Serving up a whole pie or just a slice…

March 7, 2011

I recently met with a university researcher with a very exciting platform technology that could be used for a number of applications, for example: manufacturing batteries or solar cells.  We talked about the fact that there were multiple markets and business models.  He could sell equipment, license technology, go into manufacturing a final product or a component, etc.

One of the topics that came up was whether a holding company structure was best – create a top level company to hold the IP and do initial research and then spin off market specific companies (maybe one makes solar cells and one makes batteries).  I’ve had the same discussion with a number of other platform technology companies in the early stages.  In almost all cases, I am not in favor of complex parent-daughter company structures because:

First, if you are raising capital, the holding company structure may make it more difficult.  Many times, at the early stages, you don’t know enough yet to pick the business model or even the best market.  It is going to take some time and money to figure it out.  As an investor, we recognize the need to adapt the plan as new knowledge about the technology performance, cost and the market rolls in.  We want to participate when the “aha!’ moment hits and the market and busness model becomes clear. So, I tell founders that we don’t want to invest in a slice of their intellectual property.  VC’s look to invest in a company with flexibility to adapt, not a technology or narrow market.

Second, building separate but cooperative teams just adds too much complexity to an early stage company.  I am a big believer in team dynamics, communication and aligned incentives – all of which are made difficult when part of the team works for a company that is a licensee of another. R&D alone is a problem – if R&D is not part of the market focused daughter company, can it really depend on the holding (parent) company to solve urgent problems?  No way would an investor want to put money into a daughter company that is unable to both solve it’s own problems and innovate and create more products (later I’ll do a post on single product companies vs. market facing innovative companies).  Would a team at the parent company be fully incentivized to solve the daughter company problems?  VC’s invest in the best people and want them have all the tools and incentive to build the right technology.

Third, if carving the intellectual property up into separate companies makes sense, you can do it later.  I am not opposed to selling off parts of a company or spinning it out later.  In fact, it may make perfect sense.  Hold off on making the structure complex before the reason to do so is crystal clear.

Fourth, because I think most VCs feel the same way as I do about this, when I see startups structured this way, it can be something of a warning about the experience level of the company’s legal team.
It turned out that the researcher with the manufacturing technology had an interesting underlying reason for wanting to go with a holding company structure.  It was not to try to optimize financial returns by selling parts to investors.  His objective was to keep the R&D from becoming completely focused on supporting one market, ignoring other applications for the platform technology.  You can read my prior posts about experimentation and adaptation to see why I totally buy in to this objective.  That being so, creating a holding company structure at the start is not, in my opinion, the best approach.  I think that, in the sort and medium terms, he can keep a vibrant, opportunity-driven R&D focus initially by selecting investors that appreciate the value of innovation.  Later, the size of the market opportunities and availability of funds should steer the R&D in any company toward the most valuable targets. 

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