Republished from Techcrunch.

Interest in startup accelerators and incubators has exploded in the past several years, but how effective have they been? One thing that has become clear is that “incubator” and “accelerator” refer to two very different models for startup workspaces, and the distinctions may have significant effects on startup success.

The key distinctions between incubators and accelerators are time period and structure. An incubator gives startups workspace and community at an affordable rate for an indefinite time period. Accelerators generally have workspace and a cohort that forms a community. They are run over a fixed time period with some significant degree of structure with regard to education and coaching. Accelerators are also capped by a demo day after which startups have to make it on their own, without further subsidy from the accelerator.

While the business incubator concept has been practiced in the U.S. since 1959, it has only been since 2005 that accelerators have become an alternative, and their rapid ascent in popularity over the past decade has been striking.

Y Combinator and TechStars are the two most well-known and successful examples of the accelerator model. But seemingly every day, they are joined by new industry, regional or corporate implementations of this approach. Universities, like MIT, have taken notice in the strong interest from its students in such programs and while there were strong and varying feelings about the efficacy of each model, there was little concrete data to validate the assertions being made.

So it was with great interest that I got to see the difference firsthand through two programs MIT ran for its student entrepreneurs during the summer of 2012, one using an accelerator model and the other an incubator model. Running proper experiments on startup education is hard, but through a series of accidental but fortuitous events, the teams selected for the programs were similar enough that we can draw conclusions about the programs by comparing their levels of success.

Accelerator Vs. Incubator

The accelerator, called the MIT Founders’ Skills Accelerator, or FSA, (now the MIT Global Founders’ Skills Accelerator, or GFSA), was announced in the spring of 2012 and attracted 129 applications for 10 spots. As a result of the extraordinary demand, the applicant teams were of such a high quality that we had a deep pool of qualified candidates beyond the 10 we could accept for the student accelerator program. As a result, we were able to procure space for a student-led incubator, called the Beehive Cooperative. Since the caliber of the FSA and Beehive teams were very similar, it significantly lessened the “selection bias,” which suggests that FSA teams would have stronger outcomes because they were stronger teams to begin with. In all, some 40 teams participated in the Beehive that summer.

Each program had dedicated workspace in its own location, and participants quickly built strong communities that were fostered by the program leadership. The difference came in the educational structure.

The FSA put teams through twice-weekly seminars, countless individual meetings with mentors, and monthly “board meetings” that held teams accountable to the milestones they set at the beginning of the summer. Teams could earn up to $20,000 by meeting the milestones. By contrast, the Beehive offered occasional guest speakers, but otherwise participants had to take the initiative to schedule meetings with our center’s mentors.

The results proved informative for how we design programs to support student entrepreneurs. We expected to see both groups make good progress because they would receive lots of encouragement from the peers in their community, and the dedicated workspace would allow them to focus better. FSA teams would probably do better with the more high-touch support, but with so many strong Beehive teams, we expected some level of improvement across the board.

However, while some Beehive teams did achieve success, the overall rate was much lower than the accelerator teams. The rate of progress was noticeably lower as was the drive to get their team to achieve “escape velocity” – our term for being a strong enough team to move out of the “MIT bubble” and establish itself as a standalone company.

An unexpected side effect of the Beehive was that teams did not want to leave the community they had built. The very social bonds and support that created such positive effects also had the negative effect of creating an environment that was too comfortable. The image of an incubator as a warm comfortable place to hatch eggs comes to mind and starts to haunt us. Fortunately for us, we had two forcing functions – many of the students were on the verge of graduating, and the extra space we had for the program was temporary due to an impending renovation of the building.

Does that mean that the Beehive experiment was a failure? Absolutely not. But while we would enthusiastically do it again, we would redesign the program. What made the difference between these two programs, and how specifically would we redesign the Beehive program to be more effective? A lot of it boils down to a simple chart:

Teams participating in the Beehive tended to follow line A on the graph, in which they made initial progress but stagnated over time. By contrast, teams participating in the FSA underwent several forcing functions throughout the program. Within the first 30 days, they put their ideas (and teams) to rigorous testing, so that by the end of the month (“t1” on the graph), they either had to show they were on the path to great success (line B), or they had to scrap or significantly revise their idea (line C). The individual components of their business were regularly scrutinized, as well.

Now, you may say, “Of course line B is the goal, but it’s hard to achieve. Isn’t the moderate success of line A better than the failure of line C?”

The answer is an emphatic NO! Companies following the path of line A are the “barely living.” Their rate of progress has slowed to near-zero – significantly less progress than they could make doing something else, both for the entrepreneur’s benefit and society’s benefit. As the rate of progress slows, the entrepreneur’s rate of learning slows, making them less-prepared for tackling the challenges of future startups. The startup will last only as long as the money does, if the entrepreneur doesn’t lose interest first.

By contrast, companies that follow the path of line C don’t waste time and money doing something that doesn’t work. In failing, they learn a lot about how to improve. They are ultimately on a better path to end up on line B with a successful company. Some may even decide, after enough line C failures, that they do not want to pursue entrepreneurship, giving them the opportunity to establish a career years earlier than the stagnant startup stuck on line A.

Therefore, a well-designed accelerator will force its participants onto either line B or line C by default, preventing or at least dramatically reducing the occurrence of line A. And we found in the FSA that teams that followed line C were able to quickly retool and establish strong businesses along line B.

An example is Loci Controls, which started out as an idea involving network-connected solar panels. A few weeks into the FSA, they saw major shortcomings both with the idea and the composition of their team. They added a team member and began exploring turning landfill gas into energy. They have seen a lot of success, and were just funded by CommonAngels. A second example, from our 2013 GFSA class, started with a very specific medical idea, and realized within two weeks under the pressure of the GFSA that they were not on line B. They regrouped and developed a new venture, ImSlide, around power line de-icing that was much more successful for them.

In these two cases in particular, the defined time period, hands-on mentoring, and uncompromising board-meeting sessions resulted in hard decisions being made sooner rather than later, with no option to choose a “comfortable state.”

Our experience with the Beehive is in line with other data about incubators. Dane Stangler, the vice president of research and policy at the Kauffman Foundation, reports that “Multiple studies have shown that incubators don’t work and, worse, they frequently subsidize companies that would otherwise fail. One report suggested that 90 percent of public and private incubators in the U.S. were ineffective. True, there are a handful of successful incubators, but incubators suffer from a design flaw: they are more often about real estate than entrepreneurship.”

As for accelerators, the data is not in yet, but MIT’s experience is encouraging. One key question to consider is whether the success of teams coming out of accelerators is due to the accelerator’s ability to attract and select great teams (sorting or selection value) or to the actual added value created in the program (added value). MIT professor Yael Hochberg pointed me to a study done by Columbia professor Morten Sorensen that showed in venture capital deals that 60 percent of the value created is based on selection value, and only 40 percent is added after the selection.

Our FSA/Beehive experiment reduced the selection bias as much as possible, and we were still able to see a significant improvement from teams in the acceleration model versus teams in the incubator model. It makes sense to me that when a team is forced out of its comfort zone, it will rise to the occasion far more than a comfortable team; it is why I channel Eleanor Roosevelt and tell teams “to do something every day that scares the daylights out of you” if they want to be great.

We will certainly do a program similar to the Beehive in the future, because the number of MIT student entrepreneurs is vastly more than the FSA’s super-high-touch model can support. But we will make it more of an accelerator than an incubator, incorporating lots of time-defined forcing functions and a more hands-on mentorship approach. This has also influenced how we design the accelerator program going forward. An overview of our continually evolving accelerator program is available online.

We hope this insight can also help future programs elsewhere to be better designed and for entrepreneurs to understand the strengths and weaknesses of each. “Incubator” and “co-working” spaces (which, due to the great economies of scale they provide startups, often resemble incubators in function) can have a positive role in a robust entrepreneurial ecosystem, but their limitations should be known and carefully considered.

Programs can and must be thoughtfully designed to avoid stagnation and instead provide a positive impact on entrepreneurial growth. This experience reminds us that “comfort” is a word that negatively correlates with great innovation and entrepreneurship.

Republished from Techcrunch.

Building stuff does not make you a startup. “But don’t we need to build stuff and iterate quickly?” I get asked a lot.

Well, sure. Once upon a time, when companies used the “old-school” waterfall model to develop products, pushing entrepreneurs to think in terms of building a minimum viable product as quickly as possible made sense. It substantially accelerated the development process. By narrowing the product scope to core features, you start the customer feedback loop quicker and you can more rapidly iterate based on that feedback.

But the pendulum has swung too far toward building stuff and away from spending some time getting to know your customer first. And the result is that more startups are building blindly, without focus, as well as falling victim to the “IKEA effect.”

The IKEA effect, coined by Michael Norton, Daniel Mochon, and Dan Ariely, is that when you make something yourself, you value it way more than you should. The trio did tests showing that amateur origami makers valued their creations as equal to those made by experts – even though the expert-created pieces were objectively of a much higher quality. The phrase is named after the well-known Swedish furniture chain where “some assembly required” is an understatement. As a result, as soon as we build something, we all tend to move increasingly from inquiry mode to advocacy mode at the very time where the former is needed and the latter can blind us.

One of our recent alumni teams, who will remain nameless for reasons you’ll quickly see, is absolutely in love with the technology they have created. They have developed some impressive award-winning technology which has the promise to significantly improve the Human Computer Interface. They have built a demo that is in high demand, and each time someone expresses interest in a piece of their technology, they get excited and add some more to address the interested party’s desire. With their demo and impressive technological skills, they have gotten money from business plan competitions and investors, which I think is possibly the worst thing that could have happened to them.

Neither the “someone” watching their demo at a conference nor the business plan judges nor the investors are paying customers. What the team calls an “MVP” is simply a sexy proof of concept. They say they are testing hypotheses, but the hypotheses they are testing relate to technological feasibility. They claim they are “pivoting” – which means they have run out of business ideas but not money – on a regular basis. And as a result, they’re not making progress.

Why are they devoting all their time and money to building when, as a startup, they have precious few resources? Because they built it themselves, and they love it, and they’ll be darned if you tell them their MVP isn’t attracting any paying customers and that they should instead focus on an honest dialogue about customer needs. They are too beholden to the IKEA effect. They claim to be in inquiry mode but really are much more in advocacy mode for what they have developed.

Compare this to another recent alumni team, FINsix. The company won recognition and a slew of awards last month at CES for its product, a miniature laptop power adapter that is a quarter the size of today’s power bricks.

But when they first showed up in my class, they only had a promising technology from the labs. I’m sure that power supply geeks will be impressed by Very High Frequency (VHF) switching that is 1000x faster and with a 10x reduction in converter size. “The elimination of heavy components, like magnetic core transformers, enables superior resistance to mechanical shock and vibration,” according to their website, which sounds like a good thing, too.

However, none of that helps a well-defined group of customers address a pain that they’re willing to pay money to address. FINsix recognized that, and so rather than build, build, build, they took some time to learn about customer needs.

“We were able to test the [VHF switching] concept with many different markets using an electronic brochure and extensive surveying to determine our beachhead market of laptop power suppliers,” co-founder and CEO Vanessa Green told me. A brochure.

There is a lot less emotional investment in an electronic brochure than an MVP that the engineers build. And their analysis allowed them to consider a range of markets, from cell phones to LED lighting, before determining that laptop power adapters were the best way to gain a core group of paying customers that would sustain the company so that it can develop more products.

Had they fallen in love with their technology, or the first prototype they built, they may never have gotten to the point of selling a consumer laptop charger. Think that app makers are immune to the dangers of an MVP? Sure, an app has less initial investment required, but otherwise, a business is a business. It’s easier to spin the roulette wheel when you don’t need as much upfront or sustaining capital, but that doesn’t mean you have a solid startup.

You can’t build great products in the dark, without a well-defined customer. And you can’t develop the right product for your customer if you fall in love with a prototype that nobody wants to buy.

So unless your end game is hoping that before the money runs out a competitor will buy you for your engineers or technology, you need to stop obsessively building, and start an honest dialogue with potential customers about their needs. It may not be as fun as tinkering with a “product,” but it is far less stressful than playing the acquisition lottery. That is what we call “disciplined entrepreneurship” where you can have both great technology and great marketing, leading to epic products. It is a false dichotomy to think you can only have great technology or great marketing, as some commenters have recently claimed in a myopic comparison of Stanford and MIT graduates.

Think I’m a conservative East Coast entrepreneurship instructor who’s behind the times? Last week when I was in San Francisco and chatted with David Bergeron of T3 Advisors and Cory Sistrunk and Ed Hall of Rapt Studio, they were right on the same page. “The MVP mentality has unintentionally taken us away from ‘user-centered design’ and a focus on the customer,” they told me. “We have to focus on the WHYbefore we can focus on the HOW and WHAT.”

For the entrepreneur, stop obsessing about your MVP.  Your first question, before HOW and WHAT, has to be “FOR WHOM?”

Republished from The Boston Globe. An interview written by Michael B. Farrell

Demand for such education is ‘off the charts,’ says MIT author of a how-to book

Q. Why are more people pursuing entrepreneurship?

A. When you look at the other options, they really aren’t very appetizing. People are disenchanted with working on Wall Street. Working at a large company and getting a job for life — that option doesn’t exist anymore. People like Jeff Bezos of Amazon.com are the new rock stars of this generation. People like him are the ones changing the world.

Q. What’s the biggest mistake people make when starting out?

A. People tend to focus on what they want instead of what the customer wants. They start building a company and try to push stuff out instead of determining who the customer is and building the company for them.

Q. You argue entrepreneurship isn’t innate. So, can anyone learn how to run a successful business by reading your book?

A. Entrepreneurship can be taught. Is it being taught like math in a classroom? No. It has to be taught in a different way. The overall need the book is fulfilling is that overall demand for entrepreneurship education is off the charts. It used be close to zero. When I went to college there were no classes in entrepreneurship. It is hard to teach entrepreneurship, but we do it all the time. It doesn’t mean you’re guaranteed success. But entrepreneurship needs to be thought of like a discipline.

Q. So, is the book a way of bringing entrepreneurship education to the many people who aren’t able to study it at places like MIT?

A. Is it about helping what’s going on here in Kendall Square? Yes. It will help entrepreneurs in Kendall Square. But only a few thousand people can be added to MIT each year. The question is what do they do in places like Lawrence, where you’ve got a lot of young people looking for jobs. You can be like Sal Lupoli from Sal’s Pizza, whose business is growing because he understands how to be a successful entrepreneur. We are trying to take what people can get at MIT and bring it to the rest of the world.

Q. Your book has an illustration of the 24 steps to a successful start-up and there’s a pot of gold at the end. Isn’t that misleading since most start-ups fail?

A. People believe the failure rate in start-ups is something like 90 percent. That is not true at MIT. You’re going to experience failure throughout the process, but most people are going to succeed and keep marching on. We have to have people who are ambitious and reaching for these big goals. The gold doesn’t just mean money.

Q. Is failure in business something that should be celebrated more?

A. We have to accept that if we want innovation-driven entrepreneurship, failure is part of the process. We celebrate wisdom that comes from failure, but not just to say that it’s OK to fail. You’ve got to try to win. It’s got to hurt when you lose. But you can’t be afraid of it.

Q. For people who aren’t getting the sort of mentorship you provide at MIT, where can they go for help?

A. There are a lot of organizations rising up. There’s Techstars and Y Combinator that are teaching people how to do this. Those are for-profit. But the question is, are they just skimming from the top and preparing start-ups to get funded and claiming success? You can also go to the Small Business Administration, and some chambers of commerce are running programs, too.

Q. But at some point, are too many people pursuing start-ups? IBM and Google still need employees.

A. Everyone can’t be an entrepreneur. If you are going to have 50 percent of the people become entrepreneurs, who is going to work for them? There’s a saturation point, but we’re nowhere near it.

Republished from Ewing Marion Kauffman Foundation.

Not all startup companies are created equal. Although both innovation-driven enterprises (IDEs) and traditional small- and medium-sized enterprises (SMEs) can provide valuable products and services and create jobs, IDEs – startups focused on addressing global markets based on technological, process or business model innovation – can potentially create hundreds or even thousands of high-skill jobs if they succeed.

The distinctive differences between these two forms of entrepreneurial ventures – and their importance for governments and policymakers wanting to support long-term economic growth – is the subject of a new paper released today by the Kauffman Foundation. “A Tale of Two Entrepreneurs: Understanding Differences in the Types of Entrepreneurship in the Economy,” examines IDEs and SMEs, their roles in local, regional and global economies, and their differing needs in terms of financial and policy support.

While traditional SMEs don’t require an innovative product, process or business model to succeed, IDEs are based on building competitive advantage through innovation on one or more of these dimensions.

For this reason, IDEs are more likely to be founded by teams of individuals with diverse skills and often higher levels of education than SME founders. SMEs focus on local or regional markets and create “non-tradable” jobs, whereas IDEs consciously pursue global markets and create jobs that can be performed in different locations. Funding sources also differ: SMEs tend to be individual or family owned with little outside investment, while IDEs have a diverse ownership base with external investors.

Because of their global aspirations and the criticality of both capital investment and competitive advantage, IDE entrepreneurs face much greater risk than SMEs – but the payoff can be much greater. Unlike SMEs, which typically grow in a linear fashion, IDEs tend to start out losing money but achieve exponential growth if successful. Government policies and programs, however, tend to favor SMEs, which often produce faster, more visible results – an approach that may undermine the success of potential new IDEs. [more…]

Download the full report as PDF.

Republished from Forbes. Co-written with Matt Marx.

When we teach our introductory entrepreneurship class at MIT, we take it for granted that each of our 75 students will be able to start an American company upon graduating. But many of them lack one thing they need to be able to do so—permission from the United States government to continue working in our country.

In this academic year, three in 10 MIT students, including four in 10 graduate students, are not U.S. citizens or permanent residents. So for them our entrepreneurship class is likely to remain just an academic exercise. Their student visas expire when they graduate, leaving them with two options, to leave the country or find an existing company to sponsor them for a chance at an H-1B visa.

Either way, they can’t start a company in the United States. Their only hope is to secure a visa extension for “optional practical training,” after which they must apply for an H-1B visa for their startup once it grows large enough to be recognized as a legitimate enterprise—among other things, one that employs 25 or more employees. But even if they follow this path, they are not allowed to become a majority shareholder in their own startup.

Much discussion about immigration views it as a zero-sum game, where a set number of jobs at existing companies will be awarded either to Americans or to foreigners. Indeed, the logic underlying the H-1B process is that a visa should be granted only when a qualified American cannot be secured for a position. The present view of immigration policy, where the resulting labor supply is applied only toward jobs at existing companies, misses the essential contribution that would-be immigrant entrepreneurs sitting in our classroom can provide, the creation of new American companies, and with them new American jobs.

Innovation-driven entrepreneurs are the engine of a vibrant economy. Their high levels of education and their pursuit of global markets and rapid expansion create jobs and economic prosperity. And many of them, such as these MIT students, were not born in the United States. There is a global competition to recruit this talent, and countries such as Canada, Singapore, and Australia have introduced policies that are far more welcoming than ours. Although strides have been made in retaining immigrant science, technology, engineering, and mathematics students, these measures are largely designed to let immigrants to fill jobs in existing companies. Would-be immigrant entrepreneurs still face major obstacles and uncertainty.

However, a window of opportunity around immigration may be opening. Alejandro Mayorkas, director of the United States Citizenship and Immigration Services, recently addressed a group of MIT students and acknowledged the benefits of keeping talented foreign-born entrepreneurs in our country. He is working to streamline USCIS procedures to aid entrepreneurs as much as possible under existing laws and has just launched a website, www.uscis.gov/portal/site/uscis/eir, to help entrepreneurs understand their options. Meanwhile President Obama and a number of congressional Democrats and Republicans alike have publicly expressed a desire to help foreign-born entrepreneurs stay in the United States.

Certainly we don’t pretend to have all the answers, and we are mindful of moral (and political) hazard. But we see three areas that the U.S. government should revisit in order to address the needs of foreign-born entrepreneurs’ desire to start American companies and create American jobs.

First, immigration policy needs to focus not just on skilled immigrants filling positions in existing companies, but on immigrants’ potential to create new companies, leading to the creation of new jobs. Perhaps a new EB-1 (priority worker) category could be created for entrepreneurs, similar to the existing category for scientists. The United Kingdom has designed a new entrepreneur’s visa for just such a purpose.

Second, we need to appreciate the talent of these entrepreneurs rather than making them feel like aliens. We have heard more than one outstanding foreign-born student reveal feelings of being treated like a suspect at a crime scene rather than a highly valuable asset. Other countries are increasingly becoming more welcoming to them, so our customer service policy has got to become more sensitive.

Third, one of the great advantages of startups is that they typically move fast and run lean and mean. They eschew bureaucracy in favor of action and experimentation, which is what makes them so great. We are in a competitive market and must actively recruit this talent and be more responsive to its needs.

We hope that our talented, foreign-born students at MIT and other higher learning institutes aren’t shown the door at the conclusion of their American education. Let’s instead use immigration as a tool to promote innovation-driven entrepreneurship and the gains in jobs and economic prosperity that result.

Or to put it another way, what if Steve Wozniak had been born not in San Jose but in Saskatchewan?

Republished from Xconomy.

Energy innovation and investing are exploding right now. Technological breakthroughs are seen as perhaps the greatest hope to solving our dire energy challenge. However, what is often overlooked is the link between finding or creating new sources of energy and the effects on food and water.

Indeed, if you think of energy as a coin, the flip side is water and food. The scary thing is that food and water are both lower on Maslow’s hierarchy of human needs—i.e., they are more fundamental to human survival. Yet, the current rush to create new sources of energy—including “clean” energy—may have potentially disastrous tradeoffs on our food and water supplies. Going forward, trading off energy creation for water—meaning creating new sources of energy that depend on heavy use of water, as many do—will be less and less acceptable. That’s why the most exciting opportunities in energy entrepreneurship and investment lie in strategies that create more water or energy without adversely affecting the other.

The Linkage of Energy and Water

At a fundamental level, we can think of the greatest and greenest energy producer in the world—the leaf—and observe through the process of photosynthesis that energy, water, and food are an interrelated system. But let’s also look at some other examples:

• Biomass—This is the most obvious source of tension between food, water, and energy today. Corn as a feedstock for ethanol has been a contributor to the dramatic rise in prices of this commodity and hence food (although the exact amount of its effect can be debated). The development of cellulosic ethanol will go a long way toward alleviating this tension by eliminating the dependence on corn or other foodstuffs for ethanol production. But there are also other, more subtle elements to the equation that add new sources of tension. Ethanol production from plants requires substantial amounts of water—and it must be clean, fresh water, which is the most precious kind. Biomass has been the poster child for the tension between alternative energy and water/food but it is far from alone.
• Nuclear—Traditionally, nuclear power plants have been built near large sources of water to promote cost-effective cooling.
• Enhanced Oil Recovery—After initial production starts to slow down, oil wells traditionally have been flooded with water to boost pressure and improve oil recovery. This made excellent economic sense in the past, and will be even more economically attractive with the new price levels for oil.
• New Heavy Oil Recovery—Heavy oil is viscous, harder to recover, and less economically attractive than the normal light sweet crude oil that is the standard today because of its costs of extraction and refinement. Driven by attractive new price levels and national security concerns, Canada is developing a large amount of this huge potential energy source in what is known as the “Tar Sands.” The increasingly preferred method to extract heavy oil a process called SAGD (steam assisted gravity drainage), which uses prodigious amounts of water.

These are only a few examples, but they illustrate the tight relationship between energy, food, and, especially, water today—a relationship that often forces painful tradeoffs when we try to produce more energy. But there are no laws of nature I am aware of that make this tradeoff necessary in perpetuity.

The Next Wave for Energy Innovation and the Future Focus for Productive Long-Term Energy Investing

I am often asked by investors and entrepreneurs, “What do you like with regard to the energy space?” My answer is twofold:

1. Water and,

2. Any company that decouples energy and food/water. The company should produce or save energy without adversely affecting the water and/or food supply.

Water has been overlooked as an area for entrepreneurship and investment for good reason: it is a very challenging arena. Water is similar to energy in its diversity and the magnitude of challenges it presents (see What’s Wrong with Energy Investing Part II)—and it has even more conservative ultimate users and buyers. Nonetheless, water’s time in the limelight has come, and many companies built around clean water technology that couldn’t get a second look a year ago now are drawing tremendous interest. Often these companies have been around for over a decade because that is how long it has taken such ventures in the past to get traction. In addition, new companies like NanoPur, a venture involving the use of novel carbon nanotube technology to improve the energy efficiency and cost effectiveness of desalination (and a finalist for the recent MIT Clean Energy Entrepreneurship Prize backed by NSTAR and the U.S. Department of Energy), are springing up with much higher frequency. The new economics of water make companies that increase the supply of clean water a compelling value proposition that will only increase over time. While there may be alternative energy sources and fuels, there really is no substitute for clean water.

The second point I raised above is really a necessary condition for building sustainable energy companies in the future. Only a year or so ago, venture capitalists routinely asked each new potential investment company about its India and China strategies. Similarly, for energy companies, the question will be, “What effect will the venture have on food and water?” Those companies that can decouple the tradeoffs between the two will be interesting, and those that do not, will not be attractive investments. Even existing, well-managed energy companies are now closely examining this issue, which will only increase in importance. An example of a potentially exciting new company in this regard is another finalist from the aforementioned MIT Energy Prize competition: Sequesco. This team of three PhDs plans to develop genetically modified non-photosynthetic bacteria (an approach different than photosynthesis-based algae production) to more efficiently convert harmful CO2 into biomass fuel. This is a double play (i.e., it decreases CO2 emissions and increases energy supplies) without negative ramifications on water or food—at least that we know of yet.

In summary, trading off water for energy is a devastatingly bad idea, for as wise old Benjamin Franklin said, “When the well is dry, we learn the value of water.” In the first stage of energy innovation, we began to deplete the well. But in the second stage, beginning now, we must move on from this folly and find more intelligent solutions.

Republished from Xconomy.

I had the good fortune to receive a substantial amount of feedback on my first post on this subject a few weeks ago. The feedback was productive and helped to clarify key points and in general reinforced my conviction laid out in the Part I entry. In that article, I advanced the idea that while “we should and must invest in renewables and alternative energy for the future,” to do so to the exclusion of hydrocarbons means “we are majoring in minors.”

My point was simply that a more balanced approach to our energy investments should be pursued that focuses as well on the hydrocarbon reality we face for the foreseeable future. While we develop alternatives for the longer term, I argued, we must simultaneously invest in making hydrocarbons a cleaner, more efficient form of energy—as well as energy efficiency initiatives. “Just to put this in perspective,” I wrote, “…If we could find a way to reduce CO2 emissions from automobiles by 1 percent it would be, from a quantitative and practical point of view, thousands of times more positively impactful than increasing solar energy production by a hundred times.”

The post generated a lot of comments, but the numbers behind my argument are quite compelling in the end, so I can’t say that my view has changed. My second installment on this subject will be regarding a topic that is much harder to qualify. But I believe it is another fundamental, yet often-overlooked factor that has to be dealt with more realistically if energy investing is to succeed: our critical shortage of energy entrepreneurs. Clearly, money for energy innovation is no longer an issue, but the entrepreneurs to effectively put that capital to work will prove to be a system constraint.

People in many industries will whine and complain about how their industry is so unique and more difficult than others, and so one has to sort through this groaning to find the truth. After some close analysis, though, I have concluded that for energy, unfortunately, it is definitely true. Energy entrepreneurship is much harder than entrepreneurship in other sectors, and I believe most investors have yet to come to grips with this fact.

To explain my case, I will break the discussion down into some key points (which follow below). These are general points about energy ventures and so may not apply specifically to individual cases—but in aggregate I believe them to be true. They present a real challenge for the energy sector today and into the near future.

All Entrepreneurs Are Not Alike, or Energy Entrepreneurs Are A Rare Breed Indeed

When new industries arise (e.g., computer hardware, software, telecom, internet, wireless, medical, biotech), they have their own unique characteristics. Obviously, the technical talent required differs greatly in these industries, but so do the entrepreneurial skills required. Entrepreneurs are the change agents who commercialize the disruptive invention, and the inventor (a technologist or some sort of visionary) needs them to create a meaningful new venture. The entrepreneur is the great integrator and the propeller of the new venture.

An entrepreneur who is successful in software usually is particularly skilled at identifying market opportunities and then executing a market-pull, customer-intimate, product strategy in a rapid fashion—getting innovations to market quickly and then iterating to improve the products. These skills are clearly transferable to Web 2.0 venture creation but are not as relevant, and, in fact, may be counterproductive, in a biotech entrepreneurial venture. Biotech entrepreneurs need to have a much more methodical approach over a longer period of time than Web entrepreneurs, and they must possess a distinct ability to manage a company and a project through significant regulatory obstacles. Similarly, as I will explain further, Energy Entrepreneurship is much different than any brand of entrepreneurship we have seen to date. In fact, I would argue that being an entrepreneur in the energy arena is unquestionably the hardest form of entrepreneurship by at least one order of magnitude.

While it’s easy for me to say that energy entrepreneurship is harder than entrepreneurship in other sectors, it’s a bit presumptuous of me to estimate how much tougher it is. I do so, however, to make the point that there is a big gap between it and other fields that people are underestimating right now. Let’s look at all the attributes or dimensions of expertise that an Energy Entrepreneur needs:

1. Multi-dimensional knowledge of science and engineering disciplines. While the entrepreneur is most often not the technologist or inventor, he (note: I use “he” and “his” in the gender neutral sense) does need to understand the core scientific drivers of the market as well as the technology or science drivers behind his various product offerings. For many new Energy Ventures that could well mean possessing an understanding of aspects of chemistry, biology, engineering, biotechnology, environmental science, computer science, and production systems, to name just a few. Does that make energy entrepreneurship unique amongst technology sectors? To the magnitude that such expertise is required, yes.

2. Longer time frame. While there are exciting exceptions like EnerNOC (NASDAQ: ENOC), the time frame required for an energy company to get traction is much longer than with companies in most other sectors. Ann Winblad, the software venture capitalist, said at the recent MIT Technology Review Emerging Technologies Conference that her companies took a long time to bear fruit—an average of 6.2 years. While for Ann that may seem long, most energy companies, even poster success stories like EverGreen Solar, can only dream of such short time horizons. While the current enthusiasm for energy companies is compressing the time before they bear fruit, the historical starting point (for good reasons) is significantly greater than 10 years. Indeed, if the time required for energy companies to bear fruit could be reduced to an average of 10 years, it would be a substantial improvement (Which raises a question as to how venture capitalists with 10-15-year funds can handle energy investing, but we must keep moving and stick to the main topic…). The persistence and patience that Ann said is so difficult to find for typical software startups is a fraction of what is required for energy companies. Biotech companies are similar in this regard, but in general, energy is far outside the bounds of other sectors.

3. Bigger scope and scale from a financial standpoint. Just from a financial standpoint, a typical energy new venture requires large amounts of capital. Investors have to make significant initial bets and then be ready to follow them up with even bigger bets. While energy is not unique (biotech, telecom, and now wireless—see Helio—come to mind as similar stories), it does add another dimension of required sophistication.

4. Ability to deal with public perception and often-intense emotion. Energy is inextricably tied to controversial natural resources, public safety, and environmental issues—not to mention questions about economic impact. Part and parcel with this come public politics and emotion. Some of it is clearly justified, and some of it is not. But, as ex-football coach Bill Parcells said, “it is what it is,” and the energy entrepreneur needs to be adept at dealing with it. (See the comments on my first post for evidence of this tendency.)

5. Adroitness in governmental affairs. Energy is not just emotional—it is politically charged with a significant policy dimension. If one chases down the full value chain of energy-related products, he or she will almost always find that they are directly affected by governmental actions. This action can be regulation (such as utility rate setting in the U.S.), subsidies (e.g, U.S. or Brazil ethanol production or Germany’s solar industry) or price setting (think OPEC). This is generally something entrepreneurs (and venture capitalists) hate. It’s not unique to the energy sector: the medical and biotech arenas have similar considerations. Strong capability and comfort in dealing with government affairs relating to policy and economic issues is absolutely critical to the successful energy entrepreneur.

Any one of these factors alone adds complexity to the already challenging task an entrepreneur faces, but the challenge becomes particularly daunting when the compounding effect is considered.

Numerous Routes for Attackers in Other Fields, Not in Energy

In addition to these traits, there is another important and challenging market condition that exists in energy that is fundamentally different from other high tech industries today. It is the imperative to effectively deal with (e.g., by partnering, collaborating, or at least neutralizing) the very people you are trying to disrupt. To a much greater degree than in other sectors the existing hierarchy in energy cannot be ignored.

Entrepreneurs thrive as “attackers” armed with disruptive technologies, business models, or other ideas that they bring to bear against the “defenders”—specifically the entrenched, resource-endowed hierarchy that is being threatened. Since the demise of IBM’s monopoly (Isn’t it hard to fathom that less than 25 years ago the biggest concern IBM had was anti-trust suits because it dominated the computer market so completely?), there have been multiple options for technology-based entrepreneur-attackers to create new products and to get to market. There has not been a dependence on a real or de facto monopoly on the defender side. It has been relatively easy to bypass the defender completely, or use defenders against each other to get the disruptive innovation to market.

For example, when Lotus came up with its breakthrough 1-2-3 spreadsheet, it did NOT have to work with IBM to have it fit into IBM’s closed mainframe architecture. It could operate on the open personal computer platform. Today, when Web 2.0 companies arise, there are no monopolies controlling the infrastructure that they need to deliver their offerings to customers.

Contrast this to the entrepreneur who wants to harness wind energy in the Dakotas and finds that there is no grid available to deliver the energy to the customer. To solve this problem would require dealing with numerous de facto monopolies (including utility companies but also state, local, and federal governments) that ultimately make the problem essentially intractable.

Energy entrepreneurs, especially those in energy production, don’t enjoy the luxury of having numerous possible routes to market—because it is almost always the case (even though they try to avoid it if they can and a few succeed) that they must deal with the existing hierarchy, which controls the infrastructure.

This is a difficult challenge in general because existing successful hierarchies are very content in homeostasis and resist significant changes (as Clayton Christensen details in The Innovator’s Dilemma). In energy, it is even significantly more challenging because those controlling the infrastructure are notoriously (and appropriately) conservative beyond what would be seen in other industries. While renewable and energy efficiency entrepreneurs might complain about utilities (sometimes with justification), they don’t have an option but to deal with them. Building a parallel grid is not a viable option. They must find extremely creative ways of working with the controllers of the infrastructure. Likewise, to be a player in the massive oil and gas industry, entrepreneurs usually need to find a way to work with those who control that infrastructure. The costs of the infrastructure are just so high in energy that having multiple options is much less likely than in other industries. It is not simply a barrier that was created because someone “built a brand”—there are huge costs required to build the infrastructure which cannot be overcome with a marketing program.

In Summary, Thoughts and Action on the Solution

As Albert Einstein said, “seek simplicity and distrust it.” The model I am proposing is not relevant for all energy startups, but it is for the majority of impactful new ventures that should and need to be created. The energy entrepreneur has to be able to manage significant technical resources to address the multidimensional science, engineering, and systems challenges which alone would exceed the entrepreneurial requirements for any other industry. If that were all, it would be enough—but it is not.

Like the most elite high-tech entrepreneurs, the Renaissance Energy Entrepreneur must have these multi-disciplinary science and technology skills like an elite high-tech entrepreneur, represented in the “Seed Innovators” circle in the model to the right. These include understanding and building innovative business models to optimize monetization, as well as a keen awareness of the standard successful new venture creation process. This must be managed over a long period of time while simultaneously addressing the other two circles shown in the diagram—the “Government” (policy and public relations) circle and the “Big Players” circle (representing the need to diplomatically and effectively “massage the existing controllers of the infrastructure”). This combination is what makes this an exponentially more difficult task. The Energy Entrepreneur today who can do this is very rare indeed and in huge demand.

First, we need to openly recognize the challenge in front of us and not believe there are simple solutions. I recently heard a very smart venture capitalist say that he plans to “take successful entrepreneurs from other industries who want to give back now and put them in energy.” In general, I find this approach sorely lacking. For a sports analogy (which is a bit of a stretch I know, but it makes my point), transferring Michael Jordan’s extremely prodigious mental and physical athletic talents from basketball to baseball didn’t really work—nor will it generally work in energy entrepreneurship. The idea of transferring entrepreneurs from other industries and putting them in energy may be our only option in the short term, but they risk getting whiplash as they seek to master steep learning curves in multiple dimensions.

At MIT, starting in our “Energy Ventures” class, we seek to build this new renaissance energy entrepreneurship capability by having multi-disciplined teams working off the model above. We have selected a number of the most talented and passionate students at MIT from multiple science disciplines and coupled them with top policy graduate students and MBAs with significant energy background and put them into teams to work on building new energy companies. We are watching the experiment with great interest. The full results are not in, but we do know that it is much different and much harder than most people realize.

There are many other efforts to cultivate energy entrepreneurship in organizations such as the MIT Energy Club, MIT Enterprise Forum, TIE (The Indus Entrepreneurs), and the like. We plan to create a unified competition platform (the MIT Energy Prize) with significant support for prospective energy entrepreneurs inside and outside our community to help audition and improve their skills in a highly constructive, networking environment. It will be a learning process for everyone.

While there is still much to learn, we do know that in time, through these efforts (and many others), a new breed of entrepreneurs, the energy entrepreneurs, will arise to meet the challenges of the energy sector. When that day comes, another major bottleneck to resolving the energy challenge will be removed. But until then, we must recognize the limit in the system and act appropriately.

Republished from Xconomy.

I just returned to Kendall Square after spending a spectacular weekend at Squam Lake in New Hampshire and at the forefront of my mind—and what I could not shake over the weekend—is the state of the development of the New England energy ecosystem. Granted, I have a personal agenda, as in 30 days I commence teaching a new class at MIT called Energy Ventures. Still, it’s an extremely relevant question for the local economy, and arguably the nation and the world. Energy is, after all, the biggest industry on the planet and certainly faces the biggest challenges. Therefore, it offers the biggest and most attractive opportunities for investors and others who want to make a difference.

A lot of smart and well-intentioned people have made a lot of progress in recent years in developing the regional energy ecosystem. But let’s not congratulate ourselves too fast. For every EnerNoc success story, there has been a GreenFuel setback (hopefully temporary). Not that such setbacks are necessarily a bad thing, especially if they cause us to reflect and learn how to improve. So the question that we should seek to answer is “what is working and what is not working in developing a New England-based energy ecosystem?” Or even more specifically, “what’s wrong with energy investing?”

To answer this question, we might refer to the Beatles’ George Harrison, who sang in “Got My Mind Set on You” that “it’s gonna take time, a whole lot of precious time…to do it right.” But the time is precious indeed, and I think enough results are in to make two important points about energy investing.

Majoring in Minors

While there clearly used to be a shortage of private equity capital for energy ventures (and rightly so because of their highly cyclic nature), that problem has gone away. Money is now gushing in. By my simple calculations, the amount of money available to energy ventures from dedicated private-equity funds quadrupled from 2005 to 2006, soaring from approximately $5B to $20B. I believe this is even understated. The point is that the money is flowing in at an amazing rate. But where is it going? Energy as a sector is almost as non-specific as technology or transportation. We have to peel back the label and take a closer look.

The lion’s share of the money that is dedicated to energy is earmarked for renewable or alternative energy. Renewable or alternative energy is a fantastic thing and it is necessary, but wholly insufficient, to deal with the energy problem. The biggest part of the energy riddle that needs to be solved resides—and will continue to reside for the next 50 years—with the hydrocarbon side. How do we find more to meet the booming demand? And, how do we find ways, through technology, process, and/or business-model innovation, to reduce the environmental impact of hydrocarbon usage? Renewables is a rounding error when compared to the 80 to 90 percent of the demand that hydrocarbons (i.e., oil, gas, coal—ah!, there it is the four-letter word of energy) fill and will continue to fill for the foreseeable future.

We should and must invest in renewables and alternative energy for the future and there will be some big wins there relative to investing. But with all the new money and attention rushing into this small part of the sector, we are majoring in minors. The major focus should be how do we deal with the continued need for hydrocarbons and how do we make this cleaner energy. Just to put this in perspective, the world would be dramatically better off from an energy-supply standpoint if we could find a way to improve recovery rates at oil and gas wells by 1 percent than if we built a million new wind turbines. If we could find a way to reduce CO2 emissions from automobiles by 1 percent it would be, from a quantitative and practical point of view, thousands of times more positively impactful than increasing solar energy production by a hundred times.

For the investor, this line of thought would seem to make sense as well. One of the top funds of any kind in the U.S. last year was First Reserve Corporation, and while they do not release their results, we know they did very well. One gauge is that they were the top fee producer on Wall Street last year. They also just raised an additional $7.8 billion to continue to do what they do best—investing in the basic energy industry with a focus on making the good old hydrocarbons industry more effective and efficient. These days the herd mentality of private-equity investors, in my humble opinion, has them putting too much money into renewable/alternative energies and not enough into fixing the core business of energy, the hydrocarbons. There will be a correction but until such time, I think this is a fundamental problem with overall energy investing.

Not Enough of the New Brand of Innovators/Entrepreneurs

The nature of the energy industry is far different from that seen in IT, healthcare, biotech, telecommunication, or any other field and it requires a new brand of innovator/entrepreneur which is in short supply relative to demand. The lessons from other industries do not translate effectively in many cases. The scope, scale, time horizon, interdisciplinary skills required, and the question of how independent a new venture can be from the existing infrastructure are problems that, in combination, are unique to the energy industry. But more on that in the next post…