A Note on Innovation, Capital Formation, and the Role of the Society of Kauffman Fellows
Phil Wickham, Charter Class
Until the near-collapse of the global financial system in September 2008, innovation was seen as peripheral to the overall economy. The people who practiced it were a collection of high-IQ nerds and cowboy/cowgirl investors with appetites for risk, relegated to insignificant corners of corporations (R&D labs), universities (entrepreneur centers at business schools), and the suburbs of Silicon Valley, Austin, Boston, Seattle, and so on.
And then the tide went out.As the winter of 2008–2009 unfolded, it became clear that Wall Street was no longer about capitalism, but about gambling and criminal mischief. The nation's ability to fund its most promising growth companies (a slow and difficult business) had been replaced by quick-profit computer-automated hedge fund trading systems too complex and fast-moving for any regulator to understand.1 Corporations and endowments bet heavily within these systems, and yet another group of companies made a fortune insuring these bets; the ending was ugly, and the promise of a burgeoning "financial services" sector full of high-wage job growth ended with it.In 2009, innovation was the "last man standing," perceived as the only hope to generate real economic growth and offset the decay of our established industrial job and tax base; this perception has been proven with a tidal wave of data over the last two years. New impact data indicates that the aggregate revenue run-rate of all Kauffman Fellows-affiliated investments exceeds $130B, approaching 1% of the U.S. GDP. Innovation has leverage.Venture capital practiced professionally with a focus on enabling society's best entrepreneurs can and does accelerate the growth of high-impact organizations, resulting in outsized gains in wealth, jobs, and tax revenue. In the following brief, I discuss the definition of innovation underlying the Center for Venture Education, explore the foundations of capital formation, and introduce the Society of Kauffman Fellows as an organization based on those ideas.
Defining Innovation
In order to dialogue on a topic, the parties must first agree on its definition. Definitions of innovation are often relatively complex and consider such factors as "research and development… software, human capital, design, marketing, and new organizational structures."2 These elements are definitely part of the picture, but for the Society of Kauffman Fellows the definition is simpler or arguably more focused: innovation begins and ends with the quality of organization-building.
Within this framework, the quality of an organization is determined by the quality of the solution it aims to deliver, the size of the opportunity, and the organization's ability to reach the largest percentage of users served by that opportunity. Innovation solutions can address pain and disease, with Genentech as the U.S. pillar of medical innovation, or enable new and productive human behavior—Cisco, Amazon, and Google are extraordinary examples of communications and commerce innovation.Innovation identifies technologies and potential market opportunities, turns ideas and inventions into compelling solutions (products and services), and builds an infrastructure that sells, delivers, implements, and supports those solutions.Innovation as organization-building is an overarching concept with an array of key human components; each person's role is required for the success of the ensemble. Designing a widget in an isolated lab or garage, a product that might enhance someone's life or career, is the role of the "inventor." Identifying and fulfilling a new market need for a customer—often before the customer knows herself—is the "entrepreneur." The "engineer" is the solution designer between the inventor and entrepreneur. Scaling a small group of dreamers into a real company is the role of the "manager," while the person who funds these dreamers is the "venture capitalist." Walk-on roles are played by researchers, lawyers, accountants, policymakers, and others. The cast list for successful innovation performance is sizeable indeed.
Understanding the Foundations of Capital Formation
It seems every corporation, university, and government entity has developed a keen interest in discovering the recipe for innovation, thinking, "Why can't we build our own great new organizations and reap the benefits?" However, grasping the recipe is challenging without a focused definition of innovation providing simple metrics for gauging success. Add a lack of awareness of the context, nuanced interplay, and complexities of the many professional roles comprising an innovation ecosystem, and success becomes all but impossible.
We commonly employ the skyscraper metaphor at the Society of Kauffman Fellows when deconstructing the innovation recipe. Leaders from all walks are fascinated with building gleaming towers, especially if they are taller than their neighbor's towers. We think this effectively captures the tone around the world these days with regard to enabling innovation ecosystems: Build it fast and build it tall. Like the steel, glass, and concrete of a skyscraper, the basic building materials of innovation are similarly obvious: intellectual property, markets, and entrepreneurs. However, every distinct entity has enough inventiveness, access to opportunity, and people who can connect, so why are the vast majority of gleaming towers of innovation built in Silicon Valley and almost nowhere else?There is more to building a successful innovation ecosystem than access to the basic building materials. At 160 stories and over 2,700 feet high, Burj Dubai is (for now) the world's newest and tallest gleaming tower. Arguably more impressive is the 170-foot-deep, 110,000 ton steel-and-concrete foundation upon which the tower sits—as with all gleaming towers, before you go up, you must go down. The higher your expectations, the deeper and more stable your foundation must be.As with skyscrapers, the secret to success lies in the proper foundation. So what does the foundation of innovation look like? How do you create a deep foundation for the next great solution-delivering organization?Margaret Wheatley wrote a seminal book3 in 1992 describing the different "laws of physics" that apply to nascent innovation organizations. Unlike the "Newtonian" laws that apply to large corporations, the U.S Army, or a third-world government, innovation operates in a "quantum" environment. Walk into any large, established organization and odds are you can quickly understand power structures. If the right person applies force to an object, it will move in a predictable way.In Silicon Valley, however, we have a dynamic mix of objects defined as much by individual attributes as they are by their relationships to other objects. The objects are difficult to map since they can change phase instantly, the way a Nobel Laureate from Stanford can cross the street to a Starbucks and suddenly go from the pinnacle of the academic world to the least important person at a small table of innovators trying to build a new organization.The "foundation" of innovation, as we see it, is the science of capital formation that the Society of Kauffman Fellows was created to study and codify. This science is built on three pillars: awareness, assessment, and alignment. Being both more complex and more subtle, awareness is a topic for a longer, more in-depth article; here I focus on assessment and alignment. These two pillars of capital formation begin with an understanding of who all the players who touch the innovation process might be and how they fit together: who is key at the outset of a project and who should be brought into the organization-building process at a later stage.Once the key start-up team is identified, the proper effort must be made to align that team around a narrative arc (business plan): Why are we here today and where do we want to go together in the future? How will we resource and nourish that narrative arc? Young organizations are like children, just as susceptible to malnutrition or obesity with all their negative side-effects. With expertise in resourcing must come an ability to design incentive structures to keep the founding team moving in a common direction, understanding that the goal will shift multiple times as the ground starts to shake under the tower and the wind starts to howl at its upper levels.This is not an intellectually challenging concept, but it is behaviorally challenging when instinct and political pressure push a group to skip the digging and supporting and move directly to the tower-building phase. We have observed that the failure to build proper foundations causes more failure than does bad technology, incompetent management, or small markets—in fact, dysfunctional capital formation is the silent killer of most innovation.
Introducing the Society of Kauffman Fellows
The Society of Kauffman Fellows was created in 1995 with the goal of building a community of entrepreneur-centric, values-driven investors that would become influential enough to enhance the entire innovation capital "food-chain." At the time, many experts in and around innovation asked why it was even needed; in fifteen years, we think we have found the answer to that question as well as support for our vision for the next fifteen years.
When a team of innovators comes together with the dream of building an exciting new organization, it will not be long before the venture capitalist gets involved. Often characterized and even romanticized as anywhere from hero to villain, the reality is that the venture investor plays a critical and well-defined leadership role in the early stages of successful innovation.Venture capitalists have better patterns of best practices and access to key resources than any other player in innovation. While the entrepreneurial team is best positioned to lead the structure-building process, we believe that the foundation-building process should be led by the investor. The best venture investors are coaches to an entrepreneurial team, so not only do they help design the foundation of the organization, but they also continue to lead the alignment and constant realignment process until the dream is a stand-alone entity.As of this writing, the Society of Kauffman Fellows is comprised of Fellows and Mentors in 180 firms in 28 countries and across six continents. Our vision is to optimize the awareness of and best practices for the science of capital formation globally. The Society is both our intellectual property engine and our distribution system for this effort.Every year we recruit 25-30 new candidates for the Society of Kauffman Fellows, each of whom is required to do original fieldwork in the science of capital formation. In this report you will find a selection of such studies from recent years, and much of this content will become standard curriculum in our global efforts.
Phil Wickham
Phil is President and CEO of the Center for Venture Education. Phil was in the Charter Class of the Kauffman Fellows Program, serving his fellowship under Ed Kania at OneLiberty Ventures in Boston, and was founding Vice-Chairman of the CVE Board. Prior to joining the CVE staff, Phil served as a General Partner at JAFCO America Ventures and at Copan, based in Munich, Germany. In his venture career, Phil made over 30 investments, including Ikanos, Web Methods, Com21, Emergent, and Trilibis. Phil received his BS from the University of Arizona and his MBA from Rensselaer. He serves on the board of the non-profit SVASE (Silicon Valley Association of Startup Entrepreneurs) as well as on the boards of Trilibis and S2 Technologies.
1 David Weild and Edward Kim, A Wake-Up Call for America: A Study of Systemic Failure in the U.S. Stock Markets and Suggested Solutions to Drive Economic Growth (Chicago: Grant Thornton, 2009).2 Organisation for Economic Co-operation and Development (OECD), Interim Report on the OECD Innovation Strategy (Paris: OECD, 2009), 4, quoted by Innovation Ireland, Report of the Innovation Taskforce (Dublin, Ireland: Stationery Office of the Government Publications Office, 2010), 2.3 Now in its third edition: Margaret Wheatley, Management and the New Science (San Francisco: Berrett-Koehler, 2006).
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