By Angel Mehta, Managing Director, Sterling-Hoffman Executive Search
Angel Mehta: There has always been so much talk about how engineers and business people don't connect, but naturally, most technology companies are going to be founded by technical people. How do you think this issue should get resolved?
David Lane: Well, let's put it this way… I started my career as an Electrical Engineer at Hughes Aircraft Company, and I gained an appreciation for what electrical engineers do. I decided to expand my business base so I went to work for IBM selling computers, which included mainframes and SNA networks. I think EVERY engineer should carry a sales bag at some point in his/her career - it is a real critical stop along the way towards making one a better business person. From there, I was introduced during a summer job into the venture capital community between my years at the Harvard Business School and decided I liked it enough to pursue a job in that industry. That was in 1987, and I've been involved in the venture capital business since that time.
But back to the point, I remember a very specific situation at IBM where, if I remember correct, 20 years ago there was a new storage technology in which IBM invested about $100 million to develop. I tried to convince one of my customers that the technology was better then any other that IBM had ever produced. The customer, rightly so, asked me not to describe the technology but to talk about how much it cost, what was the power usage, price performance, power requirements, how much square footage it would take, the cooing requirements, etc. This was when mainframe storage was in large physical boxes. So my customer quickly taught me that technology may or may not provide a solution that they would value and technology is not a sufficient solution in and of itself - and that's a very valuable lesson for all engineers to learn.
Angel Mehta: So when you meet entrepreneurs that are technical in nature who may not have that experience, how much of a strike against them is that? How do you communicate that to them?
David Lane: What I look for is an entrepreneur who can 'empathize' with the customer. Entrepreneurs should understand their customers pain points. The best entrepreneurs don't necessarily have to have been a customer nor do they have to have sold to customers. But all good entrepreneurs sell their concepts, and sometimes products, every single day of their life. I look for people who frequently touch their customers and do not believe they're building a monument to the 'technology Gods', but rather a valued solution to their customer set.
Angel Mehta: What were some of the more significant experiences early on that prepared you for a career in venture capital?
David Lane: In venture capital you deal with many diverse people, and a successful venture capitalist has to be able to work closely with all types of people. The Silicon Valley in may ways looks like the "United Nations of technology", as entrepreneurs come from all over the world to make their mark. I think some of the things that shaped my career and outlook on life early on was growing up in Los Angeles. As you might image, LA is a very diverse city.
In fact, there were 99 nationalities represented in high school; it was really a microcosm of the world. My high school was basically an 'inner city' school - there were gangs and gun fights and things of that nature. It was incredibly helpful to me because it gave me an appreciation for and understanding of people who come from different parts of the world. That's important in the venture capital business because you deal with entrepreneurs who come from all around the world.
Angel Mehta: Let's talk about Diamondhead… what was the planning process like - how did it come into creation?
David Lane: In the middle of 1999 my prior fund was rapping up the investment cycle, and I had made a decision not to raise a new fund with my partner. I was having discussions with my current partner, Raman Khanna, because he was being approached by other venture capitalists to join them, and he was asking me how he should negotiate with these different firms. Prior to that time, I had brought Raman on to the Board of one of my portfolio companies. He was the Chief Information Officer at Stanford University at that time and had a wealth of business contacts, IT knowledge and had spent a lot of time with start-up companies. So we looked at creating something that had our own footprint on it as opposed to stepping into someone else's environment.
We believed that the structure of our firm and our sub-focus on the university environment could, in fact, create a unique and differentiated venture capital fund. Because our investment areas are the communications and computing infrastructure, the first thing we did was we went and got Sun Microsystems, Oracle, Fujitsu, - in total about seven corporate partners - to form our core corporate partners. They also provided our initial capital commitments. We then went out and signed up our world-class industry advisory board, of which we were extremely proud. At the same time we also added strong advisors on the university side; there are five universities that we targeted. We looked to create an ecosystem where entrepreneurs stepping out of either corporations or universities would have a lot of resources available to them in the very beginning steps of their journey.
Angel Mehta: Were there any other firms that had the focus, at least, early on in terms of extracting technology from campuses?
David Lane: Not to my knowledge. The five universities we targeted because of our focus were Stanford, UC Berkley, Caltech, Carnegie Melon and USC. We have strong personal relationships within those top tier research universities.
Angel Mehta: Tell me about some of the challenges associated with extracting deals from academia as opposed to the beaten path.
David Lane: There are very strong similarities between typical venture backed start-ups and university spinouts in that they typically involve first-time entrepreneurs. First-time entrepreneurs usually don't have strong corporate partners, and they typically don't always know the company infrastructure that needs to be created whether its law firms, accounting firms or search firms. That is almost always the case spinning out of universities and it's usually true for the ones that are spinning out of the corporate world. Diamondhead created an ecosystem that entrepreneurs can leverage to their advantage.
Angel Mehta: Since entrepreneurs from Academia don't have a track record, how do you evaluate them?
David Lane: Yes, that's a good question. Part of it is you quickly have to determine if the individual is interested in creating a solution that customers will engage in or they're trying to continue a research project. The best entrepreneurs who are spinning out of universities from our standpoint are those who have already talked to potential customers so there's a strong appreciation from the start that they just can't create technology that no one would buy. Most of these individuals, if they're savvy, are already doing consulting projects to industry so they're actually touching industry on a constant basis.
Further, there are people inside of universities who have one foot in the academic world and one foot in industry. One example is Dr. James Gibbons, who is the former Dean of the Engineering School at Stanford. He also used to be on the Board of Cisco for many years. Entrepreneurs inside Stanford look to people like Dr. Gibbons who can assist them in spinning out their concepts from their university environment. We look to our Diamondhead Advisors, such as Dr. Gibbons, for introductions to the most promising spinouts.
Angel Mehta: The plans that you used to get or still get from Academia - are they by undergrads or graduate students or the faculty themselves? Where do they come from?
David Lane: That evolves over time. Clearly in the dot com era every student who could write created business plan, but that's no longer the case. Typically the best deals we see are professors and a couple of graduate students looking to commercialize their technology. Now, my firm also tends to invest in deals that are not service deals but are product deals, and they're typically built on a lot of intellectual properties. So our requirements for making investments gravitate towards professors who have been working on research for several years and now are developing it into a product.
Angel Mehta: Now that the economy is 'recovered', what do you see as the biggest challenges for startup CEO's?
David Lane: I think the biggest challenge for start-up enterprise software companies and enterprise focused-companies broadly is that CIOs are trying to decrease the number of venders with which they deal. Also, CIOs are concerned about the financial stability of private companies. Hence, there's a reluctance to buy from start-ups and that continues to be a significant challenge today for all private companies.
Angel Mehta: If a CIO decreases the number of vendors, wouldn't that lower their leverage when negotiating?
David Lane: I think the problem has been, especially over the last couple of years, a lot of private companies and, quite frankly, even public companies have gone out of business. If you're the CIO, and you are investing money and your operational staff's time, you don't want to buy a product from a company that might disappear. So I think the sensitivity is great to the over-financing by the venture community. The risk is high enough to make a CIO forget about his/her lost leverage when trying to negotiate pricing for any given technology. Viability of a vendor is first.
Angel Mehta: Do you have a general guideline for how capital should be allocated within early stage software companies?
David Lane: You apply resources to the highest leveragable positions inside your company. Clearly at the beginning that's in engineering and product definition, i.e. trying to map technology into markets. Then over time you're clearly going to add sales people and, at some point, marketing people for a typical enterprise product focused company. Most of the start-ups tend not to need a lot of marketing early on - but they do tend to need business development people and sales people early in a company's life. So I would say that one area we avoid is putting too much money into is PR. PR is just not the best area to focus on before the company has its initial customers and a fair amount of revenue traction.
Angel Mehta: Has the BPO phenomenon allowed software companies or early stage players to stretch the cash out a little longer?
David Lane: How do you define BPO?
Angel Mehta: 'Business Processes Outsourcing', specifically referring to offshore design and development.
David Lane: Yes - that's a very, very important area. Probably half of our companies have had operations overseas from their very earliest stage. One of our investors is a company named "HCL" which has roughly 10,000 programmers worldwide. It's part of our Diamondhead ecosystem, and we realized that that's an important step for companies to go through to take advantage of the cost structures of the engineering resources around the world. The challenge with that is the CEO or the VP of Engineering has to understand how to run a multiple site environment as well as how to deal with an outsourcer.
Angel Mehta: What could you personally be better at, in your role as a venture investor?
David Lane: I think if there was one area that I wish I had more clarity in is how people think and react… what really goes on inside each entrepreneurs mind and how they're going to react as their business environment changes. An entrepreneurs reacting to a changing environment will make or break a company. A start-ups environment, both internal and external, is extremely fluid. One thing that I have learned over the last 17 years of sitting on start-up company board of directors is that the start-ups initial strategy will morph and evolve many times before the company will be a success. There are a lot of different business situations that the entrepreneurs encounter and their reaction to those changes in their environment will determine their success or failure.
Angel Mehta: What's the worst part of the venture capitalist's job?
David Lane: Shutting down a company. It's clearly the worst part of a venture capitalist job because you have to tell people that they no longer have employment and their dream of building their company won't happen. Every investor knows that a certain percentage of the deals in which we invest do fail - completely fail. It's a fact of life that if you're in the venture capital business you will close down a certain percentage of your investments, but that doesn't make it any easier to tell people they're out of work.
David Lane has more than 25 years of experience creating, building and financing information technology companies. During the past 17 years David has managed investment funds totaling over $2 billion. Prior to co-founding Diamondhead Ventures, David was responsible for managing the IT venture capital portfolio for Harvard University's multi-billion dollar endowment. David can be contacted at david@dhven.com for interview feedback.
Angel Mehta is Managing Director at Sterling-Hoffman, a retained executive search firm focused on VP Sales, VP Marketing, and CEO searches for enterprise software companies. He can be reached for feedback at: amehta@sterlinghoffman.net
