VC Business

Dec 14, 2017

In Spite of the glamor associated with it, VC business is a tough business. Most VCs don’t even in provide market returns to their investors, let alone outsized returns! VC investments are risky investments and a majority of them fizzle out where the total invested capital is lost. The remaining companies have to provide big returns to overcome those losses and provide good returns overall. Dirty little secret of the VC business is that almost 80% of the funds don’t even return the invested capital let alone any ROI.

Most of the funds are organized as partnerships where the Limited Partners (LPs) provide the capital and General Partners (GPs) manage the money. A typical partnership provides for 80-20 split of the profits, where the LPs who provide all the capital get 80% of the profits and GPs pocket 20%. Further 2% is allowed every year as the fund expense. Funds have a 10 year life. For a VC fund to provide 5X return, which is less than 18% per year, on a $100 million dollar fund, it will have to produce total value of $600 million, of which $500 million would be returned to the LPs (hence 5X) and $100 million will be retained by GPs as their share of the profits. For this to happen, every investment will have to produce 6X return. If half the investments fail, then the remaining half will have to produce 12X returns. VCs typically invest only 80% of the capital as they spend about 20% on expenses over 10 years. That says winners will have to produce 15X on winners. Math gets worse if more than half the companies fail. Also, 15X winners are not that common.

For VCs to return 5X, they have to have a couple of super-hits, meaning 50X or even 100X returns. For this kind of returns, the initial valuations have to be reasonable. Higher the valuation in the beginning, lower the chances of making big hits. Also capital efficiency plays a big part too. Lower the capital efficiency, meaning high burn rates, results in more capital raised; diluting all stakeholders. This requires much bigger win to get those multibagger returns.

The situations gets dire very quickly. VCs and entrepreneurs who do not focus on profitability sooner rather than later discover that even a win does not give any satisfaction.

Like I said in the beginning, most VCs lose money. In India all the VC capital invested in last 20 years has not been returned to LPs. India has proven to be a bottomless pit. There just have not been any big hits to speak of. Microsoft was profitable after only $1 million of capital raised and Google was profitable at $2 million. They turned out to be big winners for everybody involved.

Duane Murray

Nov 26, 2017

Duane Murray was the the fourth founder of Excelan. We had an ambitious hardware development plan and we needed somebody to supplement me. Duane’s name popped up in my head. Duane had worked with me for four years. He had interned under me at Singer-Link in 1976 and came on full time in 1977. Both of us had gone separate ways in 1980, I went on to work for Zilog and he had gone to work for Tandem Computers. When I called him to let him know that I was starting a new company, he immediately asked when could he join. No discussion about title, salary or equity followed. He just assumed that I will take care of him.

Duane was a hardware engineer par excellence. He handwired the initial boards that I had designed and debugged them. He totally relieved me of actual design work. I designed the initial Multibus Ethernet board but Duane designed all the other busses- Uni Bus, Q Bus, PC Bus, VME Bus. Duane was a most dependable individual and was like me, a perfectionist.

Later when I became CEO and realized that our sales and marketing was not very effective. I plucked Duane out of engineering and made him director of Technical marketing with an explicit charter of making our sales process effective. Duane moved into sales area and with his usual zeal set about to find out why a large number of incoming calls were not converting into sales. He quickly discovered that actual sales were very much technical in nature and a usual initial buyer was a ‘nerd’ and needed a “nerd’ on our side to close the deal. We put several engineers on the frontlines and started to close sales rapidly. Duane was later promoted to VP of marketing. He made a great VP of Marketing.

Incidentally, Duane did very well when the company went public. I had assumed that Duane would do a start-up of his own after leaving Novell. That was not to be. Instead, he opened a restaurant and lived happily ever after.

Making of a CEO Part 5

Jan 23, 2017

I felt very good and confident about things as the 1985 drew to close. Company had established itself as a profitable venture with a very sharp market positioning. We were the go-to company if you needed to network your heterogeneous environment. We had gone from $5. 2 million in revenue and $2.5 million in losses in 1984 to $10.1 million in revenue and  $100K in profits in 1985. Additional $5 million of revenue had produced additional gross margin of $2.6 million. We had a high spirited holiday party that year. I expected the growth to continue and profits to in 1986. The board even talked about going public in 1987.

So it came as a big shock when board talked about bringing in a new CEO. This time to dress the company for an IPO. The Wall Street was not used to seeing Indian CEOs back then. We needed a new CEO not because the company had done poorly but because it had done too well. The thought was to consolidate the value by going public. No body wanted to risk a failed IPO. I was asked if I wanted to risk my net-worth just because I wanted to stay the CEO. Board was extremely diplomatic and did not want to risk alienating me. I had done what they thought was impossible. A potential write off for the VC firms had turned into a potential 10X return. I was to be made the chairman of the board.

As expected Excelan kept growing and improved its profitability. We transitioned from the survival mode to growth mode. We loosened the hiring and increased the marketing spend.  A virtuous cycle had set in. The board hired C. Richard Moore, the GM of HP’s Calculators division as CEO. HP under David Packard had a tradition of promoting only tall people to senior management positions. David himself was 6′ 8″. At 6′ 5″”, Dick Moore looked the role. He joined us in April of 1986.  I stepped back and had all my direct reports, report to Dick. I did attend our staff meetings but let Dick drive them. It was not that long before Dick started to see a slow down coming. In the summer I took a much needed vacation but when I returned the company’s mood was decidedly downbeat. While I was gone, Dick had put in a hiring freeze and cut back on the marketing in anticipation of the slow-down. Sure enough a slow down materialized. I found this very interesting as our incoming leads had slowed to a trickle just as we cut back on the advertising.  I told Dick that I saw growth returning and overrode him to increase the marketing spend. Within days the leads started to flow in growth resumed. It was much later a I realized that so called GMs from HP were nothing more than product line managers. Financial control and management was with the corporate. Most of the GM’s had no P&L responsibility. I was very disillusioned by the situation but the company was on its way to going public. I had resumed the reins behind the scene and Dick was fine with that.

Company went public in February of 1987. It was a very successful offering. Excelan had done $22.3 million in revenue and had produced $3.5 million in profit in 1986. I wished we had not slowed down the company on purpose for a couple of months. Right after the IPO We acquired Kinetics, an Apple networking company. Open Macs were selling like hot cakes and we had to have a solution for them. Rest of 1987 continued with growth as usual. Stock Market crash of October 1987 and cut our stock price to below 7 from over 21. Company had gone public at $12/share. In 1987, our revenues topped $39 million and we made $6 million in profit but we were now worth one third the value in the market.

Dick was coasting as I was running the company. It was not that long before a scandal broke involving  Dick. We had just gone public and for the Wall Street Dick was still our CEO. Board decided to sell the company rather than fire Dick. NET made an offer to acquire us with no premium over the market price. I went along with it but made it very clear after the deal was signed that I was moving on. NET did not want Dick as a part of the merger so he was let go by the board. After I got to know NET and its management better and before the merger was closed, I told my board that I did not trust NETs books. I felt that they were cooking the numbers. We broke the merger. A few months later, NET scandal broke in public and their stock price dropped by 90%. Our merger was stock for stock and we had been saved from a disaster by a whisker. I became the CEO again and this time I was truly in charge. For the first time, I was not an interim CEO or behind the scene CEO. The company went on to do well. Doing $69 million  in revenue and $10 million in profits in 1988.

In spite our tribulations we kept improving our position in the market. TCP/IP had emerged as a winner in the protocol wars. Both Novell and Microsoft became our partners. In the middle of 1989 Novell made an offer to acquire Excelan with a 50% premium over our NASDAQ price. We became a part of Novell in late summer of 1989. I joined the Novell board and was made CTO of Novell.


Making of a CEO Part 4

Jan 19, 2017

Although, picking TCP/IP proved to be the right decision ultimately, it was any thing but easy decision at the time. TCP/IP was seen as tainted protocol, developed by DARPA ( Defense Advanced Research Projects Administration) for long haul, slow and unreliable networks using phone lines and was seen as unsuitable for high speed reliable networks like Ethernet . It had very little industry support. Xerox PARC had developed XNS as lean mean protocols to go along with Ethernet and most of the networking start-ups were adopting them. Most of the industry groups were adopting ISO protocols as their favored protocols. IBM and DEC had their proprietary networking protocols (SNA and DECnet) that they were selling and promising a future move to ISO. Big customers like Boeing and GM had lined up behind ISO too.

The problem we were faced with was very simple. How do we sell enough of hardware and software in a very short order to survive as a company. We knew customers have an immediate problem of connecting a plethora of computers they had bought. How to knit them in to a working network? Xerox had put XNS protocols in the public domain but had decided to hold back applications. Various start-ups were developing their own proprietary applications, essentially making them non-inter-operable with with others. ISO protocol were in early stage of development with no working implementations. IBM and DEC were too happy to pay lip service to ISO protocols while trying to lock-in customers in to their proprietary networks.

We figured that a working solution is the need of the moment. TCP/IP offered that. It had implementations on all sort of computers and operating systems. It had two very useful ready made applications: FTP (File Transfer Protocols) and Telnet (Virtual Terminal Protocols) that customers could use immediately. We also figured that though they were designed to work in slow and error prone networks where response times were slow and extensive recovery routines were needed to make network work reliably, there was nothing inherently wrong with protocols so they would have trouble on high speed reliable networks. The error recovery software would not burden the network if there were no errors.

Excelan was a technology supplier to OEMs when I took over. We had over 30 OEMs but none was taking the volume. I decided to go to the end-users directly by packaging solutions for IBM PCs, DEC VAXes and UNIX Machines and promoting them directly to the end users. The packages included every thing customer would need to connect his computer to the Ethernet networks. All the hardware, software, cables, nuts and bolts were included in the box. Customers were offered full satisfaction or money back warranties. We had priced in 10% dissatisfaction where we may have to fly out a technician at our expense to make the network work. Solution was an immediate hit. Only 1% of the customers needed help initially and it went down from there as we improved our documentation and process.

Initially, we thought our target market would be scientific computing market. This meant research labs, engineering departments and universities. That’s where we focused our marketing energy. We were surprised to see Wall Street emerging as a largest market. As a matter of fact we were not able to identify any one industry that preferred our solution, we were getting business from all sort of customers in all sort of industries. Networking was one of those horizontal capability that everybody needed and we were the only game in town if you had a heterogeneous environment.

We were feeling very good about our business and counted marquee names as our customers. But press and industry associations were forecasting an immediate  demise of TCP/IP and mass adoption of OSI Protocols. Boeing and GM, both of them a very large customers of Excelan, joined hands to form  an association to promote MAP/TOP (manufacturing automation protocols; Technical oriented protocols) built on OSI protocols. Most of the European companies lined-up behind this effort. Siemens, an OEM of ours, had forbidden us to claim them as a customer as they were a big champion of MAP/TOP. GM corporate networking Czar summoned me to come visit him in Detroit. I was told in no uncertain term that I had to drop TCP/IP and move to OSI protocols if we werw to keep GM as a customer. Excelan would be black listed soon and there would be no more business from GM unless we publicly announced that decision.

It was a strange quandary as our business kept getting stronger while disparaging of TCP/IP was reaching a crescendo by the fall of 1985. I was getting more convinced that TCP/IP would be an eventual winner as it was a working solution that was being adopted widely. While other protocols were being hyped, TCP/IP was improving and getting battle hardened under real use. It was hard for me to imagine that customers will rip out their working networks to install some unknown new protocols.

Among all this confusion, we got our largest PO (purchase order) from GM. I realized that corporate Czars have a luxury of indulging in their fantasies while operating managers need working solutions. It was a sure  sure sign that time had changed when Siemens came back to ask for the relief from the agreement that neither Excelan and nor Siemens, could publicly announce the relationship.

It was another couple of years before TCP/IP was widely seen as the future of networking and another 10 years before the emergence of the browser and the Internet. Even though very lonely as the only champion of the TCP/IP in the industry, I felt secure in my decision to bet the company by those in coming POs!