Silicon Valley vs. Saginaw Valley
I’ve been making trips around the state talking about the unique aspects of BlueWater Angels. As an angel network, we apparently are quite innovative. I really didn’t realize the extent to which our industry relies on cookie-cutter deal structures. That’s fine, since it leads to greater operating efficiencies, but it often leads to other problems. The trouble seems to be from not understanding where the tools of silicon valley apply and where there are strong differences in our markets that require different approaches. Read the rest of Ken’s Blog
No where is the difference between the Silicon Valley and the Saginaw Valley startups more pronounced than in the gross margins the companies face. Software, delivered through the cloud, usually has a gross margin of over 90%. That means that startups may have high fixed costs but their follow-on funding is all about buying market share and generating sales…not providing production feasibility. The investments we see in Michigan have real production costs beyond the proof of concept and they have real working capital costs that need funding for the company to grow.
This simple difference has profound consequences for the deals. First, when a company with a gross margin of 50% adds $1m of new sales it will need to finance inventory and receivables. In many cases A/R takes 90 days to clear and their is another 3 months of inventory carrying costs. That means the $1m of sales will require another $500k of working capital. We have to worry that growth will continually outstrip financing forcing more rounds and more dilution. Second, the most successful software startups go to market with an MVP that can be sold without complex integration in a another product. The greatest gadget for a car, for example, has a long complex risk-adverse supply chain that must be penetrated. The carrying costs of production capacity necessary to prove capability must precede a long slow sales cycle adding to the capital requirements for the startup. Finally, the lower gross margin reflects real operating activities that can be a source of problems as materials and operations introduce new risks.
In software, if it works today, it works tomorrow. Computers can be frustrating but they are always consistent. Once it works, it works. Bits don’t have supply shortages or quality control issues. So, BWA does business a little different at times but that’s probably a good idea. On a completely different front, the lobbying work the ACA has been doing in Washington is having an impact. Angels across the nation have put a full court press on Congress and they’ve been making themselves heard at the SEC. The threat of increasing the financial minimums to be an accredited investor may not be inflation-adjusted (which would literally double the threshold). But the real big news is that as
Congress has become more engaged the discussion has turned to how to get MORE angels, so there is now open discussions of adding other exemptions for competency based on education like accounting or legal degrees or even MBAs. God forbid, America might once again become a nation of capitalists.