s superstars. Just like
Julia Roberts and Tom Cruise, the superstar CEOs command
big bucks and big percentages (of equity)—driving up the cost
of the start-up—but are “worth it” because they give investors
and VCs a sense of security.
• Your idea, your work, their company. The VC’s CEO gets
10 percent of the company. VC-placed board members get 1 percent each. Your entire technical team gets as much as 15 percent. Venture firms get the rest. Subsequent funding rounds
lower (“dilute”) the amount owned by the technical team. Venture firms control the board seats. The VC on your board sits
on 11 other boards. Board members visit once a month or once a quarter, listen to the start-up’s executives, make demands,
offer suggestions, and collect personal stock options greater
than all of the company’s engineers hold, with the possible
exceptions of the chief technology officer and the vice president
of engineering. The VC’s executives control the company. You
and the rest of the engineers do the work.
One company I know got a good valuation a year ago.
Over the year, it grew rapidly, developed its product, met or
exceeded its milestones, and spent its money according to
plan. When it was time to get money again, the funding
environment had changed. Last year’s main investor wouldn’t “price” the shares or “lead” the new funding round. The
“price” declares the number of shares and the valuation of the
company. Think of the company as a pie. It is a certain size
(valuation) and it is cut into a number of slices (shares). An
investor “leads” by offering a specific price for shares for a
large percentage of the next round. Other investors follow at
the same price. Even though the company’s engineers had
executed flawlessly, the round came in at less than a third of
last year’s valuation.
As a part of closing this “down” round, the last year’s investors renegotiated the previous round, effectively saying,
“Since this round is lower, we must have overpaid in the last
round. We want more equity for the last investment.” If there
had been fraud by the entrepreneurs instead of flawless execution, renegotiating the previous round might have been
reasonable. Imagine the opposite scenario: “In light of market
developments, it’s obvious that your idea is worth much more
than we thought, so we’re returning half the equity we took for
last year’s funding.” It’s so ridiculously improbable that you
can’t read it without laughing out loud. That we accept the converse highlights the entrepreneur’s weak position. Values at variance
The VCs know money and they don’t care about the technology; the entrepreneurs know technology and they need money.
Money knowledge applies across all the start-ups; the technical knowledge is unique to each. The VCs don’t care about any
single technology because they spread their investments across
the opportunities. Knowing money isn’t the same as knowing
value. A year ago, VCs were lining up to give money to Internet dog-food companies; this year, they wouldn’t back an inventor with a working Star Trek transporter.
It’s financial; it’s not technical or personal. To the VC, the
engineer and the ideas are commodities. The venture firm
squeezes the technical team because it can. VCs believe that
they are exercising their responsibility to maximize return for
themselves and for the fund’s investors.
Reducing the engineers’ share of the pie is counterproductive, however: they become demoralized; productivity
suffers; eventually, they leave. Engineers are not commodities. Replacing a chip designer one year into a complex
design delays the project six months while the replacement
engineer learns and then redesigns the work-in-progress.
VCs don’t appreciate that the electronics revolution is built
on the backs and brains of engineers, not of executives.
Moore’s law and engineering talent drive the electronics rev- S P E A K O U T olution. Tremendous market pull for its products builds
momentum. The pull is so great that the revolution is indifferent to the talents and decisions of its executives (legendary
blundering causes only ripples), but it depends on the talent
and the work of its engineers. The engineers are the creators
of wealth; the VCs are the beneficiaries. Fixing the problem
The engineers building the future deserve a fair equity share
in the value they create; today they don’t get one. For them to
get their share, wealthy engineers must fund start-ups. And
they don’t have to be Bill Gates to do so. “Qualified investors”
can participate in pre-IPO funding. This means your net worth
(exclusive of your home) must be at least a million dollars or
you must meet minimum annual income requirements.
These days, the millionaire’s club isn’t all that exclusive. Many
engineers are qualified investors.
If you are a qualified investor, participate in start-ups as an
“angel” investor. An angel investor participates in early or “seed”
funding rounds. Don’t do it with more money than you can
afford to lose, however, because it is risky. To change the situation I’m describing, start-ups need your money and they need
your advice. More money and more start-ups bring faster pro- gress and create more wealth. Creating wealth isn’t only about
money; it’s about quality of life and it’s about raising the standard
of living for everyone (but that’s another essay).
Engineers should band together to form venture funds.
Start-ups need more angel funding and they need better-organized angel funding. I’d like to see a dozen or so $100 million
venture funds run by nerds. These nerd-based venture firms
would work at the seed round and at the next funding round
(called the A round). They provide initial funding and advice
and they, with the benefit of professional financial advice,
represent their start-ups in future funding negotiations with
traditional venture firms.
Here’s a third suggestion. I’d like to see an engineer-run
start-up whose goal is to raise $100 million in a public offering. The money becomes a fund for sponsoring start-ups. It’s
a public venture firm and it sells shares to raise money. Investing in start-ups wouldn’t be exclusively for rich people; anyone
who could buy stock could be investing in start-ups. Ideally, the
public VC firm would be managed and run by nerds with
empathy for nerds in the start-ups.
I wanted to publicly thank more than a dozen people for
help on this essay, but they all said “NO!” None can afford to
have the VCs find out that they contributed. • Congress Needs Nonpartisan
Advice on Science, Technology
BY JON M. PEHA
Car n e g i e Mell o n U n i v ers i t y I EEE SP E C T R UM and Policy-makers,” March 2001, pp. 15–17] the way policymakers in Congress gather and process information is fundamentally different from the methods of technologists. Congress uses an adversarial system, where e...
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