What applications might they suggest, William A. Sahlman asked his students, for "electronic ink"—particles and dyes, embedded in a surface, that could be charged to form changing texts without the bother of paper and printing? The class snapped to attention, and a swarm of ideas buzzed down from the semicircular banks of seats in Aldrich 9. Price tags (retailers wouldn't have to re-mark them for discounted sales). Billboards. Sheet music (self-turning scores). Eyeglasses with news headlines projected inside the lens (prompting Sahlman to interject, "So, as you're purportedly watching me..."). Newspapers with built-in refreshable video. Menus (no more regrets from the waiter that the daily special is sold out). Maps. Camouflage clothing that changes in different lighting (Sahlman again: "So if you hadn't read the case and wanted to disappear...").
Clearly the students, enrolled last fall in one of three sessions of Harvard Business School's elective "Entrepreneurial Finance" course, found the possibilities intriguing. They were having fun. But then Sahlman, who was having as much fun as anyone, had to rein it in. Asserting his pedagogical role (himself MBA '75, PhD '82, he is D'Arbeloff MBA Class of 1955 professor of business administration and cochair of the school's entrepreneurship and service management unit), he pointed out that none of these ideas was a business. Indeed, technological euphoria and the seemingly limitless potential of new ideas could be inimical to operating a real business. All fall, the news had been sobering, as the dot-com bubble deflated, paring billions—ultimately trillions—of dollars of stock-market value from the "idea" companies that had been spawned, many by Harvard MBAs, and funded in a two-year orgy of enthusiasm for Internet enterprises. "At some boards of directors," he said, driving the point home, "they institute a $50 fine for every new application you think of."
That challenge faced E Ink Corporation, the subject of the class's case discussion, every day. Founded in 1997 to revolutionize the mundane printing business with new display technology, the company had its eye on multibillion-dollar markets like electronic newspapers. But to realize that vision, its scientists had to get into harness with business people and apply themselves to routine tasks like perfecting their technology, learning how to manufacture it, and financing the needed investments in research, development, and marketing through a combination of product sales and venture funding.
And so emerged several lessons beyond the technicalities of finance. In 80 minutes of give-and-take among students, professor, and manager, the class touched on the tension between the romance of ideas and the reality of enterprises, the conflicting motivations of the participants in an immature business, and the staged growth and resource needs of a young enterprise. Financial acuity counts, to be sure, but as Wilcox explained and E Ink's experience made clear, its prospects depend on a welter of fundamentally human choices.
Twenty minutes after Sahlman's finance students finished dissecting E Ink and one floor up in Aldrich Hall, Myra Hart's "Starting New Ventures" class prepared to talk by speaker phone with one of the computer era's most successful "serial entrepreneurs." After the students reviewed a case that involved setting the price for Handspring Inc.'s first public stock offering, cofounder and CEO Donna L. Dubinsky, MBA '81, got on the telephone. Faced with accepting $20 million less than anticipated from the stock offering, she told the class, the company never hesitated. It had chosen to go public in mid-2000—after two years of existence and two quarters of selling its Visor handheld computers—to establish its staying power with customers and suppliers in its fast-growing market, and to facilitate possible acquisitions.
Prior to jointly founding IWA, the three had worked in management consulting and investment banking: each, however, did have substantial experience with beer.
HBS professor William Sahlman
With that, Hart guided the conversation to broader topics pertaining to venture formation. Her first-name rapport with Dubinsky reflected more than their experience as business-school classmates. Beyond serving as MBA Class of 1961 professor of management practice and co-head of the entrepreneurship and service management faculty, Hart, MBA '81, DBA '95, had direct knowledge of her course material: in 1985, she was one of the four founding officers of Staples Inc., the office-products retailer whose sales now exceed $10 billion per year.
Hart wanted her budding entrepreneurs to hear how Dubinsky's early days at Handspring differed from the conditions she had encountered at Palm Inc., which she had joined in 1992 (following a decade in the computer and software industries), just after the company was founded to develop handheld computing devices. Like E Ink, Palm sought to create a new market based on seemingly promising technology—and its first designs didn't work. She and her management colleagues were unknowns, and the product failures subtracted from their slight credibility. And at the time, she said, "the capital markets were totally different," with venture financing rounds of $500,000 the norm for a company with Palm's record and prospects.
Handspring's birth, in July 1998, was huge news in the high-technology industry. Dubinsky and her colleagues had made an enormous success of PalmPilot and its operating system, and that core management team now promised newer and better things in a booming business. Their credibility translated into tangible benefits for the new entity: the ability to recruit personnel and to entice suppliers (vital for companies like Handspring, which outsources its manufacturing); favorable relationships with retailers; and access to capital, in a venture-financing market that had rebounded from a feeble state after the recession in the early 1990s (only $1 billion was committed in 1991) to unprecedented strength as the decade ended (with weekly commitments exceeding $1 billion). Given that context, Dubinsky said drily, Handspring was launched with "a whole lot less ambiguity."
In the lessened "ambiguity" of the Palm-to-Handspring story lay many of the lessons Hart hoped her second-year students would hear as their teams raced toward end-of-semester classroom presentations of their own business plans—for firms ranging from child-care services to a buyout fund focused on media properties. She began a conversation in her office in South Hall, now home to the business school's entrepreneurship and services faculty, by describing how "Starting New Ventures" evolved from an existing course on product development. "My response was that there's a big difference between a really great product and a company," she said. Given the constraints of costs and the problems of marketing, to cite only two factors, "Starting new businesses is a much more complicated task."
Hart's new-ventures course was designed to focus on those challenges "horizontally"—across all the functions managers need to address from the original business plan through the first eighteen months of an organization's life. For companies that are "up and running," she said, "we have 100 other courses already." Such is the pace of business development that "Starting New Ventures" has spawned its own spin-off this year, a separate course focused on launching technology ventures. That has let Hart's class focus more on retailing, services, and other "old economy" businesses, and has perhaps skewed its enrollment more toward international, minority, and women students, who perceive opportunities to start new businesses in underserved communities earlier in their careers than ever before.
Her course has evolved into a practicum, alternating cases with students' business plans — the latter evolving with guidance from venture capitalists, attorneys, and business "incubators" who specialize in nurturing nascent firms for an ownership stake or fees. For those who listen, Hart and the participating managers from companies covered in case studies have leavened every technique with a broader perspective. That began early in the semester, when Hart challenged students to ask, "What is opportunity, how do I either discover it or create it, how do I evaluate it in the framework of others that might be available?" Their answers, she hoped, were not solely financial or technological, but "very personal — it depends on you and what you bring to the opportunity."
The cases and exercises then marched through "the parameters of a well-designed, de novo business," she said, from focus ("the difference between a good idea and a well-functioning business model"), through capability (what it takes to execute a plan and gain access to needed resources, owned or not, over time), to scalability ("These students are not small-time operators, aiming to run the best restaurant in town") and adaptability. No one who has taken an entrepreneurship course at Harvard has evaded this last point—the problem, as Hart put it, of "how nothing ever proceeds according to plan, and how you adapt strategically and tactically." Should a start-up survive, cases studied later in the course emphasized finance, human resources, and the processes on which "growth and scale depend" in the larger enterprise.
"My research," said Hart, professor and entrepreneur, speaking from experience, "is all about the importance of experience. The subtle message is that here are people who did well the first time—and a lot better the second time." For the people who established a company like Handspring, she said, the essential difference was the degree of knowledge—both "knowing," on the part of entrepreneurs who can prepare themselves for what they face, and "being known," by networks of other people who can supply the thousand things it takes to fuel a business.
Here is how William Sahlman, business educator and scholar, began a paper, "Some Thoughts on Business Plans," much used—and cited — by the current crop of entrepreneurs:
[Sahlman] smiled as he was handed the business plan for Internet Wicket Ale Inc. (IWA), an interactive, on-line marketing company being formed to sell premium beers made by microbreweries over the Internet. According to the president of the company—a soon-to-graduate MBA candidate at a well-known eastern business school, a prototype Web site had already been developed.... [A]n early review had described the Web site as "way cool." Participating in the meeting were two other MBA candidates. Prior to jointly founding IWA, the three had worked in management consulting and investment banking: each, however, did have substantial experience with beer.
For all its value as a (largely unheeded) cautionary note about the Internet investment bubble, from its first sentences the paper also captured Sahlman's central approach to the phenomenon he studies and the way he teaches it. In a separate discussion, he said, "The core idea — an innovation in entrepreneurial finance—is to make prominent the role of people in making decisions." Thus an early reading for the "Entrepreneurial Finance" course, on the nature of financial contracting ("deals"), highlighted immediately the "contractual impossibility theorem: there exists no perfect deal." Even initially good deals, in other words, have collapsed as perceptions changed.
Early sessions of the course (taken by more than half the second-year MBA students since 1986) introduced the human factors underlying the seeming paradoxes of venture financing. Entrepreneurs have found, for instance, that venture capitalists provide cash only in stages, rather than in an initial lump sum (E Ink's $200-million problem). In supporting inherently risky start-ups, they place a high value on the "option to abandon" funding—to terminate the experiment if it appears unpromising, and to cut their losses. This model—organizing a business so it is "scheduled to run out of capital periodically," as Sahlman has written—has naturally proven effective in concentrating entrepreneurs' energies. But they have benefited, too, because the planned plunges over the cliff have also given successful entrepreneurs opportunities to raise subsequent rounds of funding at ever-higher company valuations, preserving more ownership rewards for the founders and their fellow managers.
Applying these dynamics to all parties in deals (investors, employees, suppliers, and so on), Sahlman has concluded that the proper way to analyze any decision is to begin looking at what can go wrong, then at what can go right, and what decisions can maximize the reward-risk ratio. The answers have always had to be sought in human terms. Thus, he counseled, the way to read a business plan is from the back, where the venture's principals describe their experiences. Thus also "one of the most important lessons of entrepreneurial finance: from whom capital is raised is often more important than the terms"—because involved investors help recruit key managers, establish sales contacts, and more.
As Sahlman guided the students through the term sheets for various financings, he gave equal weight to analytical tools and human risk factors. One deal demonstrated why entrepreneurs might offer costly guarantees up front for their investors—in return for greater payoffs for the founders if their company flourished. Another was fatally flawed because it gave the initial investor little incentive to supply more money, and also discouraged others from stepping forward to join a second round of financing.
Even as he provided formulas for valuing the likely returns from deals, Sahlman reminded the class, "The short answer to most questions I'm asking this morning is, 'I have no idea.'" He explained later, "The tendency in business schools for the last 20 years has been to fall back on a false prophet of analysis"—that with sufficient industry knowledge, market data, and statistical wizardry, "The answer would somehow mysteriously pop out and the right decision would be made. That's just not the way I think the world works."
In his pedagogy, he said, "The big idea is people making decisions about the world with large amounts of uncertainty. And the second big idea has to do with making experiments." In other words, he has defined the new venture as an experiment, fueled by increments of funding, the purpose of each of which is to buy the company time to collect more information on its product or services, skills, customers, and competition—and, if the results are encouraging, to proceed to the next stage of funding and operations. For a serial entrepreneur like Donna Dubinsky, much of that extra information already existed—limiting the "ambiguity." "A good experiment," Sahlman said, "is the right people with the right amount of resources doing the best they can."