The VC in My Dorm Room
Students have gone beyond starting their own companies. Now they're funding one another's ventures
Matthew Fogarty is getting pitched, which happens a lot, since part of his job is finding deals for an early-stage-investment firm. This meeting is like a lot of the pitches he hears. The company, Brightroom Inc., is an Internet start-up -- one that allows participants in marathons and other events to buy photographs of themselves online. The CEO and cofounder, Burch LaPrade, clicks through the mandatory PowerPoint presentation.
In a brisk British accent, Fogarty fires questions at LaPrade. He's interested in one partner that Brightroom has already signed up, a company that organizes road races and other events. That's a one-year contract? For all their events? Exclusive? Did you pay much for it? The answers: Yes, yes, yes, and no.
"Ha!" Fogarty exclaims with satisfaction, settling back in his seat. One thing he likes about Brightroom is that exclusivity. No competitor can sell pictures of the same event, which makes the product resistant to the Internet bogeyman of competitive price-cutting. "The market for online photos is different from the market for books," says Fogarty. "It's big and it's kind of safe."
But Fogarty is bugged by the thought that selling photographs on the Web is a business without many obvious barriers to entry. Brightroom's unique proprietary technology seems minimal. What prevents competitors from signing their own exclusive deals with other race promoters? In the end, Fogarty thinks Brightroom might be a tough sell. This just isn't ITU's kind of deal.
ITU is the company that Fogarty works for: Information Technology University. The wonky name gives only a general clue about what ITU is all about. It's not a university; it's not even affiliated with a university. Universities are where the nine-month-old ITU goes to look for deals. It searches for businesses being started by graduate students or professors or both and vets them for possible investment. Fogarty has discovered that universities are rich spawning grounds for fresh entrepreneurial talent.
Something like ITU was bound to happen sooner or later. What better place to look for promising start-ups these days, when universities are incubating more and more success stories, building on the foundation formed by companies like Dell Computer Corp., Yahoo Inc., and Akamai Technologies Inc.? According to the Association of University Technology Managers, a nonprofit group based in Chicago, in 1998 alone 364 companies were started around technology developed in universities. On campuses -- particularly campuses with progressive entrepreneurship programs -- canny investors find concentrations of professors and graduate students working together to develop high-potential start-ups. Universities are hotbeds of ideas for ways to turn the bleeding edge of technology into something marketable. Undergraduates who grew up eating, sleeping, and breathing the Internet are encouraged to concoct new ways to exploit its riches, and professors hand over their Rolodexes to help business-school students who can't wait to start and run their own companies. In the race to find -- and fund -- the Next Big Thing, universities are the new frontier of opportunity.
ITU isn't the only group to have that brainstorm. In the past 12 months a host of new investment organizations have sprung up that specialize in campus start-ups. In many cases students have launched them. There is Silicon Ivy Ventures, a venture-capital firm created by a trio of student entrepreneurs, including a cofounder of Raging Bull Inc.; UniversityAngels.com, an online angel network that hooks up alumni investors with student or graduate start-ups; StartEmUp LLC, a venture firm founded by four Duke University students; Lux Capital Group, a technology-focused venture company launched by a group of young Wall Street investment bankers, analysts, and entrepreneurs; and SpringBee LLC, a kind of matchmaking service, hatched by a Brown University undergrad, that promises to connect techies with great ideas to entrepreneurs who can build companies around those ideas.
"We kept seeing a lot of student businesses that had really interesting ideas, with teams that had the right skill sets, if not the experience, and most were not getting the time of day from VCs," says Joshua Newman of Silicon Ivy Ventures, who ran a Web-development company while he was an undergrad at Yale. It wasn't until those student companies had scraped together some funding and launched that venture capitalists "were knocking down their doors," he adds.
That was the same motivation that ITU's three twentysomething founders -- CEO Jonah Schnel and cochairmen Adam Winnick and Chad Brownstein -- had when they started it, last January. After meeting promising would-be entrepreneurs who were in business school, each of the three realized that there was an untapped market there. Most old-line venture-capital funds were too fat to bother making small, early-stage investments.
At the time Winnick and Brownstein were in the middle of opening a venture-capital fund for Pacific Capital Group, the merchant bank headed by Winnick's father. Schnel had been Brownstein's classmate at Tulane University, where they'd often talked about starting a business together, Schnel says. So, with a $6.6-million cash infusion, Los Angeles-based ITU became one of the fund's first investments.
To track down the hottest start-ups on campus, ITU hires people like Fogarty, who joined up in May. In his first two months he read some 200 business plans and heard about 30 pitches. (A really good business plan is "a joy to read," he says.) In addition to scouting, he advises some of ITU's investment start-ups on recruiting, strategy, and networking -- anything that might help them get to the next round of funding. He spends a lot of time on his cell phone and tools around in a lime green Karmann Ghia convertible. It's what such VCs do.
Yet he's still a student. Fogarty just finished his first year at the Haas School of Business at the University of California, Berkeley. He listens to a lot of pitches in cafés because he doesn't have a real office of his own. His cell phone serves as his office. He'll keep doing this VC stuff at least until he graduates, next year. In fact, all seven of ITU's campus partners, as they're called, are business-school students.
"Nobody else who works while they're in school gets to do as much as we do," says Bradley Harrison, an ITU campus partner at MIT Sloan School of Management. "We do everything. We take the board seats. We do due diligence. The only step we don't do is the final OK." That's left for ITU's investment committee, which consists of the three founders and two board members. "We're doing deals, and everyone on campus knows it," Harrison adds.
That student-centric approach has some disadvantages, including an occasional bit of academic diplomacy sacrificed to enthusiasm. Haas entrepreneurship professor John Freeman was surprised and "slightly miffed" that ITU didn't contact the business school before it started doing deals there. (An ITU spokesman insists that the company always contacts the schools' career centers and that it did so at Haas.) "Most universities don't want commercial enterprises doing business on campus without some kind of vetting," Freeman says. "They might be crooks, after all." (He does allow that he saw nothing unsavory in the one ITU term sheet that he has read.)
And to some of ITU's competitors, who rely on a network of seasoned VCs and experts to evaluate business plans, using students as analysts seems bizarre. "We are not so comfortable with the idea of coming up with some random schmoes to unleash on campuses," says Silicon Ivy Ventures' Newman.
But to ITU's Schnel, it's a no-brainer. "You have to be in the trenches to know what's going on," he says. "To really listen to the university market, you have to be there. We want to have the best market reconnaissance on campus of any venture-capital firm in the country."
By the time he got ITU under way, in January, Schnel had a pretty good idea what kind of start-up it would invest in. Leave the mushy e-commerce plays to other VCs -- ITU would focus on hardcore technology, innovative software, and engineering that it hoped would be just a little ahead of where the world was. ITU was designed to fund only early-stage start-ups, making investments of $200,000 to $500,000 and receiving equity stakes of up to 25%. For starters it concentrated on a few top schools -- Berkeley, Stanford, MIT, Harvard, and Columbia -- with the goal of investing about $1 million on each campus.
Recruiting campus partners turned out to be easy. Schnel simply contacted each business school, and the résumés started flowing in. The company pays a stipend roughly equal to the amount a business student would earn in a summer internship -- but more is paid out in the form of equity in the start-ups in which ITU invests, Schnel says. That lure helped bring in students with strong prior experience and an entrepreneurial bent: MIT's Will Chu, for instance, had cofounded an Internet financial-services company, and Harrison had helped start an incubator and been a consultant to a couple of start-ups; Berkeley's Kai Xu was a former Hewlett-Packard software engineer, and Fogarty had worked at Unilever on supply-chain reengineering.
Originally, Schnel planned to have just one campus partner at each school. But by April, his first hires were swamped with business plans that stuffed their e-mail in-boxes. He started hiring faster.
"Our friends were coming to us for advice or contacts before. Now they know we have money," says Harrison. By midsummer, thanks to its fledgling campus network, ITU had invested a total of $1.6 million in four start-ups: three at Berkeley and one at MIT.
The most advanced of the four is SkyFlow Inc., which was closing in on its next round of funding just two months after ITU cut it a check. Chief technical officer Anthony Joseph, a computer-science professor at Berkeley, started the company in August 1999 with CEO Nibha Aggarwal, who'd gotten his M.B.A. from Haas in 1997. Joseph had developed software for wireless applications that could enable consumers to access the Internet on their cell phones.
Berkeley campus partner Xu met Aggarwal in April at a mixer for entrants in the annual Berkeley business-plan competition. When SkyFlow won first prize, just four weeks later, ITU was ready with a term sheet for a $500,000 investment. "All the VCs knew about them, so we had to close the deal ASAP," says Fogarty.
That was fine with SkyFlow, which had to move fast before its market opportunity slipped away. "ITU moved very quickly and very aggressively," says Aggarwal. "The typical VC moves very slowly."
ITU offers some typical incubator-type support to the companies in its portfolio -- accounting, business-development, finance, human-resources, public-relations, and legal assistance -- but all those services are based in ITU's Los Angeles headquarters. Fogarty, as SkyFlow's main point of contact with ITU, helps the start-up communicate with L.A. and visits the SkyFlow offices once or twice a week. He has participated in high-level strategizing with SkyFlow's management, helping figure out which market to chase and what kind of competition is likely. And he lugged boxes with the rest when SkyFlow moved out of Berkeley Business Incubator's basement to spacious new offices.
The same basement, a warren of drab cubicles under Berkeley's Bancroft Hotel, still houses ITU's most recent investment, Opient Inc. Fogarty first got to know Opient's cofounders, Khai Leong, Nobuyuki Tanaka, and Nathan Keker, in his entrepreneurship class last fall. They wrote a business plan "for some optical bit that's going to change the world," Fogarty says. His opinion then: bullshit. But now, he says, "it turns out that Opient does have an optical bit that's going to change the world." Tanaka, a Haas student and an engineer with 10 years of experience at Japanese fiber-optics companies, is developing a more efficient process for integrating components within fiber-optic networks. It's a good product to be selling in a world that's hungry for fast, cheap connections.
So in May, just before exams, Fogarty found himself working out a term sheet with his Opient classmates, all of them probably using negotiating tactics that they had just learned in Professional Skills class. "It was fun because it was like a textbook negotiation," he says.
It was no simple classroom exercise, though. ITU ended up investing $400,000 in Opient. Considering Opient's long-term needs, which include leasing a research lab, that's chicken feed. This fall Opient will try to raise a lot more money. (The amount was reported to be up to $35 million, but Keker says that's false, adding that Opient will not disclose the actual amount.) But ITU's money and infrastructure support will enable Opient to get up and running. This past summer the start-up's team put together an advisory board and began developing relationships with future suppliers and customers. It still needs to hire an additional engineer. Opient is looking to ITU's human-resources and business-development people in L.A. for help.
Although Fogarty is taking a board seat, his role at Opient will otherwise be limited, he admits. "My skill set overlaps quite a bit with Opient's," he explains. What he can do, based on his experience as a project manager at Unilever, is help the Opient team put together a plan of action they can stick to.
Fogarty is also spending time with another start-up: OnWafer Technologies Inc. He meets twice a week with OnWafer cofounders Costas Spanos and Kameshwar Poolla, members of Berkeley's engineering faculty. OnWafer has developed a new method for measuring temperature in the supersensitive semiconductor-manufacturing process. It claims the technology could increase chip production by 5% and save semiconductor makers billions. ITU has invested $350,000 in the business.
On a Tuesday in July, Fogarty huddles with the founders in Spanos's neat, book-lined office in a Berkeley engineering building. He's coaching them for a pitch to a new VC for their next round of funding. As Poolla clicks through PowerPoint slides, Fogarty gently pushes him to make the presentation less technical, more explicit -- basic but necessary tips in today's fund-raising game. "You're assuming that the people you're talking to know a lot," Fogarty says. "I think it's important to say that you expect revenues of X million. People have no idea about the size of the market."
Hiring is the other big item on the agenda. Spanos has been searching for more engineering talent, with mixed results. He called two leads that Fogarty had given him, but neither bit. "I felt like I was trying to sell encyclopedias to someone," he says. However, he's ready to make an offer to another engineer. He and Fogarty quickly run through the compensation details. Spanos is doubtful that the candidate will want equity at this stage. Fogarty disagrees. "That's probably why he wants to work at a start-up," he points out, so Spanos decides to limit their offer to 2% equity, max. Fogarty says he'll forward a job description to the other campus partners to see if they know of any good candidates. Can't hurt, Spanos says.
Meanwhile, on the East Coast, Fogarty's counterparts Chu and Harrison are keeping an eye on Isovia, the creation of a team of MIT alumni and graduate students. It's another wireless play, one in which ITU has invested $375,000. Isovia's technology allows massive enterprise software systems to interact with wireless devices. This summer Chu and Harrison have worked their networks to come up with five business-side hires for Isovia, most of them from Sloan or Harvard Business School, with a few more in the pipeline. Now ITU's business-development team is prepping Isovia for a next-round-funding road show.
Such road shows are the real test for ITU, and in that way, the company is emblematic of the new type of venture funds: there's a lot to prove. Will other investors validate the start-ups into which ITU has sunk time and money? And beyond the initial financing rounds, what's the long-term outlook for its portfolio companies? A recent unpublished study from the University of Pennsylvania's Center for Technology Transfer provides a sobering indicator. Managing director Louis Berneman examined the post-initial-public-offering stock performance of 35 companies started around technology licensed from universities. He discovered that as of March 1999, 31 had done worse than the Standard & Poors index. (Berneman's advice to universities that take equity in start-ups: sell as soon as you can after the IPO.)
Consider this, too: MIT, that hallowed hotbed of high-tech start-ups, doesn't necessarily encourage students to launch businesses while in school, says Kenneth Morse, managing director of the MIT Entrepreneurship Center. "You'll fly higher if you know what you're doing, and you won't know what you're doing until you've been out in the market," Morse says. "If someone absolutely must engage in premature incorporation, we strongly advise getting some adult supervision as soon as possible."
On the other hand, there's no shortage of entrepreneurs or wanna-bes on campus these days, and some of them are starting real companies. Business-school professors are embracing the practical side of entrepreneurship by investing in student businesses once the students graduate and by serving on boards. (See " The Profit-Minded Professor," Inc., State of Small Business 2000.) After all these years of coaching players, entrepreneurship professors across the country are itching to get into the game -- if they're not in it already. So why shouldn't ITU play, too?
"I couldn't believe no one else was doing this kind of thing," says Will Chu of his reaction when he first heard about ITU, last spring. "It made all the sense in the world. How could I not want to be part of it?"
Emily Barker is a senior staff writer at Inc.
Related resource: The Young Entrepreneur's Survival Kit
One reason why entrepreneurship programs are so powerful is that they attract big money. When an entrepreneur wants to "give back" these days, it's often university entrepreneurship programs that benefit. Consider these recent contributions:
Amount: $60 million to the University of Virginia
Donor: Frank Batten Sr., retired chairman of Landmark Communications Inc.
Purpose: Establishing an entrepreneurial resource center in Reston, Va., and creating a venture fund
Amount: $50 million to the University of St. Thomas (Minneapolis- St. Paul)
Donor: Richard Schulze, founder and CEO of Best Buy Co.
Purpose: Expanding entrepreneurial programs and opening a law school
Amount: $25 million to MIT Sloan School of Management
Donor: William Porter, chairman emeritus of E*Trade Group Inc.
Purpose: A new building to house Sloan entrepreneurship programs
Farming Out Their Expertise
When entrepreneurial thinkers develop academic programs, they are sure to exploit every resource. Consider Ball State University and its colleagues in the National Consortium of Entrepreneurial Centers, which offer the services of their students. The fee each charges to have one of its business-school students review a business plan for Beacon Global Venture Capital?
Everyone's an Entrepreneur
These days, it's not just M.B.A. students who are packing entrepreneurship courses. Schools such as Alfred University, University of St. Thomas, and Miami University of Ohio are upgrading their programs, thanks to an influx of cash from alumni who are entrepreneurs. The schools are making deliberate efforts to offer entrepreneurship courses to students who ordinarily would never think of taking a business class. It's gone so far that there are even classes in entrepreneurship for poets.
Three years ago St. Thomas began integrating its entrepreneurship classes with the rest of its undergraduate curriculum, says professor Nancy Carter. The goal is to teach an entrepreneurial way of thinking, no matter what the discipline, she says. A nursing student, say, might want to start a business somewhere down the road. This way, he or she will already have the necessary basic knowledge.
So when Trevor Lambert, a double major in theology and philosophy, decided that God didn't intend for him to be a priest after all, he wound up taking an introductory entrepreneurship course. What he learned -- not just basic skills but a new attitude toward taking the leap into starting up -- helped him launch a fledgling log-home-construction business.
At Alfred University, assistant professor David Pistrui recently introduced a course on entrepreneurship and the arts, with the aim of developing a concentration in the subject. Student Tom Czechowski wrote a business plan for his rock band after taking the course. "We're actually making some money," he says. "We started merchandising products -- T-shirts, stickers, postcards. We've got a mailing list, so we can send out newsletters."
For Alfred's art students, says Pistrui, "business is kind of a dirty word, but entrepreneurship is a happy medium because it's kind of an art and a science."
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