Be Smart to Attract Smart

A friend of mine, who recently moved his tech company to Portland from SF, is joining a group of other Tech execs for a meeting with the governor. He asked me what I suggest he discuss…what should the State be doing to improve the Tech eco-system in Oregon?

I’ve always believed that a good entrepreneurs don’t let the government get in their way. Like Gary V puts it “I’m completely of the notion the government can’t stop me.” But despite my libertarian business leanings, I think there are things the State of Oregon and the City of Portland should be doing. Oregon and Portland can leverage its strength – affordable, high quality of life – and encourage the continued influx of over-educated young people.

There is a burgeoning creative class in Portland, yet our economy is out pacing the talent pool. I don’t know of a single local tech company that isn’t wanting for additional talent. My own company SweetSpot hasn’t been without a slew of unfilled reqs for the last three years. Oregon State University, Portland State University and other Oregon programs are upping their game and turning out more qualified programmers, but that isn’t enough…we have to continue to import.

First, we could start a program to target the top several dozen Computer Science programs across the country. Any graduating student with a 3.0 or better should be provided a plane ticket to Portland, a couple nights at the Ace and an intro to half a dozen local tech companies. With Portland’s national reputation, there’d be no problem wooing some of the best and the brightest out for a few days of micro brews, fine food and interviews. State and local development agencies could fund this. A few hundred thousand dollars could see a very good return in the form of highly compensated new taxpayers.

Second, we need to advance policies to improve and encourage life for Tech companies. Oregon and Portland should embrace the digital re-invention of all our daily activities. Things that can continue to make Portland a great place to live, especially for highly educated young people. We should reverse the silly antiquated policies that restrict services like AirBnB, Uber, Lyft and other “sharing economy” apps. By embracing these innovative services, we not only improve our quality of life, but also encourage innovation and growth for local tech companies. It’s time our city leaders get their heads out of their…out of the sand…and figure out creative ways to encourage, not inhibit these new services.

Don’t treat new ride sharing services like antiquated taxi and traditional limousine services. Don’t treat AirBnB like traditional hotel services. Embrace and encourage digital reputation and dynamic application mechanisms to enforce quality and safety with regulations as a backstop. Embrace game dynamics that drive pricing and usage optimization decreasing congestion and waste.

With a few policy changes, Oregon and Portland could go from technical backwater that can’t even develop a functioning web site to the place every smart technical savvy person wants to live. We’re competing for talent with San Francisco, Boston, and New York, not to mention London and Berlin. It’s time we start acting like it.

Scale…It’s the Hard Thing

I just read Ben Horowitz’s excellent book, The Hard Thing About Hard Things. It reminded me how hard it is to scale a high-tech growth company. I’ve been involved in four ventures that made the leap to scale. When it is done in short period of time – inception to $100 mil in revenue in 5 years – it’s a bit like a jump to hyperspace…Hollywood can only describe it as streaks of light. Ben does an excellent job of analyzing and articulating all the elements of scaling a business. It’s really hard, but as last years Unicorn Club discussion highlights, it’s really rewarding.

Building high growth Tech companies to scale is the Portland’s next big economic challenge. The acquisition of Simple by Spain’s BBVA is the latest example of Portland’s ability to build successful tech companies. But even Simple is an order of magnitude from the bench mark of high tech scale – $1B in valuation.

Five years ago Portland undertook a concerted effort to build a vibrant tech startup ecosystem. Resources, public  and private, rallied around multiple efforts, formal  and informal. The results have been impressive. Startup tech jobs are indeed leading Oregon out of the recession. Over a dozen active incubators are helping to mint dozens of viable Portland companies each year.

Can Portland companies now make the jump to scale? It’s going to be harder than sparking the initial startup ecosystem. Portland benefited from the fortunate confluence of several factors that provided a fertile environment for startups. Portland has been a desired destination for collage educated young people  for more than a decade. The recession set the stage for individuals and institutions to take risks on new ventures and local capital was willing to provide modest seed funding required to fuel fledgling ventures.

But the primordial stew to spark the creation of scale companies is a different matter. Starting with the talent; the smart young people migrating to Portland may be able to move up an incubator fueled learning curve to succeed in a Startup, but As Ben points out, expertise and experience required for scale is a much higher standard. It’s much harder to grow organically. And, unlike the SF Bay Area, Portland doesn’t have a pool of successful scale companies to draw upon.

To date Portland has shown little appetite to take the risk required to scale a company. Like my own venture, SweetSpot, many Portland companies are finding early exits rather than driving to scale. The list is long – GetListed, Geoloqi, RNA Networks, CroudCompass, SmallSociety, SecondPorch, StepChange, Instantiations, Giftango, Meridian, Preka, Rumblefish, Simple, Vizify. While these demonstrate great success in Portland’s ability to mint Startups, they also show our lack of ability to grow companies to scale.

A viable growth company can always find capital. But, as I’ve written about earlier, it’s more expensive in Portland than areas. Portland has a number of growth companies that have accessed expansion capital – Elemental, Urban Airship, Puppet Labs, Janrain, Act-On Software, Jama. We’ll see which are successful at jumping to scale.

Expertise, talent, appetite for risk, and access to capital are just the table stakes to execute at scale. They just get a company to the table of contents of Ben’s book. Then the hard things begin.

I think more than anything, Portland needs to find the desire to scale. My first experience with Portland’s Startup ecosystem is indicative of the old attitude that is still too prevalent. I left my last Bay Area job in ’07, ending a weekly commute to Palo Alto. In my last year, the company doubled revenue with a top line above $100 mil. In Portland I started working on a business plan for mobile application venture. When I pitched one of Portland’s most active Angel groups, a fund partner told me the plan had no credibility because I showed a revenue curve that went from zero to $100 mil in 5 years. I was told to be taken seriously, I should instead show a 5 year pro forma to $20 mil, for none of their investments had ever gotten anywhere close to $100 mil in 5 years.

I find it refreshing every time I talk with Luke Kanies at Puppet Labs. Puppet is in a multi-billion dollar market place and to Luke success is nothing short of leadership in that market. That’s a standard for scale. A few more Lukes and a perhaps an IPO could turn the tide for Portland.

Portland Startup Tax – Bad Investor Behavior

I want to wrap up the discussion about the Portland “startup tax” with a focus on Portland investors. My last post outlined mistakes Portland entrepreneurs often make. Now I want to focus on bad investor behavior.

Most investors I’ve met in Portland have a horror story about getting stuck in a company that ends up going nowhere. Or, being in a growing company but getting washed out on a later round.  This has lead to a number of investor behaviors that often prevent good companies from getting access to growth capital.

Early stage Silicon Valley investors have developed entrepreneurial friendly investing behaviors that coupled with lean startup methodologies have proved extremely successful. Many of Portland’s bad investment habits hobble Portland entrepreneurs and add to the Portland startup tax. Here are a few practices Portland investors need to adopt to lower the tax.

Quick Diligence

Too many Portland investors see virtue in time consuming comprehensive diligence. Traditional business diligence looses its relevance with nimble, agile and lean early stage startups. Scouring existing financials and forecasts has limited relevance in a lean startup that depends on speed and agility. Plus the distraction to the founding team is costly.

Investors should invest in areas in which they have knowledge and are comfortable. It’s most productive to limit early diligence to the market space and the team. Most oving quickly and helping founders focus on the business.

Fund Fast

Many Portland investors are drawn to contingent funding. Forcing entrepreneurs to find additional funds is too often viewed as a test that lowers risk. I’ve seen several instances when entrepreneurs tie themselves up for months trying to find additional investment dollars so they can take down contingent investments. Rather than test, this can kill a company by exhausting entrepreneurs and delaying execution. If a company needs more money that an investor can supply than the investors should do their share to syndicate the deal.

Set Reasonable Valuations and Caps

Portland investors often force low valuations because they can. But, this can be counter-productive. Too much early low valuation money crowds a cap table scaring off later stage capital. Later rounds that leave the founders with too little ownership increase the execution risk (by demotivating and distracting the founders), limiting the upside for everyone. In Portland, this often drives early sales of companies even when they have tremendous growth potential.

Forcing low caps on notes is the same as setting too low a valuation. The idea of a note is to avoid pricing a round before there’s enough business to value. Investors should either use a note as intended – a quick lightweight way to bridge a company forward (with discounts and interest as the incentive). Or, they should price a Series Seed round. The cap should merely protect an investor from not appropriately participating in extraordinary appreciation. A note with a low cap can either telegraph a low valuation for a subsequent round or scare off investors with a inappropriate differential in share price.

Keep Terms Simple

Funding terms only get worse in subsequent rounds. Early multiples of participation, ratchets, anti-dilution ratchets and other onerous terms rarely ever go away. And although they may seem to favor investors, they can encumber companies and compromise the ability to raise needed capital and restrict strategic options. Early investors are most successful when they align their interests with the entrepreneur’s.

Portland’s seed and angel investors need to better partner with entrepreneurs. Putting a company in a position to find the best future investors optimizes returns for everyone. All behavior that slows a company, or attempts to protect the early investor from the entrepreneur essentially increases the Portland startup tax and limits everyone’s upside.

The Portland Startup Tax – Bad Entrepreneur Behavior

Last week at Immix Law Group’s PowerUp Event on fund raising we discussed the Portland “startup tax” that local entrepreneurs pay when raising capital. My last post looked at the tax entrepreneurs pay due to lack of local capital. Now I want to look at bad entrepreneurial behavior that makes building well-funded scalable businesses harder. Too often Portlanders get in their own way.

Growth capital is looking for companies that can scale to a big exit. To attract capital, companies need to structure for investment and scale from the beginning. There are several best practices often missed by Portland Entrepreneurs:

Delaware C Corp

Half the early Portland startups I see who are looking for early funding are Oregon LLCs. Another third are S Corps. When raising money, optics is important. An LLC communicates that you’re not sure what you want to be when you grow up. An S Corp is even worse. Oregon needs to get past a well-deserved reputation for no-growth life style companies. An S Corp tells me the entrepreneur is running the company to maximize their personal tax benefits. A C Corp, in Delaware provides the optimal accommodation and protection for investors. It says from the beginning that you are in it to grow a big company and make money for all involved.

Get Lawyers and Accountants that work with Silicon Valley VCs

There are well established, hard won “rules” for high-growth startups; best practices that have evolved over decades. Some corporate lawyers are fluent in this game. Unlike many legal situations, they know optimizing their client’s position means staying within norms and providing balanced documents; not trying for client advantage in the short term. It means playing for a five to ten year growth curve. I’ve had multiple capital raises where we minimized cost by convincing the investors to go bare and just use company lawyers in drafting and executing documents. This was possible because they trusted the lawyers were operating within comfortable norms.

Entrepreneurs can easily get up to speed on the High Tech Growth game through blogs and sites that lay out best practices and model legal agreements. Portland has several Law firms facile with Silicon Valley Venture investing. If you want access to VC capital use one of these firms. In fact, they generally charge very little (if anything) to get a company set up and on this path because they understand the cost of early money and how large potential fees will be when a company finds scale successfully.

Structure your Cap Table by working backwards from your exit

An entrepreneur building a $100 million plus company should be able to layout what the company cap table looks like at $100 million: founders shares, a couple rounds of financing, employee options, a few shares for advisers, and warrants for banking and other partnerships. An entrepreneur that lets a Seed or Series A valuation be driven solely on a handful of beta customers and a MVP is not setting up for growth. Early validation and traction should be accompanied with a vision for a large addressable market and a credible plan for scale.

More than once I have found myself as an early investor in a Portland startup struggling to find capital because of a cap table messed up with low valuation early financings.

Vesting for all Founders shares

Founders and investors need protection against a founder or early employee leaving and taking too many shares. Four year vesting ensures everyone is in it for the long hall and if there isn’t a fit, the company can recover shares to adjust. Starting a four-year vesting day one protects the founders, communicates the right thing to investors and prevents a painful reset of the vesting clock later.

Intellectual Property discipline from day zero

Track every line of code from day one. Establish proprietary rights agreements with every contributor. Track open source licenses carefully. Getting IP assignments after the fact is always hard and expensive. Take it seriously and behave like your effort is valuable from the beginning. This makes it far easier for an investor (or acquirer) to take it seriously and value it later on.

Too often Portland entrepreneurs don’t do these out of ignorance or neglect. You already have to explain to potential investors why you’re in Portland and how they can make money here. Showing you understand drill can minimize a painful Portland startup tax.

The Portland Startup Tax – Lack of Local Capital

Last week I presented at Immix Law Group’s PowerUp Event on fund raising. It gave me the opportunity to discuss the Portland “startup tax” that local entrepreneurs pay when raising capital.

It’s no secret that raising capital in Portland is harder than in the Silicon Valley or even in Seattle. Portland has so little native investment capital. Check any credible source, like the NVCA Year Book, and you’ll see that Oregon has double digit millions under professional management. These numbers barely register on the same graph as Washington, which has single digit billions. You can’t even get Portland’s amounts to show up on a graph when compared to California’s nearly triple digit billions, even with a log scale; California has over 4 orders of magnitude more capital under management relative to Oregon.

This means Portland entrepreneurs have to raise money from elsewhere and pay a tax in the form of: time, valuation, and lower levels of support. Fund raising outside the area takes more effort than fund raising down the street. And because it’s harder to get investor attention, fewer investors result in lower valuations. This means Portland companies give away more company for less money.

Plus once they get VC money, Portland entrepreneurs receive less benefit than companies local to a venture group’s networks and support. CEOs outside Silicon Valley constantly bitch about VCs only investing in companies in easy driving distance. But this is a real practical consideration. Not only does it require less partner time, but support in the form of mentoring, introductions, and educational sessions are higher return with tight nit groups of local companies. Portland entrepreneurs get fewer opportunities for help at a higher cost than their Silicon Valley based sister companies in the same VC portfolios.

This part of the startup tax will never entirely go away. But it will get better as Portland’s many successes attract more capital at a lower cost, and Portland companies represent a higher density in VC portfolios.

I think the more interesting contributor to the startup tax is our own bad behavior. In my next blog posts I’ll discuss how we need to get out of our own way. Our own bad behavior, by both Portland entrepreneurs and investors, contribute significantly to the tax we pay.

The Overthrow of Successful Portland

Last Friday, 7 new companies launched onto the Portland tech scene. The latest class from PIE (the Portland Incubator Experiment) demoed their wears at the Gerding Theater in a Demo Day. Portland shares the Demo Day ritual with the Silicon Valley and other tech centers across the country, but Portland’s is a bit different. Like the others, Portland’s is the product of smart tech geeks, demonstrating the latest innovations in mobile, social, cloud computing and big data. But as Rene Gleason, Global Director of Interactive Strategy at Wieden+Kennedy, pointed out from the stage these companies are the product of Portland’s creative class. Portland’s tech scene is just one facet of a creative renaissance in Portland. And it’s a harbinger for some great things to come.

Portland’s tech ecosystem has emerged with a mix of creative agencies, sportswear and apparel producers, and specialty manufacturers. In a town filled with inventive restaurants, indie music, artisan foods, boutique beers and spirits and world-class wines. Galleries and studios dot our city’s core streets. Like other tech centers Portland is minting scores of tech startups every year. But Portland’s benefit from a unique cross-pollination. With PIE, an unapologetic “experiment”, they’re crossed with one of the worlds best creative agencies and its brand clients. With the TechStars Nike+ Accelerator, the cross was the world’s leading sports shoe and apparel brand. The Portland Seed Fund and the Portland Startup Challenge are public/private collaborations. These are just a few of the dozen plus accelerators uniquely leveraging Portland’s ecosystem.

Alan Webber, a former Portland city leader and founding editor of Fast Company, recently spoke at TechFestNW and issued the challenge to Portland in a the question “How do you overthrow a successful city?”

Portland is undeniably successful, and we’ve made great strides in the last several years. But if you look at this young creative class and their startups as just the beginning of the “overthrow” the new emerging Portland could be pretty remarkable.