FUTUREVIEWS, October 2009

Adam Mikkelsen discusses the business models that will prevail or perish over the next five years and the major economic trends that will shape the future of business

Adam Mikkelsen is a principal with Cooper and Company, an investment firm based in Newport Beach, California, with interests in global real estate and private equity. Adam leads the evaluation, structuring and execution of the Firm’s private equity investments and is closely involved with the operations of portfolio companies.

Prior to joining Cooper and Co in 2000, Adam formerly practiced as a corporate attorney in the New York office of Kirkland & Ellis where he acted for institutions in leveraged buyout transactions. A New Zealand native, he also practiced corporate law at the New Zealand firm Russell McVeagh for 5 years prior to moving to the US. He holds Ph.D, LLB and BA degrees from the University of Auckland, New Zealand and is a CFA charterholder.

WTRI: As a person who works in Venture Capital, what do you think are the adaptive business models that are most likely to survive in turbulent economies?

MIKKELSEN: The more this kind of turbulence continues, the more I realize that luck and chance and random outcomes play a part, and good decision making and being able to control your outcomes play a part. Reflecting on it, I think the influence of the first is probably much bigger than most people are willing to acknowledge. So what you can do about it? The main thing is probably to increase the opportunity for beneficial chance to operate by preventing yourself from making obviously bad decisions. You’re never going to be able to control and get perfect results, but you can improve your chances by eliminating, at least to some degree, untenable or irrational approaches and outcomes.

WTRI: What kind of business models will survive in the next five years?

MIKKELSEN: I think that the types of products that will have a major impact on the economy, are products that have global appeal that can grow into markets outside of the western world. I think the big brand names you see now will still be around, they’ll still be powerful. They’ve got the ability to adapt to changing conditions.

My other sense is that the type of business models which are going to do well are going to be ones that are scalable without requiring huge amounts of capital. Companies will do well that have products or services where the intellectual property component is high and the physical component is relatively low. People decry the death of the manufacturing base in the US, but that has also been the engine of growth. The ability to generate economic growth without requiring huge amounts of capital increases, so you’re able to grow faster than you would have if you had a manufacturing base. I think its probably that shift toward knowledge based work that is going to define successful business models.

WTRI: What major economic trends have you noticed in since you’ve been in venture capital that make certain kinds of businesses more or less attractive to venture capitalists?

MIKKELSEN: I’ve seen two major trends in the past 10 or 12 years, and this isn’t just limited to VC, this is in the private equity sphere as well. The period’s been marked by two huge bubbles: the tech boom, from about 1997 to 2000, and the more recent, leveraged buyout bubble fueled by low interest rates. What you find in both cases is an increase in hype and a decrease in the rigorousness of the decisions being made. You look back at the tech boom and ask yourself, “how could people have funded something that depended on such unrealistic assumptions?” But it happened again with hype around leveraged buyouts. Now the bubble is in the green tech/clean tech area. Here, the investment community’s has been suspending disbelief about funding some of these companies. You’ve got to make sure you have some rigor in how you look at opportunities and distance yourself from the type of growth predictions that are put in front of you. Investments are often made based on how much a company can be sold to the next person, rather than looking at the fundamental growth prospects of the company.

It’s a cliché, but another major trend that is going to have a major impact over the next 20 to 30 years is the role of emerging markets, particularly China, in terms of fueling growth in the world economy. Companies that can appeal to an international consumer base or an international buyer base and can be scaled quickly without requiring huge amounts of capital probably have a better chance of success and delivering shareholder returns in the long term.

WTRI: How do you think your role as a VC fits in to all of this?

We focus on two areas - clean energy and financial services. These areas appeal to us because the markets are global, they are scalable, and we have some confidence about the long term growth driven by by fundamental demographic factors. Look at the role of pension savings, private savings, or the demand for energy. In ten years time there’s absolutely going to be a greater global demand for those products or services. Those markets will be much larger than they are today. It’s a function of how people live their lives as they get richer.

Secondly, the decision making processes that people go through when they are thinking about buying goods and services in these markets are fundamentally the same no matter where you are. It’s not like selling Barbie dolls or clothing in which you have to have an extremely intimate knowledge of the local market. Our kinds of products and services are essentially sold by the ‘numbers’. With financial services, the array of products or the types of approaches you can take with people in that area is pretty much the same worldwide: they want a return on investment. How you structure the deal financially is something that doesn’t alter from market to market. There are local laws and regulations, but the basic structures are the same. It’s the same with energy – how much power can you produce at what cost? So by dealing in areas that are fundamental to how people live, we can have confidence they still be around and still be strong in two or three decade’s time.

WTRI: What types of business models are still vulnerable? And what haven’t these models really learned yet?

MIKKELSEN: Venture Capital has moved from its individuals, person roots to become an institutional market in which VCs are funded by pension funds and endowments, and have capital that they have to invest, because the partners are living off the fees which are generated by assets under management. If you’re compelled to invest, you’re not going to be making investment decisions for optimal reasons. Let’s say that you look at 100 deals a year. If you feel you have to invest in 3 or 4 of them, that’s different from being able to walk away and do nothing. and to be honest, a lot of investors in these funds would be better served if the VC walked away more, and invested less capital. But under this model VCs necessarily invest in deals in which they wouldn’t be investing their own money.

The second thing is the amount of money these funds have to deploy. As this goes up, the field gets more competitive, valuations get pushed up and returns get pushed down.

In terms of mistakes people make, what I’ve seen time and again with other VCs, is that they begin designing a set of rules to minimize risk. One rule may be that you can’t invest more than 10% of your fund in one deal. A company might need a little more capital, but the VC can’t provide it and the company can get shut out. Artificial decision making pressures get fitted onto a model which needs to be fluid and dynamic and flexible.

The third aspect has to do with the fact that you often don’t even recognize mistakes until after they’re made, because you didn’t know enough to ask them in the first place. Mistakes are made by investing in an economic model or an opportunity in which you just don’t know enough, or your assumptions are faulty. Oftentimes, you think you can do good due diligence on something, but most of the time you don’t even know the right questions to ask. You don’t know what you don’t know. There’s no way to totally prevent this, but you can try to avoid the most obvious peril by not straying outside your area of expertise.

Last, you can have a great idea and a great market, but you have to have the ability to execute. Anytime you hire new senior people they can look great on paper, great in interviews, good references, but we’ve found its been basically a random outcome in terms of what you get. It’s very difficult if not impossible to predict outcomes on the basis of traditional way in which hiring’s been done.

What I like about what WTRI’s work is that if you can have more insight about putting the right people in the right position, your outcomes could be transformed. And so that in my mind is an issue that is very worthy of further work: give people the ability to select for the right job, or improve the decision making processes when they’re actually there.

WTRI: It seems that because things change so quickly in this economy, people who are put in top management positions and are unqualified, don’t have time to become qualified, and don’t have time to recover when they’ve made a big mistake.

MIKKELSEN: Well, things are changing much more quickly than they used to. It’s not a function of people’s brain’s working more quickly, it’s a change in communication technologies. Whether the impact of mistakes is magnified or not - it probably is. It depends on what you call a mistake but I think that bad decisions or bad outcomes can much more easily advertised and have a bigger impact then they used to. The power of viral bad news has certainly gotten a lot more powerful. Bad press can be created by anyone now, not just a reporter in a newspaper. And there’s really not much you can do to control it. This will probably force more transparency and openness between companies and their customers.

WTRI: Do you see opportunities with the economy going where it’s going?

MIKKELSEN: Well, yes of course. An environment in which capital and credit isn’t abundant forces a competitive winnowing out of ideas and companies. People who don’t have viable business models are probably going to be put out of business faster. I see that as a positive thing because capitalism’s all about creative destruction. There’s also an opportunity to get rid of some of the closed mindedness that is created when people get too complacent, as we saw in the last economic bubble.