BUSINESS FORUM: Co-investments and conceptual businesses

Q. We are a €20 million venture fund in Eastern Europe. Would you be willing to introduce us to American VCs who are interested in co-investing with us, both here and in the US?

A. Sure. I will keep my ear to the ground for you. I am sure there are funds that are willing to accept additional capital and also to bring others on board to coinvest. After all, the laser/photonics industry can use additional seed capital! Outside of some really big firms, most of the funds in the US would only invest locally, choosing those within easy reach. I believe few if any US funds are willing to invest in faraway places that are outside of their control.

Q. The concept of starting with a prototype business you described makes sense. How would this apply to a photonics startup?

A. Starting a photonics business using this prototype approach makes perfect sense because ours is not being viewed as a hot industry that has investors flocking to it. A venture capitalist can be more easily convinced to make a modest investment to get their foot in the door for a potentially big opportunity. Starting with a simple business also allows a technical founder who has no prior business experience to learn and prove that he or she has the aptitude to run a full-fledged business.

Now let me remind our readers what is involved in “prototyping” a business.

Many conventional startups are geared up from day one to build out the company as if the business will develop strictly in accordance with the business plan. That involves hiring a full senior executive team, building out the facility, and implementing the necessary operational infrastructure to run a substantial business. The catch is that most business plans tend to be overly optimistic. Business may not develop as quickly while senior executives would continue to spend in the meantime, sometimes creating work to keep busy.

It is easy for an entrepreneur to take this approach in their eagerness to build out the business quickly, and to forget the first principle of entrepreneurship: Create the maximum possible value with a given amount of capital; or simply put, spend wisely to achieve capital efficiency.

A more sensible approach is how we engineers are taught to manage a product development project: First, complete a prototype and work through all the manufacturing processes before committing to volume production. I coined the term “prototype business” in my book to draw an analogy that would remind entrepreneurs to do likewise before committing to a big investment in building out the company. So spend as little as possible to validate assumptions and the business model before making the logical next move. What you actually do to prototype the business is different for each business, and is based on your judgment call. Getting a few orders shipped to respectable customers is always the best move; getting potential customers to express genuine interest is a distant second.

Your options are wide open when you have the beginnings of a real business. You can raise money at an attractive valuation to grow fast, modify your business model, or even choose to abandon the project. You may also become an attractive acquisition target.

What about having first mover advantage? I was struck by the recent announcement that Johnson & Johnson is getting out the coronary stent business it pioneered. How can that be, given that J&J is a health care and pharmaceutical behemoth? It proves that being the first mover does not always provide an advantage, considering pioneers get arrows in their backs. It is true that first developing the business prototype actually slows you down, but doing it properly can avoid haste-makes-waste mistakes. But you certainly do want to put in place an intellectual property (IP) strategy to avoid being shut out of the market by blocking patents.

Milton Chang

MILTON CHANG of Incubic Management was president of Newport and New Focus. He is currently director of Precision Photonics, mBio, and Aurrion; a trustee of Caltech; a member of the SEC Advisory Committee on Small and Emerging Companies; and serves on advisory boards and mentors entrepreneurs. Chang is a Fellow of IEEE, OSA, and LIA. Direct your business, management, and career questions to him at miltonchang@incubic.com, and check out his book Toward Entrepreneurship at www.miltonchang.com.

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