Radically innovation refers to that type of innovation so powerful and different that it can completely change the profession, institution, industry, business, or person in one fell swoop.  Thinking about how radical innovations come about and how they impact the world around us is a favorite subject of Tom.

I bring it up here, because I believe that radical innovation is the key to success in whatever you do – and not just radical innovation, but, as Tom puts it, “continuous radical innovation” – the constant search for those things that will turn your world on its head.

It is true that most businesses are looking to innovate, but to think about radical innovation really changes the way you view things.  It’s very different from thinking about “constant innovation” or “continuous improvement” which is the mantra of many businesses today.  As Tom quipped during his speech, “General Motors followed the mantra of continuous improvement all the way into bankruptcy.”

 Put another way, and to borrow from the world of academia, continuous improvement gets college campuses wired, installs the latest lab environments in the buildings, and creates a campus environment more rewarding for the students.  Radical innovation moves the entire university experience online and does away with the campus altogether.

Continuous improvement puts shocks on your carriage.  Radical innovation replaces the horse with an engine.  Continuous improvement accelerates the reload speed and accuracy of your rifle.  Radical innovation gives you a machine gun.   You get the idea.

The challenge is to continuously seek the radical innovations in your business – to look for and to go after the very technologies that, if developed elsewhere, would bring a swift and painful end to your business.  In the mean time, of course you need to look for ways to improve your business, your products, and your practices.  However, time and resources need to be spent going after the radical, not just the better.

This probably sounds a lot easier than it is.  Radically innovation is an unpredictable, expensive, and messy business.  With limited resources, the temptation will always be to direct those resources toward the projects that will have the most immediate and predictable impact.  Just as you would imagine the mad scientist to find himself surrounded by doubters (right up until the invention actually works), you’ll find that investors, employees, partners, and competitors will view resources directed to these “rogue projects” as wasteful, silly, and distracting. 

Thus is the challenge of going after radical innovation within an ongoing enterprise.  The near term benefit sits squarely on the opposite, and in a world of business that’s often driven by quarterly numbers, high rates of employee turnover and movement, and a desire for immediate satisfaction, it can be extremely difficult to manage the balance of resources between what is today’s reality, and what might change that reality. 

The pressure will be on improving today’s reality.  But if you’re not careful, you’ll have the world’s greatest carriage company – right up until Henry Ford hands you your lunch – just ask GM. 

You see, Rose-Hulman is widely known (in the very small circle that follows such things) as the #1 undergraduate-focused school for Science, Engineering, and Mathematics in the US, and has been for quite a while now.  Rose prides itself on this feat, as well they should.  However, I’ve been trying to push them in a direction to trumpet more of their business successes as well.

Holding a whole variety of administrative positions during his time at Rose, Tom was also first and foremost, a teacher.  He taught in the economics department, the only non-technical major available at the school.  While I was there I was signed up as a double-major in computer science and economics, but my interactions with Tom was primarily in his specialty area of entrepreneurship.

I took a 300-level class called “The Entrepreneur” which is about the only business-ish class you can take at the school.  I wrote my first business plan as part of an independent study course Tom mentored for me that we called “The Entrepreneur II”.  Basically, I launched my first business with a mountain of technical training, a vision, the business mentorship of Tom Mason behind me. 

Now, you can declare a minor in Technical Entrepreneurship, thanks to Tom.  Likewise, they’ve launched a graduate program called Engineering Management, which is everything that a tech-minded engineer wishes his or her MBA program actually had been. 

As far as technology focused universities go, Rose is light-years ahead in thinking about the intersection of entrepreneurship and technology and what it means for students.  This achievement rests squarely on the shoulders of Tom Mason.

Now, what’s important to note is that Rose-Hulman is not a big school.  The total student enrollment is 1,800, hardly larger than my own high school.  The student-to-faculty ration is 12:1.  It’s a small place where your interaction with professors is high, and the professors themselves teach all the courses, most of which meet 4 or 5 days a week.   Classes are packed together, bells ring to mark the ends of periods.  The classroom buildings are all connected together to form one large structure.  The whole thing operates with a pace that is lot more like a high school than a traditional university.

Despite the small size, Rose alumni have gone on to do some great things.  Bernard Vonderschmitt was the founder of Xilinx.   Dennis Carter is the VP of Marketing at Intel that came up with the “Intel Inside” campaign.  Andrew Conru founded Friend Finder, Mike Hatfield founded Calix, Cerent, and Cyan.  In 2009, Forbes magazine picked the top 20 most promising companies in America – two of them were founded by Rose-Hulman grads (one of which is my own Scale Computing).

If you think about that last point for a bit, it’s pretty shocking.  Forbes reviewed over 4500 companies during their selection process.  2 of 20 winners hail from a school of 1800 students, tucked away in an obscure midwestern town most famous for being the home of Larry Bird’s college days at Indiana State. 

Something special goes on at Rose, and when it comes to connecting innovation, education, and entrepreneurship, they owe a great deal to the work of Dr. Mason.  One of his greatest insights is something I’ll share in my next blog post, and it relates to how innovation impacts all aspects of business. 

To do so, I try to have a number of things ready to go from the outset.  The idea is that you’re going to start by providing some limited information and overview of your opportunity, and gradually work into more detail and depth.  You don’t want to unload all of your information at once, you want to tease the potential investor into wanting more.  It’s simple human nature that you’ll pay more attention to something you’ve decided for yourself that you are interested in, and so you want to generate that interest first, provide the detail later.

So, from start to finish, here’s a list of some of the tools that I use:

-       Target list:  You want to make a list of the potential investors you’re going to call, familiarize yourself with the partners, their investments, and their funds history before you make the call.

-       Voicemail Script: Write a very short (30-45 seconds) pitch you can leave via voicemail.  You will probably not get a call back, but you want to quickly state who you are, why you’re calling, let them know that an email is en route with more info, and ask for a meeting.   You don’t want to ad lib this on the fly, because you’ll miss something and need to call back.  This will cause you to look unprofessional and unpolished, so write it down first.

-       E-Teaser:  This is a short email, essentially two very short paragraphs that again tells the story of what you do and why you think that investor would be interested.  You’re still just trying to get a meeting or get them to ask for more info.

-       At-A-Glance: This is a document you can think of as the back of your company’s baseball card – quick stats that might answer a few questions.  I put things like “Year Incorporated:” “Number of employees:” “Revenue (if any):” “Business type: (Delaware C-Corp, etc)”.  Here you are trying to provide nothing more than a sense of where the company is today so that there is a frame of reference for the investor when they talk to you.  This is a PDF I’d send to them if I get some kind of initial response – for example if they agree to schedule a meeting, then send this to them to keep them thinking about you ahead of that meeting.

-       Opportunity Overview: This is a document that is essentially your executive summary from a business plan.  I don’t call it an executive summary because thinking of it as an overview of the investment opportunity will help get you in the right frame of mind when writing it.   You want to deliver the same basic information you would expect from a business plan, but you need to organize and deliver it in a way that answers the questions of the investor.  Shoot for one page, and settle on the fact that it will probably be 2-3 pages long, but you are looking to cover what you do, the target customer, the pain you solve, the history of the founding team, and what kind/size of investment you are looking for.  Don’t over do it or it will be far too lengthy – if you were making a movie this would be the movie trailer – it paints the picture, hits on the target audience, but doesn’t blow the plot.  This is a good doc to send two days or so ahead of that first meeting.

-       20 Minute Investor Presentation: I’ve hit on this before, and I made a short video (which needs some updating) about How to Pitch an Investor in the past.  Check that out for an overview of content and organization.

-       Financial Model: This is the excel spreadsheet version of your business plan, probably going out 3 years on a monthly basis, and covering your P&L, balance sheet, and cash flow projections.   This will take you quite some time to put together, but hopefully you started your investigation here when considering starting a business, and you’ve been working on it over time.  This is something I share with potential investors after that first meeting if they ask for it, or after the second meeting for sure.  As discussions get more serious, they’ll want to see how you intend to spend the investment money, what assumptions went into the model, and what the risk points are to achieving success.

-       Technology Presentation: If you are a company with some kind of technological advantage or idea, you’ll want to prepare a 20 minute overview that covers the details of your technology and how it fits in the marketplace.  If you get to the point in the discussions where an investor wants to dive into this detail then you are making good progress toward a term sheet.   Offer this when asked for more technology detail.

-       Thank You Email:  You’ll want to send a thank you email after you give a presentation.  If you are pursing your fundraising correctly, you’ll be having lots of meetings and won’t want to start with a blank slate every time you want to write one of these.  Draft a short and sweet message, and edit it as need be, but it’s a good opportunity to drive home your points again, so long as you do so in a sentence or two.

-       Business Plan: Ah, the business plan – loved by some, hated by many.  Do you need a full blown business plan?  No, not really, at least not in the classic sense of the business plan document.  What you need is all the stuff above.  However, the reason to write a business plan is because it’s a lot easier to write a long, lengthy overview of your business than it is to write all of the above.  So in reality, you want to start here (and with the excel financial model), and then extract all of the above from the messaging here.  When an investor asks for a business plan, I normally do not send them this.  Instead, I’d send them the Opportunity Overview and the financial model.  Even then, I would not do that until after we’ve had a meeting, and by the end of that meeting, they should know everything you’d stick in a plan anyway.  In most cases, the true “business plan” document never makes it out of draft mode for me – it’s a document used for brainstorming and organizing my thoughts, such that I can extract the pieces above.

Over the course of pitching, you may find it useful to put together some ancillary documents that cover common themes and questions that come up.  Maybe a page of frequently asked questions (again, keep it short), or a document that compares you to a specific competitor.  These are things than can be circulated (usually) in the post-Opportunity Overview stage. 

There’s a little bit of art to knowing when to send each document, such that you stay top-of-mind for those potential investors, and there is no absolute right or wrong way to do it.  What you don’t want are big gaps between when the investor hears about you, and what you do want is to have them thinking about you even when you aren’t right there in front of them.  Hopefully this list will get you started thinking in the right direction, and having this all prepped before you start will go a long way toward moving things along quickly, and looking professional.  

First and foremost, I will agree wholeheartedly with Peter that the health insurance system in the US is absurd.  The concept that health insurance is provided by your employer, versus being something you get for yourself, defies logic.  Your employer does not (generally) pay for your car insurance or your homeowners/renters insurance, so why health care?  You can trace back the history to where this originated, (and it stems from yet more government regulation and tax code manipulation), but suffice it to say that it doesn’t make logical sense to have your insurance tied to your employer.  It limits your choices and creates an artificial tie to your employer that is completely unnecessary.

Peter argues that the SHOP Exchange, a shared pool of insurance for small business will help startups.  I disagree.

Some of the benefit touted for small businesses is a 35% tax credit to offset the cost of providing health insurance.  There are a number of limitations to this scheme that make in ineffective for many startups:

1) the business must have fewer than 10 employees and an average salary of less than $25,000 per year.

The average per capita income in the US is $37,000 per year.  Even in the poorest state, Mississippi,  the average income is $27,000, well north of the maximum average salary to qualify for this tax credit.   Most states are north of $35,000 – 40% higher than the minimum threshold.

Second, the offset to the insurance cost is a tax-credit to the company.  In order to get a tax credit, a company has to be in a situation where it is paying taxes already.  Many startups are not making a profit, and therefore are not paying income taxes to begin with. 

Even if you hire people at 40% below the average salary in the US for the early days of your startup, you are almost certainly going to need to increase salaries before you start churning out a profit.  So by the time you actually can utilize the tax credit (when earning a profit), you’ll no longer qualify because your average salary will be over $25k/year.

So to get the credit, you must (1) be profitable, (2) pay an average salary of under $25k, and (3) have 10 or fewer employees.

In fact, the only age group where the average income is below $25,000 are those in the 15-24 year old age group, largely consisting of part-time employees.

While there are certainly some small businesses that qualify, I would hardly call such a system a boon to startups.  I suspect no one who visits this site has their eyes set on creating a company that pays it’s employees and owner next to nothing while squeaking out a profit and never growing past 10 people.  That’s hardly a vision of the American Dream that drives people to become entrepreneurs.

For all that, the estimate is that premiums will drop 1-4%.  I suspect the margin of error for such a calculation is north of that range, but I’ll let it slide for the moment.  Using Peter’s own numbers suggests that for his group plan, he would save $6.75 a month.

Call me a skeptic, but I don’t believe the make-or-break decision on starting a new business is going to come down to seven bucks a month.

2) Employers can choose not cover employees. The minimum penalty is $750 per employee for businesses with over 50 workers

If you don’t provide adequate coverage for your employees, there *was* a $750 fine.  Peter argues that this gives employers an out, in that they can just pay the $750 and not provide health insurance if they so choose.

While we won’t know how the law will play out until someone tests it, it is likely to not be this easy. 

First, in the “fix-it” bill that was approved after the first legislation became law, this penalty was increased to $2,000, so the $750 number is no longer correct. 

Second, if an employer does not provide insurance and an employee gets seriously ill, it is likely that the employee would have grounds for a lawsuit, given that the employer was knowingly in violation of federal law by not providing insurance.  The courts will have to decide, but it seems plausible – even likely – that a court would find in favor of the employee, force the employer to provide the coverage, force the employer to pay for damages incurred by not proving coverage, and also sustain the $2,000 penalty. 

As such, the $2,000 penalty is not an out so much as it is a near guarantee that you’ll be paying for healthcare, damages, and the $2,000.  That is not a help to startups at all.

3) Simple economics suggests insurance premiums will increase.

Regardless of where you stand on the morality of the issue, you can’t argue with the fact that forcing insurance companies to eliminate lifetime maximums and eliminate pre-existing exclusions.  Previously, you could, for example, purchase a policy with no lifetime limit, or purchase a policy with a limit of say $2 million in maximum benefit.  Guess what?  The policy with the cap was cheaper – of course. 

So no, in eliminating these things, the rates will have to increase.   Some hold out hope that by increasing the number of people in the pool that are young and healthy, it will offset these increases.  I remain skeptical of this math, as the sheer volume of people who already did have coverage and would experience a premium increase grossly outweighs the number of new people added to the insurance pool as a result of the legislation.

You have probably also read about the “Cadillac Tax” that is part of the new law.  This provides for a 40% tax on any health plan that exceeds $10,200/year for an individual.  The rate itself is absurdly high, but what you may not know is that the insurance company itself pays for the tax due.   This will, or course, result in higher insurance premiums as well, and would likely be spread across the entire insurance pool, not just on those plans were the tax was triggered. 

By the way, Kaiser reports that in 2009, the average premium for employer-provided health care was over $13,000.

Conclusion

It seems logical and inevitable that this law will result in increasing insurance premiums that will negatively impact all businesses, large and small.  Tax credits are of no use to most early stage startups, and the SHOP programs have a near meaningless cost benefit even if you take the CBO numbers at face value.

I am all for health insurance system changes, particularly those that would help move insurance choice directly into the hand of individuals where they can choose from a variety of plans that meet the needs of their families.  Let people decide if they want to pay for a plan that excludes an existing condition or allows for coverage, covers unlimited benefits, or caps out at $2M in benefits.  I see no reason to limit consumer choices.

Certainly allowing insurance companies to write policies where they can drop the insured when a health problem arises is borderline fraudulent, even if such provisions exist in the fine print.  If health insurance were primarily purchased by individuals rather than companies, I suspect consumer protections would have already been put in place against this kind of practice. 

What will benefit startups is a more competitive insurance marketplace, where a larger choice of plans and providers lowers cost.  What will benefit them even further is a market in which insurance is held by the individual, so that when you are trying to convince that prospective employee to leave their current employer and join your startup, an hour long conversation about the difference between your health plan and their current health plan ensues.  If insurance traveled with the individual, then they can weigh the benefits of the new job with the old more easily, without the burden of trying to navigate the switch from one plan to another without triggering a lapse in coverage and putting themselves and their families at risk.

Yes, that's right.  Already some fairly absurd limitations are put on who can invest in a startup, via what's the Accredited Investor provision.  I've not hit on it at McStartup in the past (that I can remember), but the idea is that only individuals with a certain income or net worth can invest in startup companies. 

This, I assume, is the government is trying to prevent you from harming yourself.  The logic is that if you mortgage your home on something as risky as a startup, you could ruin your financial future, and that is something they feel is unacceptable.  You should instead by lottery tickets and play slot machines.  Startup investing is way too risky.

If you want to turn $10k into $1 million, like Dell's original investors did, that's too bad for you, unless you're already a millionaire to begin with.

That's how it is today.  Under the proposed *new* rules, even millionaires can't invest in a startup.  You will need to have a net worth of over $2.3M in order to make that investment.

How insane is this?  If you had $1M in the bank, and your made a $10,000 investment that went bad, does that ruin your financial future?  Are you left in the streets?  A burden to society?  I think not.

Sometimes a great startup can grow from a $5,000 check a budding entrepreneur gets from his uncle.  If that Uncle didn't write that check from an account holding $2,395,000 more dollars, then, under this proposal, that $5,000 investment violates US Securities law. 

Clearly (here comes the sarcasm), an uncle with only $2.2M in his account is an untrustworthy, financial lunatic, prone to squandering his money.  We, as a society, can not possibly let them invest $5,000 in a nephew's business plan, can we?

That, at least is the view of Senator Dodd.  Perhaps you agree, and feel that only very wealthy people have any right to invest money in startup companies. 

On the other hand, maybe you think other people are quite capable of making their own decisions on how to invest their own money.  Maybe you even think someone who isn't wealthy could logically conclude their nephew is a better investment than lottery tickets.

If so, I suggest you contact your senators, and tell them to strip this kind of lunacy out of the proposed legislation.

Jeff writes:

I want to start a LLC.  My question is if I need people to invest some capital and I want to let them buy into to company with stock options how do I set that up?  Does that make sense?

So the short and technical answer to your question is "no" - because LLCs don't have stock.  They have a stock-like feature called "units".  You can accomplish the same thing with an agreement that gives the option to purchase units in the future, although it's a little different than dealing with traditional stock options, and I'm not sure it would accomplish your goals.

However, the bigger question is why would an investor want an option rather than the stock / units now?  Generally speaking, someone who invests dollars into your company is going to want, and likely should receive actual ownership today.  Someone who invests time in the company, on the other hand, may be better served with an option such that they don't have to write you a check today. 

I have almost no information about your particular situation, but I would suggest that if you are looking to raise outside investment dollars, that you look to issue actual ownership rather than options.  It's always a good idea to talk to your accountant when looking at the ramifications of doing an LLC vs. a C-Corp,  and to understand the motivations of your investors in that regard as well.  Most professional investors are not interested in seeing a pass-through loss they can write off on their taxes, as you could have if you choose partnership style accounting under the LLC.  Instead, they'd rather the company accrue the losses to write off against future gains. 

But it all depends on your particular situation.  If you are expecting to raise a little bit of captial now and grow your business to profitability in short order, then an LLC probably makes sense.  However if this is a raise money, get a little further along, look to raise money again to go big type of business, you'd probably be better served with a C-Corp.

Regardless, I can't think of a situation off hand where it makes sense for a cash investor to receive options rather than ownership...  actually wait, I can:  If you are raising money from a non-professional investor now and expect to raise money from a professional investor later, delaying issuance of ownership (and thus, delaying the selection of a pre-money valuation) can make sense.  I have recommended in the past that this be structured as a loan that converts into equity with a bigger round of financing -- something called a convertible note.   

I've touched on that concept in a few previous posts here and here.

Whichever structure you choose, best of luck with the new venture!

- Abandon Stealth Mode

- Tell the World

- Ask for Help

- Start Selling Now

- Keep it Simple

- Hire Smart People

- Shorten your Pitch

- Invest in PR

- Thank Helpful People

- Make More Calls

- Read more McStartup (LOL!)

- Ignore your Competition

- Focus your Market

- Define your Message

That was fun.  In other news, Scale has lauched into Japan.  Our newest partner, Bell Data of Tokoyo, will introduce our SMB storage solutions to the Japanese marketplace.  Cool stuff.

We (I) take a break from our (my) normally riveting startup-centric commentary to bring you this exciting piece of gratuitous, self-promoting news:

• NY Times: Scale Raises $9M Second Round led by Benchmark
• TechCrunch: Benchmark, others, store $9M with Scale Computing
• Venture Beat: Scale Raises $9M to sell Enterprise Storage
• Indy Star: Scale lands $9M in Venture Funds
• IBJ: Scale Computing Lands $9M from Silicon Valley

There are hundreds of reasons why someone, be it an individual, a bank, or a venture capitalist, might pass on your investment.  They might have different portfolio requirements, they might have competing investments, they might be on a different time horizon from what you present, they might not like the color of your tie, they might be out of money, they might not like where you are located -- who knows. 

However, I think if you go into the process with the right mindset, it makes this all a little easier to understand.  I view raising capital as being similar to an aspiring actor auditioning for a part.  Sure, if you don't get the part, there is going to be a piece of you that takes it personally -- but there's also an understanding that you probably won't get the part, and that if you don't, it *might* be because they think you are a lousy actor, but it might also be that you were too tall, your eyes were the wrong color, your voice was wrong for the part, or that they just ate a bad tuna sandwich for lunch and were more focused on that than on your audition. 

So what is an aspiring actor to do?  Lots and lots of auditions, of course.  The same holds true for raising capital -- they key is to schedule lots of "auditions", dust yourself off from rejections, and get back into the mix until you "get the part".  

And guess what?  Over time and lots of these auditions, you'll get better at it, you'll start to understand what the investors expect and are looking for, you'll become more confident, and your whole pitch will move to the next level. 

I can tell you some statistics from personal experience:  I've successfully raised capital for my companies 7 times or so -- but I've literally been rejected more than 100 times, probably more than 200 times.  This is how the game works, and if you aren't getting rejected, you aren't trying hard enough to raise your funding. 

But he's right, I do need to try and stay more on top of this, if for no other reason than I enjoy helping entrepreneurs get their ideas off the ground.

All that said - I was asked by a number of folks who attended the presentation to make the slides available to them, so I'm posting them here.  There is no recorded voiceover, so I'm not entirely sure how useful these are if you weren't there to hear me, but you're welcome to have a look at them.  If enough people ask, I will go ahead and get a recording up of the actual presentation.

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