Immunex, a small Seattle biotechnology company, stumbles into a hugely successful and groundbreaking product. Enbrel, a tumor necrosis factor, is immediately recognized as the most effective treatment for rheumatoid arthritis--a $300 billion market in the United States. After almost 20 years of unprofitability, Enbrel is a lifesaver for Immunex. But it could also become the company's worst nightmare. Immunex, after years of being cash starved, has not been able to build production capabilities to satisfy the sudden and massive demand for its drug.
To illustrate the decision-making process concerning how and when to build commercialization capabilities in a small biotechnology company. Also, to explore options for reacting to an unexpected demand in a hypercompetitive market.
In 2000, Millennium Pharmaceuticals was the poster child for successful genomic companies. Millennium's fast growth and exuberant valuations were due to the elegant alliances the company had forged with top pharmaceutical, biotechnology, and agricultural companies. However, as the market shifted and Millennium was forced to fully integrate, the type and structure of its alliances no longer worked.
To illustrate how strategic alliances are used in biotechnology as growth tools and to demonstrate the impact of market conditions on the evolution of alliances.
Describes the growth of a biotechnology company as it shifts from a service research organization to an integrated human therapeutic company. Maps the management changes from 1982 to 1998, as the company responds to volatile market pressure.
To illustrate the challenges of shifting strategies in a research-intensive organization; to point to the different management styles needed at different stages of a company's life cycle; and to demonstrate the unique issues of product development in a biotechnology firm.
Presents Connetics, a biotechnology and pharmaceutical company, from its founding in 1993 through the final clinical trials of its flagship drug compound in 2000. Throughout that time, the company had experienced the failure of another compound, while successfully in-licensing other pharmaceutical products that would immediately generate income. Ultimately, the pivotal trial in 2000 was a failure, and CEO Tom Wiggans must manage the company through this failure (the stock went from about $25 to $5 after the results were revealed publicly).
To examine issues associated with biotechnology finance and strategy, and to address the challenges of managing through crises and making difficult strategic decisions with imperfect information.
ImmuLogic Pharmaceutical Corp., a development-stage biotechnology company, is considering making an initial offering of common stock. The diverse perspectives of the entrepreneur, venture capitalist, investment banker, and institutional investor are explored. Problems of valuation are highlighted. The challenges posed by "windows" for public offerings are considered.
To explore implications of going public; to examine he motivation of the various actors in the going public decision; and to understand the problem of valuation.
To develop the next generation of risky products, ALZA, a mature and profitable biotechnology firm specializing in drug delivery systems, must raise $40 million. Organizational constraints and competitive concerns demand that the work be done inside the firm. However, accounting considerations and concerns about shareholders' reactions to the introduction of new risks to the firm lead the CEO to consider off-balance-sheet means to finance the new venture. To finance the new venture, the firm creates a new financing vehicle: a unit consisting of callable common stock plus warrants. This case examines the CEO's decision leading up to the issue of the units and the establishment of a new research and development subsidiary.
To (1) demonstrate how strategic, organizational, accounting, and shareholder considerations may constrain financing decisions and lead to financial innovation; (2) allow students to examine the mechanics and logic of rights offerings and the role of underwriters; and (3) allow students to value a new security with embedded options and to use this valuation to examine anomalies in the pricing of a new product.
Pablo Valenzuela, vice president of R&D at Chiron Corp., faces several choices for how to allocate scarce resources across several promising projects. These choices will determine Chiron's position in several emerging biotechnology and diagnostic markets, including tests for hepatitis C, HIV infection, and others. Valenzuela must examine Chiron's capacity, its strategy, and the character of the opportunity, including the impact of these choices on joint venture partners.
To address issues in aggregate project planning and development strategy. Illustrates the interaction between development capacity, business strategy, and project opportunities in a rapidly changing technical and commercial environment.
Sandford Smith, CEO of Repligen, faces the breakdown of negotiations about a proposed joint venture with a large pharmaceutical firm. He must decide whether to proceed using his firm's internal resources or whether to seek to revise the proposed collaboration. If the deal is to be revived, he must decide on what aspects to compromise.
To address the terms and conditions of collaborate arrangements and to look at the impact of contractual terms on the value of collaborative efforts.
Aberlyn Capital Management, a venture leasing firm specializing in providing capital to biotechnology firms, proposes to introduce a new product. Aberlyn will base a lease on an intangible product: the patent of a biotechnology firm. This poses a series of short and longer run challenges.
To understand financing alternatives for high-risk firms and to consider the valuation of complex securities; to address the optimal introduction of a new security.
|Published:||December 4, 2006|
Venture capital firms often consider investments in companies located far away or in unfamiliar industries. How do they spot these opportunities and also reduce risk? It's the power of networks, says Harvard Business School professor Toby Stuart—and understanding how they work in VC is just now starting to be understood. Key concepts include:
- Networks are important in all industries, but especially so in VC where investment opportunities can be located far away from the centers of venture capital.
- "Spanning ties" enable investors with fixed locations and industry expertise to learn of opportunities outside their geographic and industry domains, while also reducing risk.
- Ties are more likely to form between VC firms in the context of bandwagons, such as a "hot" IPO market, that create a rush of excitement around particular types of companies.
About Faculty in this Article:
Toby E. Stuart is the Charles Edward Wilson Professor of Business Administration at Harvard Business School.
Most of us have experienced the power of networks. There's the job found through a friend's sister's boyfriend, or the lifelong partner met through a neighbor's cousin.
But how do networks play into business—particularly the relationship-rich industry of venture capital?
New this year to the HBS faculty, Toby Stuart studies networks and how they enable or impede certain organizational and entrepreneurial behaviors. In a working paper, "The Evolution of Venture Capital Investment Networks," he and coauthor Olav Sorenson of University of Toronto's Rotman School of Management examine the effects of geographic distance and a "hot" IPO market on the formation of networks in the venture capital industry.
The fact that the world is connected through spanning ties has huge effects on the spread of all manner of things.
"The origin of that paper goes back to when I was on the faculty at the University of Chicago's Graduate School of Business," Stuart says. "I was part of a committee examining why there wasn't a more vibrant life sciences industry in the Chicago area when all of the requisite ingredients were in place. I became very interested in the role of geographic space in establishing networks."
The vital network
Venture capital shares some of the same qualities as the life sciences industry in terms of the crucial role played by networks, Stuart says.
"Networks are important to all businesses, obviously, but they're absolutely essential to the functioning of VC and the technology-based industries in which VCs often invest. And in addition to person-to-person social networks, firm-to-firm networks are vital in both contexts.
"For example, about two-thirds of venture capital financing rounds involve syndicates of investors rather than single firms. And most young companies are very narrow in scope in terms of the scope of their internal activities, which means that they need to extensively partner with other companies to bring their product to market. These syndicated and partnerships weave together firm-to-firm networks."
There's a general understanding of the role played by proximity and likeness in establishing local network clusters—but how to account for the appearance in a network of a distant player with no immediate connection or similarity to others in its group?
Look at your own life, says Stuart. "To put it in social terms, you probably know a lot of people who know one another. For many of us, most of our time is spent within small clusters of people—at the office, in our neighborhoods. But you also have connections to people who are distant from the small set of cliques in which you live your daily life.
"We have better theories about how you formed a group with your immediate coworkers, friends, and neighbors than we do for those connections that are outside the circle."
Yet those "spanning ties," as Stuart calls them, have important implications in a variety of contexts.
"The fact that the world is connected through spanning ties has huge effects on the spread of all manner of things ranging from information about positions among job searchers to the potentially rapid spread of communicable diseases," he says.
A market bubble can effectively rewire some of the links in the network.
In the case of venture capital, spanning ties enable investors with fixed locations and industry expertise to learn of opportunities outside their geographic and industry domains.
"They're instrumental in the movement of capital from money centers like New York to entrepreneurial centers like Silicon Valley and Boston," he explains. "In addition to providing access to information about investments and invitations to join syndicates, firms with broad, far-reaching networks are often more comfortable investing in a start-up from a distance because they have reliable, local partners to advise and monitor the new venture."
In their paper, Stuart and Sorenson posit that these ties are more likely to form between VC firms in the context of certain events, such as a "hot" IPO market. "A market bubble can effectively rewire some of the links in the network," says Stuart. "That sort of heated environment creates a rush of investment activity that increases the number of participants hoping to quickly take a company public. It results in some unlikely bedfellows in the syndicate network."
Another factor that can reconfigure a network is risk, Stuart adds. "The general reluctance in doing business with strangers revolves around trust," he says. "You don't know how to assess their competence and don't have a sense of how to 'read' them."
However, spanning ties are more likely to form between the lead venture capital firm and distant investors as the size of the syndicate grows, thus decreasing the risk associated with each organization's investment. The lead VC also perceives less risk in forming a relationship with a distant syndicate partner when they are seeking investment at a later stage of a company's financing, when they enjoy geographic proximity to the start-up in question, and when they are a specialist in the start-up's industry.
Under these low-risk circumstances, a firm starts small by engaging partners they believe will be useful to work with in the future. "The next time around, that entity is part of their working set," Stuart says.
Taken more broadly, spanning ties weave together the fabric of the network and contribute to the diffusion of information across the investing community—a dynamic Stuart will study further in Networks in Technology and Entrepreneurship, a work-in-progress that will combine data analysis with insights culled from interviews with HBS alumni working in the high-tech and entrepreneurial arenas.
"The book will examine the role of networks in career development—from recognizing entrepreneurial opportunities to raising capital to growing a business," he says. "It will also look at how the very same networks that enable some individuals to become entrepreneurs can constrain others—some women, for example—because they are outside the core social networks in their areas."
Stuart, the Charles Edward Wilson Professor of Business Administration, was recently awarded the 2007 Ewing Marion Kauffman Prize Medal for Distinguished Research in Entrepreneurship, an award given every two years to one scholar under the age of forty whose research has made a significant contribution to entrepreneurship.
About the author
Julia Hanna is the Associate Editor of the HBS Alumni Bulletin.
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|Published:||January 3, 2007|
|Paper Release Date:||December 2006|
|Authors:||William Kerr and Ramana Nanda|
What effect does an increase in banking competition have on the entry of start-ups? In particular, does an increase in banking competition have a differential effect on the entry of start-ups relative to the opening of new establishments by existing firms? The U.S. branch banking deregulations provide a useful laboratory for studying how banking competition affects small businesses. Prior to 1970, all but twelve states had stringent restrictions on the ability of banks to open new branches or to acquire the branches of other banks within the state; beginning in the 1970s and until 1994, all but two states removed these restrictions. In this research, Kerr and Nanda studied the entry of newly incorporated businesses between 1976 and 1999 using detailed data collected by the U.S. Census Bureau. Their findings matter for understanding how reforms that affect the financing environment may improve the real economy through the reallocation of resources in the non-financial sectors. Key concepts include:
- Interstate branch banking deregulations had a positive effect on both the entry rates and entry sizes of start-ups relative to the facility expansions of existing firms.
- These beneficial effects were evident in multiple sectors of the economy and stronger in more financially dependent industries.
- While greater banking competition may hurt entrepreneurs through a decline in relationship banking or loan subsidization, the positive net effects point to substantial increases in credit provision to start-ups.
- The impact of financial market reforms on product market entry is an important micro-foundation for understanding and fostering economic growth.
About Faculty in this Article:
William Kerr is an assistant professor in the Entrepreneurial Management unit at Harvard Business School.
We study how U.S. branch banking deregulations affected the entry of new firms in the non-financial sector using establishment-level data from the U.S. Census Bureau's Longitudinal Business Database. The comprehensive micro-data allow us to study how both the entry rate and the distribution of entry sizes for new startups responded to changes in banking competition. Moreover, we distinguish the relative effect of the policy reforms on the entry of startups compared to the opening of new establishments by existing firms. We find interstate banking deregulations had a strong positive effect on the birth of new firms relative to the facility expansions of existing firms. We find limited evidence that the intrastate banking deregulations influenced entry. Our results have implications for existing theories of financial constraints for entrepreneurs, as well as research looking at the effect of banking competition on the efficient allocation of capital.
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|Published:||October 16, 2006|
When a delegation of Harvard Business School faculty visited Chinese entrepreneurs, they came away with something unexpected: the start of what could be a fundamental rethinking of how entrepreneurship works. Key concepts include:
- At least in selected areas, entrepreneurs in China are thriving and opportunities are abundant in times of change, chaos, and uncertainty.
- National, regional, and local governments continue to play a role in business formation, and can be helpful securing resources for entrepreneurs.
- Studying China provides fertile ground for rethinking what conditions are necessary to foster a healthy entrepreneurial environment.
About Faculty in this Article:
Daniel Isenberg is a senior lecturer in the Entrepreneurial Management unit at Harvard Business School.
Travel Dates: June 11-18
Travel Party: Fifteen people, including nine faculty members.
Locations: The cities of Beijing, Hangzhou, and Shanghai. Companies and institutions visited include Tsinghua Science Park, Microsoft, Li-Ning, Gome, Beijing Genomics, Zhejiang University, Huawei, Wahaha Beverage, Shanda, Fosun, Focus, and Tsinghua University.
Purpose: Begin to comprehend some of the fundamental changes in the Chinese economic and social system, and how entrepreneurship is being facilitated to play a role in this. Also important: Make contacts that will be helpful in research and course-development activities at HBS.
Sean Silverthorne: What were some of the group's conclusions about entrepreneurship in China, at least in the areas you saw?
Dan Isenberg: Yes, it is important to take into account the fact that we only saw a select portion of the entrepreneurial activities in China, in particular in the major eastern cities Beijing, Shanghai, and Hangzhou.
First of all, it is impossible to grasp the scale of the transformation without seeing it with one's own eyes. The physical, economic, and social immensity of the change is impressive to say the least.
A second conclusion is that it is impossible to comprehend the vibrancy, energy, and enthusiasm without experiencing it firsthand.
Q: Although moving toward a more capitalist system, the government still plays a strong role in the economic environment of the country. Does that presence help or hinder entrepreneurial efforts there?
A: Time will tell, but I think in the short and medium run it is clear that the government is a major driving force. By the way, "government" is not a monolithic entity. There are national, provincial, and municipal governments. All are playing roles, but my sense is that the regional governments' roles are the most significant in terms of creating the infrastructure to support entrepreneurship—university programs, tax incentives, incubator programs, educational programs, and the like.
Q: Your travel group seemed very impressed with the high quality and education of workers there. Was that a surprise?
A: Again, bear in mind that we met a very limited and select group of people. I think different faculty had different reactions based on our initial personal expectations, but given the high quality of Chinese students that we have at HBS and that we meet in U.S. companies, I don't think we were very surprised. Impressed, yes, but not surprised.
Q: What's a "sea turtle" and why is it important in discussing the development of entrepreneurism in China?
There are many paths to successful venture creation, and viewing the phenomenon from a completely different perspective is enlightening.
A: We heard the phrase "sea turtle" a few times. These are the Chinese who spend significant time abroad and then come back to China to "lay eggs," that is, start new ventures. In addition to bringing with them insights, skills, attitudes, tangible assets, and contacts that are useful to their ventures, the government has created incentives to attract them back to China, and is more lenient or flexible regarding new venture formation.
Q: This was an unusual trip for HBS in that it involved quite a number of faculty, and faculty representing different disciplines. Was that cross-pollination of viewpoints and knowledge helpful?
A: Not only did we have a variety of faculty interested in entrepreneurship from different perspectives, we also had two prominent venture capitalists from the Boston area. As in any good case discussion, the different perspectives, questions, and insights were extremely enriching. After every company visit we would continue back on the bus to discuss and debate what we saw and how we interpreted it. And I think we formed stronger bonds among ourselves, including some new friendships that are already manifesting themselves in plans for research collaboration.
Q: The group almost to a person spoke about how the trip not only changed their perspective on entrepreneurship in China, but also how they think about entrepreneurship in general. Could you discuss that a little bit?
A: There is a popular song in Israel that goes, "The things you see from there, you cannot see from here." I think we developed a greater appreciation for the fact that there are many paths to successful venture creation, and viewing the phenomenon from a completely different perspective is enlightening.
As one example, we saw the powerful, and in this case positive, role of the government. We also saw that whereas a modern infrastructure really helps, a lot of entrepreneurship can occur without it, and then when successful, entrepreneurship itself creates, enables, and facilitates economic development.
There are a number of "chicken and egg" processes, or feedback loops here. I learned a saying in Chinese: "You can catch big fish in murky water." That means that the big fish are hiding when the water is clear, or they have already been eaten. Translation: There are big opportunities in times of change, chaos, ambiguity, adversity, and unclarity. China is certainly a "work in progress."
Q: What advice would you give HBS Working Knowledge readers who are thinking of creating new businesses or ventures in China?
A: Go there now. When there, listen, observe, learn. When you are ready to do business, form a network of trusted insiders to help you get things done there.
About the author
Sean Silverthorne is editor of HBS Working Knowledge.
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In early 1997, Cephalon, awaited an FDA panel's decision on whether its drug, Myotrophin, would be approved. If the drug was approved, the firm might need substantial additional funds to commercialize as well as to buy back rights to it (which had been sold earlier to finance its development). The firm's CFO is considering a variety of financing strategies, including buying call options on the firm's own stock and paying for those options by issuing shares at the current time.
To introduce students to the use of equity derivatives as part of a risk-management strategy, to examine the application of cash-flow hedging in a corporate context, and to examine the pricing of a derivative security with large jump risk.
A new firm is being created to speed up the process of mapping humans, animals, and plants by combining gene technology with rapid gene identification to improve the health and well being of the human population and the productivity of crops and animals. How does one manage this process?
To examine the new technology that will revolutionize the food and health system and discuss how to create the appropriate structure to maximize this technology for the stakeholder.
AllerGen, a young biotechnology firm, is heading for trouble, possibly even bankruptcy. The company's one product--a vaccine for people allergic to cats--may never make it to market. And turnover is on the rise, not only because of the vaccine's uncertain future but also because employees are increasingly unhappy working for founder and Chief Scientific Officer Harry Huston. Although Harry is an excellent scientist, he has no business background. Several years ago he recruited a president and COO to bring some much-needed business savvy to the organization, but that executive left after a year because Harry simply wouldn't let him do his job. It hasn't helped matters that AllerGen's board consists mainly of Harry's friends and family, who go along with whatever he wants. Recently some scientists at AllerGen had the phenomenal good luck to develop, almost by accident, an alternative potentially lucrative product. But Harry won't give the go-ahead to develop a business plan for it. "There has to be someone who stays the course and works for the sheer joy of finding the cure," he says. "There are people out there who need this vaccine. Some very badly. That's why we're here. Not for the money." It's up to two senior scientists to make Harry see that he is holding AllerGen back. How can they convince Harry that changing course is critical?
In R00106 and R00114, commentators Matt Benasutti, Mark Lipton, George N. Hatsopoulos, Dorothy Beckert, and Warren D. Miller offer advice on this fictional case study."
Abgenix has a unique method for generating antibodies useful in treating a number of diseases, including cancer. In early 2000, the company's cancer has performed very well in animal testing and is moving to early stage human testing. Abgenix must decide whether to sell the product development program to a large pharmaceutical company or to enter into a joint venture to push the product ahead.
To introduce the issue of deciding whether to define your product as access to a technology, a developing program for defining a product based on the technology, or a finished program and marketable product. Exposes students to product line planning in largely uncertain environments.
Traces Monsanto's efforts to become a global biotech powerhouse under Shapiro's leadership. Examines how his crusade to save the world through genetic modification foundered.
To introduce students to the importance of building alliances with all members of the supply and demand chain and recognizing cultural and geographic differences.
As a biotech start-up company involved in studying human genomes, Perlegen needed to develop an organization that fostered innovation and teamwork among a group of highly trained professionals from both the science and technology fields. Perlegen's CEO, Brad Margus, had joined Perlegen from the shrimp processing business after learning that two of his three sons had been diagnosed with a rare genetic disease. A Harvard MBA and self-trained geneticist, Margus looked forward to the opportunity to dedicate himself to Perlegen's scientific mission. During his first nine months on the job, Margus had hired a number of junior-level and mid-level employees; now it was time to fill out the senior management team. Margus's first senior management hire was Greg Brandeau, the former vice president of computer operations at Pixar Animation Studios, who signed on to be Perlegen's CEO. Brandeau faced a number of challenges as he integrated into the Perlegen organization, including the fact that he lacked a science background, his two direct reports had already been hired, and he would be the third leg of a tight-knit, two-person senior management team already in place.
To show how leaders build an organization to support breakthrough innovation, manage "stars," and foster cross-functional cooperation.
In 1993, Calgene is on the verge of introducing the world's first genetically engineered plant product--a tomato will taste better and stay fresh longer. At the same time, it is using biotechnology to produce improved plant products for the cottonseed and the industrial and edible oil markets. As it develops and brings these products to market, however, it faces a series of marketing and public relations hurdles, including regulatory requirements consumer education activist resistance to production, and distribution logistics. How Calgene reacts to these challenges may determine whether it succeeds or fails in its quest to revolutionize the business of agriculture. A rewritten version of an earlier case.
To introduce students to the unique challenges encountered in the world of bioengineering, an increasingly important but controversial topic in society. Addresses product selection and target market selection for new-to-the-world products. Much of the discussion can focus on whether Calgene has chosen the best product with which to go to market and, if so, whether it has chosen the best strategy for entering that market.
After taking 30% of its Conoco oil and gas subsidiary public in the largest domestic initial public offering (IPO) in U.S. history, management of E.I. du Pont de Nemours and Co. (DuPont) is considering divesting its remaining interest in Conoco. This goal is to be accomplished through a relatively uncommon transaction called a corporate "split-off," under which DuPont's shareholders will be given the option to exchange their shares in DuPont for shares in Conoco (but, in contrast to a more conventional "spin-off," they are not obligated to exchange their shares). Management's objective in restructuring is to move DuPont away from its traditional energy and chemical business toward the life sciences (agriculture, biotechnology, and pharmaceuticals).
To discuss the economics of IPOs and the rationales for corporate restructuring. To assess the potential value enhancement for DuPont's shareholders of divesting of the company's slow-growth oil and chemical business. Also, contrast alternative techniques for breaking up a conglomerate, including spin-offs, asset sales, carve-outs, tracking stocks, and split-offs. To debate the merits of the company's proposed risky strategic shift into a new "hot" industry whose prospects are highly uncertain.
What makes for the ideal entrepreneurial opportunity?
To learn about the frameworks firms use when evaluating potential venture opportunities, Mike Roberts, executive director of the Arthur Rock Center for Entrepreneurship, and HBS senior research associate Lauren Barley recently interviewed four venture capitalists from leading firms in Silicon Valley. The following are excerpts from their responses.
Russell Siegelman (HBS MBA '89)
Partner, Kleiner Perkins Caufield & Byers
The most important requirement is a large market opportunity in a fast-growing sector. We like a company to have a $100 million to $300 million revenue stream within five years. This means that the market potential has to be at least $500 million—or more, eventually—and that the company needs to achieve at least a 25 percent market share.
The second factor involves a competitive edge that is long lasting. It is usually an engineering challenge that is tough enough to give the company an edge, resulting in several years lead or longer, if we're lucky. We look for a tough problem that hasn't been solved before. The solution can't be so straightforward that someone can look at the blackboard and say, "I know how to do it."
The third thing is team. We look for engineering vision and execution, sales, and entrepreneurship in a team. Typically, it's at least two people; sometimes it's three. In the early stages, I tend to invest behind an entrepreneur, not behind a professional manager as the CEO. Entrepreneurs have to have a clear sense of the opportunity and how to build the business. But the best ones are willing to reexamine their assumptions and are willing to veer left or right or pivot all the way around when the data suggests they're headed in the wrong direction.
So overall it's a funny mix. When we review an investment opportunity, entrepreneurs have to have a pretty good story to tell about what they want to do. I think it helps to be cocky, there's no doubt about it, but if you're not sufficiently confident, you're not going to be successful in selling your idea.
Sonja L. Hoel (HBS MBA '93)
Managing Director, Menlo Ventures
I always look at the market first. By that I mean a strategic view that includes evaluating market growth, market size, competition, and customer adoption rates. If a company has a great market, it doesn't need to have a complete management team or positioning story or sizzle. The details can be filled in later.
We have a process here called SEMS, or Systematic Emerging Market Selection. We do a SEMS project for every investment we make. Twice a year at our planning meeting, we talk about new markets or problems that need to be solved.
We track four things and relate them to the success of our investments: market size, the team, unique technology, and whether the product is developed at the time we invest. We found proprietary technology is important but doesn't make much of a difference as a unique differentiator for significant returns. Market size and a developed product matter most. We have much better luck if the product is in beta or shipping, although we do invest in start-ups without a developed product. Often someone has a great new technology, but hasn't looked at the market the technology is going to serve.
In order to create a barrier, the technology has got to be hard to execute. Some companies have patents; some don't. We encourage them to have patents because it's a more litigious environment than it was ten years ago.
We also look at the management team. If we've got a founder who's in it for the lifestyle or unwilling to upgrade the team if necessary, we have a conversation about the willingness to hire new team members.
We also look at location. It is very easy to hire good people in Silicon Valley and in the Boston area. In other places, it's a lot more difficult.
Fred Wang (HBS MBA '92)
General Partner, Trinity Ventures
In no particular order, for us they are team, market opportunity, and the product/value proposition for the solution. Technology differentiation or business model differentiation is also important to sustain a competitive advantage.
One potential point of differentiation between us and some other firms relates to how we think about the CEO. A couple of years ago, we analyzed our successful companies across multiple dimensions. The one trait of all our successful companies was that the CEO we backed at funding was still the CEO at the sale of the company or IPO. So now, to fund a company, we need to believe that the existing CEO could bring the company to a successful outcome.
We found proprietary technology is important but doesn't make much of a difference as a unique differentiator for significant returns.
— Sonja L. Hoel, Menlo Ventures
As a result, we spend a lot of time focused on the CEO and the members of the management team: the quality of the people they attract, their biases, their strong points, and their overall depth.
We've also done some analysis that suggests another big determinant of success is the sector; it's a sector bet. If we're investing in the right sector—even if the team is more mediocre, or the execution isn't as good—the rising market lifted all the companies in that sector.
Our rule of thumb is we'd like the company to get to $100 million in revenue. Realistically, if we can see the company get to $50 million in revenue and the valuation is right, it could still be a good venture deal. In a decent IT market, a $50 million revenue company should be worth at least a $100 million to $200 million outcome. At that point, we're making a good venture multiple, potentially a five to ten times type of return.
Here's one that we typically won't do: It looks like a great technology, really groundbreaking, could be a huge market, but it's a technologist—sometimes a wild-eyed technologist—who's driving it. The businessperson is either weak or not there at all. The hit rate and the time it takes to constantly arm wrestle with the technologist are issues we try to avoid.
Director, Alta Partners
There are two schools of thought in evaluating new opportunities. In the first, the venture capitalist says, "I invest in people first and foremost. Smart people will find great opportunities, and they will always know the sectors or technologies better than I would." In the other, the venture capitalist says, "I don't care about people; I care about markets. I look for big opportunities, big painful problems that customers have. If management doesn't work out, I can always fix management." The truth is obviously somewhere in between, but I tend to place more weight on the market opportunity versus the team. In our experience, markets trump people and trump technology.
When analyzing the market for a new product or service, we try to determine whether the product is a replacement for an existing product or whether the product is offering something new and previously unseen. The replacement product can be called the better, cheaper, faster model. With these opportunities you can estimate market size by looking at the revenues of the existing product shipments.
Conversely, a product that provides new functionality previously unseen, we call the brave new world model. Here, the market size and demand are really unknown. These often are in the consumer sector. Netscape, Yahoo!, and the Sony Walkman are examples. The brave new world model certainly has a greater market risk but not necessarily more technical risk.
Additionally, there are market timing issues. If we're too early, there's no market demand, and we have to survive until the demand reaches us. In that period of time, we have two problems: We have to keep the doors open and feed everybody, and we may be susceptible to being leapfrogged by technology. So we don't want to be too early, but we don't want to be too late.
Everyone wants the $1 billion market. We don't necessarily target market share for our companies; we target revenue. We expect north of $60 million to $80 million in revenue in three to five years. We get to market size by estimating how many customers feel the pain. We like customer pain.
We also look at the technology to see how proprietary and difficult the solution to the problem is. The ideal case is four Ph.D.s solving a problem they've been working on for two years, and somehow they've struck upon the magic solution. And it's two orders of magnitude better than whatever else is out there. Finally, we want the team to have conviction. We get a little concerned when the entrepreneur comes in and says, "I'm in this to flip it in a year." So if we get the impression they're not in it for the tough times, then it's definitely a problem.
About the authors
Mike Roberts is a professor at Harvard Business School and executive director of the Arthur Rock Center for Entrepreneurship.
Lauren Barley is a senior research associate at Harvard Business School.
Why does entrepreneurship flourish in some countries and struggle in others? Economists and policymakers are divided on whether the rapid rate of global financial integration, specifically the explosive growth of foreign direct investment, helps or hurts local entrepreneurs and domestic economies. To see the differential effects of restrictions on capital mobility on entrepreneurship, Alfaro of HBS and Charlton of the London School of Economics analyzed data on 24 million firms—listed and unlisted—in nearly 100 countries in 1999 and 2004. Key concepts include:
- Contrary to the fears of many, capital mobility has not hindered entrepreneurship: Instead, international financial integration is related to greater firm activity.
- Countries with fewer barriers to international capital have a higher proportion of small firms. By the same token, firms tend to be older in less financially integrated countries.
- International financial integration might increase the total amount of capital in the economy and improve the availability of capital and credit.
- Thanks to FDI, local firms could benefit from linkages with foreign firms.
- This work did not look at growth or the overall welfare effects of capital liberalization on individual countries, an important area for future research.
We explore the relation between international financial integration and the level of entrepreneurial activity in a country. Using a unique data set of approximately 24 million firms in nearly 100 countries in 1999 and 2004, we find suggestive evidence that international financial integration has been associated with higher levels of entrepreneurial activity. Our results are robust to using various proxies for entrepreneurial activity such as entry, size, and skewness of the firm-size distribution; controlling for level of economic development, regulation, institutional constraints, and other variables that might affect the business environment; and using different empirical specifications. We further explore various channels through which international financial integration can affect entrepreneurship (a foreign direct investment channel and a capital/credit availability channel) and provide consistent evidence to support our results."