Odds are, your startup isn’t going to be the next Facebook, Google, or even Instagram. Odds are, your startup will lose money for your investors. If we’re really being honest, odds are your startup won’t even survive.
And yet, startup fever has captured the imagination of the mainstream. Blame the lore behind movies like “The Social Network,” or wantrapreneur reality shows like “Silicon Valley.” Or perhaps it’s pure and simple money-lust mixed with the millennial ethos of following your passion. However it happened, suddenly everyone’s got a dream and an app. Everyone who doesn’t is an angel investor. We’re even exporting startup swag by the box to startup fanboys around the world.
Eventually, something’s gotta give. Most recently that “give” has taken the form of the so-called Series A crunch. We’ve argued that a Darwinian thinning out of startups could be a good thing. The tech world is overheated with boring, derivative widgets, FNAC ideas, and apps. Not all of them deserve a gold star.
But for every 100 cynics who have seen too many pitches for the latest subscription-photosharing-SoLoMo-crowdfunding app, there’s a contrarian believer who wants to save good ideas from bad execution.
Operating under the radar in Silicon Valley is a network of experienced founders and builders who’ve made their names turning around ailing startups. They’re hired guns, parachuting in at the eleventh hour to rescue dying companies. Until recently, they’ve operated independently with their own networks. But last year, entrepreneur and tech executive Steve Hogan formalized the operation. The result, a firm called Tech-Rx, is Silicon Valley’s first turnaround shop.
Hogan is the kind of guy that puts you immediately at ease, like a jovial favorite uncle. It’s an important quality to have when your line of work consists of demanding control of a beloved company from its founders. Even when doling out searing criticisms of startups, Hogan’s candor is unflappably positive. He’s been around Silicon Valley since 1968, when he took his first engineering job, and he has the war stories to prove it.
He also invested some of his earnings in venture funds. By those bad survival odds I described before, most of the companies his funds invested in did not survive. And yet, watching so many of them fail didn’t sour him on startups. It made him even more hopeful. “Our mission [at Tech-Rx] is not to make these companies go away,” he says. “It’s to try to get them on the path to salvation.”
He’s a believer in the Silicon Valley promise that innovation drives society forward. His job, however, has a slightly more sinister connotation. As he described the way Tech-Rx works with companies, I couldn’t help but think of Jonathan Banks’ chilling character Mike in “Breaking Bad.” Mike is the guy the drug lord calls to clean up a mess every time Walter White and Jessie find themselves in a pickle. Dead girlfriend? Wife causing problems? Each time, Mike shows up with a pair of gloves and a gym bag full of the right tools. A few hours of discreet, methodical work later, and the mess never happened. This archetype isn’t unique to “Breaking Bad” — the The Wolf character in “Pulp Fiction” plays a similar role.
With slightly more noble motives than his fictional counterparts, Hogan has been acting as a startup fixer-upper in various forms for the last few decades. Over the course of his career, he’s founded and sold two companies, acted as CEO of five companies that sold, and directed turnaround efforts at another 14 companies, 11 of which sold for a respectable return. (Three, he says “died miserable deaths.”)
According to Frank Vargas, a Partner at Rimon Law Group who’s known Hogan since he worked as a VC lawyer at Wilson Sonsini in the 80s, Hogan’s experience as an operator sets him apart from Six Sigma ninjas fresh out of business school, slick private equity pros from Wall Street, or VC’s who haven’t built companies themselves. “You have to really understand how a company works to fix it really quickly. To learn that, you really have to have operated,” he says. “What these guys have is the experience. That’s what makes them good.”
Hogan decided to formalize his turnaround services last year, creating a network of 12 industry executives to save failing startups. In addition to his twelve partners, he’s raised a fund of an undisclosed size from a large network of angels to financially prop up the companies. The idea of a turnaround shop isn’t new — there’s a whole category of turnaround investors in the private equity world. But Tech-Rx is the first one focused on tech, run by tech operators. Its mission — to sustain innovation — is as Silicon Valley as it gets.
Since launching Tech-Rx officially this winter, Hogan has struck two, with a dozen more in the pipeline. The company doesn’t disclose its investments because of the possible negative signal — it is not often publicly known that these companies are in trouble. Not to mention, VC’s rarely want to openly discuss an investment that’s gone bad. “When that occurs, they drop them off their website until they either die or are cured,” Hogan says.
Hogan is quick to point out that this isn’t about creating the next Facebook. Once a company reaches him, it’s already missed that opportunity. No, the ultimate goal for each situation is to sell the fixed-up companies in two to five years. The fact that this plan includes minting a solid return for his network of angel investors doesn’t hurt the cause, either. If successful, he’ll achieve at 3x to 5x return in that time frame. Venture capital firms start out aiming much higher over a longer period of time, but few of them actually do it. If Hogan manages to hit that target, he’ll beat the pants off of the actual average returns for VC funds.
Now, around 20 companies approach Tech-Rx each week, many of which are not in true distress, they’re just “Series A Crunch victims.” They are the zombies of Silicon Valley. They’ve got enough cash — or, in some cases, revenue. They don’t need to shut the doors immediately, but there’s no more money coming to take them to the next level.
Tech-Rx is most interested in companies that are on the brink on death — weeks or even days away from the deadpool. Typically they’ve raised between $1 million and $5 million to build a product that hasn’t gotten much traction. Their investors aren’t willing to put in more money, and they can’t find a buyer (though Yahoo seems to be singlehandedly changing that trend).
Hogan and his team assess the situation within two days. They first check whether the top talent has stuck around. “We have to make sure the crown jewels are with the company,” Hogan says. “We can’t do much if it’s just a bunch of worker bees and fed-up investors.” Similarly, the “attitude and integrity,” of the remaining team is a big factor. Tech-Rx recently pulled out of a deal on the day of the signing after the founder made a casual remark about walking away if it didn’t work out in a few months. Then Hogan’s team examines financials, which are often sloppier than you’d imagine for young, money-losing companies, he says. Lastly, they assess the landscape of potential buyers. If there are no logical buyers in sight, Tech-Rx won’t step in.
When the firm does step in, it offers terms that are slightly more benevolent than a company would get in a cram-down round, where the white knight investor takes 95 percent of the stock, simply because the company has no other options. Tech-Rx invests between $500,000 and $5 million into companies, taking 50 percent of the common stock, offering 20 percent to any new management it brings in, and leaving 30 percent for existing shareholders and founders. That’s usually a relief to investors, Hogan says, because there’s still hope they’ll at least get their money back. By this point, they were expecting a big zero.
From there, Tech-Rx calls on its network of partners with expertise ranging from software to biotech, pharma, and hardware to fix things up.
While he’s at it, Hogan has taken a stab at re-inventing venture fund structures, too. Hogan structured Tech-Rx’s angel network as a restricted angel fund rather than a traditional 10-year venture fund. He was burned on investments in four small venture funds, three of which returned zero capital (the other returned .18x). The funds he backed went off-target from their initial strategies, as firms are wont to do when they have 10-year life cycles. As Hogan is helping failed companies find salvation, it’s almost as if he’s also getting his own redemption for those failed VC investments.
“No one likes the fund model anymore,” Hogan says, joking that many of his angel investors are older and want more liquidity. “If we get into a 10-year fund, half of these people will be dead by then,” he says with a laugh.
So Tech-Rx is structured as a restricted angel fund. Investors are in control of their individual equity in Tech-Rx companies and can choose whether to invest in each company. They write $20,000 or larger checks, and they’re conditioned to make a decision in five days given the urgency of most turnaround situations.
Not every turnaround is going to succeed. Hogan’s hope is that with his experience and network, he can create the conditions most conducive to success. Even through the messy, sometimes gut-wrenching slog of whipping failed companies back into shape, Hogan is a relentless optimist. He doesn’t like seeing good products disappear. He doesn’t like seeing entrepreneurs’ hard work go to waste. And most importantly, he believes in innovation, however generic and all-encompassing the term may be. “This is entirely driven,” he says, “by the believe that all innovations are ultimately good for society.”
[Image courtesy Wikimedia]