How many times does an entrepreneur with a great idea believe they are the only one suited to run their new venture? Usually, they believe they need to be the CEO. However, even if they are the well suited to lead a venture in the beginning, they are not the one to drive to higher levels beyond development. When this expansion phase occurs, the board usually has the difficult task of letting the entrepreneur/CEO know that it is time for him to take a new role in the company.

Often this communication does not go well, and the end result is that the entrepreneur cannot understand the message and leaves the company.

Here are two case studies I’ve personally witnessed:

1. Typical CEO transition scenario

A three year old company is doing very well. Making lots of profits and growing. The CEO and the board hire a seasoned executive with more big company experience than the entrepreneur/CEO has to help the CEO. The CEO and the new executive bond well, and it looks as if this transition will go well. In fact, the entrepreneur/CEO tells the new executive that he is glad the new executive has come on board, and that he will know when it is time to turn the reins over and step aside. About a year later, the board wants this transition to take place, but instead of knowing that it is time for prudent change, the entrepreneur/CEO starts fighting his board and terminates those executives on staff who agree that it is time for the change. This plays out over several months and by the time the board realizes what has really occurred, the company has lost market share, revenue, profits and cash. The change finally occurs, but it is too late, and the company ends up going out of business, when this did not have to happen if the transition had occurred smoothly.

2. Ultimate irony scenario

Another example is even more interesting. It would be funny if it was not so sad. An experienced venture capitalist decides to change “sides of the table”. An entrepreneur comes to him with a great idea but understands that he does not have the skills or inclination to run a business, only be a developer. The VC decides to run the company for a while until it gets going, at which time he will hire a new CEO, and go back to being a VC. As the company progresses, the business is able to raise in excess of $100 million towards building the company. It becomes clear after the major institutional round, at least to some of the employees and board members, that it is time for an experienced CEO. The VC acting as CEO however now decides that he is the only one that should lead the company and refuses to listen to his fellow VC’s and board members. He fights the board for quite a while, and in the meantime, the company’s spending runs out of control. By the time the board finally removes him from his position, the company is nearly out of cash, and has not completed its milestones. The irony of this is that the VC/CEO had experience on the other side of the table many times and witnessed other entrepreneur/CEOs not wanting to be replaced and fighting with the board. But in this case, he got enamored with the idea of running the company, he took it personally and lost sight of his original mission.

So, we give advice to young entrepreneurs to remind them that having a successful business should be more important than stroking their egos by being the CEO. Most entrepreneurs are best at developing ideas not at managing businesses. We advise that they have to be ready and willing to step aside – many times early on or earlier than they might like – and appreciate that it is nothing personal. It’s just part of the process of building a successful company.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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1. Management. The first one is similar to the old adage regarding real estate. A wise person once said that when buying real estate there are three things to look for – namely, LOCATION, LOCATION, LOCATION. All else falls in line if the location is good. Well when I look at a company to either invest in or help, the first thing I look at is really three things – MANAGEMENT, MANAGEMENT and …. MANAGEMENT.

Without sound management, companies cannot and will not succeed. When looking at management, I like to look for a team of managers who respect each other, who are, or want to be, collaborative in style, and probably most importantly, who are decisive. Not making a decision is worse than making the wrong decision, or worse yet, not making any decision.

Some danger signs to consider when reviewing management is the way the CEO interfaces with the board of directors. A CEO who will not allow open and complete access by board members to the Executive Staff, not just the CEO, is probably insecure, or perhaps hiding things from the board. He may not want to risk having his staff contradict what his message to the board of directors has been. A CEO and team that keep missing deadlines or objectives is another sign that things might be going awry. These missed deadlines and objectives are a clear indication that the staff is probably not communicating, even with each other, on a truthful basis. Their credibility with the board will also suffer. So, bring in a coach or a replacement may be necessary to get the management to work in an effective and cohesive manner.

2. Technology. The second thing to look for is TECHNOLOGY problems. These problems can fall into two different areas. The first, and probably most important would be called technological feasibility. A good example to demonstrate this would be looking back at the computer about 15 to 20 years ago. When COMPAQ first introduced a portable computer, it was heavy, with two floppy disk drives, and a six inch green CRT display. If someone had proposed producing a two pound notebook with a flat panel high resolution color display, a 128 GB solid state drive and a quad core processor, people might have really liked what was being described. However, technology had not advanced far enough, or small enough, to accomplish these lofty specifications. Therefore, an investor who had invested in this dream would have faced technological feasibility issues, and the company probably would have failed.

The second issue surrounding technology is poor execution. If the technology is feasible, but the team has not been able to complete development, then refer to the first point above, because the problem probably resides with management.

3. Marketing. In essence, the question here is can the company generate sales for the new product or service? In most cases, a young company is established and capitalized to fill an unaddressed primary need in an emerging or existing market. Assuming the market is real and the technology works, a failure to generate sales traction is a marketing execution problem. Either the marketing guys spec’d the wrong product to begin with or they failed to successfully market the product once it was available.

So, as you prepare to invest in a new company, or are involved in an existing company, be aware of these three areas and stay vigilant to avoiding the common mistakes made by many others.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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We have dealt with distressed companies through multiple cycles over the past 20+ years and are sure of one thing: even if you never have to liquidate and wind down a company, it is best to understand the issues associated with such a potentiality before they progress too far.  So, with the help of Cooley Godward Kronish, we created a primer for executives and investors regarding legal, strategic, and operational issues facing distressed technology companies. We periodically offer that primer in a seminar/webinar, and our next one is scheduled for May 12. We hope you can join us.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms.  Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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A little research on the subject, with much thanks to Wikipedia:

“Texas Hold ‘Em is one of the most popular forms of poker. Hold ‘em exploded in popularity as a spectator sport in the United States and Canada in early 2003, when the World Poker Tour adopted the lipstick cameras to show each poker hand.

A few months later, ESPN’s coverage of the 2003 World Series of Poker featured the unexpected victory of Internet player Chris Moneymaker, an amateur player who gained admission to the tournament by winning a series of online tournaments. Moneymaker’s victory initiated a sudden surge of interest in the World Series, based on the egalitarian idea that anyone—even a rank novice—can become a world champion.

In 2003, there were 839 entrants in the WSOP Main Event, and triple that number in 2004. In the 2005 Main Event, an unprecedented 5,619 entrants vied for a first prize of $7,500,000. This growth continued in 2006, with 8,773 entrants and a first place prize of $12,000,000 (won by Jamie Gold).

Beyond the World Series, other television shows—including the long running World Poker Tour—are credited with increasing the popularity of Texas hold ‘em. In addition to its presence on network and general audience cable television, poker has now become a regular part of sports networks’ programming in the United States. “

It is thought that spectators of Texas Hold’em now rival that of football and stock car racing in the United States, a phenomenal prospect.

Many amateur tournaments have sprung up to allow “friends” to play poker, network with each other, and give proceeds to charity. Could there be a better combination? As an example, The Brenner Group is hosting a charity tournament next month to raise money for The American Red Cross, and two well known valley companies, Bridge Bank and Orrick Herrington & Sutcliffe have agreed to co-sponsor the event.

So, if you were wondering why all of the Poker Tournaments are springing up, you now have all the facts.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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In the post dot-bomb era, VC’s became increasingly risk adverse, and wanted to fund only those ventures with proven entrepreneurs and only ventures that had already been fleshed out to remove much of the technology risk, leaving only a market risk to conquer.

Now, since the Great Recession, VC’s have gotten even further risk adverse, although they claim otherwise. Today, most VC’s are concerned about their Limited Partners interest in the start-up space, because their own liquidity has been diminished, but probably more importantly, they have had negative returns on the VC sector of investing for over ten years! So the VC’s are looking to invest in deals that might have a reasonably short exit in order to increase their returns. Also, by looking at shorter time frames for exits, they are almost sure to invest in later stage ventures which by their nature have taken some, if not all, of the techno logy risk out of the equation.

The rise of the angel

So what does that leave for early stage entrepreneurs? In the late 1980’s and early 1990’s wealthy individuals became a source of capital for early stage deals. These individuals became known as angel investors. In the late 1990’s, and especially in this decade, these individual angel investors organized themselves into groups. By acting in a group, many angels believe they get the collective intelligence of the members of the group, which broadens their own market for possible investments. They also get to spread their investment risk out, by investing smaller amounts individually into more deals collectively. This formula is beginning to replace the traditional venture capital model.

Angel investors have more tolerance for the time it takes to build a successful business, because they don’t have to answer to limited partners, they only have to look in the mirror and satisfy the reflection looking back at them. Angel investors are prepared to invest in early stage companies, and when structured properly, they are able to see a positive return when an exit does – hopefully – occur. Be aware however, that angels are more intelligent now than they used to be. Today, they also look to how much capital the enterprise will require beyond the angel round. If this amount is large, they might want to have some later stage venture capitalists actually look at the deal to judge their future interest in the team and the space.

So, if we look at the funding order available for entrepreneurs today, the first place they should look after their own family and friends, should be to the organized angel investment groups. They still have to deal with more individual investors who make their own decisions, but they are typically dealing with intelligent, qualified investors. So, we can say that these angel groups have now taken the place of the traditional venture capital early stage funding.

When the entrepreneur has fleshed out the technology, and maybe even the market, traditional sources of venture capital may be available to increment the angels’ investment.

Time will tell whether this change in the funding ecosystem is permanent or temporary. But for now, entrepreneurs need to work with angel groups.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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Seek sources of capital other than venture capital

If you have built significant value, you can pursue different types of capital for sustenance or liquidity. There are exceptions, but for the most part the IPO windows are virtually closed, regardless of how much value you have created.

So, if your historical financial investors (e.g. venture capitalists) have run out of the willingness or ability to continue funding your business while you wait for a great payday, you need to know that there are other ways to fund your business. One such way is to look for a strategic investor. These are typically not traditional financial investors but may be one of your customers or suppliers, or even one of your competitors. This investor might also be a company that is looking to expand through new technology. These parties may see value in funding the company to continue to watch you grow or to assure their supply chains are maintained. These investors might be interested in investing in you to see if they should consider acquiring you at some point in the future. Or, they may start a discussion about an investment and determine that acquiring you in the current market would be advantageous to all parties. Valuations in these circumstances are typically much better than a traditional financial investor, because of the different motivations which they bring to the table. To accomplish this strategy successfully, you should enlist the services of a competent financial advisor, who has managed these sorts of transactions.

Final liquidity option – selling your company or its assets

In our last blog, we spoke about restructuring in the difficult times. However, sometimes restructuring cannot work and forces the board to look at ways to receive anything, even a small amount, representing the value of the assets of the business. In most venture capital backed technology companies, there are primarily two types of assets: fixed assets which you can see and touch: furniture, computers, servers, lab equipment, etc.; and intangible assets which are the ones that probably have the most value. Intangible assets include intellectual property, such as patents or patent applications. Depending on your industry, and the strength of your patent portfolio, many companies might be interested in acquiring these assets. Defensive patents are those which other companies might want to purchase to prevent or block other companies from developing new products which compete with a core business. Offensive patents are those which a company acquires to allow it to pursue a strategic business opportunity faster and with greater defensibility. Lastly, the longer you can maintain the core of the business, such as the development team, the more likely it might be that someone interested in the intellectual property might also be interested in the team that developed it, and might pay a premium to acquire this.

If you cannot keep the team together long enough to see if there would be a buyer for the intellectual property and the team, selling the fixed assets usually requires retaining a financial advisor to conduct the auction of these assets. The value that will be received at auction is typically very low, but can generate a little cash to allow you to conduct a sale of the intangible assets. Retaining a financial advisor with experience in selling the intangible assets can result in better results for the stakeholders, which are the creditors and/or the shareholders.

So while liquidity events come in different sizes and shapes, there is always a way to generate some liquidity for your stakeholders.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

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Our first seminar, “Issues Confronting the Financial Expert” is scheduled for Wednesday, July 22nd from 8:00-9:30am and focuses on key issues and challenges facing financial expert witnesses and litigating attorneys in the development and presentation of financial analysis testimony, with a particular emphasis on valuation. As an approved MCLE provided we are pleased to provide one hour of credit for this session.

Just a few of the topics to be covered …….

• The role of the financial expert witness.

• The court’s expectations and rules of evidence for valuation testimony.

• Daubert challenges.

• The differing definitions of value encountered in litigation.

• The various authorities, professional organizations, and professional standards for valuation.

Look for additional seminars in the months ahead.

Read more about Silicon Valley news, trends, and commentary in The Brenner Banner

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In recent months, I have written about the problem with the venture capital industry as a whole. This post will deal with the inevitable fallout of the venture capital problems, and that is – what is a company to do when it runs out of cash and its investors can’t or won’t provide follow-on financing? 

Surviving Without Additional Capital

Nowadays, most vc-backed tech companies are facing the challenge of surviving with little new resources, and increasingly it forces them to restructure themselves for survival. These restructurings are best instituted with outside assistance from someone who can bring a fresh set of eyes to the issues and be able to focus on the bigger picture, which may have been lost due to the complexity and challenge of the issues at hand. The Brenner Group has been providing such restructuring services for tech companies since 1987!

When we are called in, the first thing we do is to work with investors and management and find out if there is enough substance in the product and technology to even try and restructure the business. In many cases, the answer is “no” which may be hard for an entrepreneur to accept but can often occur in popular but crowded market sectors. However, we often find there is substantial traction and/or IP that is worth salvaging which will lead to the development of a restructuring plan.

Top Priority is Cut the Burn

The earlier a company faces the challenge of not being able to raise significant institutional capital and assembles a restructuring plan, the more resources will be left to work with to move forward. The first thing that needs to be addressed is SURVIVAL! Survival means reducing the cash burn (the net amount of money a company spends each month.) The largest spending category contributing to the cash burn is usually headcount. When headcount is reduced, many categories of spending follow, because they are linked to headcount.

But my experience has shown me that most times the first headcount reduction is not carried out completely and requires a second or third, or even fourth reduction which may seriously hurt morale, as employees do not know when the next reduction in force (“RIF”) will occur. Effecting one RIF instead of many is essential and can actually boost morale and allow the company to increase the productivity of the remaining employees.

A restructuring requires a zero base budget to be prepared without any regard to the existing spending levels or headcount. The restructuring expert, from firms like The Brenner Group, helps companies prepare this zero base budget. The key inputs to the budget process are: (a) how much cash do we have?, and (b) how many months must we survive until we reach cash flow breakeven or cash flow positive or close additional funding? This budget will then be worked, and reworked, to see what can be accomplished with the remaining resources available to the company.

After the zero based budget has been completed, matching existing people to this budget allows a company to determine which employees fit the new budget and job definitions, and which are excess in the short term. These remaining people fill the necessary roles to get the company to cash flow breakeven or a funding event sometime in the near future. That is what survival means, and it often means losing some very good people, who cannot add enough value or are just not affordable in the short term.

Restructurings Often Lead to Wash-out or Re-cap Financings

Restructuring might also mean that a small amount of capital may be required even in the reduced spending scenario. This would mean raising new capital from existing/new investors or friends and family, but could be at a significantly reduced pre-money valuation – maybe even close to zero. This is called a recapitalization, and many times is part of a restructuring plan. A recapitalization round of financing will typically dilute, or “wash out” existing investors and employees. Plans must be in place immediately after the recapitalization to re-incentivize the employees who remain after the restructuring. New investors will have to understand that this needs to be accomplished, or the restructuring will not be successful. Again, restructuring professionals, such as The Brenner Group, can help determine how to accomplish the recapitalization of the company.

There are many more facets of a restructuring which will be addressed in future posts.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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At the PricewaterhouseCoopers Shaking the Money Tree event for the first quarter of 2009, the standard answer to almost every question became 50%.

The amount of new VC money raised compared to a year ago, the number of deals done in the first quarter; the amount of money invested in the first quarter compared to a year ago. These are striking statistics. And while 2008 was actually the fifth best year for dollars invested and dollars raised since the statistics were first being recorded, 2009 looks to be – well 50%. That could make it the worst year in the venture industry since 1996. If we discount the 2009 dollars back to prior years, it might actually become one of the worst years in history.

The exit alternatives for VCs have also further deteriorated. In the first quarter of 2008, there were 5 VC backed IPO’s. In the following three quarters of 2008, only 1 VC backed IPO (3rd quarter). And none in the first quarter of 2009. The number of M&A transactions continued the same type of decline – remember the answer to all questions was 50%. And the average deal value for M&A fell to under $50M in the first quarter, compared to more than $115M in a comparable period last year. The average VC deal consumes approximately $15M to $20M over its life. If the total return is averaging less than $50M, and remember that most deals don’t even get to the M&A stage, it’s hard to imagine an attractive ROI for VCs based on these realities.

New Federal Tax Proposals Would Increase the Pain for VCs

Now, couple all of this with proposed tax laws from Washington that will tax VCs carried interest – their share of any potential gain on investments made by their funds – at ordinary income tax rates instead of capital gain rates, and we have to begin to wonder what will replace VCs, as their model continues to collapse.

Clearly there will always be a place for some type of venture capital investment. But I believe that an organized angel investor community will continue to grow and fill the gaps left by VCs. However, angels also need some sort of exit strategy. A return to a more normalized stock market is needed to make this happen, but angels are used to waiting a little longer than most VCs. In a more normalized stock market, there will more IPO’s, and there will be stronger currency for potential acquirers, as their own stock values increase. In either case, lower valuations mean better deals for the investors and lower terminal value requirements.

So, let’s all hope that someone invents the next “big thing” that everyone must have. Together with this, we should see our stock markets returning to “normal” in 2010 or 2011, and that we will see a new investing model that may combine aspects of the old venture model, the current organized angel model, with something new sprinkled in to make investment capital plentiful again.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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Limited Partners are under pressure
First and foremost, many long standing, quality VC and PE funds are concerned about whether their Limited Partners (LP’s) will be in a position to fulfill capital calls in the coming months or years. Limited partners in the leading VC funds are dominated by pension funds, university endowment funds or similar trust funds. Typically, these sources of capital have internal guidelines about balancing their portfolio between various investments, such as public securities, debt, government instruments, international, etc. Private equity and venture capital have long been part of their investment mix.

Now these LP’s are facing a several major issues that adversely affect VC’s:

(1) The value of their other investment sectors, such as public securities, has significantly eroded over the past year (the DJIA is down 33% over the last six months). As a result, the absolute amount allocated by LP’s to the VC and PE sector is out of balance and will probably be curtailed in order to balance their portfolios;
(2) Investments in venture capital funds have had returns hovering at or below zero for the past decade. Notwithstanding historically low interest rates, the portfolio managers are probably evaluating whether the VC sector can or will return to higher yields, which are demanded by the higher risk inherent in venture investments; and
(3) The management fees charged by VC funds are typically based on capital committed, not actually invested. So, many of the funds are still drawing large management fees without being able to call capital. This fact might further upset the LP’s who watch their capital being drawn out as fees by VC fund managers, while the new investments have slowed down.

Therefore, many VC’s, including many of the Tier 1 firms, are not making capital calls at this time, because if the calls are not met, they would have to admit that the traditional model is broken. They also are trying not to upset the apple-cart of their ability to draw the management fees, even while returns have been unacceptably low for the LP’s.

Need a robust public market
So, as the reader ponders these issues, probably the biggest question is how can we fix the venture capital model, or what will it be replaced with? The answers are not yet clear.

One obvious possibility is to gain momentum for positive exits for portfolio companies through IPO’s or M&A. But when this can occur is very unclear. The re-emergence of a viable US IPO market is probably at least 8 to 10 quarters away, unless something dramatic shakes our world and stimulates an economic recovery. The first signs of market recovery, which may spark renewed IPO or M&A activities, may include a positive consensus developing among analysts and other market watchers regarding a recovery, and/or strong growth within specific high profile technology segments.

M&A exits will help, but when?
As for M&A, the temperament among corporate development officers is similar to that of a schizophrenic…on the one hand they are salivating at the availability of relatively cheap deals, but on the other their better judgment forces them to horde cash except where a deal is strategically compelling beyond anyone’s doubt. While there will be plenty of interesting potential sellers, the strategic buyers will only cherry pick those deals that are strategically critical or those they can “steal”. Until the economy shows signs of resurgence, whether through profits or market caps increasing (probably both), cash will be horded by typical acquirers like Intel, Cisco, Oracle, and Microsoft.

Recent financial market dynamics have exacerbated the pressure on the traditional venture capital model by imposing further constraints on capital availability and decreased exit options. At a minimum these forces will be with us for the next few years, creating greater stress on all participants in the venture community. Ideally these dynamics will provide the impetus for a new and improved venture capital model, but in any event, it is unlikely to be business as usual.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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On November 14, 2008, Gerald Celente, a renowned US trend forecaster, appeared on Fox Business Network (See the YouTube video of Gerald Celente) and predicted that by 2012 we’d have economic depression, tax rebellions, riots, and more families concerned with buying food than Christmas presents in the United States.

Celente also predicted that in 2009 and beyond food-producing gardens will become common on people’s lawns, as resources generally become more scarce. Other predictions for 2009 and later include a possible revolutionary advance in renewable energy technologies, miracle cures from stem cell research, a shift toward holistic healing practices and a crash of the overpriced college-industrial complex. Celente says to escape the mood of economic depression people will be delighting in entertainment and alcohol.

While I am aligned with many gloomy predictions—including some of what Celente articulates—I can’t buy into the doom scenario with him, particularly for those of us fortunate enough to live and work in the Silicon Valley area. This writer believes that 2009 will surely see a continuing decline, and that it will be at least the end of 2010 before we see any signs of national economic recovery, and this may not come without a major global conflict, of the type we never wanted to see again.

However, Silicon Valley has much going for it and may bounce back sooner and better than the rest of the country. First of all, the drop may not be as precipitous, either in terms of job losses or real estate pain. The last recession was led by technology, and this is a more classic consumer led recession. So, we may be a little more insulated than the last time around.

Also, we have several sectors here that may actually fare quite well during the next several years. Certainly with President Obama’s push for energy independence, green tech may be a real bright spot for us here in Silicon valley. Life sciences also stands ready to continue its climb.

But interestingly, I like Internet opportunities as well. This is because of the wholesale move to smart phones and the accompanying demand for low cost, instant entertainment that will only become more voracious during the difficult economic period ahead of us. Perhaps it represents the ultimate irony: the cause of our last economic meltdown – in 2001 – was the over-hyped Internet companies. Now that sector may actually be part of an economic solution from 2009 onward.

More importantly, I believe our venture capitalists will decide that they need to actively support these sectors, as they have been doing for decades — that is, building companies and jobs for years to come, and all this without 1 cent of TARP bailout money.

Rich Brenner is Founder and CEO of The Brenner Group, one of Silicon Valley’s premier professional services firms. Rich is a veteran executive, entrepreneur, investor, board member, and philanthropist.

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