Conversation with Bill Stensrud, investor, entrepreneur

Paul Kedrosky Interviews Bill Stensrud

Kedrosky: I’m here with Bill Stensrud, principle, interactive fitness, private investor he tells me. I was calling telling Bill I was thinking he was more like a recovering venture capitalist, or as his words, a recovering entrepreneur. But whatever you want to call him, Bill is a former Midas list member, a sometime critic, I suppose, of the venture industry but also a wildly successful venture investor in his own right as well as, I think probably more importantly in Bill’s mind, a highly successful entrepreneur across various ventures including some that he’s got going now. So, I thought we’d spend a half an hour with Bill talking a little bit about sort of his … sort of the genesis of Bill Stensrud as an entrepreneur and investor and then talk a little bit about what he’s doing now. But, thanks for joining us, Bill.

Stensrud: Well, thanks for having me Paul.

Kedrosky: So, let’s start off, I guess, with a little of obligatory background. Tell us a little bit about sort of how you backed into becoming an entrepreneur, I suppose, or maybe walked into becoming sort of more an entrepreneur back, I guess, in the ‘90’s. But, why don’t you give us a little bit of history in terms of some of your first entrepreneurial ventures and how that adventure panned out.

Stensrud: Well, it’s nothing like being in the right place at the right time. When I graduated from MIT, I went to work for Bell Labs and had the good fortune to work on some of the very early sort of pre-internet projects like the Arpanet. I was recruited out of AT&T to join a Silicon Valley start up called Rolm, R-o-l-m, in the ‘70’s. It was a fun venture. I spent time with them. They built the first sort of digital telephone system. That planted me firmly in the Valley and planted me in Silicon Valley with a background in telecommunications at the beginning of the sort of microprocessor and internet era. I had the good fortune to grow up in the Valley from the ‘70’s to the ‘90’s in a small series of entrepreneurial ventures including one called StrataCom, which I was founder of and which developed the same relay network industry. Was recruited to San Diego in the early ‘90’s to be the CEO of a company called Primary Access which built dial access equipment for companies like AOL, and MCI, and Prodigy and CompuServe. And then, out of a series of good fortunate sort of business, businesses that I was associated with that were successful including Juniper Networks, and then in 1997, I joined a venture firm in San Diego called Enterprise Partners. Stayed there for 10 years which was probably several years too long, and then 2007 I retired from that. Since that time, I’ve been a private investor focusing on what I called sort of micros venture opportunities which are small companies that back cash flow up quickly.

Kedrosky: Let’s come back to that. I don’t want to steal the punch line here, so we’ll sort of work our way back over. But, maybe just quickly kind of across some of the highlights here. You know you talk about sort of having been a founder at StrataCom. What was the genesis of StrataCom from your standpoint in terms of what drove you to think this was the right thing, and the right time and the right, I suppose, opportunity?

Stensrud: Well, I’ve been involved in building packet networks all the way back to the Arpanet. The theory of packet networks was you invested a lot in the technology to compensate for the fact that the lines that connected the switches and the users to the switches were slow and highly error prone. And so, we built networks around these slow error prone lines, and you spent a lot of energy and time and expense fixing errors because they happened all the time. By the late ‘80’s, the lines were fast and not at all error prone, so we had an insight because instead of taking a packet and correcting it on every link in the network, you could just relay through the interim links or interim switches and do the error correction end to end. That made the entrance, which is enormously faster and enormously cheaper and enormously higher [inaudible] budgets. That was the salute insight that led to the frame relay industry, so we built the first strain relay switches. Coincidentally, we built them around an ATM or [inaudible] model, which at the time was a good move. And so, StrataCom became the supplier of ATM switches to companies like AT&T, and Sprint, and to the [inaudible] post and all over the world. We built the company to about 12 hundred million. ATM took over from … you know, so the IBM’s SNA as the sort of dominant [inaudible] network infrastructure for corporate networks.

Kedrosky: In today’s, sort of … I don’t know the right way to think about it, but into today’s dollars, how much money went in? How much money sort of was the … I don’t know … early days of the company were required to do what you wanted to do?

Stensrud: So, the total amount of capital raised by StrataCom, you know, beginning to end was about $22 million. The company achieved a run rate of about $450 million in soft line revenue and was bought by Cisco in 1993 for $4 billion on a $20 million capital in investment of a bunch of guys.

Kedrosky: Nice for them. Nice for the founders.

Stensrud: It was nice for everybody.

Kedrosky: Nice for everybody. This kind of … and I mean you can take it forward and talk a little bit about, you know, Juniper as well I guess. But, I thought all of this kind of fits in with something that you and I have talked about a number of times and you’ve written about as well. But, this idea. You know there was a comment you made a while back about something Steven Chu at the DOE had said with respect to this idea of, you know, kind of the new tool. This idea that when you look at a market and you’ve got sort of a platform technology in mind that, you know, all sorts of things start to open up, and you say you know what I could use this for this, and this and this. In many ways, what you’re saying with respect to the having done this at the right time was that sort of a new tool presented itself to you, and you brought it into StrataCom or wherever else. Is that sort of the way … is that the right way in some ways to think about it that that’s what was going on at the time was that there was a new tool? It was really a question of figuring out where to bring it.

Stensrud: Yeah, Steven Chu has a remarkable interview on YouTube. It’s an hour long, and it deals with what he calls “The Primacy of the New Tools.” The thesis there is that if you have sort of a fundamentally new tool or an invention it often has applications that you could never have even dreamed of when the new tool was actually invented. I believe that the entire technology run from, you know, 1960 to 2000 was based on a single new tool. That was the transistor, and the transistor gave rise to integrate circuits to software, to computers, to microprocessors, to the internet and a thousand other things. Each of those became sort of second generation new tools, and each of them created enormous white space of opportunity for people to find applications that disrupted change, enhanced super charged industries and made a whole new array of things possible. The tool … the sort of branch of the new tool that started with the transistor that set me on my career was networking. It started with, you know, the very early forms of corporate networking, frame relay, the early packet networks and then ultimately the internet. The internet became sort of the driver of my career starting in the … in the mid … early ‘90’s. Pretty much everything that I have done since then has in some way been made possible by this new tool that was the internet.

Kedrosky: So, okay. This new tool was the internet. It sort of presented all these opportunities, and you know, as you say, you were cheerfully leaped on top of some of them. Is that … you know and I think to extend the argument. You make the case that this new tool is not just sort of fundamental from the standpoint of an entrepreneurial lens for doing this, but it’s also fundamental from an investor’s standpoint because it allows you to kind of … I don’t know. It doesn’t make things sort of into a just add water, but by the same token, you’re not forced to take on all sorts of risk that you might not otherwise have to take on. You make the case, and for example, I think in biotech or clean tech, I forget which, that there really isn’t a new tool in those domains.

Stensrud: Yeah, I mean I think the reason why … look, you know. Information technology, according to the McKinsey Report, went from about two percent of the GDP in the year 1960 to about 35 percent of the GDP in 2000. So, imagine how much sort of expansion that represented, and if you’re an investor, you’re investing in the right … the most rapidly rising tide of all times. There were so many opportunities to get it right that if you couldn’t as a venture capitalist make money between 1960 and the year 2000 you were an idiot. You were able to find a way for your boat to go down and arise in a massively rise and tide. That rise and tide was created by, you know, this enormous new age of technology, and so the problem with … or the virtue of an investment thesis based around new tools is not that everything is going to work or not that it’s easy to do. It’s just that there is so much white space. The white space results in an opportunity to do things that have never been even thought of before, and it also … because it doesn’t mean there’s no competition, but it does mean if you have the staff [inaudible] that you’re generally able to find places where you can ecologically live long enough to build critical mass without trying to go after somebody who is totally entrenched in the industry.

The problem with something like clean tech is that while there is a market need for a technology that is ecologically friendlier that doesn’t produce carbon there is no disruptive tool that I’m aware of. There’s no flat category. There’s no transistor. There’s no internet. There’s nothing that is emerging that’s going to give the entire industry this opportunity to bring disruptive change. If you look, for instance, at batteries over a thousand years … I’m exaggerating obviously … but if you look at battery technology, it’s gotten sort of one percent better year after year for 60 years. So, how does a trend like that create a venture opportunity? If you’re going to invest in something, you want to be investing in something where you can make it a hundred times better. You do that only where there is something completely disruptive being brought for the party.

I mean it was easy to attack IBM …. well, it wasn’t easy, but it was possible to attack IBM as a start up in an era where you had microprocessors and transistors and all sorts of things. You had a set of tools that allowed you to attack IBM and do things they couldn’t do. It is much clearer how you attack Exxon and Shell, and you know the big energy companies. I don’t understand what the disruptive tool is. I don’t know how you’re going to create something that is ten times better. Jack Kelly, who is famous as being, you know, sort of the marketing genius behind IBM in its early era, once said that the definition of hell was waking up running a company that has a product that’s ten percent better than IBM’s. I think that’s sort of where the absence of government intervention …

Kedrosky: Yeah.

Stensrud: … political capacity of some of the big venture guys to get the government, but you know … I don’t know … $500 million into test [inaudible] or to create an uneven playing field through sort of massive government subsidies. I don’t understand what the disruptive pool is in clean tech and where … where it’s going to go.

Kedrosky: Is this … does the argument apply … I mean I’ve already made a similar case that there’s at least a parallel over in biotech as well where it’s not … it’s also not obvious what the transistor is in the world of … I mean we’ve argued at one point that it was … you know it was the genome. It was the proteome. It was any one of a number of different therapeutic approaches, but none of those have really panned out in the sense of having turned into being widely applicable platform technologies where the risk was reduced. Or, am I looking at it a little too skeptically?

Stensrud: I would say that … I have effectively zero hope that, you know, clean tech as I understand it, which may be wrong, is ever going to turn into a big area of sore investment. I do not believe biotech is there today, but there is this … this huge amount of energy that’s gone into sentimental technology. The technology and the understanding about technology is getting, you know, better and better. The real silver bullet in biotech is ultimately going to be personalized medicines where they can essentially construct a treatment for you based on, you know, the unique sort of nature and nurture of the genome and the environmental issues that have caused whatever problem you have. I don’t know whether we’re five years or 50 years away from this, but I do believe that at some point the tool kit that is necessary to really create a disruptive playing field in life sciences is going to emerge from this. You know at my age, I’ll probably be dead by the time it does, but … you know and one of the things that you’ve got to realize is that this new tool theory. It’s not like the transistor was the last one you know. If you think about it for a minute, electricity, you know, and the ability to essentially transmit electricity created exactly the same explosion in innovation, everything from washing machines, to refrigerators, to hair dryers, to buy burgers to God knows what you know. I mean came out of that huge expansion in innovation from the building of the electrical grid. There will be another one. I don’t know what it is. If you figure it out, tell me, please, but it might be …

Kedrosky: But, doesn’t this …?

Stensrud: … biotech.

Kedrosky: Yeah, go ahead.

Stensrud: Well, it just might be biotech. I don’t know.

Kedrosky: I had an interesting … I was talking about this in a semi related way with Dean Kamen of Segway fame DEKA and everything else, dialysis products last week. We were talking about this that in some sense … I agree it’s going to come, but often wonder if IT in some sense … in some sense, hasn’t spoiled us because we’ve lived in an era of 30 or 40 years where, you know, Moore’s Law and everything else. Not only was this kind of rapid pace all around us in a weird way, it was actually kind of predictable. We sort of knew the pace at which things were going to get blown up, and they were going to get blown up on a pace roughly according to how quickly we could increase, you know, line density and clock speeds on chips at some level. And so, it sort of spoiled us in terms of making us cranky consumers of innovation in every other market. We went why isn’t this stuff changing faster in clean tech. Why isn’t stuff changing faster in biotech, and the answer, of course, is is that, you know, shuffling bits around and solving problems in basic science is really freaking hard. That’s what we’re running up against.

Stensrud: Yeah, I mean biotech is very hard, and until we have a sense of computer models and until we can turn it from an art into a science much like making, you know, line density smaller and transistor sites smaller it’s going to be a tough place to innovate, and it’s going to be very expensive. But, I have to say if you think about the change that happened with the emergence of the electrical grid and the appliances, there’s a really good … and I don’t remember where it was, but there was a really good documentary that was done on this subject. It didn’t happen as fast as the sort of computer revolution and the technology revolution, but I think that was a matter of just a slower world. Had that kind of thing happened in a faster world but the amount of change in a household from 1900 to 1950, which is roughly the same amount of time, you know, was … if you look at a home in 1950, you had one pair of clothes. You had kerosene lamps and then by 19 … by 1900. By 1950, every home had electricity, and you know, televisions and appliances out the wazoo, and so, it was a huge change in 50 years. So, ’60 to 2010 is also 50 years. It’s the same period of time.

Kedrosky: Right. No, it’s a great metaphor, and I mean, as you say, it has many of the same … you know in terms of releasing this kind of, you know, pre-Cambrian explosion of … I don’t know … entrepreneurial speciation or something like that. It had many, many parallels. I’m curious, you know, as a kind of segwaying over into some of the things you’re doing now, just to walk through. In a weird way, is the venture industry itself being disrupted I mean partly because of its own poor performance, but some would argue that, you know, some of the things we’re seeing in Super Angels and micro VC’s and all this sort of thing represents a kind of credible threat to at least an aspect of what venture is doing and maybe one slice of its activities. Do you buy any of that?

Stensrud: Well, yeah. I mean I think the venture industry … you know we drilled for oil and ran out of oil you know. I mean the reality is the wells are dry. And so, the venture industry got very, very big when there was a lot of oil to be pumped. Now that the sort of scale of the opportunity is much smaller, the industry is huge. As a result of that, there’s too much money, too many firms. The scale of the venture firms and the industry is completely out of sync with the scale of the opportunity, and because venture firms got large, their scale required them to focus on opportunities that were very large. So, they became dinosaurs, and I think that much … to use the sort of overused metaphor … the small furry mammals are where the action is in the venture industry now. You have to be able to, you know, make an investment business work with less money overall, less money per investment, and you have to be able to make the venture model work with much smaller liquidity, which then the industry got used to in the ‘90’s. So, I do think there’s a new model that’s emerging where the players are smaller, the funds are smaller, the investments are smaller, the liquidities are smaller, and the amount of money the partners is lower.

Kedrosky: What do you mean? No more seven figure pre-carry comp?

Stensrud: No, none of that at all.

Kedrosky: What kind of business is that?

Stensrud: Well …

Kedrosky: It’s a different one.

Stensrud: It’s a different one. Yeah, that would be the right answer.

Kedrosky: Yeah, it’s a different one. So, does that … I mean not to push too hard on this, but does that make you a … and we’ll flip over to some of your current activities after this, but does that make you a believer in some of the … quite honestly, it feels like hyperbole to me. But, is some of the hyperbole about what we’re seeing with respect to these micro venture firms? I know you’ve been sort of paying some attention to the emergence of some of these characters that are … are they the small furry animals you’re talking about, or is it something else?

Stensrud: Well, you know, the original that your business list sort of wealthier, successful business people investing their own money in ventures and providing sort of mentoring to a company where the portfolios are small and it [inaudible] other people’s money. I think that is the model I’m pursuing, and it’s the model, I know, that a lot of other people are pursuing. I think that’s, you know, a model that has come back into favor because it fits, you know, the size of the industry as I talked about it earlier. I do think that, you know, as people are able to raise small funds from other people if they invest in wisely, if they look at the whole capital efficiency, if they’re willing to wait for, you know, their share of the pie until they achieve success, that may be a reasonable model for an industrial venture business where people are investing other people’s money, not just their own. There are some challenges with that though because funds like that don’t generate, you know, a lot of fees, and so, the partners who want to do something like that probably have to have significant part of their own money into the deal. They have to be capable of being patient, and you know getting their piece of the pie as a function of later success and not just sitting there clipping coupons.

I am a little bit perplexed by what I see as the sort of Super Angel phenomenon because I don’t know what a Super Angel is exactly. An Angel, for me, was always somebody that invested their own money. A Super Angel seems to have become someone who creates a fund and invests a lot of … makes a lot of small investments. It’s unclear that that model scales, but frankly, I don’t have an opinion that I don’t understand why it’s any different than, you know, sort of traditional venture was back in the ‘70’s. It just looks like a, you know, “Back to the Future” kind of …

Kedrosky: Yeah, I mean and I think … right. I think some of the people have been making the claims about Super Angels have been kind of sort spanked back into reality. It really is just kind of micro VC thing. If you’re managing someone else’s money, you’re a VC. It’s just how big you are. If you’re managing … if it’s your own money, as you say, this questions the scale, but you’re an Angel one way or the other. Why don’t we use that as a way of sort of jumping over into what you’re doing now? You’ve talked a bit about sort of what you think works and sort of being more patient, not clipping coupons. In a sense, it strikes me that that’s a little bit of what you’re doing now in terms of, you know, trying to build things, almost having a holding company portfolio approach. So, why don’t you describe a little bit about what you’re doing and what sort of … how that sort of has come together?

Stensrud: Well, what I’m doing is building businesses around cash [Inaudible]. I made an observation that there was a lot of, you know, sort of bad behavior in the startup world, [inaudible] large, over the last, you know, 10 or 15 years. I thought that that behavior came from a cultural imperative to focus on the … essentially the exit. The idea was that there’s a greater fool out there, and if you build the top line, you can kind of ignore the fundamentals of the business because a rapidly growing top line will result in … or affect your story … will result in an IPO, an acquisition where you can get out before you’ve actually finished building a real business, and you know put your money in your pocket and move on. I think over the last 10 years the number IPO’s and the number of acquisitions has demonstrated that that strategy is largely flawed. And so instead, what I’m focusing on is being … investing businesses where the focus of the business is on generating, you know, positive cash flow. That’s the way businesses used to be measured in the old days. Now, the second thing you want is growth, but you want growth with positive cash flow, not growth without positive cash flow.

One of the things that we’ve done relative to … I’ve sat there and said I want people to act like owners. I want everyone in the organization to feel like an owner. The traditional way of getting somebody to act like an owner is to give them a stock option, and so, now you have a stock option. Since the owners are the holders of the stock, we should be acting like an owner. But, as we’ve known in the industry now, the holding time of a shared stock over the last 60 years has gone from, I think, 40 months in 1960 to days in 2010. So, stock holders are no longer owners. They’re traders. I believe the employees who get shares of stock or stock options, you know, sort of become traders. They’re really there … they will work hard, but they’re there to see the pot of gold at the end of the rainbow, to see an exit to get their stock to do with money.

Instead what I’ve done is built companies around the model that says that I will take the positive cash flow in the company, and I will give half of it to the employees and [inaudible] some kind of phantom stock program. So, instead of looking for an exit or trying to build the value of the shares, everybody thinks every day that if they spend another dollar, fifty cents will be theirs. If they make another dollar, fifty cents of it is theirs. So, we’ve had a … we’ve had considerable success in getting businesses to cash flow positive very rapidly. My attitude is if you have a business that’s growing and generating cash and the cash is growing and the employees are getting half of it and they’re getting more and more every year, then who needs an exit.

Kedrosky: And, is it … I mean it’s too soon to tell obviously, but it’s an appealing idea. Is it working? How do you know?

Stensrud: Well, I don’t know for sure. I have … I’ve had two businesses that I’ve put up in this manner. The first business was a software business working on software tools for the music industry. We will hit, you know, cash flow possibly this year, but it took three years to do that, which is longer than I expected for a variety of reasons. The second business is an interactive internet enabled fitness business that we started on November 8th of last year. We were actually … had our first cash flow positive quarter in early this year, and by this quarter, the entire business will do $10 million in revenue 2010. The last quarter will be solidly cash flow positive. We had a company which was an acquisition of a failed company, had 90 employees. We solely acquired it. We now have 18, and we’ve done the business in a way where we can make money at one quarter of the revenue that the predecessor company was making when it went out of business. It was losing money, so we’ve got a business that I’m quite proud of. While it’s too soon to tell, the one year in we have succeeded in getting everyone focused on the right goals and making money.

Kedrosky: Well, I mean … and as you say, too soon to tell, but at least … it’s soon enough to know that there’s a reasonable prospect that this is going to … I guess how shall I say it? Incentives are aligned to do the right things.

Stensrud: Yeah, incentives are aligned to do the right thing, and the other thing I have to say … I mean there’s nothing new about venture [inaudible].

Kedrosky: No.

Stensrud: For months of history, people have started businesses with the idea that, you know, everybody involved was there to help make money not to sell the shares.

Kedrosky: I had someone tell me recently that the reason why venture capitalists, in so far as it works in the Bay area and doesn’t work anywhere else, that the dirty secret of why it works in Bay area is that it’s fundamentally built on the idea of friends selling to friends. You know I think that’s probably true, and you know as you say, that really kind of gets away from the idea that these things were supposed to generate more cash than they consume. When you do that, options open up. If you’re option is friends selling to friends, that’s a very different thing all together.

Stensrud: Yeah, well once you’ve built a business that is growing and generating cash, you can do anything with it. You can keep it growing. You can own it. You can sell it. You can share it, but if you’ve got a business that is not generating cash, then somebody’s got to keep putting money into it. That severely limits the options.

Kedrosky: Well, that’s probably a great point to end on, so I’ll … let’s stop right here. Thanks very much, Bill. It’s been a great discussion.

Stensrud: Well, thank you for inviting me, and stay in touch Paul.