Start-ups in search of capital are finding a new kind of investor -- adventure capitalists: successful ex-entrepreneurs who contribute themselves as well as their money.
Start-ups in search of capital are finding a new kind of investor -- adventure capitalists: successful ex-entrepreneurs who contribute themselves as well as their money.
Like every aspiring merchant, David H. Chung had an idea. Not only did he think his telecommunications box was very clever and worth presenting to the world, but, since it stood to save big companies large amounts of money in data transmissions he was confident it could be very profitable as well. The only problem, as usual was that he needed money to develop it. So Chung cast about in the plentiful pools of capital that had been gathering in California's Silicon Valley over the past several years, but he had little luck. For one thing, the venture community didn't warm to him: He hadn't even bothered to draft a business plan. And Chung didn't take to them, either: They wanted too large a share of the business.
Even 450 miles from the border, that is what is called a Mexican standoff, and it might have gone unresolved were it not for the arrival of Charles Ying, erstwhile part-owner of Atex Inc., a text-processing computer systems business whose sale a few years back had left him with a good deal of cash to spend.
Ying, 37, was retired. But he was no ordinary retiree. Instead of lying on the beach or hanging out at the country club, he spent most of his time trekking about the country in search of investment opportunities. An engineer with a degree from Massachusetts Institute of Technology, he was looking for people with ideas that he felt could someday develop into technologically sound and sellable products. When he found one, he intended to play an active role in giving shape to the operation and bringing the product to market.
Chung was just the sort of person Ying was interested in, and he listened closely as the young semiconductor engineer explained his concept for an artificial-intelligence machine that squeezed redundancy out of data transmissions. As a result, said Chung, computers would be able to talk to one another over cables more than twice as fast as was currently possible. Such a device would be worth millions to any large company that rented expensive phone lines to handle data flow -- provided Chung could come up with the product. "I need money to develop the thing," Chung told Ying, "only I don't want to give up half the company to raise it."
Ying couldn't fathom the tortuous learning algorithms Chung was demonstrating; it just didn't seem likely that the program could really do all that he said it could. But this is often the case with technological breakthroughs, and such was the nature of Ying's quest: to discover a person with an idea that would bewilder ordinary venture capitalists. Ying decided it was worth the gamble. He told Chung he could have enough capital to construct a working model. Then, if Chung produced it by an agreed-on date, "I'll give you money to do some manufacturing with and get into business."
As it happened, Ying had used just such a pay-as-you-go financing technique to keep Atex afloat in its lean years, a decade earlier. He, too, had tried to peddle a complex notion without the benefit of a proto-type or the rudiments of a business projection -- and he, too, had had doors slammed in his face. Chung had an additional problem, moreover. He possessed "a personality that would not attract venture capital," says Ying. "If there was a venture capital checklist of reasons to reject a deal, David would be checked off on every entry."
To Ying, none of that mattered. He didn't even ask for the standard reassurances that usually go with obtaining seed-level capital. It was a bold, swashbuckling, risk-taking plunge into an amorphous business situation and an undefined market -- a gamble for which "venture" is too tame a term.
"Adventure" is more like it. And Ying is not its lone practitioner. Indeed, quite a few well-heeled retirees have been taking up the sport lately. "Every successful engineer I've talked to -- I mean those who intellectually know they don't have to work -- is putting his money at risk to make a living," says Ying, who already holds cards in half-a-dozen hot high-tech hands and flies around the country scouting out investments. By "putting money at risk," Ying doesn't mean the Nolan Bushnell approach of bringing small businesses to a climate-controlled greenhouse where they can be watched over like fragile seedlings; rather, he and his fellow adventurers actually get out among the rocks and clear the fields. Why? "Probably because that's the only thing we know how to do."
These are not, however, members of some dismissable, rag-tag band. Indeed, they include retirees, resignees, and executives still at work in some of the country's most successful high-tech enterprises. Many have already endured the same slow-moving, mistake-ridden ordeal that rough-hewn entrepreneurs like Chung expect to undergo -- but may be spared, thanks to this high-rolling crew. With the confidence born of hard-knocks experience, "working" financiers like Ying are beginning to beat laid-back venture capitalists and investment bankers at their own game. They are able to deliver the goods precisely at the critical point where the old school is stretched thin; that is, they can supply both business and technological acumen in a hurry.
Once, of course, venture capitalists did supply that expertise, and new businesses welcomed it, but lately some entrepreneurs have grown cautious. "Venture capitalists sometimes are meddlers," says Federico Faggin, a physicist who left Intel Corp. 10 years ago to start up Zilog Inc. with some $500,000 in venture money, then sold it to Exxon Corp., and in 1982, founded Cygnet Technologies Inc. "If you have trouble, you should be allowed to get yourself out of trouble. But some venture capitalists want to 'help.' They get irrational and want to run the show." With dozens of companies in their portfolios, moreover, venture capital firms simply cannot know the particulars of each company very well. Their concern is natural enough, given the sums at stake, but it is often so misdirected, says Faggin, that "many companies go out of business merely because venture capitalists can't keep their hands off them." Moreover, the venture capital firms can afford to lose a few: Traditional venture capital has always assumed that enough investments will pay off to balance the inevitable failures.
Not so with adventurists: They expect to make every project a success, and not by vast infusions of capital, either. Many a start-up has taken in unneeded capital simply to get a big-name venture capitalist on its board, ostensibly tapping him for guidance, influence, and prestige. Ying operates the other way around, parceling out funds only when they are called for. The result is that businesses like David Chung's Chung Telecommunications Inc. (CTI) can be coaxed from soil that conventional capital would consider untillable.
And -- with Ying's support -- Chung did, in fact, produce a convincing prototype of his sophisticated machine. At that point, he was in the enviable position of possessing a product many people needed but no one could duplicate. Ying advised Chung to take the model to large businesses with communications networks; then, once they started salivating, he should get them to pay in advance for the product. If that didn't do the trick, Ying confidently pledged, "I'll write your business plan."
In effect, Ying already had such a business plan, the same one he had followed 10 years earlier, when he, his brother Richard, and a third partner, Douglas Drane, founded Atex. Like CTI, Atex had been avoided by venture capital. Yet in 1981, Atex Corp. was shipping $53 million worth of editing systems. That October, the founders sold it to Eastman Kodak Co. for some $75 million in stock -- and, more remarkably, retained 80% of the company.
"We had heard the stories about how there were long directories of willing venture capitalists, but suddenly they weren't there," Ying recalls. "It was the winter of 1973-74, and we were told that, in the last 12 months, there had been only two private deals -- and they were both second round. We didn't know what we were doing, which is probably why no venture capitalist ever called, but we had good ideas. Richard and I were experienced in minicomputers, and Doug had been selling systems. We told them, 'We have the technical and the marketing [know-how], so what more do you want?' They were probably just being polite by telling us it was hard times. I know why -- now. I'm in that same position today, but once we, too, were just a couple of engineers and a salesman getting together without a product." These days, Ying admits, even he sometimes has to rein in aspiring founders shorter than they would like. "Look," he tells them, "you have no track record."
That was something they couldn't learn in school, as Ying himself knew from his own salad days. He had come to the United States from Hong Kong, having applied blindly to MIT, a college he had found listed in a catalog and applied to because it waived the application fee for foreigners. "MIT tried not to teach you about the real world. My kids would tease me, 'You went to MIT, and you don't know how to fix a TV?' And the last thing [MIT taught] was anything to do with practical business. They didn't tell us that [you need more than] a good product to be successful in business." Nevertheless, Ying made up for that academic oversight and went on to become one of MIT's more respectable graduates: Using only the interest on the interest on the interest of the Atex cash-out, he can afford to send his TV out for repairs. As ill-prepared as they were, the three Atex partners tried mightily to get outside financing, but -- in the end -- they had to make do with capitalization of a mere $2,500, curried from the founders' savings. Leading a hand-to-mouth existence, they figured out from day to day how to run a business on thin air. "We were too busy to ask for any advice," Ying remembers. Nevertheless, they quickly had to learn a new vocabulary, the pivotal word of which was "cash." "What we relied on was a bank line. We always had a line of credit at the bank. That's just sound management." Because Atex "never operated with much of a cash balance," Ying was forced to plan for the worst. "What happens if sales suddenly drop? What happens if our software development is behind schedule and our customers stop paying us? How much of a cash cushion do we need?" As Atex grew, its cash needs got bigger. Ying aimed at having a month's worth of cash available just in case none came in. "The last thing you want to do is run out of cash," Ying instructs his current charges, "because that's when you lose the company. Ask Adam Osborne."
In building Atex's cash reserves, Ying had used the same tactic he later urged on David Chung: He got it from would-be customers. His own product had been a multiterminal text-editing system for editors and writers that, Ying promised, could instantaneously set pages in type. His first customer was U.S. News & World Report. The magazine was about to phase out of an old-fashioned typesetting operation, so Atex seemed to have come along just in time. Well, almost: The trouble was that, like CTI, Atex had nothing concrete to show. To help speed its arrival, U.S. News sent a check a couple of days before Thanksgiving, 1973. But there was a catch. In order to get further payment, Atex was obliged to demonstrate a working prototype by the first week in January.
"It's so impossible to do," industry observer John Seybold consoled Ying at the time "that if you pull it off, the rest of the financing will be a snap." On New Year's Day, Ying announced to his partners, "It's working!" Not even Archimedes uttered "Eureka!" more passionately.
Indeed, that type of seat-of-the-pants adventure might be called Ying's Principle. Following it, Chung got customers to finance his company's early growth. CTI's first products are now on the market, and the pleased founder has given up only a fraction of his company. "He built the box," says Ying, "and it's selling. I think he's going to make a significant impact on the whole field of telecommunications." And to this day, Ying hasn't had to help him write the promised business plan that his new associate, David Chung, had disdained.
If Chung Telecommunications does make it, its success will be a tribute not only to Chung and Ying, but to Richard Black as well. Black is the former chairman and chief executive officer of AM International Inc. More to the point, he is part of "the Network," as Ying refers to the word-of-mouth buddy system of investors who occasionally take adventure-capital fliers and who help each other out when a flight is struggling to gain altitude. Ying considers Black a kindred spirit: "He doesn't country starting companies. He's basically doing the same thing as I am."
At the time Ying discovered CTI, Black was already involved in six start-ups. Ying offered to share his discovery in exchange for Black's special expertise. Using his contacts with banks and other large companies that could most benefit from Chung's technology, Black helped to formulate CTI's marketing strategy. "The Network is alive and well," Ying happily concludes.
Indeed, it is alive and well. Black himself is now on the board of another Ying-assisted company, Verticom Inc. Ying and his brother, meanwhile, have also started an investment company that has been licensed by the Small Business Administration as a minority enterprise small business investment corporation in Seattle.
So it goes. And if these capitalist-retirees hit the jackpot with the businesses they are now seeding, those companies will spin off yet more capitalist-retirees. Although barely begun, this spirited breeder reaction eventually could have enormous significance, not only for capital investment, but for the economy as a whole.
All the more so, since there are indications that the adventuring spirit is spilling over into low-tech and no-tech arenas. Consider Michael Berolzheimer, who cashed in some chips and set up a program for raising consumer-oriented businesses. In this case, the chips were not silicon; they were wood chips that Berolzheimer salvaged from saw mills and packaged into fireplace logs. The company he founded, Duraflame Inc., was started with about $35,000 of his own money, and was acquired by a subsidiary of The Clorox Co. in 1978 for more than $9 million.
Berolzheimer found that the traditional venture capitalists "had no personal experience with market-driven operations, so we decided to do it ourselves." He and an associate gathered a $12.75-million capital pool called The Early Stages Co., digging out businesses that ordinary venture capital ignored, among them a shampoo maker in Boston and a packager of snack foods in San Francisco. Like Ying, Berolzheimer rolls up his sleeves alongside each entrepreneur. "I love to work with these guys and help them avoid the mistakes I made." He is already committed to half a dozen start-ups.
Robert McCray also struck out in a non-technology direction after cashing out of the valve and control devices manufacturing business he founded. With his new fortune, he decided to invest broadly, rather than launch a second company of his own, as is a current Valley vogue. "But I want to be part of the management of the companies," he insists, "not just a silent partner." In five years, he has fired up five companies. He got involved in one venture when his neighbor joined him on an evening stroll and announced, "I want to start my own business, and I understand you're the person to talk to." McCray put in $30,000. Today the company -- a photocopier distributor called Offtech Inc. -- employs more than 60 people. Departing again from venture tradition, McCray granted the founder a call on his stock, which was exercised.
By standing shoulder-to-shoulder with founders, as it were -- rather than communicating sporadically from a distance -- the adventure capitalists hope to spare greenhorn businesspeople-engineers even the slightest false start. For the most part, they are engineers themselves, and they appreciate and tolerate, for better or worse, an engineer's singular sensibilities.
"Everybody makes mistakes," says Ying. "You don't run a business without making mistakes. But engineers have a disadvantage, because they tend to be too logical. To them, everything has to have a reason, but a lot of times in business, there is no reason -- half is luck, half is common sense. There are definitely instincts you need to succeed in business that are different from those you need to succeed in engineering. But I've found that anybody can adapt to them." Harking back to his own pre-Atex roots, Ying genuinely feels that "these people that I come across deserve a break. It's good for everybody. Nobody loses. First, the entrepreneurs win; then if they succeed, I win -- and the U.S. is maybe a little bit closer to Japan. That's why I'm doing what I'm doing, instead of sitting on a beach in Maui."
The same empathy can be an invaluable asset in dealing with delicate situations that involve investing in people and ideas. Ying and some associates recently made such a "person" investment in a 27-year-old engineer named Steven Kirsch.
After earning his master's degree from MIT a few years ago, Kirsch decided to go west. So he hopped a plane, crossed the continent, and, landing in the Valley, set out to fulfill his self-appointed mission: not to build a better mousetrap, but a better "mouse." The mouse in question, invented by Kirsch at age 24, is a palm-size LED-equipped device that when moved around on a pad, "reads" a grid and correspondingly directs a microcomputer's cursor on the video display.
Kirsch's mouse was a very sharp animal, but Kirsch himself was an unfocused sort who could test the patience of an investment banker faster than four straight losing quarters. When it came time to raise working capital, Kirsch had only the barest bones of a business plan to pass around. If he had management skills, they weren't evident in the rudimentary mouse-making operation he was running out of his apartment. Nor did he understand the protocol of the search for capital: When a well-meaning friend advised him to trade in his '72 Buick for something a little more presentable, Kirsch asked if that meant a '73. To sponsor Kirsch under such dubious conditions required a vision that could see well beyond the inchoate picture he presented to the ordinary world. His promise was not as a tactical businessman, but as a brilliant inventor, whose social clumsiness could be overlooked and whose ideas could be harnessed. Were there not investors around willing to take such uninsured risks, Kirsch's clever seeing-eye mouse might have died aborning.
But, fortunately, there were such investors around, and Kirsch's Mouse Systems Corp. did get an early round of working capital -- from an elite pack of 20 or so highly liquid Silicon Valley entrepreneurs who call themselves Summerhill Partners. The group has counterparts in other regions, notably New England, where some 65 executives from high-tech companies have pooled their pocket money into a venture fund managed by Eastech Management Co. Summerhill, however, is not so much a fund as a loosely organized "club" whose members meet monthly to review possibilities. The group was organized by Thomas Whitney, a former electronics engineer who cashed in an Apple Computer Inc. vice-presidency to devote full time to venture capital activities.
Ying is one of Summerhill's most active members and ardent advocates. "Everybody [in Summerhill] is 'busily' retired," says Ying, who has observed such capital klatches from coast to coast. "I haven't seen anything like it before." Besides Ying, the group includes such Valley denizens as ex-Apple Computer vice-president John Couch; Manny Fernandez, founder of Gavilan Computer Corp.; and L. William Krause, president of 3Com Corp.
This roster is all the more impressive in view of founder Whitney's concern that "when we do find the situation, we try to have one or two of the partners take a very active role in the company." Any proposal that comes before the club is closely examined by partners proficient in the field; if it passes muster, it may then be recommended to the rest. Assuming the rest are receptive, the club performs its own due-diligence search and takes an equity position.
In making investments, Summerhill members also provide a "service" to stockholders of private companies, who, under Securities and Exchange Commission rules, often find themselves locked into positions, unable to sell their stock. The club will often absorb the block for an agreed-on amount. One of 3Com's founders, for example, was able to sell private stock in this manner last year, well before the company registered for a public offering. Of course, Summerhill doesn't provide this service out of pure magnanimity: Its coffers stand to swell substantially when the companies go public.
It was through Summerhill that Ying first met Kirsch. Like most Summerhill candidates, Kirsch had found the group by word of mouth, having been steered to a monthly meeting by the founder of a high-tech company with whom he had interviewed for a job. Before appearing, "Kirsch had bounced around the Valley a bit trying to raise money," remembers Whitney, with a little bit of nerve and possibly some design talents, but who had a long way to go to make a company."
The Summerhill adventurers, of course, did not read him that way. He made his Mouse presentation and, says Ying, "he was bright, bright, bright! The director of corporate engineering for Hewlett-Packard was there and listened to him. He said, 'This guy could be another Steve Jobs; he has the raw talent. This may not be the right product, but let's bet on the guy.' "
And bet they did. All told, Summerhill came up with $300,000 for Kirsch -- $50,000 from the partnership itself, and $250,000 from individuals, who are allowed to participate on their own behalf as well. Having invested the money, the group then weighed in with expertise.
"We felt that as good as Steve Kirsch was as an engineer and idea generator and inventor," says Whitney, "he did not have the talent to grow a company into the size that we had in mind. . . . He needed someone to learn from." Summerhill placed three of its members on the Mouse board, which -- Ying recalls to his dismay -- had previously "consisted of nobody." As part of the package, Kirsch agreed to let an executive officer take over. Summerhill recruited a general manager of Zilog, who was soon at work hiring a management team. At the same time, the Summerhill members of Kirsch's board helped him negotiate a mouse deal with nearby VisiCorp. Not surprisingly, Mouse Systems showed a profit in its first year of operations.
"We found a diamond in the rough," Ying reflects. That diamond was very rough indeed: Not only did Kirsch lack a board of directors and formal business plan, "he had no financial projections, he had no idea how many units he was going to ship the next month, and he barely knew his costs. Yet he was already busily working on a next-generation product. Those were the symptoms that would scare a venture guy to the moon.
For Ying and his buddies, however, it was just another adventure.