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The Silver Lining

artworkThe picture of economic doom and gloom has already been painted, yet entrepreneurs and entrepreneurial mentors say the forecast for certain startups couldn't be better. Here's what to consider before taking the leap. -- By Mary Tamer

When markets and housing prices are down, and the only thing rising faster than the cost of gas and food is the unemployment rate, why would anyone risk building a new business in a bad economy?

According to a number of entrepreneurs with ties to MIT and MIT Sloan, the proper question should be, “Why not?”

Albeit a more challenging time, say entrepreneurs and funders alike, we are currently in a period that is rife with opportunities for a multitude of reasons, not the least of which is the growing pool of unemployed talent created by the loss of jobs in nearly all sectors. Yes, markets are down, and angel and venture capital (VC) funding are harder to come by, due in no small part to a dearth of initial public offerings (IPOs) and fear on the part of investors who are still tallying stock market losses. Yet, while the tightening of VC funds may be a factor for larger, higher-risk ventures in need of significant startup capital, the same is not true for new companies built on innovative ideas that can run on moxie and a shoestring budget.

“When money comes easily, it goes easily,” says Erika Williams, SM '78, an interim CEO and board member of a number of Silicon Valley companies. “While it is definitely the case that it is more difficult to find venture money right now, my take is you are better off to bootstrap yourself until you can find good customers. When you have a great idea and you want to get funding … investors are going to want a big chunk of the company, and you end up with a small sliver. So you are better off building as much as you can to take the company as far as you can on your own resources.”

But, resources aside, if now isa good time, is it a good time for anyone armed with an idea and a dream?

“The economy does drive startups,” says MIT Sloan Professor Ed Roberts, SM '60, founder and chair of the MIT Entrepreneurship Center. “Still, there is no correlation between the economic conditions when you start and the later success or failure of a company. So, if you're looking for an outcome five or 10 years downstream, do it now.”

“The percentage of people who are capable of being entrepreneurs is much higher than people realize,” says Alec Dingee, SB '52, chairman and co-founder of MIT's Venture Mentoring Service (VMS). “If you've lost a job and you're hard pressed to find an alternative, the easiest thing to do is go start a company.”

As is often the case, the numbers speak for themselves. A quick review of recessionary history and the Fortune 500 points to countless examples of ventures started in tough economic times—Disney, Microsoft, Hewlett-Packard, Hyatt, Burger King, CNN, and MTV, to name just a few. These startups eventually found their way to fruition and beyond. As Alexsis de Raadt St. James, SF '01, founder and chairman of The Althea Foundation, a social venture fund based in San Francisco and London, points out, “Of the 2009 Fortune 500, half of the top 50 companies, and seven of the top 10, were founded in a recession. Now is the time.”

Should you plan to plough ahead, here's more of what the experts have to say on the secrets to entrepreneurial survival and potential success.

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THE RIGHT PEOPLE

American industrialist and philanthropist Andrew Carnegie once stated that teamwork “is the fuel that allows common people to attain uncommon results.”

“Right now, you have all these terrific people who are available to get together and start a company,” says Tim Rowe, MBA '95, co-founder and CEO of the Cambridge Innovation Center, a flexible office space facility in Kendall Square that houses 200 small companies on 10 floors. “Funding without the right people won't get you anywhere, and you can't do anything without the right people around you.”

With the U.S. unemployment figures continuing to rise, with a high of 9.5 percent as of July 1, there are more of the “right people” available than there have been in over 20 years—and some will clearly choose to start their own ventures, or to work within them. Today's labor supply is strong as a result of corporate and organizational layoffs as well as buyouts taken by “bright, capable people,” according to Dingee.

“This is an excellent time,” agrees Williams. “There are a lot more people available who do not require huge resources. I know a fellow who started a company in 2002 who was able to get people to work for him for almost two years without any cash payments. They were getting paid in stock. Now another friend is starting a company, and it is amazing the number of talented people he has been able to tap.”

NECESSARY RESOURCES

Few places, if any, can rival the cultivation and entrepreneurial output of a place like MIT—and few know more about this than Roberts.

A serial entrepreneur, Roberts holds four degrees from the Institute. He was a driving force behind the MIT $100K Competition, the MIT Entrepreneurship Center (E-Center), the Entrepreneurship & Innovation (E&I) track at MIT Sloan, and the world-renowned MIT Enterprise Forum, which today boasts 24 chapters worldwide.

“There's a totally different world of entrepreneurship today at MIT,” notes Roberts. “The kids at MIT have no idea what entrepreneurship was like here 15 years ago.”

But Roberts certainly does, having watched the number of students taking entrepreneurship courses increase from 200 to 1,500—and the number of professors and lecturers rise from two to 30.

“We now have 30 courses and infinite clubs,” Roberts says of the expansive range of offerings available to budding entrepreneurs. “In addition, the $10K Competition is now the $100K Competition—and that is a misnomer since we gave away a total of nearly $500K this year in categories that include nanotechnology, biomedical technology, and clean energy.”

It is for this very reason that MIT's Venture Mentoring Service (VMS) was launched in 2000 by co-founders Dingee and MIT Professor David H. Staelin as another means “to support entrepreneurial activity throughout the MIT community” by students, faculty, staff, and alumni. Through VMS, a group of more than 100 volunteer mentors helps budding entrepreneurs with everything from business plans to customer and product development.

“A place like MIT provides an enormous amount of resources that you can lean on and borrow,” says Roman Lubynsky, SM '89, an entrepreneur and senior venture advisor at VMS. “The ecosystem that is there to support entrepreneurs is great, and VMS is just one of the examples. You can come to our mentors, and they will explain the different aspects of entrepreneurship and offer advice on how to keep moving forward.”

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FIND YOUR NICHE

Dating back from his own early days of entrepreneurship in middle school, Rowe learned the importance of finding the right niche to frame a business plan.

Realizing that a number of his parents' friends were buying personal computers (PCs) for the first time, Rowe seized upon the opportunity to start his own consultancy, charging $150 to advise grownups on how to pick out a home computer, set it up, and then use it.

“PCs were new and people didn't know how to use them,” says Rowe. “It was a fun opportunity.” And, he says, a lucrative one. Many years, and a number of businesses later, Rowe co-founded a solution to another unmet need via the launch in 1999 of the Cambridge Innovation Center (CIC), “the area's largest and most popular flexible office space facility for small and growing companies,” according to the CIC website.

Today, CIC houses 200 companies on 10 floors at One Broadway in Kendall Square, providing attractive office space equipped with all possible modern conveniences. Price is determined by “the type and size of space” the business needs, ranging from $250 to $1,000 monthly per person. Rowe notes that CIC has continued to grow over the past decade—and in recent months—at a consistent rate.

“You need to carve out that niche that no one else is doing,” says Dr. Ronjon Nag, SM '91, a founder of Lexicus, a pioneer of speech and handwriting technology, which sold to Motorola for an undisclosed eight-figure sum in 1993. Now CEO and co-founder of the wireless applications company Cellmania, Nag says that “if you are resourceful enough, you will find your space. If anything, the recession makes you more astute in your thinking.”

STRENGTH IN NUMBERS

During a March 2009 appearance on CNBC, Kauffman Foundation President Carl J. Schramm stated that more than half of the companies currently on the Dow Jones Industrial Average were started either in bear markets or in recessions. In addition, Schramm—who has led the world's largest foundation dedicated to entrepreneurship since 2002—added that one-third of U.S. gross domestic product comes from firms that did not exist in 1980.

“That's how important entrepreneurship has become to the American economy,” Schramm says. “In past recessions, the boom of entrepreneurship has actually resolved the recession once the bottom has been hit.”

Rowe, who has been at the helm of CIC through two significant economic slides, believes the worst may already be over.

“This is our second time through a downturn,” says Rowe, “and the first time we were surprised to make it through. This time, we are surprised how well it has gone. We have remained profitable throughout this entire downturn.”

CIC has also grown in the midst of the current economic slump, from 180 companies on October 1, 2008, to 200 companies today.

“You hear a lot of different things about the economy, but my direct experience is that we are seeing more new companies than we usually do, in addition to a lot of hiring,” Rowe says. “As a measure, in the last two weeks we added 55 new people to the center. On average, our companies have five employees; so across the 200 companies, they have hired 55 people. I don't know where else in the economy you are seeing that kind of growth.”

BELIEVE IN YOUR IDEA

Among the more recent additions to CIC is MassChallenge, a new venture capital competition co-founded by Akhil Nigam, David Constanine, and John Harthorne, MBA '07, inspired by MIT's own $100K Competition, which Harthorne won in 2007. Their premise: to promote the development and growth of startups in Massachusetts by providing grants of $50,000 and seed funding for winning business plans to launch immediately in the Commonwealth.

As the team of three refined the pitch on their idea and began networking, they found support in the right places, including an endorsement from Gururaj “Desh” Deshpande, SM '07, co-founder and chairman of Sycamore Networks. Deshpande's support of the MassChallenge idea led not only to the provision of free office space at CIC, but ultimately paved the way for a $100,000 planning grant from the John Adams Innovation Institute of the Massachusetts Technology Collaborative.

Within 48 hours, notes Harthorne, the $100,000 state grant was converted into $325,000, thanks to additional contributions from Deshpande, Microsoft, and the Kauffman Foundation. This builds a base of support for the significant fund raising that still lies ahead to reach their goal of more than $25 million.

“Entrepreneurship is a contact sport … it can't be learned in a classroom,” says Harthorne, citing a quote from Joe Hadzima, former chair of the MIT Enterprise Forum. “You have to have perseverance and you have to believe in your idea.”

You also have to convince funders and customers alike that your idea is as good as or even better than you think it is.

“It's very important to care about your idea and to think about it all the time,” stresses Harthorne. “You have to be able to say, ‘This is going to change the world,' and you have to believe it.”

THE SPECTRUM OF FUNDING

While self-financing—also known as bootstrapping—may be the name of the game for certain types of ventures in a down economy, the same is often not the case in the realm of life sciences, which encompasses biotech, pharmaceutical, and medical devices.

“That's where there are heavy problems for mainly two reasons,” says Roberts. “One, life sciences companies need a lot of money; and two, they take a lot of time … so there's no short run. With a device company, you can say, ‘I can be to market in 12 to 18 months.' Right now, device companies can get funded, but biotech or pharmaceutical companies cannot unless they get money from a foundation like the Gates.”

Roberts, who has also worked for years as an angel investor, said that in tough economic times, angels are “quick to flee.” Or, to quote MIT Sloan's Sarofim Family Career Development Professor Fiona Murray, “In times like this, angels go to heaven.”

“Our preliminary findings suggest that investment from VCs and angels is more limited and more focused on short-term targets and high levels of capital efficiency,” says Murray, who has been working on this issue along with PricewaterhouseCoopers and the Massachusetts Life Sciences Collaborative.

“What this means for entrepreneurs in this sector is finding plans that have shorter time to revenues, are less capital intensive, and can meet value-creating proof-of-concept milestones in a timely and effective fashion,” Murray says. “This is certainly pushing attention toward diagnostics and devices, and away from very high-risk and long-term drug discovery projects.”

Murray also cites “the emerging role of foundations in funding life sciences investments as well as entrepreneurs having to make more creative use of government funding, including Small Business Innovation Research (SBIR) and some dedicated sources of state funding or funds from the American Recovery and Reinvestment Act (Recovery Act).”

It should be noted, however, that it is not only the life sciences entrepreneurs who have a chance to apply for funding through SBIR or the Recovery Act.

“There's a huge stimulus package geared to drive economic activity,” says Harthorne, whose venture has already benefited from a state-based grant. “So you have to ask, ‘What do people need? What sort of hidden assets do I have? And how do I leverage my story and my history?' ”

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THE VALUE OF SWEAT EQUITY

Serial entrepreneur and angel investor Peter Schmidt, SM '92, said that when he and his wife, Hollie Schmidt, LFM '92, embarked on their latest joint venture in 2001, at the point of the dot-com collapse, “we probably picked the worst time in the last 50 years to start a high-tech consulting company. We survived on our savings for over a year before our market began to recover.”

“In a recession, there are more real opportunities, but it is also harder to go after them,” says Schmidt, who has started more than 10 for- and non-profit organizations, including a software venture co-founded with his wife while both were at MIT Sloan that later sold to Teradyne for $20 million.

“As a recession matures, a couple of things happen,” he explains. “Companies have reorganized and are now understaffed for what they would like to achieve. This gives entrepreneurs a chance to bootstrap … which works well in many high-tech companies where you can apply the same skills to your job as well as to your own effort. Hollie and I worked seven days a week at our first startup, so we worked 40 hours a week at our jobs and we could still work 40 hours a week on our company. Even after it became profitable, we kept up the 80 hour pace for three or four years as we grew it.”

Initially, Harthorne and his partners at MassChallenge did exactly that as well. They maintained full-time jobs while working on their new nonprofit venture out of a home office and “using a mirror as a whiteboard.” Others, like Nag, ploughed ahead with their ideas, but without full-time jobs, amid the humble beginnings of a small garage.

“We were a classic Silicon Valley startup, with no money and no Web site. It was all about networking, and we lived hand to mouth, month to month, in a very tiny garage,” Nag says. “But we got incredible press. A two-line story in PC Week led to a mention in InfoWorld, then NPR, the New York Times, and then the cover of Fortune magazine ... . Three months later, Motorola bought the company.”

UNDERSTAND YOUR MARKET

When times are tough, venture ideas based on problem solving and cost savings are key, say entrepreneurs and entrepreneurial mentors, as are the customers needed to buy them.

“A lot of times, people focus on the product development process, but don't think as much about the customer development process,” says Lubynsky. “It's important to do as much as you can to explore customers and validate your product. You have to get out there and talk to them before you build a lot of technology. This way, you learn an enormous amount about your target customer and probably find other target customers as well.”

“You need to understand your market very well,” says Williams. “Where will you find customers? Will they be willing to pay for what you are producing?”

Ideas based on something even simpler may work, too, as is the case with Twitter, the much-buzzed-about online service founded in 2006, which the New York Times has called “one of the fastest-growing phenomena on the Internet.” Still, despite millions of registered users and a plethora of publicity, they have yet to turn a profit.

“Twitter has critical mass, and if a company is big enough yet unprofitable, the belief is that eventually you will find a way to make money,” Schmidt says. “That worked for Amazon, but most investors now would prefer there to be a real business model in place before large amounts of growth capital are needed.”

THE FINAL TEST

As a longtime consultant and mentor, Schmidt says he always asks his clients five questions that every entrepreneur should be able to answer: Who is going to buy what? For how much? When? And why?

“When I say, ‘Who?,' I want specific names, not just names of customer companies, but names of individual human beings … and when you say, ‘What?,' you have to define your product at two levels of detail deeper than your elevator pitch,” explains Schmidt. “The ‘How much?' ties in with the design, as you have to understand your value to the end user in the end user's context, and what fraction of that you can capture. ‘When?' is that very difficult question of how do you roll this out over time and how to get things cash-flow positive and fill out your product vision. And the ‘Why?' is perhaps the most critical question of all.”

It is this final question, notes Schmidt, where he needs to hear the compelling reason for why this company should begin in the first place, and what types of benefits will it offer to those who may choose to use it, or buy it.

“If you can't answer the ‘Why?' very well, that's a red flag,” says Schmidt. “It forces you to think like your customer, which is often surprisingly hard at first. If the answer is, ‘I have a burning desire to change the world with my idea,' then I say we will find a way to make that happen.”