By Angel Mehta, Managing Director, Sterling-Hoffman Executive Search
Angel Mehta: What was the worst experience you've ever had with big company bureaucracy?
Paul Maeder: Probably when I was working for a company called Andros doing artificial heart development for the National Institute of Health. So it wasn't so much the company I worked for as it was the customer: there were huge problems with the way government contract research was done. Medical research is based on a couple of bad ideas. The first problem is that medical research is run by scientists, not by engineers. For a scientist, each step in building the pyramid of human knowledge has to be absolutely proven, rock solid, beyond a reasonable doubt, before you can take the next step. An engineer would say, "Hey, I just want to make it work - who cares how I stumble upon the solution?" For an engineer, the point is to get the solution: cure people of cancer. Scientists want to build this enormous body of knowledge that's irrefutable. An engineer wants to solve the problem.
Angel Mehta: Not so sure cancer patients would appreciate that….
Paul Maeder: Not likely. The second issue is that the National Institute of Health requires you to write a proposal for each project that has to be totally incremental. No great leaps, no lateral thinking, no out of the box ideas. Let's say you're going to do a test that requires you to kill eight cows to test artificial heart prototypes. After the second implant, you discover that your design has problems and needs to change. So why bother killing the other six cows, right? Well to get a new grant, you have to kill the other cows - even if you know it's going to waste time and money… in this case, something like $10,000 per cow in surgeon's time, equipment, etc. But no matter what, you have to do exactly what you said you were going to do in your proposal; otherwise you won't get another grant.
Angel Mehta: So there's no room for learning on the fly?
Paul Maeder: None. You cannot deviate from your original plan
Angel Mehta: So was that the time that you decided you wanted to be involved with smaller companies?
Paul Maeder: Probably even before that. I just decided early on that there was something supremely depressing about having to wear a security badge and walk past security into a large building with neon lights and not see sunlight all day long. I wanted to be involved in a place where it wasn't a question of what you were allowed to do - it was a question of whether you had time to do all the things that needed to be done. So when I came out of Harvard Business School I joined Charles River Ventures in Boston and gravitated towards investing in software.
Angel Mehta: I'm surprised it was software and not life sciences or healthcare, given your early training.
Paul Maeder: So was I. Bob Higgins, now my partner, had already staked out the life sciences space at Charles River and had been quite successful in doing that. They didn't really have anybody specialized in or who understood software back then and I remember reading an editorial in the IEEE journal that said software would be the most important field over the next 20 years. So that's where I ended up.
Angel Mehta: What is the biggest difference you see between the state of venture capital in 1984 vs. the present day?
Paul Maeder: It's so much more sophisticated now. When I got into venture capital in '84 people didn't really specialize by industry at all. Everybody was a generalist. There was arguably a shortage of venture capital and a shortage of good entrepreneurs. We were ecstatic when an entrepreneur came to us who had actually graduated from college. We rarely saw CEOs who had business degrees or could speak to more than just a casual experience in the software industry because the software industry didn't even exist.
When Bob Higgins and I founded Highland Capital Partners in 1988, our 'new' idea was to specialize by industry. Today it's a generally accepted practice, but back then, it was common to look at a PC protocol company one day, a biotech deal the next day, and a specialty retail deal at the end of the week.
Angel Mehta: For a venture investor trying to minimize risk, do you think it makes more sense to put less money into more deals, or more money into fewer deals?
Paul Maeder: There's a term that venture investors used to use 10 years ago called 'the choke level'. The choke level was when you had so much money in a company that you were starting to choke. At that time, people would choke at the $1 million range. But even then, our first fund was $78,000,000 and we had 22 portfolio companies: something like $3.5 million per company. The bottom line is that it's hard to find good deals. It just is. So our philosophy is that when you do find a good deal, you're better off putting more money into that company than chasing after another group of entrepreneurs that you may never have met and have to do the diligence all over again.
The approach resonated with entrepreneurs because it meant they weren't going to have to take 25 red eyes and meet with 25 other venture capitalists to do their next round of financing. They could spend their time building their companies.
For us, the approach yielded tremendous venture discipline. We were putting in so much money that we had no choice but to do incredible diligence before diving in: it's prevented us from moving into the mode of the late 90's where investors would spread a few hundred thousand around 2 dozen companies and hope for the best.
Our first fund proved that we were on to something. We had 22 companies and we made money on 21 of them, which is an unusual batting average. Those were the days when Wade Boggs was in Boston and we used to say we had a Wade Boggs Strategy, which was a lot of base hits. Sometimes you hit home runs by accident when you were swinging for base hits, but if you swing for home runs, the only thing you can be sure of is striking out a lot. We preferred the base hit approach.
Angel Mehta: So then let's talk about enterprise software investing. We hear that the software world is saturated and that there really isn't much room or space for software start-ups anymore. So are we all just wasting our time?
Paul Maeder: Software is unquestionably more mature than it was in 1984. Many of the big problems have been solved and I think you can make an argument that there won't be many more billion-dollar software companies. However, you can still do well as a venture capitalist with small problems that can yield very profitable, high margin businesses.
Angel Mehta: Like what? Can you point to some areas of opportunity that you think are big?
Paul Maeder: There are a few areas. One big area is using the Internet to empower democracy… empowering individuals in democracy. There was a great article about the Jersey Four - these four women, whose husbands all died in the World Trade Center bombing, almost single handedly drove through the idea of setting up a 9/11 inquiry panel and embarrassed President Bush into forcing Condoleezza Rice to testify under oath. Well, they say it isn't exactly the Jersey Four - it's the Jersey Five. The fifth member of its group is the Internet. Access to public information over the Internet completely changed the dynamics of who can exert influence over the government in Washington. So that's an opportunity - using technology to bring about social change.
Transportation is a big one. I firmly believe that the experience of flying commercial planes since 9/11 is a lousy, lousy experience. You may as well take the bus. You have to show up two hours before flight time… you get moved around like cattle and you're time is deliberately wasted, taking your shoes off, putting them back on. It's pretty clear the airline industry is going to collapse under its own weight. The airlines don't make any money, the passengers are all miserable. There was a guy at the Brookings Institute that did a study where he measured the average speed when you factor in leaving your office, driving to the airport, waiting in line, etc. He figured that for a 500 mile trip, the average speed by plane was 35 miles an hour. So he figured that for any trip under 350 miles, you're just better off driving. That's pathetic!
But there's a new plane coming out - they're called micro jets - small, million dollar aircraft, with very low operating costs that are going to come on the market in the next two or three years. To get the economics to work with these kinds of jets, you have to upgrade the air traffic control system to accommodate 10x as many flights in the air as we currently have. The FAA is way behind the eight-ball on that one. You also need to have a computer in every jet that tells it how much fuel you need, where you're going, etc. So we're probably 10 or 20 years away from living in a Jetsons world where you get into a plane, you punch in the destination, and the computer flies the plane. But that kind of stuff will revolutionize business transportation and ultimately personal transportation. So that's an opportunity.
Angel Mehta: What about security?
Paul Maeder: Huge. In the corporate world, single-sign-on is still not practical. Also, the current security push in government is very political. The idea that a security guard at an airport can make us safe by going through my underwear every time I fly is not very re-assuring. Those searches aren't the reason we haven't had another incident. These people recently brought down the government in Spain. Affecting our election may be their next target. So security is huge.
Angel Mehta: But with all these opportunities you've still said that the market for software is pretty limited…
Paul Maeder: I've got a friend who wrote a book called "The Winning Performance" about the best mid-sized companies. He analyzed a bunch of companies and he found one of the most profitable was a company that repaired and replaced windows for railroad cabooses. Go figure! It was the mid-eighties…the dawn of the biotech era… PC revolution underway… and one of the best, most profitable companies was replacing windows in railroad trains. It's a lesson that if you bring new approaches to old businesses, or new solutions to existing problems, you can always build very, very interesting businesses. I think the first company in US history to reach $10 billion in revenue in 10 years (or something like that) was Staples. Think about it: Staples was started only 15 years ago. There have been stationery companies around for 200 years.
Angel Mehta: A retail play… that is amazing.
Paul Maeder: Right! Retail, of all spaces. So, yes, we've lost white space - and there will be even less white space next year. But there are always opportunities for solving problems.
Angel Mehta: So the white space is not necessarily correlated to opportunity?
Paul Maeder: No. There's nothing wrong with grey space as far as I'm concerned.
Angel Mehta: What are some of the common mistakes entrepreneurs or CEO's make when answering questions in a presentation to you and your partners?
Paul Maeder: One of the things that stands out for me is not so much the answers they give, but how the team itself interacts. The one thing that we don't want to have to deal with is team risk; meaning people not getting along after we've made the investment. If you're a member of the management team and your CEO is presenting the pitch… even if it's the 18th time you've heard the pitch, with the same jokes, you have to look at him and show you're really interested. It communicates subliminally to the audience; in this case the audience being the venture capitalist. I can't tell you how many times we've had teams come in here and the CEO is answering a question, and other members of the team are looking out the window or rolling their eyes. That immediately throws up a red flag. The second thing we look at is the pre-money valuation... Have they done everything possible without money before they came to us? The best entrepreneurs want to postpone fund-raising until they've created as much value as possible to maximize the pre-money valuation. They've built a customer pipeline, created a scientific advisory board, and assembled some leads on senior management team members. It's always impressive when a team has done that stuff before coming to us.
Angel Mehta: One of the consistent themes I've heard from CEO's or entrepreneurs of really large companies is that they had no idea that they were going to get that big. Do you find that's consistent with your portfolio as well? Or do the eventual winners show signs right away?
Paul Maeder: Google was almost shut down at one point - now they're the hottest company in the market. There's only one business law as immutable as the laws of physics, and it's that every start-up will hit a bump in the road between the time it gets started and the time it goes public. Eight out of every ten companies in our portfolio were probably in a position at one point where they would have taken thirty cents on the dollar. Some of these companies made us 80x our investment! In business there are factors beyond your control, factors beyond your knowledge, and luck can make all the difference. Nobody wants to write about that, though.
As co-founder of Highland, Paul focuses on technology investments, most notably software, as well as systems and security. Paul is a former director of Avid Technology (NASDAQ:AVID), CheckFree (NASDAQ:CKFR), Chipcom, HighGround Systems (acquired by Sun Microsystems), Mainspring (acquired by IBM), SCH (acquired by Legato Systems), SQA (acquired by Rational Corporation), Sybase (NASDAQ:SYBS) and WebLine Communications (acquired by Cisco Systems). Paul can be reached for interview feedback at: pmaeder@hcp.com.
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
