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Saturday, March 24, 2007

International Investment Capital

London may be the top European city for tech investment, but it still lags Silicon Valley. Entrepreneurs and investors gathered last week to discuss the challenges they face - and some solutions

'London is like a country in its own right,' observed Jens Lapinski, VP of analysis and consulting at Library House, about the capital's success in attracting venture capital. He was speaking at an event at Grant Thornton House last week to mark the unveiling of a new report from g2i, 'London: Anchoring European Technology Investment', which describes London as the best city to attract investment across Europe.

According to Library House's analysis of recognised investment deals, London received �485m venture capital in 2005, which is 38% of the total invested in the UK and more than the total invested in the whole of France (�457m) and Germany (�363m). The picture is particularly bright for technology companies, with IT accounting for a third of that investment, closely followed by the retail and services sector.

However, to put those figures in context, Silicon Valley attracts ten times the investment of London, according to Ernst and Young's Global Venture Capital Insights Report 2006. In fact, over 35% of the �12bn venture capital invested in the US went into Silicon Valley. Lapinski suggested that in order to catch up, London should form a 'super-cluster' with Oxford and Cambridge and 'build the things we need to support that - the infrastructure, finance and access to markets.' The aim would be to encourage collaboration across the South East, rather than each investment centre doing its own thing.

Just as important, while VC funds may be flowing, there are still significant obstacles for entrepreneurs to overcome earlier in the business cycle, not least in bridging the gap between early stage finance and venture capital. Angel funding is widely available in London - it's accessing it that's the problem, according to David Hunter, managing director of investment at funding body Nesta. Initiatives are in hand to formalise London's angel networks, including the recent formation of the British Business Angels Association, supported by Nesta. But Hunter said networks need to be clustered together better as they are around the universities in Oxford and Cambridge.

At the same time, many believe that more can be done with grants. Nesta itself handed out �22m in grants last year, many of which were in London, and the capital accounts for the single largest share of research grants. Nonetheless, Hunter suggested that some companies were leaving London because they thought they stood a better chance of accessing regional development grants.

Serial entrepreneur Philip Birch, CEO of Imperial College London spin-outs Veryan Medical and Heliswirl, called on the government to provide more help for London's entrepreneurs: 'There's a tendency [for the government] to think London is so well catered for, with experienced management teams and a truly fantastic investor base, that we'll find our own money. But a grant provides that first bit of undiluted capital that can get a company out of the starting blocks.'

Sarika Patel, director of enterprise and technology at Grant Thornton, one of the g2i partner companies, agreed that early stage funding was still a weakness in the capital, but argued that g2i was going some way to redressing this by helping companies access funding from the �50,000 to �2m mark: 'Before g2i there was nothing that connected the money and the companies seeking it across London,' she said. 'g2i brings a wide skillset and is putting those networks in place.' In assessing up to 25 companies a month for investment readiness, g2i looks at factors like skills gaps in management teams, technology weaknesses and the IP potential, as well as investigating joint venture opportunities and routes to market for its candidate companies.

Part of the investment equation is about growth potential, and many start-ups fall into the category of 'lifestyle businesses' that are happy to keep ticking over and surviving on cash flow, but with no dramatic ambitions to grow. One entrepreneur presenting at the event, Jon Holmes, CEO of Michelson Diagnostics, said it came down to motivation. 'You've got to be clear on why you're going into this. If you want to make a bit of money to support your family, that's not enough. You've got to really crave success.'

By David Longworth, Webster Buchanan Research

Why People will always be key to success

Experts argue that getting the right management team can do more for the success of a tech company than the quality of its products. The trouble is, many start-ups can't afford to hire the best talent.

'I would much rather have a first-rate management team with average technology than have the reverse - a first-rate technology with a second-rate management team. The strong management team is much more likely to succeed.'

So says John Preston, associate director of the Entrepreneurship Center at the highly-regarded Massachusetts Institute of Technology, in a paper entitled 'Success Factors in Technology-Based Entrepreneurship'. With extensive experience helping commercialise inventions from MIT students and faculty, he's seen numerous tech start-ups in action, and he believes the composition of the senior management team is one of the key ingredients. 'One of the false impressions about entrepreneurship is that entrepreneurship is an individual behaviour,' Preston says. He points to work carried out by Professor Ed Roberts from the Sloan School of Management, who found that a company's chances of success increased dramatically as the size of the team grew, up to four or five founders.

But for many start-ups, building a management team is ultimately about making the most of whatever resource is available. Many companies are set up by former colleagues or friends of friends who share a common product vision, and it's often more by luck than judgement if the team ends up with the right balance of skills. The majority of hi-tech firms are set up either by a technology specialist with a product vision, or a sales and marketing professional who spots a market opportunity - it's relatively rare for someone to have both skillsets, and it's not uncommon for tech start-ups to fall short on the sales and marketing expertise. These core skills will need to be complemented with day-to-day financial expertise and broader strategic insight: in addition, many companies will seek out a non-executive 'expert' to add credibility in the eyes of investors and customers.

Even if they recognise the need to bring in additional expertise, however, most start-ups lack the resource to do so. As John Blowers, managing director of equity funding exchange AngelBourse, points out: 'Equity capital is so scarce at this level that they can't afford to headhunt key people - so they will try [people] they know who they can beg, steal or borrow. Not many start-ups are in a position to find an 'A' team.'

Most start-ups face up to these recruitment problems with a degree of pragmatism. Temporary help is one solution, although it's not always easy to find the right people - while interim management companies do operate in the start-up tech sector, the shortage of funds makes this a less attractive market for them to focus on. Networking events are also a potential hunting ground, particularly for non-executives, although they need to be approached with a degree of caution. As Blowers points out, at worst you may find 'a rather motley collection of saggy grey suits hoping to pick up some consulting work'.

Some of these senior management challenges ease when organisations make it as far as first round venture funding, where the combination of VC vested interest and a large infusion of cash helps tackle some of the recruitment problems. In many cases, VCs will bring in their own people to fill gaps on a short-term basis, or recommend independent external directors with particular expertise. Mark Albert, Partner at Seattle-based international law firm Perkins Coie, says the most successful start-up he's worked with was a software house that lacked both sales and marketing expertise, and hired two non-executive directors with experience in each. Their role was not confined to the boardroom: as well as attending board meetings, each worked directly with the sales and marketing team on a regular basis to help with both operational and strategic issues. In some companies, a non-executive's industry connections may also open the door for sales opportunities.

Carl Showalter, general partner at early-stage venture specialist Lightspeed Venture Partners in Silicon Valley, points out that given their extensive contact network, these independent directors may also be able to help recruit additional senior executives. That will come as a welcome relief to many technically-oriented founders who are uncomfortable assuming the role of chief executive but are unsure how to find a replacement.

In the long-term, the choice of independent director can prove critical. The typical hi-tech board of a financed company consists of five people - an uneven number designed to avoid paralysis through tied votes - and is usually made up of two founders, two representatives of the VC, and an independent director. There's an inherent conflict in this set-up: although the VC-appointed directors are charged with growing the company, they also have a responsibility to their own venture capital firm, and those interests may not always go hand-in-hand. As a result, the independent director may be in a pivotal position when it comes to bringing an objective view and making decisions.

'The independent person should clearly be an expert in the areas you need most help in,' concludes Albert. 'They should complement, not counteract, the CEO. You have to take a look at where you are today and where you want to be two years from now, and see what areas of your team are most lacking.'

Written by Keith Rogers, Webster Buchanan Research

Wednesday, March 14, 2007

The New Rules on Outsourcing

Outsourcing product development is an attractive option for many start-ups. But as the services industry matures, entrepreneurs face new challenges in the way they manage their business partners

If you're wondering how to tap into the Indian skills markets and take advantage of the huge IT talent pool in Eastern Europe, it may be worth taking a quick trip to Richmond. Just along the Sheen Road you'll find the UK sales offices of GlobalLogic, a software engineering services company. With a global HQ in the US and development centres in India, China and Ukraine, it provides early and mid-stage software developers with a range of outsourced services, from help with initial design through to usability testing.

Given that the ratio of people costs to infrastructure has become so heavily-weighted in favour of the employee in the UK and US, it's no surprise that the idea of outsourcing parts of the product development cycle is becoming such an attractive option. Finding the right skills at a reasonable price can be a real challenge in some sectors, both geographically and in particular specialities - and finding the right combination of talent, price and personality can be even tougher, particularly in start-ups where team dynamics matter so much. Tapping into offshore skills, where the cost base is so much lower, definitely has a lot going for it.

One of the many challenges with offshoring, though, is that you have to know where to start. You might have a vague idea where Kiev is - you might even have an in-depth understanding of the nuances behind the explosive economic growth of India. But it's not as if you can just turn up in a hotel and start interviewing the locals. Companies like GlobalLogic, which has a bank of recruiters in India and clams to be the largest IT employer in Kiev, do have something of an edge in terms of brand, reach and hiring clout.

GlobalLogic operates as an offshore partner, working closely with client teams and handling the heavyweight coding and management of software development projects. Providing these kinds of services takes you several steps higher up the value stack than traditional infrastructure outsourcing, which tends to focus on providing infrastructure and tools to work with - these types of services, by contrast, are core to your business proposition. But ultimately, the principles underpinning any kind of outsourcing arrangement are the same. It's all about drawing a line to work out where you're comfortable collaborating with third parties, and where you feel functions are so critical that you have to run them in-house.

The problem start-ups face, of course, is that working in this kind of partnership is often unfamiliar territory. Many entrepreneurs have limited experience working alongside third party suppliers, and there's inevitably some level of friction as they muddle through the business processes and communications issues. In the future, this gap in experience may well broaden, because service providers' own expectations are now evolving.

Take GlobalLogic itself. When I met Tarun Upadhyay, the company's chief software architect, at a recent conference in San Francisco, he argued that what GlobalLogic offers is 'second generation' outsourcing. Early forms of outsourcing, particularly in the IT sector, tended to be characterised by arms-length relationships - put crudely, the idea from the customer's perspective was to get rid of a problem and wait to get the results. But that's not a particularly strong basis for a business relationship. For one thing, it's adversarial - so when problems crop up, they tend to erupt in bouts of finger-pointing rather than a combined effort to put things right. Given that blame usually lies on both sides of the fence when things go wrong, especially when it comes to communications breakdowns or missed commitments in complex collaborative tasks, it's not particularly helpful to start totting up who made the biggest number of screw-ups.

Upadhyay argues that start-ups need to approach the outsourced business relationship on the basis of building a single team - and this has some radical implications. To begin with, he believes entrepreneurs need to treat outsourced contractors in the same way they do their own employees. If you give your in-house technical people an unscheduled bonus when things go well, count the outsourced staff in as well. In fact, he says, some customers go as far as taking part in joint performance appraisals of GlobalLogic employees, and one or two of them have even handed over stock options to outsourced staff.

This kind of collaborative model isn't going to work for everybody, of course, but it may be one more indication of how working patterns are shifting - and of the opportunities and challenges that lie ahead as they evolve. Entrepreneurial companies of all sizes are having to work out how to partner and collaborate with independent individuals and third party organizations as they bring together the different skills they need. Treating outsourcers as collaborative partners rather than mere service providers is just one more piece of that puzzle.

By Keith Rodgers, Webster Buchanan Research