Since reading Barbarians at the Gate in the early 1990s, I have been a huge fan of business histories. Although I have read scores (perhaps hundreds) of business histories, my list of "must reads" is still long. Recently, I decided to read one of the books on that list, The Soul of a New Machine, Tracy Kidder's account of Data General's efforts to build a minicomputer in the 1970s. This book was published in 1981, and it deals with events during my high school years, so it is a great trip down memory lane.
Here is an observation about the founders of Data General early in the book:
Some notion of how shrewd they could be is perhaps revealed in the fact that they never tried to hoard a majority of the stock, but used it instead as a tool for growth. Many young entrepreneurs, confusing ownership with control, can't bring themselves to do this.
Hmm. The distinction between ownership and control is a familiar one in corporate law circles, but this Berle-Means concept is typically applied to large corporations. What does it mean in the startup context?
Chuck O'Kelley examines the connection between entrepreneurship and the Berle-Means corporation in his 2006 article, The Entrepreneur and the Theory of the Modern Corporation, 31 J. Corp. L. 753, but I am curious about viewing this from the other direction. As noted by O'Kelley, the separation of ownership and control is used by Berle and Means to describe firms after the decline of the classical entrepeneur, so it seems somewhat surprising to see Kidder use those terms to describe a startup.
Founders often exert a tremendous influence on a company, even when shares are held by other employees and investors. This control may emanate from their formal positions within the company (CEO, CTO) or perhaps from the respect they are paid from other employees. But I think it is fair to say that ownership matters a great deal in the startup context because it is more concentrated than in the public company context. Thus, to a large extent, ownership is control in a startup.
Two recent developments in the law and practice of business include: (1) the advent of benefit corporations (and kindred organizational forms) and (2) the application of crowdfunding practices to capital-raising for start-ups. My thesis here is that these two innovations will become disruptive legal technologies. In other words, benefit corporations and capital crowdfunding will change the landscape of business organization substantially.
A disruptive technology is one that changes the foundational context of business. Think of the internet and the rise of Amazon, Google, etc. Or consider the invention of laptops and the rise of Microsoft and the fall of the old IBM. Automobiles displace horses, and telephones make the telegraph obsolete. The Harvard economist Joseph Schumpeter coined a phrase for the phenomenon: “creative destruction.”
Technologies can be further divided into two types: physical technologies (e.g., new scientific inventions or mechanical innovations) and social technologies (such as law and accounting). See Business Persons, p. 1 (citing Richard R. Nelson, Technology, Institutions, and Economic Growth (2005), pp. 153–65, 195–209). The legal innovations of benefit corporations and capital crowdfunding count as major changes in social technologies. (Perhaps the biggest legal technological invention remains the corporation itself.)
1. Benefit corporations began as a nonprofit idea, hatched in my hometown of Philadelphia (actually Berwyn, Pennsylvania, but I’ll claim it as close enough). A nonprofit organization called B Lab began to offer an independent brand to business firms (somewhat confusingly not limited to corporations) that agree to adopt a “social purpose” as well as the usual self-seeking goal of profit-making. In addition, a “Certified B Corporation” must meet a transparency requirement of regular reporting on its “social” as well as financial progress. Other similar efforts include the advent of “low-profit” limited liability companies or L3Cs, which attempt to combine nonprofit/social and profit objectives. In my theory of business, I label these kind of firms “hybrid social enterprises.” Business Persons, pp. 206-15.
A significant change occurred in the last few years with the passage of legislation that gave teeth to the benefit corporation idea. Previously, the nonprofit label for a B Corp required a firm to declare adherence to a corporate constituency statute or to adopt a similar constituency by-law or other governing provision which signaled that a firm’s sense of its business objective extended beyond shareholders or other equity-owners alone. (One of my first academic articles addressed the topic at an earlier stage. See “Beyond Shareholders: Interpreting Corporate Constituency Statutes.” I also gave a recent video interview on the topic here.) Beginning in 2010, a number of U.S. states passed formal statutes authorizing benefit corporations. One recent count finds that twenty-seven states have now passed similar statutes. California has allowed for an option of all corporations to “opt in” to a “flexible purpose corporation” statute which combines features of benefit corporations and constituency statutes. Most notably, Delaware – the center of gravity of U.S. incorporations – adopted a benefit corporation statute in the summer of 2013. According to Alicia Plerhoples, fifty-five corporations opted in to the Delaware benefit corporation form within six months. Better known companies that have chosen to operate as benefit corporations include Method Products in Delaware and Patagonia in California.
2. Crowdfunding firms. Crowdfunding along the lines of Kickstarter and Indiegogo campaigns for the creation of new products have become commonplace. And the amounts of capital raised have sometimes been eye-popping. An article in Forbes relates the recent case of a robotics company raising $1.4 million in three weeks for a new project. Nonprofit funding for the microfinance of small business ventures in developing countries seems also to be successful. Kiva is probably the best known example. (Disclosure: my family has been an investor in various Kiva projects, and I’ve been surprised and encouraged by the fact that no loans have so far defaulted!)
However, a truly disruptive change in the capital funding of enterprises – perhaps including hybrid social enterprises – may be signaled by the Jumpstart Our Business Start-ups (JOBS) Act passed in 2012. Although it is limited at the moment in terms of the range of investors that may be tapped for crowdfunding (including a $1 million capital limit and sophisticated/wealthy investors requirement), a successful initial run may result in amendments that may begin to change the face of capital fundraising for firms. Judging from some recent books at least, crowdfunding for new ventures seems to have arrived. See Kevin Lawton and Dan Marom’s The Crowdfunding Revolution (2012) and Gary Spirer’s Crowdfunding: The Next Big Thing (2013).
What if easier capital crowdfunding combined with benefit corporation structures? Is it possible to imagine the construction of new securities markets that would raise capital for benefit corporations -- outside of traditional Wall Street markets where the norm of “shareholder value maximization” rules? There are some reasons for doubt: securities regulations change slowly (with the financial status quo more than willing to lobby against disruptive changes) and hopes for “do-good” business models may run into trouble if consumer markets don’t support them strongly. But it’s at least possible to imagine a different world of business emerging with the energy and commitment of a generation of entrepreneurs who might care about more in their lives than making themselves rich. Benefit corporations fueled by capital crowdfunding might lead a revolution: or, less provocatively, may at least challenge traditional business models that for too long have assumed a narrow economic model of profit-maximizing self-interest. James Surowiecki, in his recent column in The New Yorker, captures a more modest possibility: “The rise of B corps is a reminder that the idea that corporations should be only lean, mean, profit-maximizing machines isn’t dictated by the inherent nature of capitalism, let alone by human nature. As individuals, we try to make our work not just profitable but also meaningful. It may be time for more companies to do the same.”
So a combination of hybrid social enterprises and capital crowdfunding doesn’t need to displace all of the traditional modes of doing business to change the world. If a significant number of entrepreneurs, employees, investors, and customers lock-in to these new social technologies, then they will indeed become “disruptive.”
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Last week, Elon Musk—CEO of Tesla Motors—announced on the company’s blog “All Our Patent Are Belong To You” (apparently an homage to a late 90s, ungrammatical internet meme--thx Brian Gividen for pointing this out). Musk claims to adopt an “open source” policy for Tesla’s patents. He elaborates, “Yesterday, there was a wall of Tesla patents in the lobby of our Palo Alto headquarters. That is no longer the case. They have been removed, in the spirit of the open source movement, for the advancement of electric vehicle technology.”
Musk’s move has been hailed widely in the blogosphere as an act of altruism (e.g., here & here). Most of this sentiment has been fairly unreflective. (However, for a certain-to-be prescient analysis that focuses more on the business implications of Musk’s move, see my colleague Orly Lobel’s comments over at Prawfsblawg and Harvard Business Review blog. While I’m quite sympathetic to most of Orly’s observations, as I explain below, I’m quite skeptical of her view that the move will be “good for faster industry innovation.”)
However, like most patent “give-aways,” legal loopholes usually spoil the party. Specifically, Musk stated that “Tesla will not initiate patent lawsuits against anyone who, in good faith, wants to use our technology” (emphasis added). Of course, “good faith” is a legal term of art large enough to drive a diesel-spewing, 18-wheeler through, much less a zero-emissions Tesla (and this loophole has been roundly noted by a few observant journalists).
Most importantly, is Musk (or his lawyers) expecting that others that use Tesla’s patented technology also make their patents available to Tesla? In more narrow terms, is the result similar to Twitter’s supposed “give-away” that reserved to Twitter the right to sue a competitor if the competitor sued Twitter? Probably so.
Thus, like Twitter, Tesla’s giveaway appears ultimately to boil down to a generalized offer to cross-license with competitors, including potential entrants. As such, Musk’s “give away” is not terribly radical, because cross-licensing in the high-tech and auto industries is fairly commonplace (veritable “keiretsus” in Scott Kieff’s words).
In this regard, as Michael Schallop, an IP attorney recognized, Tesla “wants to encourage others to develop on a common platform, and to the extent that they’re doing so, Tesla is not going to stop that by using its patents offensively.” Indeed, as I have described elsewhere, forcing smaller competitors and potential entrants to cross-license typically provides the incumbent (here, Tesla) a strong advantage, because the incumbent often controls “complementary assets” that provide competitive advantages aside from IP, like robust sales & marketing channels, access to capital, and the like. So, at worst blush, Tesla’s putative altruism could actually keep small, innovative entrants out of the commercial marketplace by effectively forcing them to license their patents to Tesla.
Furthermore, as others have noted, much of the Tesla patent portfolio does not seem particularly strong, nor does it appear to include much of its fundamental technology (which appears to be kept largely as trade secrets). Like IBM’s giveaways of several years ago, one wonders if Tesla found that giving away its patents would yield more revenue by seeding its technology widely—benefiting not only from potential infrastructure effects, but also from the consulting and joint venture dollars that go along with actually explaining to licensees how to implement the technology (specifically by using Tesla’s trade secrets and know-how, which Musk is not divulging). So perhaps Tesla is “patent washing” to offer the proverbial “Trojan horse” (sorry, last cliché) to the larger auto manufacturers (and even lure gullible “anti-patent” engineers to Tesla—see Orly Lobel’s points on these issues).
Or maybe Musk truly thinks he’s being altruistic. Unfortunately, contrary to Musk’s proclamation, “giving away” patents (even putting aside the “good faith” loophole) usually doesn’t mean “open source.” The reality is that Musk’s act is likely to redound much more to his self-interest than society’s.
If Musk were truly concerned about society being able to use Telsa’s technology, he’d specifically agree to the following terms: a royalty-free license to all Tesla current and future patents to any comer in writing with the single exception of maintaining an enforcement right against incumbents or large entrants (but not startups or small entrants) who sue Tesla for infringement. Additionally, Tesla would disclose all of its trade secrets under similar terms and use vigorous efforts codify Tesla’s know-how in so doing.
Of course, Tesla’s “give-away” is quite a ways from this much more thoroughly “open source” approach. As such, I’m not particularly optimistic that Tesla’s current policy will ultimately promote faster innovation or the more rapid adoption of electric vehicles. Perhaps even more unfortunate is the general inability of the press even to spot these issues, much less analyze their ramifications.
My law school classmate Henry Olsen has another great column in National Review, this time addressing the current political talk regarding the virtues of entrepreneurship is out of kilter Ronald Reagan's vision of entrepreneurship.
Reagan almost always referred to job creation as something we all did, not something that was the province of the elite few. His speeches did not emphasize, as Romney’s did or as Senator Ted Cruz’s still do, the role of the entrepreneur in creating jobs. He celebrated the effort, thrift, and ingenuity of the American worker, not the American boss.... For Reagan, the entrepreneur was simply another type of citizen, another average Joe. He or she is not greater than us, someone upon whom we depend. He IS us, and our efforts in working are as noble and important as his in creating.
Press business article of the week has to belong to Jessica Pressler, who writes great about everything. It's about the start-up culture, the place where tech and MBA meets, and guys who dislike cleaning their own clothes. A taste:
[W]hen people in a privileged society look deep within themselves to find what is missing, a streamlined clothes-cleaning experience comes up a lot. More often than not, the people who come up with ways of lessening this burden on mankind are dudes, or duos of dudes, who have only recently experienced the crushing realization that their laundry is now their own responsibility, forever. Paradoxically, many of these dudes start companies that make laundry the central focus of their lives.
I recently finished reading The Master Switch: The Rise and Fall of Information Empires by Tim Wu, a professor at Columbia Law School. The book was released in 2010, and I can't believe it has taken me this long to read it. (Concurring Opinions did a symposium on the book in 2011.) Once I started, I found excuses to peel away from other responsibilities so that I could read the book, and I finished it in three days. If you are interested in law and entrepreneurship, this book is essential reading.
Wu's proposed "Separations Principle" ("the creation of a salutary distance between each of the major functions or layers in the information economy") is nice example of a set of regulations designed to promote the "release of energy" that Darian Ibrahim and I discuss in Law and Entrepreneurial Opportunities. Wu argues that antitrust law alone cannot create an environment in which entrepreneurial action can flourish. He details the costs of monopoly with colorful stories, and shows how government sometimes enables entrepreneurship, but too often plays an abetting role in the supression of entrepreneurship. Of course, not everyone agrees with Wu on the effect of his policy prescription, but Wu has the frame exactly right.
By the way, on Saturday, Wu was the subject of a nice profile in the NYT, highlighting his role in the debates about net neutrality, a term he coined in 2003.
UPDATE: Speaking of net neutrality and entrepreneurship...
And this from today.
The Bitcoin exchange Mt. Gox appeared to be undergoing more convulsions Tuesday [February 25], as its website became unavailable and trading there appeared to have stopped, signaling a new stage in troubles that have dented the image of the virtual currency. . . .
Investors have been unable to withdraw funds from Mt. Gox since the beginning of this month. The exchange has said that a flaw in the bitcoin software allowed transaction records to be altered, potentially making possible fraudulent withdrawals. No allegations have been made of wrongdoing by the exchange, but the potential for theft has raised concern that the exchange wouldn't be able to meet its obligations.
The apparent collapse of Mt. Gox is just the latest shock to hit Bitcoin, the price of which is now off more than 50% from its December 2013 peak:
For those better acquainted with the dead-tree/dead-president variety of money, Bitcoin is a virtual currency not backed by any government. Rather than being printed or minted by a central bank, Bitcoins are created by a computer algorithm in a process known as "mining" and are stored online or on your computer. They are bought and sold on various exchanges, including until recently Mt. Gox (whose troubles have been reported for a few weeks now).
There are many reasons, some of them even lawful. Bitcoins can be regarded as a medium of exchange, an investment, a political statement...or a way of avoiding capital controls and other pesky laws like bans on drug trafficking and human smuggling.
But the criminal potential of Bitcoin is probably overstated. The Chinese have gotten wise to its use for avoiding capital controls. Using Bitcoin for criminal or fraudulent activity would be difficult at scale (PDF). The Walter White method is still far and away the best way to ensure your criminal proceeds retain their value and anonymity.
I don't share the utopian fervor for Bitcoin expressed in tech and libertarian circles (see, e.g., this supposedly non-utopian cri de coeur), but it may have some positive potential as a decentralized and lower-cost electronic payments system. We'll see if that ever gets off the ground.
In the meantime, the Mt. Gox collapse is pretty huge news for Bitcoinland. Unlike the NYSE (the failure of which would be hard even to imagine), Mt. Gox does not benefit from any systemic significance and thus is unlikely to receive a lot of official-sector help. The situation has some early adopters running for the Bitcoin exits, like this leading Bitcoin evangelist.
Despite (because of?) my agnosticism on the currency, I'll be writing more about Bitcoin soon. (Mainly, I wanted to stake a claim to being the first to write about Bitcoin on The Conglomerate.) If your Palo Alto cocktail party can't wait, however, this explainer (PDF) from the ever-impressive Chicago Fed should tide you over.
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I am feeling a lot of joy at being back in the classroom, particularly because it's been 2 years since I've taught the Lifecycle of the Corporation. This is a class I pretty much made up, using the Entrepreneur's Guide to Business Law, and it traces...the lifecycle of the corporation (no false advertising here!). We are in the venture financing unit, and here are some cool things that have come up so far:
Airbnb: This site lets people post bedrooms in their own homes to stay in. WSJ weekend interview (pro), news from Davos from IHG CEO (con). The interview gives a great entrepreneurship overview, highlighting the fortuitous way the idea came about. Basically 2 out of work graphic designers know they need to make rent, and that a big conference is in town.
Mr. Gebbia had three air mattresses and suggested turning the apartment into an "air bed and breakfast."
Within three days, they had a rudimentary website up and booked three guests: a 35-year-old woman, a 30-year-old from India, and a 45-year-old father of five, each paying about $70 a night for several nights. "I thought we were going to get a bunch of young L.A. dudes, 23-year-olds," Mr. Chesky recalls. No matter. That month's rent problem was solved, and Messrs. Chesky and Gebbia thought they might be on to something.
For those who use the Netflix IPO case study, the story reminds me of the happenstance way Reed Hastings came up with the idea for Netflix. Also, I had never heard of Airbnb, but several of my students had actually used it, making me feel old and out of it.
This story about the Immunity Project, a non-profit that received funding from Y-Combinator and is raising money for an AIDS vaccine based on research on "controllers," individuals who seem to have an immunity that prevents HIV from developing into AIDS. They're looking for crowdfunding. And they want to give the vaccine away once it's developed.
This tech incubator that has been operating right in my backyard, whose open house I attended this past week.
And this website on VC negotiations by a former entrepreneur-turned-VC.
All in all, feeling invigorated by all things start-up. In one heady moment I said to yesterday's class, "I'm not exactly saying that you should quit law school and start a company...But maybe you should quit law school and start a company."
Don't tell the dean.
I spend a lot of time talking to people who study entrepreneurship, and many of them are enthusiasts. Of course, many of use are Walter Mittys, living our lives vicariously through the daring business people we study, so it's easy to proclaim, entrepreneurship is for everyone. Then I stumbled on this infographic that made me think that might actually be true ...
Entirely unrelated: Wharton now has a section of the full-time MBAs meet in San Francisco.
Ried Hoffman, founder of LinkedIn, is quoted as saying, "If you are not embarrassed by the first version of your product, you’ve launched too late."
According to the Times, Silicon Prairie is the big new thing, and I'm proud of the fellow Iowans who got the paper to run a story making that claim (admittedly, on a holiday weekend, but still). Here's the evidence that Iowa, Nebraska, and Missouri have become a hub of entrepreneurial tech:
Although a relatively small share of the country’s “angel investment” deals — 5.7 percent — are done in the Great Plains, the region was just one of two (the other is the Southwest) that increased its share of them from the first half of 2011 to the first half of this year.
That's it. The rest is just anecdote, layered with plenty of hedging. You can, however, tell yourself a story why Silicon Prairie might be real. Tech can be done anywhere, and so might as well be done on a flat, featureless landscape; the Midwest does well in creating high quality, not-so-high-wage white collar; and universities like Iowa State (home of the first computer!) have aggresively tried to prove their worth to the state by fostering spin-offs.
Will this conlfuence of factors create a real technological hub, to the extent that a "hub" encompassing hundreds of miles of farmland even makes sense? My guess is that it simply reflects a transformation of the economy going on everywhere, and not just in the fields of dreams. But it is nice to have a label.
The latest edition of The Economist has a fascinating article on “Chilecon Valley” that discusses the emergence of a startup community in Chile. The article focuses on a unique program of Startup Chile (a new Chilean governmental body) that gives grants to entrepreneurs in the United States and elsewhere to move to Chile for several months as they work on building their company and developing their technology. The grant recipients are then expected to network with, speak to, and mentor Chilean entrepreneurs.
The article touches on how law can foster or hinder the growth of a startup community, including by liberalizing immigration laws and allowing failed ventures to get a fresh start in bankruptcy.
Chile is making considerable efforts to diversify its economy beyond extractive industries like mining and agriculture. My spouse is co-organizing a fantastic three-day conference in Santiago from November 28 to December 1st that will focus on social entrepreneurship, sustainability, and innovation. The conference includes a fantastic line-up of speakers, including a keynote address by Al Gore, a pitch competition for social entrepreneurship startup companies, and some awesome music, including Devendra Banhart and Denver’s own Devotchka. Several panels will analyze the contribution of law to developing a entrepreneurial ecosystem in Chile.
You can check out my wife’s newly launched blog and website on the Chilean startup community here.
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No, thank you.
But I digress. The point of this post is not to direct you to IMVU, but to link to Stanford's Entrepreneurship Corner, an excellent resource for students of entrepreneurship. In fact, Eric Reis talks about his experiences building IMVU in several videos on ecorner.
Not as flashy as TED, but good stuff.
This year BYU is inaugurating the Crocker Innovation Fellowships, and I am fortunate to be on the faculty, albeit in a very limited role. Nathan Furr (Business), Marc Hansen (Life Sciences), Chris Mattson (Mechanical Engineering), and Dan Olsen (Computer Science) have been pulling the laboring oars, so far, and I will make my main contributions in the fall semester.
As noted on the Fellowship website, "The goal of the course is to change the way students view the world and inspire the next generation of innovators." Closer to the ground, the year-long course begins this semester with an introduction to innovation, continues over the summer with an internship, and concludes in the fall with the students developing their own innovations.
As a distant observer, I have been fascinated by the communications among the 20 Fellows as they build their collaborative community. They are sharing all sorts of ideas through Google Docs and LinkedIn, encouraging and correcting and building each other. Their energy is pretty infectious ... and I haven't even been able to meet them in person, yet!
Anyway, you are on notice. Watch for some great new businesses emerging from BYU in the fall 2012 semester.