What does Silicon Valley’s longest serving CEO, and now a tech investor, think about tech investing and the current state of the industry? In the episode of the Tough Things First podcast, Ray Zinn lays it bare.
Guy Smith: Well, good morning to all the audience and welcome to another episode of the Tough Things First podcast. I’m your host today, Guy Smith. As always, we have Silicon Valley’s longest serving CEO, Ray Zinn. How you doing today, Ray?
Ray Zinn: Well, hopefully better than you are back there with that ice storm. So yeah, we’re doing fine. We might get a little rain, but it looks like a decent day.
Guy Smith: Well, there’s an old joke that meteorologist is the Greek word for liar and all of the forecasts they made for ice here did not happen. So, thank God for that. We don’t need any down power lines. Hey, so what I wanted to talk about today is Silicon Valley tech investing. After your Micrel years, you got into a little bit of investing on your side. I’ve been on both sides of the pitch table in Silicon Valley, so I’m kind of intrigued by some of the commonalities, some of the traits, some of the things that we’re seeing out there in the marketplace in terms of startups and investing.
So now that you’ve been actively on the other side of that table for awhile, what are some of the common traits that you’ve noticed about companies that have been pitching to you for investment money but never got to their serious discussion phase? Where did they fall down in their approach to you?
Ray Zinn: Well, that’s an interesting question, Guy, because I’m somewhat of a old school investor, meaning that I tend to like to see all the nuts and bolts in place in a company before I consider investing. So, there are two kinds of companies that I see. One is someone who’s just iterating something that’s already been done out there and just wants to get their two cents worth in or get to get themselves involved. The other is a totally new market, something that’s kind of disruptive, and they think that they’ve got the next most exclusive idea, and it will make us all a fortune.
So, those are the two kinds of companies I see. In both cases, what I see as that is that they’re more wannabes. In other words, they want your money, and they talk about their investment being sweat equity. In other words, they’re just putting up their sweat equity and not putting any money into it themselves. I was talking to a fellow the other day, and I said, “Okay, how much money do you have in your company?” He says, “Well, you mean investment?” I said, “Well, how much do you have invested?” He says, “Well, I really can’t do much because other than selling my house, or mortgaging my house, or refinancing my house. I really don’t have the funds to do that.”
I said, “Then, why do you want to go into business?” He says, “Well, because I got this great idea.” I say, “Yes, but you’re using other people’s money to do it. So if you’re not going to put yourself at risk, why would you expect someone else?” “Oh, well, I’m putting up sweat equity, I’m working for no money,” I said, “For how long? How long has it been since you have been working with no money?” “Well,” then he kind of [ham har 00:04:21] around, and I said, “So, the money you’ve raised so far, the money you’re raising, you’re using to produce a salary shares for yourself.”
“Well, yeah. I have to live,” and that turns me off. I watch Shark Tank, obviously, from time to time, and I’ve seen the same kind of thing that when a shark see that they’ve not really, put themselves at risk, other than saying, “Well yeah, they’re working part-time or they’re willing to start in the future putting in full-time,” it turns the sharks off, and it turns me off too.
Guy Smith: Well, and just to pitch your book for you on this account, there’s a wonderful story in the book, Tough Things First, about your origin story. When you launched Micrel, you went to banks, and banks never lend money to startups, but you were putting almost everything that you had on the line, your house, your cars, your investments, et cetera, et cetera, to get going. That showed the bankers that you had real teeth in the game.
Ray Zinn: Yeah. Well, as a personal guarantee. What a personal guarantee is that you take out a loan with the bank and, or lending institution, and then you’re willing to put up your assets to protect the bank in event of a default, and that’s called a personal guarantee. I certainly did that. The banks wouldn’t never have loaned me the money had I not been willing to put up all my assets.
Now, some of my partners weren’t willing to do that, but the bank was relying on me primarily because of the strength of my net worth to back up the loans. So, the one that’s really at risk was me. Of course, I was the present CEO anyway, but the bank absolutely demanded that I personally guarantee the loan.
Guy Smith: Well, and given the way bankers views startups, I’m assuming that that had to be the position that they weren’t going to even ponder a startup that didn’t have the founders financial backing in that, because it basically creates some sort of guarantee of efforts, some sort of guarantee of commitment.
Ray Zinn: Well in a bank case, Guy, they don’t have a financial, I mean, I shouldn’t say an equity investment, in the company. They just have that loan. They don’t want to loan to a company that doesn’t have the cashflow to make their monthly payments. For example, if you went out and bought a home, or a car, or some other expensive asset and took out a loan, they’re going to use the home or the car as collateral for the loan. Then, they’re going to look at your ability to make these monthly payments to pay back that loan.
If you don’t, then they’ll foreclose on you or they’ll confiscate your car. So, they’re very specific about wanting you to have the ability to make those monthly payments. So what I’ve seen with these startups is they don’t have the cashflow yet, and so they’re unable to immediately begin payments. So you say, “Okay, well when can you start making payments? When are you going to be profitable?” Of course, they ham har around about, “Well, this is a new business,” and blah, blah. Then, that just turns me off.
Guy Smith: Well, and that segues nicely into my next question because a little bit ago, you had mentioned new markets, companies that are developing for new or pretty nascent markets. Are you seeing a disconnect between the quality of the pitches or the business readiness of startups who are going into new markets? When I’ve talked to these people, almost all of them say that they’re relying entirely on first mover advantage, and they think that’s the only thing that they really need. So, are their pitches lacking because they’re depending way too much on that?
Ray Zinn: No, I don’t think so. I think that it’s the same no matter whether they’re going into an existing market or whether it’s called a nascent market, a first mover. It’s not so much the newness of the market or the matureness of the market. It’s more how that CEO or that team views their risk, as you would, in the business.
What I want to make sure is that they’re all. In other words, it’s not one of those things that, “Oh, well.” It’s like me hiring them to run the company, and then if they just decide that they’re tired of running the company, that they all say, “Well, let’s go and look for another job,” and then I’m stuck with the investment because I’m the ones who’s got to cut the money in it. I look for that. I look for how far they’re in to the company. Does that make sense?
Guy Smith: Yeah, that does. That does. I’ve got to imagine it’s kind of tricky with these new market companies. When is it too earlier or when is it too late for an investor to sink money into a company that is attacking, or in fact, maybe even trying to create a whole new market?
Ray Zinn: Well, most of these startups that are into these new mover markets usually get angel funds. In other words, they’ll go to parents, or family, or to angels and raise a small amount of money, and then try to get the thing going. Once they get that going, it’s that kind of seed money, then they’ll go start raising money in a serious way through venture funds or other means to really launch the company. So, most of them die right before they actually get out there and start having to raise some serious money. They tend to fall apart right at the seed round.
Guy Smith: Right. But from an investor’s standpoint, how do you know when the right time to jump in is? How do you know that you’re not too early in the game, you’re not investing before they have shown some real ability? But also, when are do you know that you’re too late to the game, that maybe you’ve missed the prime opportunity in somebody who’s exploiting these new markets?
Ray Zinn: Well, those are two different questions. When you know you’re too early is when they’re not ready. In other words, they don’t have their product fully qualified or haven’t proven it, and so they’re just feeling their way along. In other words, you’re just in a very early, early stages.
When you’re know you’re too late is they’re floundering. They’ve gone for round A, round B, round C, almost the whole alphabet, and they’ve raised a tremendous amount of money, far more than they’re ever going to be able to pay back. So, they’re crying. This is their suicide round. They’re trying to make sure they take, “Okay, this will be it. I mean, this is my last round. If I can just get this round, I know we can do it. Right on the verge, we just got this customer all qualified and ready to go.” So when they sound panic, then you know that they’ve ran out of gas.
Guy Smith: Okay. Speaking of running out of gas, this is kind of a leading question, but Silicon Valley venture capitalist, on average, have a tremendously horrible profitability record. Last time I looked into it, they were getting of returns of like maybe 2% or 3% on the invested capital that they put forth. So, what are the Silicon Valley venture capitalists getting so wrong?
Ray Zinn: Yeah. Well, we should call it Silicon Valley roulette because they do a lottery. They’ve raised lots of money, and most of them have raised lots of money, and need to put that money to work. If they just put it in money market, of course, probably do their investor just as well because you can make probably 2 or 3% on money market, but the investors don’t want you to let that money sit there in money market, so they have to go out and find these opportunities. So, it’s a game of roulette, it’s gambling.
So, this whole concept of venture capital is really just another form of gambling. They’re just playing a lottery. So, they’re looking for that one deal that will make their investors a fortune. We know the record is that nine out of 10 of these startups fail. The reason they fail is they run out of money. The reason they run on the money is because they can’t get to profitability in any kind of a reasonable timeframe.
Look at some of these big companies like Uber and such as that. They’re not making any money, and it’s hard for them to sustain themselves except on cashflow. So what happens is, is that they just fold up. Within the first three years, they’re out of money, and investors just don’t see the recovery, and so they move on to the next lottery deal. So, it’s really a lottery thing. I mean, they’re expecting to hit that one in 10 that’s going to make it for them. In the meantime, of course, they bet on the wrong horse, and they spent a lot of money, and then they have less money to invest in those good deals that are out there.
So, the whole flawed concept of venture capital is the fact that it’s a timing thing. The partnership is usually a five-year partnership, and so they have to get it moving, get out there, get the money invested within the first year or first few months because, it’s going to take five years or so for these companies to really make a name for themselves and become about a viable company.
So these VCs, they spent a lot of time just rushing out, and jumping on these deals, and then just hoping that their winning lottery ticket’s going to pay off for their investors, and it usually doesn’t.
Guy Smith: It usually doesn’t. I mean, the way you describe it makes me think of a slot machine. They’re just continually putting quarters in the machine, and pulling the handle, and the hoping that one of those pulls of the handle is actually the big Jack Pot.
Ray Zinn: Exactly. Exactly. It’s exactly the game.
Guy Smith: Oh, that’s terrible game to be in. You would figure that they would take a little bit more time to analyze trends, narrow down their portfolios, really focus on a few high probability companies instead of just continually pulling the lever.
Ray Zinn: Well, they say they say they do. I mean, they claim that they go through that vetting effort, and they will tell you that they spent a lot of time and energy vetting these out. But if you ever watch Shark Tank, you know that every one of them, everyone of the sharks, is looking for the revenue, that the potential the candidate has achieved. So if you don’t have any revenue, the sharks just turn away. I mean, and the sharks are sharks. I mean, they’re looking for good deals, and they’re looking for ownership in the neighborhood of 15 to 20%.
Whereas in the case of the venture capitalists, are looking at something north of 40, maybe even north of 50. So, that’s an early round. That’s very, very seed round. When a company’s just starting out and they’re just getting their feet wet, they’re more likely to fail. If I look at all the shark programs that I’ve watched, and I bet you less than a third of them that the sharks even jump on. When they do jump on it, they want a huge percentage of the ownership of the company.
Guy Smith: Right. When you’re putting up your own money and trying to get somebody boosted to that next level, you definitely want that equity position, but that’s the game I’m afraid that they continually playing Silicon Valley. Because, so many of these startups are in the early phase, in the seed phase, maybe around a funding that the VCs are trading off the same amount of cash for more equity, and that’s their way of hedging their bets. That’s their way of trying to find that bigger payoff in the end by having that larger equity stake.
Ray Zinn: Right. That’s exactly what they’re doing.
Guy Smith: Yeah. Well, thanks, Ray. I appreciate those insights. For the audience, if you want more insights from the guy who’s basically done it all in Silicon Valley, do get a copy of his book, Tough Things First. You can get it from Amazon. Absolutely entertaining, inspiring read from beginning to end, and you’re going to walk away feeling smarter than you ever have before. If you want to continue feeling smart, tune in for the next episode of the Tough Things First podcast coming out every Wednesday.
Ray Zinn: Thanks, Guy. Look forward to the next one.