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A Different Spin On Startups
Finding Hidden Opportunities In Corporate Technology

Out For A Spin With Randy Parker

Having invested in more than a few spinouts, Randy Parker sees five common characteristics of the most successful:

1. “Vulture” capital. One thing that makes spinouts attractive to VCs is that they leverage the investment others already have made in product development. You gotta find a way to take advantage of that.

2. Veteran teams. Successful spinouts maintain the core technology team from original development, especially where the people feel passion for the product.

3. Legacy customers. Another way that spinouts can have a leg up is where there are existing customers with third party knowledge of the technology.

4. Contracts and revenue. Even better than just any customer is one that’s making profits for you already.

5. Protected IP. Parent companies protect their intellectual property both legally and by retaining the people who created and understand it. 

(McLean, VA) -- June 26, 2002 -- Despite the dotcom bubble and the tech wreck, technology entrepreneurship is still alive and kicking, and often in the last place you’d think to look—big corporations.

“We have 145,000 employees, and they all have my phone number,” says Hal Kennedy, Vice President for Technology Commercialization at Lockheed Martin. “My phone rings at least once or twice a week from someone I don't know inside the corporation who says, ‘Let me introduce myself. I have a real great idea for commercialization.’ We take them all seriously and review every one.”

Kennedy was part of a panel of speakers at this morning’s Netpreneur Coffee & DoughNets meeting who assembled to discuss opportunities in spinning out technology ventures from inside corporations and other large organizations. He has had some success at that. Since 1997 Lockheed has spun out 13 companies, 12 of which are still doing business.

Joining him were panelists who could boast similar feats, including Tom Gilbert, co-founder of Blue Ridge Networks which spun out from StorageTek; Jesko VonWindheim of CRONOS/JDS Uniphase who has been involved in several successful spinouts; and Randy Parker, Managing Partner of SpaceVest, a venture capital firm with some 30% of their portfolio companies that were spinouts from large government contracting organizations.

Exactly what is a spinout? According to David Sylvester of law firm Hale & Dorr who moderated the discussion, it’s when corporations and venture capitalists take technology or ideas or people from existing large organizations and commercialize them in the marketplace. These are entrepreneurial ventures, not to be confused with a spin-off, which occurs when a public corporation provides a distribution to its shareholders to give them value in its subsidiaries.

If that’s a definition, in practice, “You have to look at it as a deal,” said VonWindheim, “And the deal is interesting because it's a three body problem.”

The three bodies are the entrepreneur, the parent company, and one or more VCs, and they all have different motivations. That’s why the biggest challenge for the entrepreneur—in addition to the vision, the business plan, the contracts, and more—is that he or she has to act as the facilitator between the other two bodies to get the deal done.

It can be an iterative process, said Gilbert, and there’s a lot to learn along the way. For example, Blue Ridge Networks got off to a slower start than they might have because they waited too long to bring the VCs into the picture. Once you have an idea, start by talking to the parent company to keep everything above board, but the panel agreed that you should bring in the investors as soon as appropriate so that everyone’s issues get addressed early.

VCs play an important role in spinouts, not just for their money, but especially for their industry knowledge, contacts, channel connections, and other assets that help the spinout find commercial viability. The contract conditions they are looking for can sometimes conflict with those of the parent, which, for example, may want clauses such as “claw backs” which return certain rights to the parent under given conditions. Get these motivations on the table early.

Although we most often think of spinouts as coming from inside an organization, some of the most successful ideas come from outside, according to Kennedy, such as when a customer or potential customer comes with a critical need they have to fill. If the same need is felt by enough others, there’s spinout potential.

Regardless of any other conditions, the first, most critical question a spinout entrepreneur has to ask is: Why is the company willing to let the spinout happen? After all, if it was a guaranteed money maker, wouldn’t they want to keep it? There are a lot of answers to the question, some good, others that should sound warning bells, but if you don’t understand the reasoning, you can’t close the deal in a way that will make value and sense for all the parties.

Spinouts face all the same challenges as other entrepreneurs, such as raising funds and validating the product in the market, but they can have certain advantages, such as access to the research and other facilities of billion dollar parent companies. And there are unique challenges, as well. According to Kennedy, one of the most important things for a startup to do is to get managerial autonomy. It is essential, he said, because otherwise, “The parent company will pull the plant up every six months to see how the roots are doing.” The panel’s complete comments and suggestions can be found in the edited transcript and video from the event.

There’s another rule that’s just as true for spinouts as it is for all other startups—the people are what really matter. As Parker put it, “Technology-in-a-box ages very, very rapidly.  Without the human beings surrounding it who are up on it and interested in it, it has a half-life of microseconds. It's not all about intellectual property, it's much more about people.”

Copyright 2002, Morino Institute. All rights reserved.

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