Lightbank chief Lefkofsky on the value of ‘strategic’ money

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Technology entrepreneurs Eric Lefkofsky and Brad Keywell, co-founders of Groupon Inc., in March launched Lightbank, an investment firm that funds start-up technology companies. That means they can speak to the wisdom of accepting venture capital from a business owner’s perspective and from an investor’s. Mr. Lefkofsky tells Crain’s how he thinks startups should approach funding, and also why he thinks Chicago is poised for a tech business renaissance.

CRAIN’S: How would you counsel entrepreneurs to deal with the fear that they will lose control of their business if they take a capital investment?

ERIC LEFKOFSKY: I concur with the idea that you don’t want to be in a situation where you give up so much control that people who don’t know your business nearly as well as you do are steering the ship. But if you start out with a young business, the alternative to just taking capital is to take capital that comes with something else — some other attribute, skill set or advantage. Strategic money is always better in my opinion than just plain money. So even if you have to compromise on valuation a bit in order to get capital that’s more strategic, I would always take it. And that’s basically what Lightbank is — strategic capital.

We’re putting money into these businesses, and then we don’t tell them what to do. We don’t have the authority to do that. But we’re making introductions for them, helping them steer the ship and putting real resources into the business. We don’t make any investment without deploying somebody on our team to the business in a near-full-time way, so the companies get real help, not just somebody who comes to a board meeting once a quarter; this is somebody in the trenches with you, digging. I think that’s better. It produces an outcome more often than not that’s significantly better than if you let (entrepreneurs), who often are doing this for the first time, make a series of mistakes and then have to learn from those mistakes. We hedge a lot of that, and I think that’s why they take our money.

Let’s say an entrepreneur is ready to accept investment. What kind of deal should be sought?

You should bring in money in a couple of different stages. First, typically you need some right from the get-go — there’s some amount of money that’s needed to get the business off the ground. At this first stage, whether you’re talking about $50,000 or $500,000, there’s only one objective with that money: to prove that the business you are building actually works, that it delivers real value to the market, that people actually want the thing you’ve created, and that you’ve developed a credible hypothesis on how to make money off of it. You don’t have to be making money in those first months, but you do need validation. If you brought in cold, heartless accountants, you want them to agree that based on these assumptions you have made, that seem credible, this business will scale and make money. And if you haven’t proved that, you can’t graduate to step two.

During the next step, you should be bringing in significant capital to really drive the business. Now you’ve got a model that works, you’ve proven your economic hypothesis, and now it’s just a matter of scale and speed. So the question is not a matter of how much should you bring in — the answer in this stage is to bring in as much as you possibly can, because the faster you can go the bigger your business will ultimately be. Instead, the issue is really how much should you bring in during that stage without completely diluting your (share of the company), because if you’re right about the business, then every six months or year, the company will be worth a lot more. So it’s a balancing act. You want to bring in enough money in that second phase that you don’t lose your advantages of speed and scale, but you don’t bring in so much that you sell half the company for half the price that you could get if you waited a year.

Chicago’s business community has a reputation for being conservative and revenue-focused, compared to Silicon Valley, where, the theory goes, a startup isn’t under as much pressure to make money right away. What’s the right approach?

I don’t think it’s right to say, “If I go to the coast, then I can be creative and swing for the fences.” I think of it as, no matter what you do, or how risky you want to be in launching a business, if you’re not truthful with yourself, if you’re not self-aware of what’s really going on, then you’re just wasting your own time and other people’s money. So the real issue in my opinion isn’t revenue — it’s value. We look at tons of businesses that got seed funding from (Silicon) Valley. Angel investors or early-stage venture-capital firms put money on some tech guys who are super-smart, and then two years later the startups are out of money and in total collapse. There are hundreds of these businesses; it’s mind-boggling how many there are in the Valley that had promise but turned into nothing. Over and over, the basic missing thing is value. Why start this business in the first place? What problem does it solve? What’s its reason to exist? So often, there’s no reason — what they do is being done well in 10,000 other places, so why do we need 10,001? So you can take risks and be crazy, you can try to push the fold, but there’s some moment in time, three or six months down the road, when you need to look in the mirror and ask, “Does this thing really work? Does it add value?” If the value isn’t there, then either stop and do something else or change the business.

Groupon is a case in point. The same guys from Groupon did ThePoint (a previous venture of Messrs. Lefkofsky and Keywell). It’s not that we were idiots when we did ThePoint and we were geniuses when we did Groupon. We’re no smarter or dumber than we were at any of those moments in time. It’s just that we tried one model, and it wasn’t gaining adoption, so we tweaked it to become another model that did gain adoption. If we weren’t self-aware, then we would be riding ThePoint all the way into the ground.

What do you think the future holds for tech businesses in Chicago?

This is why I think Chicago is about to have its moment in the sun. What’s happened is, if you go back 10 or 20 years, there was such a significant technology barrier to building these Internet businesses because the Internet was new and the technology was very clunky and mathematical. All the tools were new tools, and they were very algorithmically arduous. So what happened was that, where there was great tech talent, you built the great tech businesses. As a result, the Valley became the Valley.

But now, in 2010, all the tools you need to build an Internet have been kind of dumb-ified. If we were building an e-commerce shopping cart in 1998, it was very tricky and took expertise. Now you can download an open-source shopping cart in two seconds and plug it into a Web site. My 11-year-old could do it.

By bringing the technology barrier down, the tech skill becomes less relevant and business skills become more relevant — entrepreneurial skills, sales skills, accounting skills and all the other attributes that lead people to be successful. Places like Chicago have always been long on those attributes, just short on tech talent. But now that those tech skills are less relevant, we will have our moment.

Source: Crain’s Chicago Business

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