Be Careful of Family and Friends as Board Members

My last post was on the importance of outside, knowledgeable board members and how some entrepreneurs unwisely try to control their boards.  I am expanding on that article with my experience with family and friends in management and on the board.

Gary Mahn and I cofounded Learned-Mahn in the early 1970’s.  When Gary and I joined together we were best friends. Bea Black had come to work for me right out of college. Later my wife Nancy Learned (now Briggs) joined us.

We were well educated, hard working, and totally dedicated to the success of the company.  But even with these attributes, I believe our personal relationships got in the way of our success.

When family and/or close friends run a company, management is often by consensus.  The problem with this is that options, which may be good for the organization but bad for an individual, are rarely discussed, much less implemented. Further, it is difficult for the leader to hold his or her friends and family members accountable. 

Our first board consisted of Gary (best friend), Bea (who I had mentored since she graduated from college), Nancy (my wife), my father (who had invested in the company) and me. For a while Bea’s father (who had also invested in the company) also served on the board. 

We thought at the time we were doing the right thing; but as I read this, it was ludicrous. I would never again invest in a company with this degree of family and friends in management and on the board. Boards need to inspire and to hold management accountable. But when management is the board, and half of it is family, there’s no real accountability. 

And if the company tries to change that structure, the results are predictable—everyone reverts to protecting their own interests rather than doing what is right for the company. Gary, Bea, Nancy and I all believed we should be on the board. After all, we were the founders and managers, we had capital invested and felt we should be on the board by virtue of our stock positions.

My father was a good businessman, but he knew little about the markets or the technology we were deploying.  We felt there were others who could bring more to the boardroom. When I tried to talk my father into resigning, he threatened a proxy fight.  This obviously impacted our relationship, but Dad and I were able to resolve our differences

Ultimately Gary, Bea and I left the company, Dad resigned from the board, and Nancy was made the president. The company made the transition from an inside board to an outside board. Ray Smelek, who was a senior vice president at Hewlett Packard, Chuck Jepson who left HP to run a technology company in California, and Gary Atkins who left HP to start Extended Systems joined the board. Their impact was huge. They demanded performance, constantly pushing Nancy and her team to move more quickly, to grow more rapidly.

I know the counsel of the board was often frustrating to management.  Its demands on management and the company were difficult.  But in hindsight, I believe the success the company ultimately achieved was due primarily to having a skilled president clearly in charge without any family or friends as employees, and to having an experienced, outside, demanding board. The company was sold to National Data Corporation of Atlanta in 1994 in a successful exit for the shareholders.  In 1999 National Data Corporation closed the Boise office.

Dr. Kevin Learned is the Director of the Venture College at Boise State and an experienced angel investor.  208-426-3875, kevinlearned@boisestate.edu

Don't Be Afraid of Outside Board Members

Its board of directors governs a corporation.  The owners or shareholders elect the board; the board delegates management of the company to management.  In my view the board has two principle tasks:  (1) to hire, evaluate, and when necessary dismiss the CEO and (2) to see that there is an effective strategy in place and being executed. 

In early stage companies, the founders generally form the board.  They are the shareholders, the board members and the officers. But when they begin to raise capital, the new shareholders will want to have something to say about who will serve on the board.  This frequently makes the founders nervous as they want to stay in control of their company’s and their own destiny.

Often we angels see boards made up of two founders and one outsider elected by the investors, or the CEO and his or her spouse, and one outsider.  I believe when the CEO does this, he or she is missing an opportunity to bring put in place a board that will not only bring expertise to the company, but will also hold management accountable and thereby accelerate the company’s progress.

When we had Learned-Mahn back in the 1980’s, we had an all inside board consisting of the four founding officers and my father.  It didn’t really work very well.  I was the CEO and the other officers worked for me.  But they were the directors, and I worked for them.  My father brought really interesting family dynamics into the boardroom where they didn’t belong.  And what good was a board meeting when all of the officers worked together all day long?  We didn’t get any outside perspective. 

After agonizing discussion, we decided to bring in outside board members to replace the three management directors that reported to me.  We didn’t replace my father, but family dynamics are the subject of another article at another time.  We were able to recruit experienced business people to the board who could bring their experience to our company.  They included Ray Smelek, who brought HP to Boise, John Dahl, who had just retired as the President of the Simplot Company, Gary Atkins, CEO and Founder of Extended Systems and Charles Jepson who was an early HP employee, and an experienced small company CEO.  

We got expert advice and counsel, and for the first time, I became accountable to people who weren’t my employees.  In hindsight, I think that was one of the best business decisions we ever made.  The outside board made us face our weaknesses and guided us to successful strategies. In fact, Smelek’s counsel convinced us to see ourselves as a financial software company rather than a company for banks.  But for him we might never had seen this blind spot because we were to close to the day-to-day operations.

Today I serve on the board of Medical Management, Inc. The company manages both physician-owned and hospital-owned medical clinics throughout the Pacific Northwest. Until a year ago the board members were all company employees who owned company stock.  A year ago the CEO, Jim Trounson took the difficult step of asking the internal board members to resign.  He replaced them with Dr. Ted Epperley, CEO of the Family Practice Residency program in Boise and Dr. Pat Hermanson, a retired hospital administrator and currently a professor of healthcare management at Idaho State, along with myself. 

We have served a year and were just re-elected by the shareholders, so apparently the shareholders are happy with the change.  The boardroom is a much different place that it was before we were elected.  We bring our diverse perspectives to the company and we hold company management accountable for performance.  The results after the first year have been terrific.

When small company management tries to hold onto control of the boardroom, I believe it is making a big mistake.  The team is giving up the information and counsel they could be receiving, and they are shying away from accountability.  Most entrepreneurs are so focused on execution, they lose sight of the big picture. An outside board will force you to confront your weaknesses and help you see opportunity where you may only see problems.

Dr. Kevin Learned is the Director of the Venture College at Boise State and an experienced angel investor.  208-426-3875, kevinlearned@boisestate.edu, http://kevinlearned.blogspot.com/

Market Feedback is Critical to Early-Stage Companies

The local Boise angels like to invest in “Seed-Stage” companies. A seed-stage company has a workable product or service in the market place and is beginning to generate some revenue. It needs to test the market and learn which customers will find the offering most attractive, how those customers can be reached and what product features are of most interest.

Often what happens is the entrepreneurs will learn that they need to make changes to the product and/or their original market is not the most interesting market.  Many years ago the company I co-founded, Learned-Mahn brought a computer-based accounting system to the market.  Our hypothesis was that most small businesses would find this attractive.  At the time most did their books by hand.

Our market tests helped us learn that our product cost too much for small businesses, and there was no efficient way to reach the target market.  But as we attempted to sell the system, we learned there was a niche with certain large companies that we could profitably reach and who needed what we had to offer. We went on to license the software to AT&T, Campbell Soup and the 1984 Olympics to name a few.

Good entrepreneurs know that almost never will the first version of a product be what the customer will pay for and that frequently the initial target market will not be most productive market.  The most important step for them to take is to bring something to the market as quickly and inexpensively as possible so that they can start to get feedback from real customers. 

We have learned that no matter how much you know about a market, you need to get out of the office and talk to that market.  And the best way to talk to a market is to ask it to actually purchase something. When you do, you get real information about real consumer behavior.

Steve Jobs knew this better than most.  His entire career he brought out less than fully featured products and got instant market-based feedback. Think of the changes that have been made to the iPhone since the first one was released, or the iPad.  Apple is superb at learning from the market place and then releasing a new version of a product that captures a much larger market.

An example of a local company who has brought an early service to the market and learned from its experience is Social Good Network.  Both the Statesman’s reporters and I have written about Social Good Network before.

The Boise Angel Alliance has invested in Social Good Network through its two angel funds. (Full disclosure, I am an investor in those funds.) The purpose of our funding was to enable the company to test its services in the market.

The company provides an on-line fund raising community for charities.  It offers several services:

•       Consumers can shop on line merchants through the community.  When they do, Social Good Network earns a commission. The consumer can then designate 50% of that commission to a charity of his or her choice.  
•        The consumer can make a direct donation to the charity through the on line community. 
•        Charities can install unique patent pending software directly on their web sites, which allows contributors to make donations without leaving the charities’ sites.

The November/December time frame was a perfect time to test these services, both shopping as well as contributions.  Their theory was that they were a consumer centric community focused primarily on shopping.  They learned that the charities were more excited about the donation services.

Armed with this information, the company now knows where to focus its valuable resources. It is changing its software road map and marketing to respond to the information it gained from taking the initial product to the market place.

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Kevin Learned is the Director of Venture College at Boise State University, and the co-founder of two angel funds which invest in early stage companies in the Boise, Idaho area.

Boise Angel Alliance Year in Review

The Boise Angel Alliance had the most active year in 2012 since we created our first angel fund in 2007.

There are many individual angels in the valley. So far as I am aware, there is only one formal angel organization, the Boise Angel Alliance. The purpose of the Alliance is to encourage the availability of capital for entrepreneurs.  It has created two funds, the Boise Angel Fund and the Treasure Valley Angel Fund.  The below data are drawn from the records of the two funds.

The Boise Angel Fund made its last angel investment in 2012, and is now fully committed. The new Treasure Valley Angel Fund was formed and as of this writing has $1.1 million of committed capital and continues to raise additional capital. 

We had our first successful “exit” in 2012. An exit is angel-speak for selling or otherwise disposing of an investment.  We invested $45,000 in a Spokane based company along side the angels there.  We were paid about $188,000 for our stock and have the potential for additional proceeds.  We have had one unsuccessful exit, a bankruptcy where we lost our entire $25,000 investment. 

In 2012 the funds invested $500,000 in five companies.  This is the most that has been invested in one year since the first fund came into being in 2006.  Simple math would suggest that the funds invested an average of $100,000 per deal. But that ignores the leadership of the funds. 

Once we commit an investment to a company, we then try to help raise additional capital. That additional capital may come from our own members, other groups in the Northwest with whom we have trusting relationships, and other angels that may study our efforts and decide to invest along side our investment. The total capital raised by those five companies in these rounds was $1,395,000 or about two dollars additional capital for every dollar invested by the funds. 

The five companies are:

CoreConcepts.  This is a local manufacturer and distributor of high performance outdoor clothing sold through specialty retailers.

MealTicket.  Meal Ticket enables food manufacturers to promote products directly to restaurants and other food service providers.

Sawtooth Ideas. Sawtooth provides an online marketplace where designers of woodworking plans can sell plans, along with innovative software that turns traditional two-dimensional plans into three-dimensional, dynamic plans.

Social GoodNetwork.  They enable consumers to shop on line and do good, by capturing referral commissions and allowing the shopper to designate a portion to charity.

VoxbrightTechnologies. Voxbright develops voice recognition software for cable television and Internet TV platforms.

The angels also provide mentoring and advice to the companies before and after the investment transaction.  One of our members serves as a director in four of the five companies.  Our collective membership of about fifty individuals is actively involved in promoting and assisting the companies wherever we can.  For example, I purchased and proudly wear clothes from Core Concepts.  My family and I shop on line through Social Good Network.

These companies will have an impact on our local economy.  At the time of our investments, they employed about 15 people.  Over time we expect that their employment will grow significantly.

Since 2007, our two funds have invested a total of $1,385,000.  Those companies have raised more than $19 million in the rounds in which we participated.  The Boise-based companies as December 31, 2012  had created about 110 new jobs.  

We recognize that these two funds can meet only a small portion of the demand for risk capital by our local entrepreneurs.  Many entrepreneurs were turned down.  Undoubtedly some of them were worthy of investment. We encourage others in a position to do so to consider investing a portion of their capital in valley entrepreneurs.  The Boise Angel Alliance stands ready to assist.  Both entrepreneurs seeking funding and those considering investing can learn more through Alliance website.

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Dr. Kevin Learned is on special assignment with the Division of Research and Economic Development at Boise State. He was the co-founder of Learned-Mahn, Inc., which he believes was the first commercial software company in Idaho.  He is past president of the Boise Angel Alliance and an investor in its funds, the Boise Angel Fund and the Treasure Valley Angel Fund.  He can be reached at kevinlearned@boisestate.edu, 208-426-3573

Update on Crowd Funding

On April 5, 2012 the President signed into law the JOBS act, which stands for “Jumpstart Our Business Startups.” I wrote about this act earlier (see The JOBS Act will change fundraising for startups, April 18, 2012).  We are gradually learning more about how the act will be implemented.

 I recently participated in an on-line seminar produced jointly by SCORE (the Service Corps of Retired Executives) and the National CrowdFunding Association (http://nlcfa.org/).  SCORE provides free counseling services to small business people.  There is an excellent local chapter in Boise (http://www.idahotvscore.org/).  My fellow Business Insider columnist Norm Becker is a SCORE volunteer.

 Crowd funding is the act of soliciting funds from groups of people who share a common interest.  Crowd funding portals such as Kickstarter (http://www.kickstarter.com/) and Indiegogo (http://www.indiegogo.com/) provide platforms where entrepreneurs can solicit contributions and pre-sales to support their projects. The portals earn commissions on the funds raised.

 Today they cannot sell stock, but once the JOBS act is implemented they will be able to do so.  The JOBS act directed the US Securities and Exchange Commission to develop rules for selling stock using crowd funding.  Current expectations are those rules will be issued in the first half of 2013.

 Crowd funding is big and growing rapidly. The amount of money raised in recent years and projected to be raised according the Association is:

 Contributions and product pre-sales only

2009            $530 million

2010            $854 million

2011            $1.401 billion

2012            $2.806 billion

 Contributions, product pre-sales and stock sales:

2013            $6.058 billion

2014            $16.615 billion

 There will be an approval process for portals like Kickstarter and Indiogogo. Once the rules are released and the portals approved, I expect the process to work something like this:

 1.  The entrepreneur submits his or her business plan and stock offering to the portal. The offering must have a minimum amount to be raised and a deadline.

2. The portal approves or disapproves the offering.

3.  Once approved, the offer is posted and the crowd (the many individuals expected to watch the portals) sees the offer and makes individual decisions whether to invest or not.

4.  Individuals interested in investing submit funds to the portal.

5. The portal holds the funds in escrow until the minimum is raised. 

6. If the minimum is not raised by the deadline, the funds are returned to the investors.  If the minimum is raised, the portal transfers the funds, less its commission to the company.

7. The company transfers stock to those who purchased it.

8. Thereafter the company conducts its business and reports to its shareholders.

While the potential to help entrepreneurial businesses is great, it won’t be a panacea and there will be real costs in time and money. Businesses without outside shareholders are often run for the benefit of the manager/owners.  With outside shareholders, they will have to be run in a business-like manner without favoritism to the founders and managers. 

Raising capital through crowd funding will be a time-consuming process, both before and after selling stock. The business will have to be prepared to assume the record keeping and reporting obligations that come with having many shareholders. And the officers and directors will likely be at risk should the rules not be followed before, during and after the offering

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Dr. Kevin Learned is on special assignment with the Division of Research and Economic Development at Boise State. He was the co-founder of Learned-Mahn, Inc., which he believes was the first commercial software company in Idaho.  He is past president of the Boise Angel Alliance and an investor in its funds, the Boise Angel Fund and the Treasure Valley Angel Fund.   He can be reached at kevinlearned@boisestate.edu, 208-426-3573. This piece was first published in the Idaho Statesman's Business Insider.

CircleUp is a Potential Source of Capital for Idaho Entrepreneurs

"CircleUp is an online social marketplace where individual investors can invest in small private consumer companies and be part of their success" https://circleup.com/

Idaho-based company Prosperity Organic Foods (www.meltbutteryspread.com) recently concluded a successful raise of equity capital using CircleUp. Disclosure:  I am an investor in Prosperity.  Prosperity produces and distributes a line of delicious and healthy substitutes for butter under the brand Melt® Organic.

Prosperity CEO Meg Carlson reports the process was quick and easy.  It was about eight weeks from the time Prosperity first submitted documents to CircleUp until it received the funds.

I visited with CircleUp COO and Co-Founder Rory Eakin. CircleUp was founded with the vision of providing the means for small consumer products companies to efficiently reach accredited investors.  Growing consumer products companies need capital to support their inventory and receivables, but it is often extremely difficult for small consumer products companies to raise expansion capital. 

Companies most appropriate for CircleUp’s services already have some traction in the market place and are seeking equity capital to support expansion.  In the case of Prosperity, this was the company’s third round of investment capital and will support national expansion from about eight hundred stores to several thousand.

Companies seeking capital submit an on-line application.  CircleUp reviews the application, does a background check on the entrepreneurs, and conducts its own research on the company and the industry.  They accept around 2% of the applicants.  Once accepted, the investment opportunity is opened up to potential investors.  Companies must declare a minimum and maximum raise.  Unless the minimum is reached, the company does not receive any funds.  After the minimum is reached, the company can continue to raise capital until the maximum is reached. 

For investors, there is a simple process to join CircleUp.  You must certify that you are an accredited investor. Once your account is set up you can then browse the potential investments. Each potential investment has a deal room where documents have been posted.  Potential investors can ask questions of the company management and exchange comments among themselves. 

Once an investor decides to make an investment, money is sent to CircleUp’s escrow account and held until such time as the company achieves its minimum raise. Then the funds are transferred to the company and the company issues its investment certificates to the new shareholders.  CircleUp withholds a commission for their services.

CircleUp is similar to the coming crowd-funding platforms authorized by the JOBS act (The JOBS act will change fund raising for startups).  Unlike the anticipated crowd-funding platforms, CircleUp is limited to accredited investors only. Accredited investors have a net worth of more than $1 million exclusive of the equity in their primary residence or meet an income test.

Based upon Prosperity Organic Food’s successful experience, other Idaho entrepreneurs in the consumer goods space may want to consider CircleUp for a portion of their capital needs.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is past- president of the Boise Angel Alliance (www.boiseangelfund.com), and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

Treasure Valley Angel Fund -- A Lesson in Raising Capital

The valley’s second angel fund, The Treasure Valley Angel Fund is now open for business. It reached its first close milestone of $750,000 in July.  Full disclosure:  I am an investor in the fund and my firm, Loon Creek Capital helped guide the fund through the organizational effort.

The new fund presents a case study in the process of raising seed capital in Idaho. It took about 24 months from early discussions until the capital was raised.   Active fund raising began in January of this year and reached the minimum in July. 

Why does it take so long to raise capital?  There are several reasons:

• Investors are conservative.  There are always more reasons not to invest than there are to invest. 
• Investors are busy.  It’s hard to get the attention of busy people. In most cases someone has to sit down personally with an investor to review the business plan, explain the risks and the potential benefits. It takes time to get these appointments.
• There is usually a “minimum raise.” Most security offerings have a minimum amount to be raised before capital can be released to the company.  In the case of the angel fund, that minimum was $750,000.  While a minimum raise protects the investors, it usually means it will take longer to conclude the offering and begin to put the capital to work. 

The implication for entrepreneurs is it takes a long time to raise capital.  You must plan for this and be sure you are beginning to raise capital well in advance of the time you actually need it. 

Now that the fund has reached its minimum raise, it is accepting applications from entrepreneurs for funding.  Applications will be managed by the parent organization, the Boise Angel Alliance and can be submitted at www.boiseangelfund.com. 

In the first fund about 5% of the applicants actually received funding.  I don’t expect the second fund to be any less restrictive.  So entrepreneurs should make sure they have done their homework before applying.

The web site contains information on the kinds of deals in which the fund will invest, the typical terms, and the processes used to make the investment decision.  I strongly advise entrepreneurs to read through this information before submitting an application.  And they are welcome to contact me for an informal discussion if they believe that would be helpful.

The fund is authorized to raise a total of $2 million and will continue to seek qualified investors as it begins considering investments in local entrepreneurs.  To be qualified, investors must be residents of the State of Idaho, must qualify as an accredited investor (generally a net worth of more than $1 million not including the equity in his or her primary residence), and must represent that the investment does not exceed 10% of the investor’s net worth, exclusive of the investor’s home, automobiles and furnishings.  Additional information for potential investors is available at www.treasurevalleyangelfund.com.

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Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is President of the Boise Angel Alliance (www.boiseangelfund.com), an investor in both of its funds, and is a principal in Loon Creek Capital (www.looncreekcapital.com) which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875.