Disruptive Tendencies

Fight or Flight? Why Big Companies Do Deals

I love the web and am constantly amazed at what one can find or learn from others skilled in the art.

I recently came across a very interesting piece in Marc Andreesen's blog: "The Moby Dick Theory of Big Companies", in which he suggests that "There are times in the life of a startup when you have to deal with big companies." He then builds a very interesting metaphorical case for SmallCo as Captain Ahab and BigCo as Moby Dick. It's an entertaining and enlightening piece, but I will endeavour to go a few steps further and try to delve into the psychology driving the players in this game.

Marc makes some interesting points about a BigCo's behavior being inexplicable when viewed from the outside. He suggests that there are some many moving parts and agendas, that the dynamic of decision making is highly unpredictable. While I tend to agree at a macro level, it's my experience that people (and a company is an aggregation of people) will react most predictably to fear. I think it was Intro to Psych class where we are all introduced to the concept of "Fight or Flight" and that it applies equally to business psychology.

SmallCo's are used to talking about the opportunities created by their disruptive technology: new markets, huge revenue, vast market share, value creation. This is a natural side effect from their creating business plans and pitching investors on how compelling the opportunity is.

Once they've convinced themselves and their investors that the opportunity is huge, they will often go out and try to convince one or several BigCo's of the same thing. Getting funding or landing a whale require different stories, but usually SmallCo re-uses their investor pitch in trying to get BigCo's attention. You may get nodding heads in meetings and even hear that they agree with your assessment of the opportunity, but all too often BigCo inertia takes over and nothing happens.

I first experienced this in a big way shortly after being recruited from a start-up into the Disruptive Technology group at Nortel in Q3/2000. MeshNetworks had just emerged from stealth mode with a classic, highly disruptive story that had the potential to impact many incumbent technologies and R&D programs in the wireless space. Nortel was heavily invested in 3G, having made a major UMTS bet, and I was advised to identify a new market opportunity created by this emerging technology rather than positioning it as a disruptor to 3G. So, I began the exercise of focusing on a net new commercial opportunity that this technology could enable for Nortel. It was a billion dollar opportunity in 3-5 years, yadda, yadda. I got the nods in meetings and the "Atta boy" from my boss at review time, but there was no sense of urgency to act.

Frustrated by this, and deciding to win big or die trying, I spoofed a news story using the San Jose Mercury News banner and inserting quotes from John Chambers and industry analysts. The banner read: "Cisco Leapfrogs 3G and Goes Right to 4G; Acquires MeshNetworks for $400m". I then printed off my mock-up and put it on the fax machine, sending it around internally. Within 5 minutes, my phone began to ring - "Holy shit! What the hell just happened? How could we have let this happen?!?"

Basically I then told them that we have a do-over, that this didn't really happen (yet). But I then asked whether this was a version of the future that we were prepared to accept. If so, not acting was a reasonable course of (in)action. If we couldn't contemplate this version of the future, then we needed to act urgently.

What did I takeaway from this?

BigCo's are largely risk averse. Status quo rules the day and that having a team of singles hitters internally is easier to manage than going to the free agent market and bringing in the guy who will either hit it out of the ballpark or go down swinging. Unless that home run hitter is also talking to another team in your division, which could lose you more games. The threat of him landing with a competitor usually changes the way in which you look at his availability as well as what you're willing to pay to get him on your team. It's the competitor pre-emption premium.

Winning vs. not losing. Opportunities or threats. Two different ways of framing the discussion.

After 20 years of dancing with 800lb gorillas, or hunting the great white whale, my experience is that BigCo action is catalysed more often from perceived threats than from potential opportunities. My hunch is that this is an 80:20 relationship, although I have no quantitative data to support this.

What happens inside companies when presented with a perceived threat? The Fight or Flight instinct kicks in. Corporate DNA is pre-disposed to fighting (they don't call it "competition" for nothing), while fleeing is anathema to most BigCo's. Status quo is not an option when under threat of attack.

You've decided, for whatever reason, that you're going to go hunt the big white whale. You've got a disruptive technology, well it's called disruptive for a reason. Change the lens through which you have them view you. Build your story around the threat to their status quo and you are more likely to get them to act with a sense of urgency.

But be careful what you wish for. You might just end up harpooning the whale and you then have to answer the "Now what do I do?!?"

That's my .02!

Martin Suter

 

Can't see the forest for the weeds (Board governance at start-ups)

Why is it that management teams in start-ups assume their Boards want to get down into the weeds every Board meeting and why do Directors buy into this approach and behave like weed inspectors? Board governance isn’t about inspecting everything that management is doing; it’s about holding management accountable for those things that are material.

Start-ups are high risk, but materiality should be those things that have the potential to impact valuation or derail a liquidity event. Sure, the product roadmap (aka Feature List eye charts) is important, but is it more important than GPL compliance?

What impacts valuation more than revenue? Yet how often do you see a Board congratulating management for “hitting their numbers” rather than asking whether these are the right numbers to be hitting? There’s no point in patting management on the back for a year in which a company grew 10%, if the market and their competitors are growing at >50% year over year.  Underperforming the market equates to declining market share, which will ultimately impact valuation, multiples, and liquidity opportunities, none of which deserve a pat on the back.

Rather than showing slides that show how the company is “performing to plan”, how about a slide showing how the company is “performing to market”?

It’s a fact of life today that companies leverage open-source software. There’s tremendous pressure to hit dates and add features, and many engineers will look to SourceForge, or similar, for code to help meet development timelines. Without a robust open source license tracking process, it’s very likely that, over time, one’s code base may not comply with all of the license obligations associated with the bits.

Non-compliance is material. Just ask Cisco, which had to publish the source code for its Linksys line when found to be in violation of its open source license obligations. Every licensing and M&A deal that I’ve done has required a representation, signed by an Officer, warranting compliance with copyright licenses. Sophisticated acquirers will require a 3^rd-party compliance assessment using a tool from a company like Protecode or Black Duck, and being “caught” during a due diligence will cripple any deal.

So rather than spending the R&D section discussing feature lists, shouldn’t Boards be focused on mitigating the risks of non-compliance with open-source license requirements? Why shouldn’t R&D be required to provide a slide, every meeting, summarizing the open-source licenses for code being used in shipping product?  Shouldn’t the CFO and CEO be required to sign-off that the company is in compliance, every quarter? Just as Financial Statements are provided and signed off on, so should GPL compliance, and as with annual audited financials, management should prepare and provide an audited 3^rd-party compliance report annually as well.

Non-compliance puts the company and its investors at risk and should be a firing offence, first time, no questions asked. It’s not the engineer that should be fired, unless he/she knowingly violated company policy (that is monitored and real and not “vapor”), rather it is any Officer of the company that was aware of non-compliance or who has oversight and ultimate accountability. This means, in most cases, the CEO.

Many start-ups take a very ad hoc approach to intellectual asset management (IAM), which is odd since it is an asset class that forms the essence of a company’s value. You may see a slide in a Board deck that lists patent applications, but rarely do you see any level of competitive analysis, either in terms of competitors’ patent positions, or potential infringers of one’s own patents. Significant money is spent on patents, without an understanding of the business objectives for so doing. As a result, many patents end up sitting in a filing cabinet or as a plaque on a wall and are never used to the company’s benefit.

So why is this material? Once again, it has the potential to impact valuation. Having been directly involved in a multi-hundred million dollar M&A transaction, where the justification of the 30X revenue multiple was based on IP portfolio strength, I can attest to the power of a coherent, well-documented IAM process. When this is supported by the knowledge of 3^rd-party IP in your space, as with a patent landscape analysis, you have a powerful justification for including IP in any discussion of valuation.

Furthermore, Directors and Officers have a duty of care with respect to the management of corporate assets. Recently, I read an article that suggests a corporate officer or director, who is aware of an infringement of some patents owned by his or her company and who fails to enforce these patents, may be held liable for breach of the duty of care with respect to the management of corporate assets. I’m not sure whether it’s ever happened, but it makes sense for Directors to expect more than a simple list of patents.

Rather than a slide documenting a company’s patents (which I can Google or BING anyways), how about an analysis of your IP and your competitors’? How about a discussion on enforcement of IP with some clear guidelines around it? How about pushing management about disciplines related to invention documentation? Are the engineering notebooks signed and dated? What about an international filing strategy? Which markets? Why?

Board members have visibility into a company’s liabilities; monthly Balance Sheets show this, but what of off Balance Sheet liabilities? Many SmallCo’s are disadvantaged at the negotiating table and as such, sign deals with indemnification clauses that effectively “bet the company”. Any contract that includes clauses for liquidated damages or in which the company provides an uncapped indemnity, should require Board approval. At a minimum, it is the CFO’s responsibility to advise the Board as to the existence of these hidden, potential liabilities, but it is the Board’s responsibility to require this of the CFO.

Lastly, I’d like to point out that Directors and Officers have an obligation to all shareholders, regardless of share class. Most Board members are representatives of investors, and often have preferred rights of some kind. But it is incumbent on Directors to represent all classes of shareholders, including common stock holders, and not simply to represent their own stock class.

So what’s my dream Board meeting?

It’s one in which the company is measured, objectively, against those metrics that matter. It’s one that isn’t comprised of 100 eye charts describing the minutiae of the business, but which is focused on issues of materiality.

CEO/Sales: How fast did the business grow relative to the market and its competitors?

CEO/R&D: Are you monitoring open-source license compliance? Will you stake your job on it?

CEO/CTO:  How are you leveraging IP to limit competition, grow revenues, create value?

CEO/CFO: What “bet the company” contractual indemnifications exist? What contracts currently under review have “bet the company” clauses?

Ultimately, it’s the Board that needs to convey to the CEO that these are issues of paramount importance to the company, its Directors, investors and all shareholders and that he/she will be held accountable. Don’t take us down the garden path every meeting and don’t pull us down into the weeds. Show us that you have your finger on the pulse of those things that matter.

To paraphrase Peter Parker, “With great power comes great responsibility”, but that’s why CEOs make the big bucks.

That’s my .02!

Martin Suter