Partner Kim Sanchez Rael-Strategy for VC-backed investments

1. How would you describe Flywheel’s investment strategy?
Flywheel focuses on three key things:  investing in capital efficient companies, building intrinsic value in companies that address global markets, and investing at valuations that are both attractive to Flywheel and aligned with the interests of the entrepreneurs. Our specific focus is on companies leveraging information technology and physical sciences, including material sciences.

Flywheel searches out the best technology innovations and the most talented people in our ecosystem. We partner with these entrepreneurs to create valuable operating companies that solve global problems, particularly around the rise of a global middle class society and their needs for digital services, physical infrastructure, renewable energy and clean water. We believe in building intrinsic value and focus on technology solutions that solve customer pain in a better, faster, cheaper way than existing alternatives. For example, MIOX, our clean tech water company, addresses one of the world’s most pressing problems: the need for safe, clean drinking water. MIOX’s products are highly scalable and can be used by a single individual all the way up to municipal water systems that treat millions of gallons of water a day.

2. Has the Flywheel strategy changed to adapt to the recent economic downturn?
It has always been our strategy to invest in capital efficient companies that can achieve cash flow break even early.  Although the downturn has amplified the importance of cash efficiency, it has not fundamentally changed our strategy. Indeed, the current market has highlighted the importance, particularly with early stage companies, of creating a lot of value early in a company’s life cycle with limited resources.

Capital efficiency in our view means that companies can reach profitability on less than $10 million of capital raised. In order to that, we advise our entrepreneurs to identify and focus on a narrowly targeted “beachhead” market, often outside of the U.S. Entrepreneurs executing on this strategy understand and work closely with their target customers very early in their life cycle and figure out their sales recipe quickly before raising significant amounts of growth capital to scale on a global basis. In this “back to basics” approach we are really just returning to time tested principles of “crossing the chasm” but updated for a focus on the global economy.

3. What are your current thoughts for entrepreneurs seeking venture funding?
We are looking for entrepreneurs who are passionate about building global technology businesses and who are aligned with the principles of capital efficiency. It’s in their best interest to raise measured amounts of capital to get their companies to cash flow break even and to be very prudent on their capital strategy and valuation. By following this approach, entrepreneurs and investors stay aligned and can select the right market environment in which to raise additional growth capital to scale to their ultimate potential. If a company’s execution plan is dependent on significant amounts of capital for continued growth, its strategy will necessarily be constrained by the availability and terms of such capital. Profitable businesses, on the other hand, typically have many more options to raise significant growth capital at times and on terms that are aligned with the entrepreneur’s vision.

4. How does Flywheel’s strategy exemplify their commitment to working closely with entrepreneurs?
We work with the most talented entrepreneurs we can find and deeply respect their commitment and expertise.  To supplement each company’s internal resources, we offer hands on assistance in building companies. Flywheel leverages each team member’s unique set of skills to build the companies. For example, in one case, a Flywheel investment team member stepped into the role of interim CFO when there was a critical, time sensitive need in one of our companies. In several other cases, Flywheel team members have assisted in marketing and public relations. 

Flywheel works closely with founding entrepreneurs to build out their company’s employee talent base. We actively leverage our extensive network to recruit and maintain high level executives.  We also recruit and screen board members with industry expertise to help accelerate each company’s growth.  For example, Flywheel recently helped recruit a key engineer and a board member with international industry expertise for Tred Displays. 

In addition, of course, we provide traditional venture capital services including raising follow-on funding for our companies and active board membership.

Partner Trevor Loy - "Current Opportunities for VC-backed Investments"

1. What do you see are the current trends in the investment sectors for venture capitalists?
The end markets for both enterprise and consumer products have grown internationally at much higher rates than growth in the U.S. This is an exciting trend for companies that are positioned to provide business or consumer products or services to those markets. However, the faster-growing economies are no longer correlated with the most developed countries, so there's been an interesting shift in the kinds of products and services that these faster-growing, emerging market economies are purchasing. These markets tend to purchase products to serve needs in physical infrastructure, basic human health, mobile network-based computing, as well as safety and security, more broadly than has typically been the case in the U.S. over the last few decades during the explosive growth of the venture capital industry. In parallel, these more recently developing economies need to build out in these various sectors in a much more sustainable way for both cost and environmental reasons than was the case during the industrial era build-out that took place in the U.S, Western Europe, and Japan in the last century. These broader sectors of the world's economy such as infrastructure, human health, communications, and safety and security need to be addressed in much more innovative ways than has historically been the case. Since the VC industry's core skill is investing in highly innovative companies to address large market needs in many ways, I believe this is not the tail-end of the VC era in information technology, but rather it's just the beginning of a new global VC era across much broader sectors. The kinds of innovations, the framework for building companies, and the financing trajectory of successful venture-backed companies in this new global era are all changing.

2. What's changing about innovation?
For the last three decades the VC industry largely funded companies based on innovations in just two core sectors, the life sciences and the computer sciences. In the new global era of VC these domains will remain essential but in addition, new domains of innovation are growing in their importance as well. These include materials science, chemistry, optics, energy, and other areas that involve physics more than code. These innovations are being turned into products and then brought to market by companies that don’t necessarily look like Google, Microsoft, or Cisco – nor are they necessarily located in the same geographically concentrated areas. These startups are often changing industries that are still considered to be mature, "old" economy in the U.S., Japan, and Western Europe. For example, such seemingly mundane product categories as concrete, wood and other building materials, and water (the most basic commodity of all) are being rapidly transformed by venture-backed innovation and entrepreneurs in a way we’ve never seen before.

In turn, with the broadening of technology and innovation sectors a new set of geographic clusters throughout the world are emerging as leaders in the global venture capital economy. In addition to the well-known historical centers of VC activity, such as Boston, Silicon Valley, Seattle, and Cambridge (UK), regions such as Israel, Beijing, Bangalore, Pennsylvania, Southern California, and New Mexico are growing much more rapidly than areas traditionally known for their VC-based economies. In New Mexico for example - the market we know best at Flywheel Ventures - over ¾ of VC funding in 2007 was invested in companies leveraging innovations in solar, biofuels, water purification and optical equipment. Unlike previous eras in which Silicon Valley or Boston rose to technological prominence, entrepreneurial companies in these newer regions today cannot succeed solely by becoming the leading domestic supplier in a particular geographic region in the U.S. Today's companies are "born global," adding both a new set of challenges along with a broader set of opportunities that put success within reach for a much geographically-broader and sector-diverse set of venture capital backed entrepreneurs around the world than ever before.

3. What's changing about the framework of building companies?
Just as the modern global era presents new challenges and opportunities to entrepreneurs, so too has it changed the framework in which many VC-backed companies have to use to be successful. The global reach of the market-based economy, of mobile telecommunications, and of the internet means that the rate at which companies can grow is faster than ever before. This is evidenced by such overnight sensations as Google, Facebook, Skype, Twitter, etc. The need, however, to compete on such a global playing field also requires young entrepreneurial companies to establish resources to compete more broadly and earlier than was previously the case. For example, several of our portfolio companies that are less than 2 years old already have international sales offices and staff. In addition, many entrepreneurial companies today find customer service and support costs to be much higher than expected, as the level of interactivity with global web-based customers fuels the need for a higher level of customer interaction than ever before. For those entrepreneurial companies that provide physical products, they now need a more sophisticated global supply chain organization, and that need is emerging earlier than ever in a company's growth.

4. What's changing about financing trajectory?
On top of these changes in the innovation base and the global exposure of entrepreneurial companies, we are seeing several shifts in the way VC’s fund innovative entrepreneurial companies today. The first such change has been in the liquidity market where VC’s harvest returns from their investments. Largely gone are the days when most VC’s exited their investments through the IPO process. Most exits for venture backed companies today, over 90% in fact, come via acquisition by a larger corporation. While the amount of exit activity has largely kept pace over the last 2 decades, the average size of these M&A exits is substantially smaller than the average size of an IPO. The result is increasing pressure on seed and early stage VC’s to limit the amount of early stage equity capital invested in a promising new company, in order to ensure that upon their harvest of liquidity from an M&A exit, they can achieve the same multiple return on capital that was previously possible in a more IPO-dominated era. Simultaneously, however, the longer length of time between initial funding and the eventual exit for a successful venture-backed company – which is not up to between six and seven years -- has led to larger and a greater number of later stage follow-on funding rounds. Crafting a fundraising strategy that succeeds over the full lifecycle of building a company is a tougher challenge facing entrepreneurs than ever before.

5. What does that mean for entrepreneurs seeking venture funding?
The good news is that the type of company in which VC’s are interested in investing is broader than it's ever been. In addition, the willingness of VC’s to invest in companies in a broader set of geographic regions is also increasing, as I mentioned above. At the same time the challenge to entrepreneurs today is that the size of the average exit for a successful VC-backed company continues to be pressured by the lack of robust IPO markets and the lengthening of time between initial funding and eventual exit, thus putting pressure on an entrepreneur to run their business in a more capital efficient manner over a longer period of time. The central challenge therefore for entrepreneurs interested in building successful companies in partnership with VC’s today is to capture the broader potential in the global markets than ever before, while allocating resources in much more capital-efficient and effective manner to deliver the same level of historically above-average investor returns that venture capitalists demand (and in turn, that the limited partners who invest in venture capital funds demand). In a nutshell, the opportunity is bigger than ever before, but the difficulty in capturing that opportunity is greater as well.