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Two CEO Letters (Plus a Corollary)

There is a story full of business wisdom that is one of my favorites.   It has many variations but a common one goes something like this:

A new CEO walks into his office for the first time and finds two sealed letters on his desk.   One has written on the envelope: “open on your first day on the job.”  The second envelope has written: “open on your last day on the job.”  The CEO opens the first letter and printed there were the simple words “blame everything on your predecessor.”  The CEO takes the advice, gets off to a strong start and has an extraordinary run as CEO, taking the business through a multi-year period of high growth, an IPO, and an industry consolidation.  On the day he retires as a company legend and an industry icon, as he packs up his office and desk, he comes across the second letter, opens it, and reads “write two letters.”  He does just that, leaving them on the desk for his hand-picked successor.

Having been a new CEO and an ex-CEO, I can say with certainty that there is a lot to this story.  It suggests a new CEO is really a restart in so many ways.  Old traditions can be put aside.  “This is the way we do things” stops applying.  Hard decisions can be made because no one will hold the new CEO accountable to previous bad decisions or bad investments or bad hires that now need to be unwound.

The corollary is that Letter 1 has a statute of limitations.  Blame everything on the previous CEO – but do it quickly and move on.  Blame is about “they” and leadership is about “we” – so make the changes fast, dump the baggage, reset the financial expectations for the board, and embrace the company as its leader.  Six months into the role it really needs to feel like and be your seat.  Twelve months in and no one remembers the old CEO’s name.  Your name is on the door and the company’ past, present, and future are now your responsibility and the responsibility of the team that supports you.  Remembering this will help keep the second letter in the drawer for a long time to come.


They Are Coming to Philadelphia

We recently invested in Sidecar, a Philly-based e-commerce marketing solutions company.  Great company, great team, and an awesome CEO.  While the company is note-worthy in its own right, it is also noteworthy for being located in downtown Philadelphia (near 13th and Sansom).   Until about a year ago, we had one portfolio company with a Philadelphia presence – now we have four.    Our first was InstaMed, which has been downtown for close to ten years.  We invested in InstaMed in 2008 and have seen its staff grow more than 10x in Philly to well over 120 people in the city by year end.  PeopleLinx, in which we invested in 2013, was our second.  SevOne, a Wilmington-founded tech company in which we invested in 2007, this year established a large development satellite on South Broad Street in order to attract talent.  Is this just serendipity and the law of small numbers or have things changed?

From 2002 to 2008 when I was running Verticalnet , which was originally founded in Horsham and then later moved to Malvern, I only went downtown to see our lawyers or for a rare social dinner.  I technically live in the city (if Chestnut Hill counts) but it was clear when I moved to Philadelphia in 2000 that the technology community that existed here had its nexus in Wayne around the 202 corridor and the Safeguard campus.  Technology companies were in office parks.  There was also a brain drain with a constant complaint that we had great universities but that we were training people in order for them to graduate and move elsewhere.  The reputation for the Philly region was that it was a great place to raise a family (which it still is), but the converse of that reputation was the difficulty in attracting and retaining young people. 

So what’s happening?  I think it is a lot of small things that have come together to begin a groundswell.  Urban renewal of some vibrant neighborhoods has been successful, with West Philly, Northern Liberties, Fishtown, and other neighborhoods offering affordable options with a restaurant, bar, and activity scene that is much more appealing for the recent graduate (and tech entrepreneur).  Philly’s start-up scene is real and growing and more fuel is being added to the fire, while an increasing number of Route 202 corridor companies are building satellite offices to attract tech talent in Center City.  What was the catalyst?  Was it Mayor Nutter? John Fry? Stephen Tang at the Science Center?  Was it Philly Start-up Leaders?   Was it Ben Franklin Technology Partners?  Was it DreamIt, GoodCompany Ventures and other incubators? VentureForth and other shared workspaces?  Was it fueled by Philly Tech Week and PACT with its IMPACT and Phorum conferences?  Frankly, I think it was an environment that was ready for this and a lot of visionary people contributed to the momentum we now feel.

The other sub-trend that has been emerging is that the types of businesses being started have changed.  Six years ago as the Philly revival began, the companies being started were consumer facing – mobile apps pursuing the next social, mobile, texting, location based ideas.  Today we are seeing strong business-facing solutions emerging with greater frequency from Center City.  These are companies with sustainable business models and experienced leaders.  These are companies that are recruiting talent in Philly and drawing experienced people into Philly from outside.  

I am not proclaiming that Philadelphia is the next Silicon Valley.  It doesn’t need to be.  What I am saying is that Philadelphia is a city that is going to be increasingly hard to ignore when looking at cities on an upswing or cities where strong investing opportunities exist for angels, venture investors, and private equity firms.   At Osage, we certainly have an eye on Philly and we look forward to seeing our number of Philadelphia investments continue to grow and our current investments continue to thrive.


Congratulations to 2014 PACT Enterprise Awards Winner Bill Marvin of InstaMed and Finalists SevOne, PeopleLinx, and Tim Kowalski of Halfpenny Technologies

On May 8th, the Philadelphia Alliance for Capital and Technologies (PACT) held the 2014 Enterprise Awards, their annual black-tie awards gala to honor the region’s top companies, executives, and entrepreneurs in the technology and life sciences sectors.  Once again, the Osage Venture Partners portfolio was well represented.  The event recognizes three finalists and crowns an ultimate winner across eleven total categories, six of which focus on technology, corresponding to different stages of business maturity.  OVP was proud to have four finalists and one winner within the portfolio. 

  • Bill Marvin, InstaMed -  Technology CEO of the Year Winner
  • Tim Kowalski, Halfpenny Technologies – Technology CEO of the Year Finalist
  • SevOne – Technology Company of the Year Finalist
  • PeopleLinx – Technology Startup Company Finalist

Congratulations to all four companies for being recognized as leaders in their categories, with a special call out to Bill Marvin on a well-deserved win, the second in a row for InstaMed, which won as Technology Growth Company of the Year in 2013.  OVP also recognizes the fact that two of the three Technology CEO finalists were from the OVP portfolio, celebrating publicly what we know privately – that leadership drives success. 

Nate Lentz, Robert Adelson, David Drahms, Sean Dowling


Softening a Startup Crash Landing

In 2003 through 2005, when I was in my pre-investor, CEO role, we bought three companies  and through this process we learned a lot about what to do differently, what to do better, and what just not to do in start-up M&A.  One company in particular taught us a majority of the lessons.  The company was a venture backed business that had raised over $40M.  It received an offer for a large exit that was turned down by the board (because it was 1999 and things only went up).  We bought the business four years later because its technology solution moved us from a point solution offering to a platform, its customers more than doubled our existing base, much of the company’s revenue was SaaS, and because we were able to buy the company with stock and at a value that was a fraction of the capital invested.  One founder planned to leave at the time of the acquisition, but the CEO planned to stay on and was key to our integration plans.  I liked him a lot and really respected him and I was truly looking forward to partnering with him.  It took me by sudden surprise when the former CEO called me two weeks after the deal closed and resigned.  While it blindsided me then, it doesn’t surprise me now.  A pilot who successfully crash-lands a plane is pretty unlikely to want to stay on board for the next leg of the flight.  Walking away from the crash may be the only thing that the pilot or a crash-landed CEO can be expected to do.

When I went through this experience as an operator, I thought it might be a one-off.  What I have seen as an investor is that this situation was not unusual.  There are three types of exits – great ones, good ones, and disappointing ones – and this is especially true for management teams given how committed they tend to be to the start-up effort.  A lot is written about great exits and good exits, but the disappointing ones are often the most difficult and are the exits that require the greatest amount of heroism, fortitude, and personal integrity from the leadership.    Think about it.  People have been with the company for five years or more.  They have worked unusually long hours and often for below market pay.  They started the company with a vision and there was a period of excitement and growing expectation as external capital was raised and expectations rose further.  Then something happened, setbacks occurred, and finally the company was sold with the management team / founders receiving possibly, at best, a percentage of the proceeds in a carve-out.  And they take a job offer that they feel they need to accept because not doing so could kill the deal.

These disappointing exits are often the types of businesses that are targeted by our portfolio companies, which see the opportunity to acquire talent, technology, IP or customers.  So when our portfolio companies are considering “tuck-in” acquisitions what should a they, as a buyer, expect when buying a crash-landed business?  Which people will stay and which will go?  What do we recommend that our portfolio CEOs think about to make the combination successful?

  • First, recognize what the employees of the company you bought have been through.  For you as the buyer, you have worked on this transaction for two to three months, you have a transition team in place, and you are excited about getting the new business integrated and starting to see value.  Be aware that most of the new employees have just finished the equivalent of a business marathon and they are collapsing at the finish line.  Asking them to get up immediately and start running again is not going to be well received.  Acknowledge that you understand how hard it has been.  Give them time to recharge.  Think about ways to personally motivate the key keepers.
  • Second, recognize in most cases that several key employees will leave as soon as they contractually can.  This includes the CEO, other co-founders, and the CFO.  Think about whether you want them locked down and miserable or if it is going to be better for everyone if they leave with a “consulting agreement” to get you access to their historical knowledge if necessary.
  • Be clear to the acquired development team and technical folks about your intentions for the acquired product and the areas of exciting innovation on your own platform.  Developers prove to be the most resilient if they can keep working on projects that excite them or if they can be transitioned to an even cooler technology.

My experience with the acquisition described above turned out to be a great one.  Certainly there were challenges but the technology was solid, the customers were relatively stable, and we got some great talent, some of whom became key members of the leadership team.  There are thousands of distressed venture backed businesses, many of which have some great core assets in terms of technology and people.  The secret is knowing what you are buying and what to expect so you can have a similar experience.

Potential acquirers have the chance to buy something valuable for cheap and to really gain some extremely talented employees.  Startups (and especially distressed start-ups) are often less like jobs and more like tumultuous relationships.  People are emotionally drained and have committed extraordinary levels of effort and mental energy to an idea that has failed.  Often they have also made financial sacrifices that are taking a toll.  Toward the end, leadership teams often work for discounted salaries or defer compensation.  Bonuses most likely have not been paid.  Stress and uncertainty and discussions of the “zone of insolvency” have likely been daily realities.  The key for retaining and motivating these people is to offer them stability and opportunity and over time many will get excited about the new vision.  Remember to be patient and let them recharge their emotional batteries – it takes time but it will be time well invested.  In then end this will buy you the loyalty and passion you are counting on from the new team.  Finally, have a going away party for the CEO and other departing leaders.  Let them leave with pride, but let them leave.  The transition is complete once the CEO has left the building.


Series B Venture Capital Strategies - Building Businesses or Building Buzz 

In the last couple of months, our team at Osage has met with a number of serial entrepreneurs who speak of very similar, painful lessons they learned as venture backed CEOs in a period from 1998 to 2002.  If you sum it up, they raised too much money in too many rounds with too many different lead investors; they spent the money too quickly at the behest of the investors; they had significant board conflict as each new lead investor drove a change in board dynamics; they were forced by the later stage investors to turn down exit opportunities at values that would have changed their lives; the world changed and business conditions followed; they exited at values well below their preferences and walked away with little if anything.  

With a portfolio of companies all thinking about funding strategies and value creation approaches, we also hear a lot of different philosophies from co-investors and potential follow-on investors.   If I had to characterize the two distinct camps into which the philosophies on the post-Series A round would fall, they would be “Buzz &Run” or the “Inside Round”.  

Buzz & Run goes something like this.  A fund argues that inside rounds are bad for reasons including they hurt the brand, they signify weakness, they undervalue growth companies, and that  any company with momentum can always find a new investor to lead a round.  They state that their fund never does inside rounds.  They state that each round should bring in a new lead who adds to the brand stature of the syndicate.  They support increased spending and look for accelerated growth while accepting higher cash burn rates.  The perspective is that if revenue can double every three quarters, there is little limit on how much the net burn should be.  For the investors there is one additional benefit – every time there is a new high priced round of capital, the funds can write-up the investment (on paper of course) and show their own investors how well the fund is doing.

The Buzz & Run models have yielded some excellent outcomes and we read about those.  The winners win big and get the press associated with having strong branded backers.  For some companies, especially those playing off of market excitement in the buzz cycle, this is exactly the right strategy.   Of course, expectations ratchet upward with each round of capital and the newest capital often controls the decision on when to sell.   Challenges can emerge as soon as growth slows or becomes more expensive, typically seen through an increase in customer acquisition costs (CAC), a contraction in customer lifetime value, or a rise in churn.  Dashed expectations tied to an impatience for triple digit growth often leads to board disharmony, especially with different investors at different places in the waterfall – this makes it even harder to raise more capital once the “bloom is off the rose,” as the previous valuation is far too high and the level of preferences becomes an obstacle.  When all is said and done, if things unwind there is often little left for the common investors, even at a $50M median industry exit.  The investors are generally fine as they have a portfolio of investments to manage (along with their position on the preference stack).  You, the entrepreneur, may feel that you have been buzz sawed much as did the Y2K entrepreneurs discussed above.

Buzz and Run - They create buzz and either the valuation runs up or the investors run away

On the other hand there is the Inside Round.   This is the antithesis of the buzz & run.   The nay sayers argue that companies do inside rounds to enable bad assets to be propped up by stubborn investors and contend that an inside rounds signifies where good money goes after bad.  Clearly this can be true - but very often there are many good reasons as well for an inside round.  

Why do companies do inside rounds?   Well, my friend Gil Beyda of Genacast Ventures did a good job in a recent blog post summarizing the reasons, which include:

  • Investors want to own more of a great company.  If a company is doing well, existing investors will lead an inside round so as not to share the deal with outside investors and dilute their ownership.  Outside investors are sometimes shown the company anyway to get a market price (valuation) and then the deal is done internally
  • If the board of directors, investors and company work well together sometimes it is best not to "rock the boat" by bringing in outside investors and board members.  Internal company dynamics are a delicate ecosystem that can be a great asset to a company but also a liability.  An inside round would preserve good working relationships with these key constituents
  • Raising capital is time-consuming.  A CEO is on the road for months, flying from coast to coast and meeting with dozens of investors.  This is a distraction for a CEO who is not able to focus on the company.  Taking an investment from existing investors who already know the company, perhaps even sit on the board, is much less time-consuming and can typically close in a few weeks.  Little diligence is necessary and the last investment documents are used.  The downside for the company is that without outside competition the valuation is sometimes lower than market

I am not opposed to externally-led growth rounds – we had two of them last year with great new co-investors and we will likely have 2-3 in the next eighteen months.  What I am opposed to is didactic views that every round must be led and priced by a new investor.  This takes away optionality and often leads to a crowded board table too early in the business lifecycle, too much capital being raised, and deep misalignment between the common shareholders (including the CEO) and the most recent high priced round of investors.

Osage portfolio company SevOne completed a $150M private equity recap in 2012 allowing all investors and common shareholders to sell 60% of their holdings.  For Osage, it was a 15x return with 40% of our stock still riding on SevOne’s future success.  For the entrepreneurs, it was an even greater win.  SevOne raised two rounds of capital with one institutional investor – Osage.  The inside round Series B was 18 months after the Series A and was aggressively priced showing meaningful appreciation in value.  We liked the business, the management, and the prospects and we wanted to own more of the company.  No one ever questioned whether the inside round hurt SevOne.  Of course, they never needed another round as they achieved positive cash flow while also sustaining high double digit and triple digit growth rates.  There is a lot of buzz about SevOne, but not because of the venture capital strategy.  The buzz is driven by what the business continues to achieve in the marketplace.

As Dan Primack wrote recently in Term Sheet in his opening “Random Ramblings”

Shortly after Facebook agreed to acquire mobile messaging company WhatsApp for a record $19 billion, I spoke to Sequoia Capital partner Jim Goetz about why Sequoia was the only venture capital firm to have ever invested in WhatsApp.

To paraphrase Jim's answer: Because it could. Ultimately the entrepreneur has final say on new investors (or lack thereof), but Sequoia didn’t fight for a minority investor on the Series A or outside lead on the company’s Series B or Series C rounds. If WhatsApp needed more capital, Sequoia was more than happy to write the check solo.

In almost every other case, a company like WhatsApp would have had multiple investors by the time Facebook came calling. Sometimes the multiple investors are a reflection of capital requirements. But, most often, it's rooted in the concept of social proof -- a validation protocol that has the effect of making risk look...well, less risky. After all, how bad could an investment be if someone else is willing to do it too?

Sometimes social proof manifests itself in seed-stage rounds, particularly via online platforms like AngelList. Sometimes it's in early-stage deals, either with co-lead investors or a single lead who brings in other institutions for smaller stakes. But, most often, it's in follow-on rounds like Series B or Series C. Here is how venture capitalist Rob Go recently explained it:

“Most VC's buy their ownership in a company relatively early.  They would like to increase it over time in their winners, but they also like getting external validation that they have made a good investment by getting another firm to mark-up their investment. Basically, this means that another VC invests at a higher valuation, making the early VC seem really smart and able to show unrealized gains. This tends to make LPs happy and make the lead partner look good among his or her colleagues”.

But Sequoia didn't fall into this trap on WhatsApp. It saw something great, didn’t fight to bring in a partner and is now reveling in the largest-ever sale of a VC-backed company. This has got to cause other VC firms to take notice. Right?”

At Osage, we bring in outside investors when management believes it is the right thing to do or when the capital requirements suggest that our fund can’t get the company to where it needs to get to without more dry powder around the table.  Validation comes from company performance not from another investor blessing our deal and anointing it Buzzworthy.  Viva the Inside Round (in the right circumstances, of course)!