gilbert: a foreign idea
I was reflecting back five years ago,
which seems like an eon when you're working in a startup
company, Five years ago almost to this week my partners and I
were calling upon a Senior VP at StorageTek to put an idea
before them for a spinout. Unlike Lockheed Martin, that company
had no history whatsoever of having done a spinout, nor did they
have a Hal Kennedy to shepherd those ideas to reality, so it was
a foreign idea.
I’m trying to think about what we did right and wrong.
One of us had been an entrepreneur before, so that helped. It
gave us some courage. We were all mid-level management people in
a mid-sized company involved in long-term development of
intellectual property that we truly believed in. One of the
things we did right was to recognize the opportunity for a
spinout when it happened.
The opportunity came about because we had been acquired
by a much larger corporation which did not value the
intellectual property we were bringing to market. They bought us
for another line of business altogether. It took about a year
for them to finish digesting us and figure out that they didn't
want anything to do with our baby. That gave us about a year to
hatch an escape plan. We truly believed in our products. We
believed in our customers who had bought the products.
Reflecting on Randy's comments about what SpaceVest found
attractive, we had existing mature product and we had paying
customers. We had a potential distribution channel in the parent
We also knew that they wanted to get rid of us. We were a
problem. We were a drain on their budget. We were a distraction
to their sales organization. Unfortunately, they had existing
customers, so they didn't feel like they could just cancel the
line of business.
We recognized that opportunity and took it to management.
The proposition we put before them was, “We will go out and
get our own funding. You can lay us off; get us off your books.
We will support this product. We will continue to bring the
promised new products to market for your core business customers
and make everybody happy.” That was such a great solution to a
big problem that they did not ask us for any equity or
royalties. It was a wonderful situation.
We valued the parent corporation as a potential
distribution partner, so we proposed a cross-reseller agreement.
We also knew that mid-level management in our original company
would be opposed to the spinout, so we went right to the top and
got their agreement before anybody got wind of it. It turned out
that there was tremendous pushback which we did not anticipate.
The folks who did not come with us valued the intellectual
property as well and thought it was a great giveaway. In some
sense it was. They gave us this gold brick and said, “Go!”
Since there was no heritage of doing spinouts at that company,
the right thing to do was to go to the very top management team
and propose the idea and get fundamental agreement before any
details were discussed.
Another thing that we did right was to recognize that we
had to protect the intellectual property. We spent a lot of time
and effort on it. Hale & Dorr and Dave gave us a lot of
assistance at the time, and I think we got that correct.
One of the things that we did absolutely wrong, as all
entrepreneurs do, was to underestimate the difficulty in
obtaining funding. We felt that because we had an existing
product that was well-regarded and an existing revenue stream,
we would just write a business plan and money would flow in. It
did not happen that way, of course. That was a near-death
experience and would have had severe repercussions for the
parent corporation, who did not protect the customers they were
trying to solve the problem for. In retrospect, that was a
mistake on their part. To have somebody like Hal doing that work
proactively rather than letting it happen by accident would have
been the right thing to do, but it did work out well.
Mr. Sylvester: In hindsight, is there something you
could have done in the early stages to make that funding process
Mr. Gilbert: I think it was lack of experience on
our part. We didn't have a clue as to what the problem was, much
less the answer. As I said, we believed that we had all the
elements for success within our grasp and that funding was not
going to be an issue. In retrospect, we should probably have
approached potential investors at the same time we were
proposing it to the parent company. We should have gotten the
VCs to look at it and said to them, “If we did this deal,
would you be interested? What are the conditions we need to make
happen before we go out the door in order to make this an
As it turns out, there was no taint for lack of
intellectual property protection, no encumbrances that prevented
that. It was just that the difficulty of getting the funding was
something we underestimated
Mr. Parker: SpaceVest was tremendously advantaged
by virtue of that experience. Because Blue Ridge did not do what
Tom just indicated in the original spinout, by the time we
stumbled across them, these guys had two to three years of,
quite frankly, living within their means. That was something we
had not typically seen in the companies we were looking at.
You're talking about a company and a culture and a management
team that focused on living within what cash it could generate
to build the business. That's the kind of situation we like to
Tom, you didn't realize that was going on when you were
doing it, but that's . . .
Mr. Gilbert: I think we realized.
Mr. Parker: Yes, but not by plan. [Laughing]
vonwindheim: a very interesting deal
Your experience is interesting, Tom.
Mine has been one of standing in the middle between the
corporation and the investor and doing spinouts by trying to
bring those two parties together. I've probably attempted
somewhere between seven and ten spinouts in my lifetime. Four
turned into companies, and three of those are still operating.
One of them, CRONOS, was a pretty big hit.
Before I go on, I want to step back a bit and give you a
good example of what VCs do to you. I've got Randy
sitting beside me here --
Mr. Parker: Do for you.
Mr. VonWindheim: To you. I've got Randy sitting beside me with ten pages
of crib notes. When we were preparing for this panel we were on
the phone and he kept saying, “Now, we have to make this
I had this great presentation I was going to show you
all. I was ready to do the projections and everything. We get
here, I look next to me, and Randy's got ten pages of crib notes
with highlights. All I've got this tiny piece of paper. Good
job, Randy, you've done it again. [Laughing]
To come back to spinouts, what I think it boils down to
is a very interesting deal. You have to look at it as a deal,
and the deal is interesting because it's a three-body problem.
Tom has just described it aptly. He said that perhaps the thing
he would have done differently would have been to bring the
money to the table at the same time, instead of just working
directly with the corporation and going out and getting money
later. I absolutely agree with that. I don't think I would have
had the courage to do what Tom did . . .
Mr. Gilbert: [Laughing] Or the stupidity ...
Mr. VonWindheim: It does depend a lot on how good you feel about your business, but,
typically, the businesses I've seen have a burn rate, and, as a
result, you have to raise money. To walk out the corporate door
before you've raised that money is a very tough situation.
Now, the drawback of a three-body problem is that it's a
very difficult deal to do. It's a unique kind of situation
because you've got the corporation with their motivations, the
new company which is still within the corporation that has its
motivations, and now you're bringing investors to the table who
have their own motivations. For the entrepreneur in the middle,
strategically placed between the corporation and the VC, it is a
tremendous job of facilitation. Your chances of failure just in
putting the deal together are quite high.
You have to ask yourself: Why is the corporation spinning
this business out? Well, they're not spinning it out because
they think they're going to make a gazillion dollars off of it
in the next two years, right? They're spinning it out because
it's a problem and they're trying to get rid of that problem.
I’ve put together a list of ten or so reasons why.
To start with, perhaps it's a really lousy business in
their eyes. You've got to watch out because you've got to pitch
this to investors as something that's other than lousy. On the
flip side, maybe it's a really good business and, as Tom
mentioned, middle managers are getting concerned about the deal.
If someone thinks it's a good business, there's no way they want
to spin it out, so, in a spinout, you've got a deal that is
usually somewhere between Hell and Nirvana. If you end up in
either of those camps, you're probably not going to be
I worked for a technology incubator where we spun out a
number of companies. My job was to build the commercial side of
the business, and, whenever we started with an opportunity, the
incubator was absolutely convinced that they had to spin it out
tomorrow. They were very motivated because it was costing them
money. After a few months, when the commercial business started
looking better and better, the CFO would come back and say,
“Maybe we should keep this internal because we're going to be
making money next year.” It’s very challenging, and it
requires a mature perspective within the corporation to make it
Here’s another reason: maybe the opportunity is not big
enough. The folks inside might say, “Hey, I've got the
customer. Everything works. It's wonderful.” But when the VCs
come to the table they say, “This looks like a $5 million
business. Why would I want to do that?”
Maybe it's only a technology. If you're thinking about
spinning out just a technology without customers and so on,
that's a very, very difficult play.
Quite often, there are business opportunities that work
within larger corporations because the corporation needs a piece
of it in their portfolio—or they did in the past. That doesn't
mean that the business unit is uniquely competitive in its
marketplace. Maybe it's just another player. That's one of the
first things VCs are going to look at. They're going to ask,
“What's going to make you unique?” It's not good enough to
say, “We've been unique because we're part of a $28 billion
corporation and we pick up business as we go along.” There's
got to be a unique competitive advantage. It comes back to: Why
is the corporation motivated to spin it out?
Then there's the experience issue. A lack of startup
experience either on the spinout team's side or the corporate
team's side can be a real problem. I've seen this personally a
number of times in deals I've put together. I've spun out a
company where we had to put together a management team that was
attractive to the investors; and I’ve worked with corporations
that were trying to spin out companies with management teams
that new nothing about the outside world. It’s very difficult
to make that work.
There's also a corporate fear of competitive overlap. If
the corporation has a concern about the spinout competing
against it in the future, you've got a problem.
Sometimes a corporation wants too much. I've seen this a
lot. Sometimes you own something and you value it a lot higher
than people on the outside. As you try to put a deal together,
you run into all sorts of problems. I was thinking about this
yesterday. I don't think I've done a single deal that didn't
fall apart at least once. The ones that were successful fell
apart two or three times before we got them out the door. The
reasons for that are often related to the negotiation process,
when the corporation thinks they've got way, way more value than
they're actually bringing to the table.
It really boils down to whether the corporation,
investor, and team motivations match up. You, as the
entrepreneur, had better make sure that they match up. At the
end of day, if they match up, you still have to make sure it's a
good deal. If all those things don't happen, it's not going to
What are the things that make a deal work? Very briefly,
again, you've got that three-body problem.
On the corporate side you've got to have a
business-focused team that's doing it for a long-term upside
opportunity. As Hal mentioned, they have an in-house technology
or opportunity that they can't drive forward within their
business structure. They should have a good process. Frankly,
I've never come across a really good corporate process for
spinning out, so that's news to me if it works. I've talked to
Hal a little bit and I think that the maturity of his
perspective is absolutely awesome for the entrepreneurs within
the company. Another thing is patience. These things tend to
fall apart, and you have to be patient to bring them back
On the investor's side, they have to be ready to work. If
they're just coming in to try to pick up a great deal, that
won't be good enough. Usually, these opportunities need to be
formed before they actually become viable in the outside world.
Dollars have to be available immediately. You would not believe
the number of investors I've seen, although I shouldn't call
them investors because they come to the table without money.
What they're trying to do is to find a deal and then
raise some money. Well, thanks, but I can do that myself. There
are a lot of these types of folks who don't really have a lot of
money and are just looking for deals. That's not going to work.
The investors also need patience. I put together a deal a few
years ago where the investor was very patient, came back to the
table three times and ultimately we worked the deal out, but I
couldn't believe that they didn't walk away.
Then there’s the spinout team. They have to have a
balance of excellent entrepreneurial experience—the operations
experience, the product experience, etc. All those things have
to be present on the team. They have to be business-focused.
Let's forget for a second that you really love what you're doing
and you believe in it. Is there a long-term business opportunity
What the entrepreneurs provide that nobody else can, and
this is absolutely the key to the opportunity, is the vision to
make it happen. The corporation and the investors cannot provide
that vision. The entrepreneur or the team is both a facilitator
and the ones who bring that vision forward. If they can do that
and facilitate between the other two entities, the investors and
the corporation, they're going to do very well.
Mr. Sylvester: Let me start with the first question.
Randy, given what Jesko said about the dynamic that operates in
the spinout decision with respect to whether the idea or
technology is valued by the corporation, how do you, as a VC,
address it in terms of your valuation, your process, and your
Mr. Parker: There are two aspects, one of which is
valuation. Let's take care of that one pretty simply. There are
all kinds of ways to value your percentage ownership in a
company. You can run comps, you can run DCFs, run whatever you
want. The bottom line is that the valuation is established by
somebody putting a number on the table and a seller accepting
the number. Period. So let's put that one aside.
The other aspect is: What is the corporate interest in an
ownership position in the spun-out company? There's a large red
set of flares that go off when corporation X—not Lockheed
Martin—says, “We've got this great technology. I've got
Joe the engineer and his buddies who think it's terrific. These
are the markets to which it can apply and, by the way, here you
go.” That's problematic because the bottom line is that if
it's that great, I don't think I need to land a division of
company X and invest in it without any residual commitment
and/or enthusiasm for it. If it’s a situation where the
corporation is saying that they’re doing this because it was
my birthday yesterday, that doesn't work. In valuation, you get
through the comps, the capital structure, who needs what, and
you get down to the bottom line: What is the technology? What is
the business plan? What's the management team look like? What
condition is the technology in? What kind of customers does the
technology service now? What can it service?
Primarily, it’s: What is the management team? What are
the attributes of the management team coming out with the
technology and/or that can be attracted to the technology?
Q: Tom, since you are in the ultra-secure
virtual private network business, which is a very hot sector,
why you couldn't go to a customer or potential customer and get
funding for your corporation? Hal, why wouldn't you invest in
that company as a necessary part of your business, for the
Lockheed engineers, for example?
Mr. Gilbert: What we had developed back in 1997 was
not widely recognized as being a valuable technology at the
time. That was in the beginning of the commercialization of the
Internet, when research firms were telling corporations that
under no circumstances should they ever put sensitive corporate
information over the Internet using any technology whatsoever.
We had the technology to do it, but no one would believe us.
Our core customers were the US intelligence community who
had tutored us in what high security needed to be. We thought
that all customers were deep-pocket customers who would just
keep buying the product once they had assessed it. Of course,
that's not the way it works.
We fundamentally didn't understand our own value
proposition. It took us, I would say, at least four of the five
years we've been in business to truly understand what business
we were in. Back in 1997 we couldn't have gone to an investor or
even a large customer and put a mature proposition in front of
them. The technology was there; we just didn't understand it
Mr. Kennedy: Let me make a couple of points. First,
a third of large corporate America is involved, at least
intellectually, if not actively, in spinning things out. Of that
third, only maybe half have a corporate venture capital arm,
which means an interest and a willingness to make investments.
Lockheed Martin does not have one. We don't invest in these
projects other than licensing our intellectual property. The
risk profile of venture capitalized companies is so inconsistent
with the risk profile of a person who would buy a share of
Lockheed Martin stock that we don't think it's appropriate for
us to be investing money in venture capital. If our shareholders
want their money deployed that way, they're better off doing it
themselves rather than having an aerospace company do it for
them. That's one of the reasons we wouldn't invest in a company
In terms of Tom’s product, now you have to start really
pulling apart industries. As a generalization, and this may
sound odd, the aerospace industry does not compete, per se, on
the strength of its computing and IT prowess. Unlike financial
institutions and other markets where IT is central to the
business and a competitive advantage, it's not so in aerospace.
We need good enough computers to calculate the fluid dynamics of
the vortices behind the wing of an F-16, but, once we've got
that, it's probably good enough. To have bleeding edge IT
systems is not in our best interest. As a result, we like to be
a second adopter or a follower in terms of IT systems, as
opposed to an innovator. We would be interested in a product
that, say, allowed virtual teaching and learning or virtual
collaboration after it had already been proven in the
marketplace. That's why we wouldn't be an investor.
Q: What effect do employees' fears of
divulging their intentions to their companies have on the
atmosphere of doing spinouts from corporations? Is it something
they have to worry about?
Mr. Kennedy: No, I don't think so. By the way, if
you look at our population internally, it's stable. I'm coming
up on my 30-year anniversary, and the place is full of people
like me. Most of us enjoy what we're doing.
Internally, we are running what amounts to a risk-free
environment right now, but I'd hesitate to generalize for the
rest of corporate America. In terms of popping up with ideas, I
am a safe haven, so to speak, in the corporation. People call me
without attribution. They bounce ideas off me. I tell them
whether or not I think it can fly. If it can fly, I always
vector them immediately back to their bosses. You can't do a
total end run around the whole management chain of a corporation
by just speaking to the person at the top or the one responsible
for these things—which in this case is me—and leave
everybody in the middle out.
There were some good points made earlier, however, about
taking the idea to the top. I have the support of the executive
office of Lockheed Martin Corporation. When you talk to me it's
like talking to the top. If I say it's a good idea, then it's
time to socialize it back down through the chain of command. It
has to happen that way.
If it's a bad idea, I tell people it's a bad idea. I am
known as a blunt guy. I will tell them when I don't think it's a
good idea, or whatever the reason is—that I don't think we can
raise capital, I don't think we can make it work, it's too core
to us to spin out, we don't want to compete with it in the
marketplace, etc. At that point, they go back to their day jobs.
I think it's a risk-free process we have set up.
Mr. Parker: The only comment I make on that is if
the generator of the idea of the spinout has fear of introducing
the notion internally to the corporation, then it's highly
likely that individual needs some EST training or something else
to deal with what's going to come down the road. That's nothing
compared to what these folks will have to deal with later.
Q: It's refreshing to see folks in tech
commercialization looking for real products, real revenue, and
real technology again, rather than some dotcom, pie-in-the-sky
investment. Hal, I have a question for you regarding GlobalStar.
Lockheed Martin was involved in a consortium to build voice,
data, and GPS in its GlobalStar consortium. Can you talk about
where it went wrong since it's in bankruptcy?
Mr. Kennedy: Not
very well. I’m the guy who starts entrepreneurial ventures.
GlobalStar was not quite in that genre, so I'm pretty far
removed from it. That's sort of a mega project. I do micro
projects, by comparison. That one came out of the notion of
growing one of our businesses into adjacent markets. My notion
of it, from a position very far removed, has been one of market
timing. Like a lot of other people, we didn't understand that
the tech wreck was on its way, especially in telecommunications.
Read the story about MCI on the front page of The Washington
Post this morning if you want to see another $3 billion
fiasco in telecommunications. We didn't understand what was
about to happen any better than anybody else did. I think that's
the root cause of what got us in trouble.
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