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 In past postings, Gerry Langeler has been discussing what happens “behind closed doors” at OVP and why they often say “No”. This posting is a story about what happened to one company after OVP and others said “No”.
It begins when I was approached by a friend to look at a company in the alternative energy space. The founders were two scientists, neither with any real management experience, but with what seemed like a true breakthrough idea in the market they were targeting.
While the idea was new, the market wasn’t. In fact, tens of millions had been invested in the market by quality venture capital firms with no real commercial success. So how could a couple of guys from Seattle, working in the equivalent of their garage, come up with a breakthrough in the space? And more importantly, given their inexperience and lack of a real team, how could they build a company?
After burning through the small amount they raised from family and two years of trying to raise money, they had gotten nowhere. So they asked me to build a management team and to raise money to take the company forward. Since I believed that, in this case, the VC’s, despite the money seemingly wasted in related technologies, were wrong, I agreed.
The first thing we did was have a smart, aggressive business development person talk with potential customers. The feedback was pretty much the same: “We’ve heard the claims you’re making before. We believed them, even invested in them and none of them worked out. Bring us a fully formed working device with the characteristics you’re talking about and we’ll be very interested.”
How to get from a demonstration in a lab to a fully formed prototype with no money? The budget said the company needed several hundred thousand dollars to get the device built. Since there are, even in this financial climate, quality VC firms investing in pre-revenue companies, it was just a question of time before one of them saw the potential. In the meantime, a bridge loan from angels could keep the company moving.
The company received several firm commitments to the bridge loan. One of the introductions made was to an experienced angel investor in California. He liked the idea, but not the bridge loan. He suggested he bring in one of his friends who headed a small investment bank to do a seed round. Within two weeks we had a term sheet. The proposed valuation was very low by almost any standard, but it was a term sheet. They indicated that they might be willing to change the terms following some due diligence.
The potential investors came to Seattle and even brought in a local expert in the field from the University of Washington. Following due diligence, they came back with a new term sheet.
The valuation increased slightly. The terms proposed that the investors take control of the company. They would bring in their own management team “right out of central casting”. The founders would have about 40% of the company prior to any dilution for management or future offerings. They would not hold board or management positions. The bank was in the process of doing a reverse merger into a public shell. The new public entity would make the investment. If the founders finished the prototype within six months, they would each get a small bonus. On the basis of the prototype being finished and the “story” that would generate, the “bank” would take the company public. And yes, the bank had done this several times before in the past. Sometimes it worked out, sometimes it didn’t, but the insiders always made money. In fact, the shell that the bank was merging into was a medical device company that had failed after its public offering due to never getting its technology productized.
The inexperienced founders heard “public” and “bonus” and decided to go in that direction. I decided not to go forward with this adventure in financing. And the “investors” are still in the due diligence process as this is written.
Whether VC’s say yes or no; their focus is on creating value from their investments for all of the stakeholders. And when they say “Yes,” they are often willing to stick with and support their portfolio companies over a long time horizon, creating “real” value as opposed to the value of a quick hit. While it may seem that “money is money”, the quality of the source of that money is often the difference between creating a “story” and building a company.
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Would that they had existing Board Members who would intervene. I can understand that the alternative energy device market has been ridden hard and put away wet, but isn't there an entity, like perhaps the new UFund of the UW, that might have a more sustainable view of what these two well-meaning entrepreneurs are trying to accomplish?
And there you have it: I will never be invited to join the vetting committee of any VC firm as my personal calculator has a 10X glitch... repeatedly...