Don't Reinvent the Wheel

October / November 2004 By: Cary Adams Volume 2 Number 5

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Are you a first time entrepreneur and research scientist struggling to convince investors to fund your company? One of the best ways to clarify your plans in ways that venture capitalists and angels will relate to is to identify a successful model company or companies, and go to school on their experience. Whether yours is a software product, a medical device, or anything else, if it has the kind of commercialization potential that will attract venture capital, there almost certainly is a successful company selling a similar or related product to the same customers, which can serve as your model.

Many scientists and engineers who are capable of developing novel technology with great commercial potential have little or no experience with sales, marketing or the management of sales and marketing. Worse, they may harbor a low regard for these functions. Scott Adams's cartoon strip Dilbert humorously depicts the engineer class oppressed by incompetent management and victimized by dishonest and clueless salespeople. Academic and research institution environments may also tend to look down upon sales and marketing and the commercialization process generally. These cultural perspectives are real and can be major obstacles to successful commercialization of research and invention. The historical notion that if you build a better mousetrap the world will beat a path to your door, may have had some relation to reality two hundred years ago, but how many people today have ever bought anything by directly approaching the inventor?

For your invention to actually be used and be helpful to people, it has to be available to them wherever they are at a price they will pay and which will more than sustain the team of sales and marketing people whose working lives must be dedicated to making your product known and available to them. The price your customers will pay must not only pay for this sales team, and for the rest of the company's operations, but also generate enough profit to pay for growth and R&D, and to suitably reward the investors and the founders, and, of course, you as the inventor.

You may know very little about this world, and investors will quickly ascertain this from talking with you or reading your business plan. If the plan doesn't address all these issues convincingly, then what you don't know brands you as likely to fail.

But if you are a true entrepreneur, willing to do whatever it takes to make your invention a success, there is hope. All the information and experience you are lacking have been gathered by other companies who are already successfully selling products to the same set of customers. If they started out as a single product company, and went public after ramping up sales, an abundance of information about them is available online through the SEC's Edgar system.
Review their recent 10Ks or annual reports, and go back to their S-1 registration statement which they filed when they went public. You will be able to find complete sets of their audited financial statements, going back several years before they went public. You can use these as a model for what percentage of your total operating costs should be allocated to various functions, like sales, marketing, research and development, administrative and general. You can learn about their sales prices and the nature and timing of sales cycles.

You may be shocked at how much money must be devoted to sales and administrative functions, and you won't be the first inventor whose eyebrows get raised. Sales that require customer-salesperson interaction are expensive, and only certain products that the customers need and will be willing to pay enough for can generate enough money to more than sustain that kind of sales force. Some products that people would buy at a certain price cannot be brought to market because that price isn't enough to pay for the sales effort. If you think you will be able to just post your product information on the web, and people will seek it out and buy it, it may be possible that you're right, but you'd better be able to show model products successfully sold to your target customers through this channel in substantial volumes, or your potential investors won't find it credible.

From your model, you can also learn how fast you can expect your revenues and expenses to grow, and this can help you determine how much outside capital you will need to raise before your company breaks even and becomes profitable and self-sustaining. You can also calculate how long it should take to provide a liquidating event for your investors. Your model and its industry can provide valuation formulas, such as a range of multiples of revenue, likely to apply when your company goes public or is sold. A fundable company pulls all of these items together to show what an investor can reasonably expect (this class of investment looks for a 40 percent internal rate of return, more or less).
Assuming that your model and your own business plan promises to deliver an attractive investment return, and assuming you've actually talked to a lot of your potential customers to confirm that they will eagerly spend your projected price to obtain your product, because they need it, then you will find that investors will take a great deal of interest in your company.

Another great thing about model companies is that they are full of people who already know how to successfully address and solve most of the problems that your company is going to face. Get the founder or retired CEO of your model company to join your board of directors or advisors, and make an angel investment. Such an advisor can be invaluable. And if you look hard in the mirror and conclude that you are not the right person to build, supervise, and motivate a sales force of hundreds who can deliver the sales your company will need to succeed (which will be true of most engineers and scientists), hire someone from your model company who has already proven himself or herself capable of this task, and who already has the industry contacts to make it happen.

You wouldn't try to design a bridge without ever having looked at an earlier bridge design, or design a chemical manufacturing process without taking into account similar designs using proven processes and existing equipment. So don't make the mistake of trying to design a company without looking at the best available models. If you find that there are no models, you're either not doing adequate research, or you are facing a task that will take a lot longer and cost a lot more than most, and present a lot more risk to any investor. Many investors will shy away from a company without a successful model for reference. If the models didn't turn out well, maybe yours is not a good candidate for commercialization, and you can save yourself several years of fruitless effort by learning from their mistakes. If you talk to investors who understand the markets you will be addressing, they will already know many of the models you should be considering. If you talk to these investors before doing your homework, you're going to sound pretty naïve, like a student trying to carry on a conversation with his professor about the professor's subject, before taking the course.

The last great thing about good models is that investors made money on them. Target the angels and VCs who made money on your model, and, if you've picked your model well and put your plan together right, they will see the opportunity instantly. You will be pushing all of their buttons. And they will be in the best position to add value, in addition to investment capital, to your company. If it's a good model, lots of investors will see the opportunity.

Cary Adams is a partner in the law firm of Murphy Austin Adams Schoenfeld LLP and the founder of the Sacramento Angels, a private investment group.