BusinessWeek asked me to write an article for them on entrepreneurship in their latest issue At Work.  You can read it here:  "Think Like a VC, Act Like an Entrepreneur".

It was fun for me to try to aim something at a more general business audience than my tyipcal entrepreneurial audience.

It was also very fun for me to see who they put on the cover of the issue:  Dwight Schrute, who has to be one of the funniest television characters ever.  While I was on vacation last week, I finished Season 3 of The Office and am looking forward to Season 4!

There is a controversy brewing in the world of government grant money to start-ups that is trickling into the VC community.  The Small Business Association (SBA) of the US government administers Small Business Innovation  Research (SBIR) and Small Business Technology Transfer (STTR) provides grants to small businesses (defined as fewer than 500 employees) to the tune of $2 billion per year.  This compares to $20-30 billion per year in VC money that flows to start-ups, so a meaningful figure in the entrepreneurial economy.

But the two worlds of VC-backed start-ups and SBIR grants have mixed like oil and water historically due to a key restriction in grant eligibility:  start-ups that are 51% or more owned by VCs do not qualify for SBIR or SBTR grants.  Thus, a young start-up in a field relevant to the government grant world has a conundrum when it considers taking VC money – it no longer will be eligible to receive non-dilutive government grants.

Many VCs argue this is a ridiculous exclusion that is fostering an adverse selection problem.  The economy is awash in VC money and so only the less promising start-ups aren’t getting it.  Instead, they get taxpayer-funded government money.  The most promising start-ups who can get VC money are not eligible for government money.  Hence, the government is serving as a funder of last resort to companies who the invisible hand of the market has rejected.
 
That may sound like an overly harsh view, but it is one that the NVCA (National Venture Capital Association) is arguing as they try to get the Senate and House to agree to loosen the restriction. Mark Hessen of the NVCA points out that “Venture capitalists have funded well over 90% of all the biotech firms in the United States”.  It is an interesting debate and the House and Senate are in the midst of it. 

I confess to being sympathetic to both views.  My father was an entrepreneur in the 1960s and 1970s who received government grant money to foster his innovations in the defense electronics community.  At the time, though, the VC community was miniscule compared to today.  In 1980, the VC industry comprised of under 100 firms with a mere $4 billion under management.  Today, there are 700 firms with over $250 billion under management.  It’s hard to argue that just because a firm is successful in attracting VC money, it is unworthy of government support.  The fact that SBIR applications have been dropping sharply in recent years (down 12%, 15% and 21% in FY’05, FY’06, FY’07) is a clear signal that something in the system needs to change.

Anyone following the open source phenomenon can’t help but be amazed at what appears to be volunteerism on a massive scale for corporate gain.  Almost every company in the world has some strands of open source code floating around their company.  Whether it is the Linux operating system, Apache web server, the IP protocol or database programs such as MySQL, open source software has permeated corporations around the globe.  According to one estimate from start-up Ohloh, there are 11,000 open source software projects going on right now in the world and 70,000 devleopers contributing to those projects for free.

Further, the impact and reach of open source extends far beyond businesses alone.  Mainstream consumers are participants in the open source phenomenon.  Wikipedia is the most obvious example, which attracts 683 million visitors annually to its over 2 million articles (source:  Wikipedia, of course) – all written by volunteers throughout the world.

Clearly there is an explanation that goes to the heart of human behavior and motivation as to why so many people are inspired to contribute so much for free.  Any reader of philosophers from David Hume to Adam Smith to Ayn Rand would point out that there must be some underlying selfish motivation involved.  Open source participants aren’t getting paid, yet they must be motivated in some part out of self-interest.  So what exactly is going on?

MySQL CEO Marten Mickos seems to have the answer.  In a recent WSJ interview, he observes, “Those who contribute to us are as selfish as anybody else…[They are motivated by] their desire to build a reputation for themselves…it gives them a feeling of usefulness in the world.” 

And I think therein lies the key insight.  Isn’t that what everyone wants?  To feel useful and recognized.  I would suggest that explanation is also at the heart of why entrepreneurship is such a powerful phenomenon.  The reward for the entrepreneur is not just about the money – although, sure, they are motivated by the money — but what really drives great entrepreneurs is the ego, pride and feeling of recognition and respect.  When an entrepreneur sells their company or goes public, it’s that feeling of being a winner and having everyone notice that is most powerful.  Ask any entrepreneur if they’d rather own 1% of a $1 billion company that changed the world and makes the front cover of Business Week or 100% of a $10 million company that no one ever hears about and you’ll learn a lot about that entrepreneur. 

The NBA Finals “There Can Be Only One” advertisements with split screen images of Kobe Bryant and Kevin Garnett and other multi-jillionare stars said it all:  “We all want respect and there is only one way to earn the kind of respect we all want.  The kind of respect they can’t take away from you.  Win.”

Fareed Zakaria's new book on post-American world order is a fascinating read.  I won't speak to the political ramifications of the new world order that Zakaria outlines, but I was struck by the one important element of America's lingering contribution to the world that he seems to have missed:  entrepreneurship.  In an era where the role of America in the global economy is increasingly uncertain, I believe that one of our chief and most respected outputs will be entrepreneurialism.

American history is full of stories of great entrepreneurs.  Like in many situations, there was a strong self-selection bias.  If you were rugged and daring enough to venture across the Atlantic Ocean, you were more likely to be willing to shake things up in society than go along with the status quo.  Walter Isaacson's biography of Ben Franklin shows that Franklin – the ingenious inventor, philosopher and writer – was above all a great entreprenuer who combined practical application with commercial instincts.  Thomas Edison, still the holder of more US patents than any individual in history, continued in this great tradition throughout the 19th century.  Bill Gates, Steve Jobs, Michael Dell and other modern iconic entrepreneurs continue to inspire young entrepreneurs around the globe to pursue the art of the possible.

In recent years, the venture capital industry has tried to institutionalize entrepreneurship and export it.  By working with different entrepreneurs in a range of industries across a range of business cycles, VCs try to figure out the formula for entrepreneurial success and impart those lessons on the next generation of young Franklins and Edisons.  After 30-40 years of perfecting the recipe, they have begun to export it beyond America's shores.  In the last decade, VCs from Silicon Valley and Boston have jumped on airplanes and traveled throughout Europe, Asia and beyond to instill their brand of entrepreneurship, sponsoring venture capital funds in these regions and localizing their company-building lessons and discipline.

China's venture capital industry has exploded, from nothing a decade ago to over $1.4 billion in 2007, with expectations that it will grow tenfold in the next few years.  India's story is a similar one, with $1 billion in venture investments made in 2007.  A closer look at the firms making these investment reveals American roots.  Many of the general partners were educated in America – typically at Harvard or Stanford.  Many of the firms contain executives that learned the art of venture capital in America, either as VCs themselves or entrepreneurs at VC-backed companies.  And an increasingly number of firms are sponsored or partially owned by American VCs.  Kleiner Perkins, Sequoia, Benchmark, Accel, DFJ and many other top-tier venture capital firms have developed subsidiaries or joint ventures in Asia and Europe to practice the art of venture capital (it's still not yet a science!) in those geographies.

Thus, although America's corporate, political and military dominance may be waning – as Zakaria reports – I would argue its entrepreneurial influence is ascending, in an accelerated fashion.

One of the things I love about being a VC is the opportunity to work with passionate, brilliant, talented (and sometimes whacky) entrepreneurs.

BzzAgent CEO/founder Dave Balter is all these things, particularly whacky.

Dave is the founder of BzzAgent – the leading company in the exploding field of word of mouth marketing.  Dave co-founded the Word Of Mouth Marketing Association and wrote the definitive book on the topic, Grapevine.

This is a guy who is so transparent that in the middle of a fundraising process, he blogged about the criteria he was using to pick his VC partner.

This is a guy who invited an "artist in residence" to hang out around the office, produce all the art that decorates the walls and illustrate his second book.

Ah yes, Dave has a second book.  A monkey is on the cover.  The final chapter has excerpts from a college essay he wrote about Captain Crunch.  Leeches feature prominently in a chapter I'm still not sure I understand.  It is truly random and whacky.

Yet it is also brilliant and insightful.  Word of mouth is an elusive but potent tool for driving your business.  Dave is the Zen Master (yes, a nod to Phil Jackson) of the field and anyone who is interested in driving word of mouth for their product or service – B2C, B2B, non-profit, whatever – would benefit from reading the book.

As usual, Dave wanted to do something different with the publication of the book.  So, he decided to self-publish it.  He's making it available for free online (click here to download) or if you want the hard-cover version, you can order it on his Amazon page.

I promised Dave I'd change my name to "Bzzgang" if the company were to become a huge success.  As a result, my wife is watching the company's tremendous progress warily.

Ask any consumer start-up what their biggest obstacle to growth is and it's likely you'll get a consistent but surprising answer:  I simply can't find enough SEM/SEO talent.  It's not a shortage of programmers that are hindering start-up growth (much of the coding talent is being provided by offshore developers anyway), but rather the talent pool hasn't adjusted quickly enough to support the new Search Economy.

Nearly all consumer businesses are banking on search as the major source of customer acquisition – both Search Engine Marketing (SEM), where their company is featured as a paid advertisement on a search results page, and Search Engine Optimization (SEO), where their company comes up "naturally" or "organically" in the search results.  Marketing and advertising dollars that were once funneled into television, radio, print and even online banners are rapidly flowing into search as the most effective, low-cost tool for customer acquisition.

The search economy has exploded at such a stunning rate, that it's worth stepping back to really appreciate it.  The leading recipient of these funds, Google, will receive revenue over the course of 2008 in the range of $16 billion, the bulk of which is paid search.  That's an entire nation's economy built around optimizing search results in the last 4-5 years!  And the category (in which Google owns a 70% share) is growing at 30-40% per year, even in the midst of cut backs (see the association's data at www.sempo.org) – in fact, researchers seem to keep raising their estimates every year of the size and importance of SEM.

Yet, the SEM figures vastly under-report the true importance and impact of the Search Economy.  No one gets paid when a company achieves customer acquisition through SEO, but companies are spending untold resources trying to optimize their websites for natural search results.  Imagine how valuable it is for a financial services firm to appear as the first result when you type in "mortgage refinance" into Google and you can see why talented SEO wizards are worth the investment.

The problem is that the speed with which SEM and SEO have exploded on the Web has resulted in a massive talent gap.  For those that can figure out the black art of search, the rewards are lucrative.  One entrepreneur proudly declared to me, "Google is my b#&%$!" (hint:  rhymes with "witch") when describing why his business has achieved competitive advantage and profitable growth in its niche.

I recently joined the MITX (Massachusetts Innovation and Technology Exchange) board of directors and was chatting with fellow board member Don McLagan about what the region needs to do to entice young, talented college students to obtain good jobs and stick around.  The Boston Globe's Scott Kirsner is focused on this topic as well, recently writing about it in his weekly column.

I have one word for our industry:  search.  Our region's companies desparately need search talent.  And it is a talent that can be easily trained in almost a vocational fashion.  Let's create a 10-week program on SEM/SEO and have some of the local stars lend their top talent to teach it, leveraging what SEMPO has already done.  Every city has large advertising councils and Internet trade associations, but the Search Economy is wildly neglected relative to its size and importance.  If Massachusetts (and other regions?) can train young graduates in the black art of the Search Economy, then a major constraint to start-up growth will be removed.  A workforce that knows how to tame Google (absent the profanity) should be everyone's goal.

The VC business is a funny one and, in my sixth year at it, I am amazed at how much I am still learning with time.  One of the fascinating things about the business is the way VCs process deals, known in the vernacular as "deal flow".

On the one hand, a VC wants to see absolutely every start-up that is happening out there, particularly those led by high quality entrepreneurs.  Obviously, the more high quality deals you see, the more likely you will have the opportunity to select a high quality deal to do.  But there's a more subtle benefit to high volume, high quality deal flow.  Looking at as many deals as possible makes you a better investor – you learn something from every deal you see and are able to detect patterns that can help you in deal selection.  A VC with good deal flow may get an opportunity to review as many as 300-500 deals per year.

On the other hand, a VC only has the bandwidth to do one or two deals per year (assuming they are an "active" VC that joins the board of the companies they invest in – "passive" VCs who don't join the board have greater deal capacity, perhaps three or four per year).  As is the case with any sales process, there are many stages to a deal.  Typically, a deal flows from the first meeting to the follow-up meeting to the light diligence (in-person visit, a few diligence calls) to heavy diligence (extensive market, competitive and technical due diligence as well as personal references) to partnership buy-in to term sheet to close.  To beat the long odds of, say, 300:1, a deal must be compelling at every stage in the process to flow through — VCs are always looking for ways to say "no" more than they are looking to say "yes" (see related blog post:  "Dr. Seuss and the Land of No").

As one wise old VC once told me, "the trick in this business is to spend very little time on alot of deals, and then alot of time on very few deals."  In other words, see everything to be a better investor, but exert a very tough first filter so that you only spend time on very, very few deals.  In my experience, a typical VC has the bandwidth to actively "spend time" or actively work on only one to two deals at any given time and perhaps 10-20 in a year — as compared to those 300-500 they get exposed to.

What's surprising to me is that entrepreneurs often don't seem to know where they stand in the deal process.  Admittedly, VCs aren't known necessarily as great communicators!  But as an entrepreneur, you should know whether you are clearly one of the one or two most important new deals the VC you're talking to is working on.  If not, then you know your deal isn't going to get done and stop wasting your time.  The odds are just too long that you're stuck at the wrong end of the funnel.

Being an entrepreneur means figuring out how to survive and thrive when you often find yourself in way over your head.  An ambitious entrepreneur is always pushing and stretching beyond their comfort zone — creating a company from scratch, evangelizing a new category, taking risks way out of any rational person’s comfort zone.  They rarely want to admit vulnerability, particularly to their management team or board, and so sometimes cover up their anxiety with bravado.  This is the exact wrong way to approach this common situation.

Believe me, I know the feeling.  In my late 20s, I was promoted to the executive team at Open Market — a billion-dollar market capitalization, publicly traded company — and found myself in way over my head.  I would come home at night, shake my head as I recounted to my wife the decisions I was responsible for making, and reflect that I really had no idea what I was doing.

But after a few years, I started to get the hang of it, gaining comfort and confidence in my position.  What happens to a passionate, ambitious entrepreneur who gets the hang of something?  They get bored.  They seek out the next big challenge.  I was fortunate to find it at Upromise, where I was asked to help start the company and serve as president and chief operating officer.  In our first 18 months, we raised $90 million in venture capital, hired over 100 employees, signed up partners and launched the service into the market.  During that period, I again often felt way over my head.  But that’s what made the experience so thrilling.  Whether it was pitching Citigroup’s chairman Bob Rubin to join our service (we were still operating the business out of my partner’s house at the time – talk about “punching above your weight”!) or negotiating a board compensation package with former presidential candidate Senator Bill Bradley, being in over my head was one of the scariest and most fun parts of being an entrepreneur.

How do you know if you’re in over your head in a healthy way as compared to an unhealthy one?  One entrepreneur gave me a good rule of thumb for this just yesterday.  He suggested that entrepreneurs follow an 80/20 rule – they should always feel in command of 80% of the business, but feel way over their head 20% of the time.  It’s that 20% stretch that makes it fun and challenging.  But if an entrepreneur is on the wrong side of the 80/20 rule (i.e., are stretching 80% of the time and in command only 20%), then there is a deeper issue.

Here are a few recommendations for those who find themselves in that situation:

1) Be self-aware.  It’s ok to feel as if you are in over your head as an entrepreneur.  In fact, it’s natural.  Don’t be afraid to recognize it, admit it, and talk openly about it with your board and management team.  Figure out which side of the 80/20 rule you find yourself.

2) Learn your way out…with help.  Seek the advice of the wise men and women around you to learn how to step up and grow into the situation you find yourself in.  Don’t close yourself off to outside advice for fear of appearing weak.  Instead, embrace smart, diverse opinions to help shape your own.

3) Accept life preservers.  Many entrepereneurs are terrible at accepting help.  After all, the reason they’re entrepreneurs is that they enjoy being their own boss and are passionate and often stubborn about following their vision.  It’s hard for them to admit they need help and, sometimes, need a life preserver to pull them out of the situation.  It may mean hiring a COO, hiring a CEO and moving into a chairman role, or other big moves that risk giving up control.

When entrepreneurs are in over their head, it can be awkward.  But it doesn’t need to be.  Be honest and open with those around you and keep an eye out to make sure you’re not on the wrong end of the 80/20 rule!

Fred Wilson wrote a blog last week on VC exits, bemoaning the lack of liquidity paths.  I admire Fred tremendously (both as an investor and blogger!) and think It’s a great blog, but it only covers a part of the story.

First, a bit of background.  VCs need their start-ups to exit in order to pay back their limited partners.  The IPO window is effectively closed for VC-backed companies and even when it was somewhat open in 2006-2007, the bar was very high (typically you needed $100m in revenue, profitability and 7-9 years of operating history).  The practical path to liquidity for entrepreneurs, therefore, is to sell your company to a larger (typically public) company for cash and/or stock – an M&A exit.  Fred points out that, as a rule, Web start-ups simply do not thrive when snapped up by the (depressingly few) prospective acquirers like Google, Yahoo and AOL – leading to an unsustainalble cycle.

Why do I think Fred’s blog only covers a part of the story?  Simply put, there are huge industries and parts of the economy where VC-backed start-ups are competing that are not covered in his analysis.  The life sciences industry, which has become a massive opportunity for entrepreneurs and VCs, has seen some terrific exits in both biotechnology (Flybridge Capital’s senior advisor, Christoph Westphal’s company, Sirtris had a strong IPO in 2007 and has a market cap north of $350m) and medical devices.  Our portfolio company, Brontes3D, was acquired by 3M for $95m after raising only $8m in capital.  Brontes, by the way, has indeed thrived under 3M’s leadership.  Nearly two years later, the entire management team under CEO/co-founder Eric Paley is still there and 3M’s resources and distribution channel has helped support taking the company’s novel intraoral dental scanning device to market (as featured in yesterday’s Boston Globe). 

The wireless industry has seen some nice exits for companies like Enpocket, 3rd Screen Media and m-Qube.  Enpocket’s management team under CEO/co-founder Mike Baker remains at acquirer Nokia and has taken on responsibility for all of Nokia’s mobile marketing initiatives.  Finally, the enterprise software industry (selling to, gasp, IT) isn’t (as my partner Chip Hazard likes to say) dead yet.  Some strong exits in that market in the last few years include Outlooksoft and Virsa (both bought by SAP), AppIQ (HP) and IM Logic (Symantec).  IMLogic’s CEO/co-founder, Francis deSouza, remains at Symantec 2 years later as an SVP running a huge part of their business (nearly $1 billion in revenue, last I heard).

A cynical observer might point out a sharp contrast here.  The "easy come, easy go" Web 2.0 start-ups may not be building real, sustained value and so vaporize under an acquirer as quickly as they appear, with "quick flip" entrepreneurs running off to do their next big thing.  Meanwhile, the "built to last" entrepreneurs across a range of "long-term value creation" industries — life sciences, medical devices, enterprise software to name a few — are more likely to stick it through and help their acquirers see real value through continuous improvement.

But then again, I’m a former entrepreneur.  Optimism wins out over cynicism every time.

It’s taken me a few seasons and heavy lobbying from my wife, but I confess to finally becoming a convert when it comes to American Idol.  The show is simply mesmerizing when you blend the individual personalities and talents of the contestants with the judges.  In particular, I find that the three judges work incredibly well together to provide an entertaining banter throughout the show – Randy, Paula and, of course, Simon.  As much as I enjoy the performances, I enjoy listening to the judges’ feedback on the performances even more.

As I was watching the top 12 contestants get winnowed down to 10 last night while catching up on email – many of which contained board packages and sundry portfolio updates – my mind drifted and I began to wonder:  if the contestants were entrepreneurs and the American Idol judges were VCs, which judge would the entrepreneurs want in the boardroom with them?

Let’s examine the three candidates.

Randy is the Domain Expert.  His experience in the recording arts field is palpable when he speaks and presumably he is very well connected.  He displays great empathy with the contestants and often gives very constructive feedback that is relevant, albeit a bit narrow.  He doesn’t focus on the overall strategy, typically, but rather picks out one or two small items to comment on.  Similarly, many entrepreneurs seek out VCs to sit on their boards who are deep domain experts and can provide them with vertical expertise relevant to their particular business.  But many entrepreneurs find the Domain Experts repetitive and overly formulaic over time ("I’m a hammer," confessed one to me the other day, "and everything I see looks like a nail to me").  At the extreme, these domain experts simply don’t help the entrepreneur see the big picture in the value creation process.

Then there’s Paula, the Cheerleader.  No matter how bad the contestant did, they can count on an encouraging word from gentle Paula.  Certain VCs display similar personas in the board room.  Missed the quarter?  Lost a key recruit?  "You’re doing great," says the Cheerleader VC, "Atta[boy/girl] – just keep at it.  This is hard stuff and we love you."  I remember one of my board members used to systematically call me or email me with a "Nice job!" message at the end of every board meeting.  At first, I relished it.  After ten board meetings of the same formula, I realized I was the recipient of the auto-encouragement-message.  When you’re feeling down and going through one of the inevitable troughs in the entrepreneurial cycle, you need that Cheerleader board member to pick you up.  But they lose credibility quickly because you’re never really sure if they’re telling you what they think, or just telling you what they think you want to hear.

Finally, there’s Simon.  The thing you love and hate about Simon is that he tells it like it is.  He is the Truth Teller.  In the board room, sometimes the feedback is tough and hard to hear ("That really stunk – your sales presentation shows that you still have no idea how to articulate your value proposition").  But when the Truth Teller gives you that rare bit of positive feedback, it’s all the more precious, because you know the Truth Teller doesn’t sugar-coat ("Last quarter was awful, but this quarter you finally got your act together and executed flawlessly.  Well done.").

These archetypes – the Domain Expert, the Cheerleader and the Truth Teller – each have their pros and cons, but when I was an entrepreneur, I preferred the Simon-like Truth Teller.  It’s the dead-on feedback from the Truth Teller that pushes a board and a company forward.  Even when it’s painful to hear.  You can’t solve tough problems in start-ups (and what problems aren’t tough when trying to create a multi-million dollar business from scratch?) until you face up to them and articulate and explore them fully.  The Truth Teller doesn’t let human nature’s conflict avoidance tendency kick in, but rather pushes you to see the flaws and address them.

Which American Idol judge would you prefer to have on your board?