Wednesday, December 31, 2008

Madoff proves Stalin wrong (click here)

It's reputed that Josef Stalin once said 'the murder of one person is a tragedy, and the death of one million is merely a statistic'. He highlighted that it's so hard to understand and relate to great events, whether positive or negative, as they are beyond our scope of relating what this really means to an individual.

Madoff's reputed swindle of such a broad swath of good and great people is a tragedy that has taken the breath away from so many of us; even most of us individuals who lack the visceral feeling for great events. A letter to the editor of Newsweek, written by Rabbi Marc Gellman goes a long way towards capturing the betrayal of so many. So says the Rabbi, 'it's an abomination'.... es verdad.

We've had our share of 'learning experiences' in '08. Wishing you a happy and healthy '09 and special joy to my dear friends Robert and Yanni on the birth of their first child.


Virtual real estate (domain names)

Over the past couple of years, while plying me with sardines and onions, my buddy Igal has been educating me about the domain name space. Arguing that domain names, due to their uniqueness ('Charlie, there are 4 corners on 42nd and 5th, but only one domain name 42nd and 5th') have more potential value, and far less holding costs than physical real estate; he's had me intrigued enough to bring the family together and build a modest (er, tiny) portfolio. Other folk with interest in this market include the multi-billion dollar PE fund Oak Investment Partners, with their large investment in Demand Media and Summit Partners and Highland Capital leading the investment in Name Media (mentioned later).

Rather than hiring folk to design the sites, build the graphics and sell the advertising, I parked them with a couple of companies where you contract with them (easily terminated at any time) to put up content and sell advertising on my behalf, and splitting revenues. It's really a no hassle arrangement and we anxiously sit back as the various checks, some as much as $1.28 :-) come rolling in. Each of the parked domains have a 'for sale' sign on them and we did sell two that netted enough returns to pay for the entire portfolio.

Looking at the current state of the domain parking business, it will come as no surprise that, consistent with the downturn in advertising rates for display advertising and PPC rates, many participants are reporting revenue declines, on a same property basis, in the 30% range. Expectations are that Q1 '09 will continue the downward trend, though 'premium'/high traffic names should fare far better than generic names which only qualify for 'remainder' revenues.

Similar to physical real estate, but with a far lower cost of entry, domain names have intrinsic 'location' value, as well as a more tangible value based on a function of cash flows. This market has seen its share of speculation driving prices to levels only justified by intrinsic value (e.g. hopes and prayers). I suspect we are now beginning to see the whiplash in valuations as domain current income plummets and intrinsic value clouds. It's always difficult to measure intrinsic value as its beauty is in the value of the beholder. DN Journal is one of the leading trade magazines covering the space. In the two links below, you will find a summary of the valuations for the top 100 domain sales for 2007 and 2008.



As businesses are only as healthy as their customers, we should expect that the scores of domain parking and optimization companies that comprise the heretofore growing ecosystem will also be negatively affected. One quality company, NameMedia has withdrawn its IPO (probably due to a combination of market conditions as well as a softening P&L outlook), and already public, Marchex has seen its market cap plummet 45% in the past 60 days.

Due to the scarcity value of physical real estate, as well as the intrinsic value of many names that are not yet developed (e.g. can't you see intrinsic value for J&J owning the parked, and obviously not optimized all supported by innovation in the ecosystem, I have no doubts about the long-term health of domain names and their supporting cast (see Sendori as an example.

Tuesday, December 30, 2008

A positive perspective on public software companies

Michael Guptan of the Stanford Financial Group recently published a bullish analysis of the public software sector (with some internet companies mentioned too). Taking a balance sheet approach, he sees an industry that has such a strong cash position, little debt, and a relatively attractive PE ratio, that it should see upside when it's generally recognized by the market as a defensive sector.

The analysis does not concentrate on expected growth in earnings as a measure for value (I am a PE/growth advocate), but does make a good case that the industry's financial dynamics should make it an attractive investment area, in a time when many people are concerned about over leveraged companies/industries.

He shows interesting data and some tidbits include:

Oracle EBITDA margin of 44% (followed by MSFT at 42%,Oracle at 36% and CA at 33%)
Amazon's EBITDA margin is 6%, while GOOG's is 37% (followed by Ebay at 34%)

For those interested in exits, and M&A in particular, he lists an interesting summary of activity, noting the following activity:

MSFT 14 transactions
IBM 9 transactions
EMC 9 transactions
GOOG 3 transactions
Oracle 6 transactions
Amazon 6 transactions
CA 1 transaction

The total number of M&A deals seems to be down around 10% to just over 1100, while the deal value is down a staggering 50% to just shy of $600B. The data does not show how the mean/median is affected, and may be skewed by an absence of mega transactions.

Looking at the margins, and balance sheet data, I would expect M&A activity by the larger industry players to continue unababted, nevertheless, the withdrawal of the Eyeblaster and NameMedia IPO's, highlight the shrinking of the public 'middle' market that is an important exit source for venture backed companies. It will take a decent time interval for the mess on Wall Street to subside before such firms will again risk capital taking young companies public again. Until then, most people in the venture sector will concentrate on advising CEO's of portfolio companies to reach early profitability, so they may be self-sustaining. This will enable the venture firms to allocate capital across a historically broad arena of prospects (getting the benefit of diversity).

At times, I wonder if this perspective is ripe for a change....

Monday, December 29, 2008

Online sales numbers

Underscoring the maturing of the overall online commerce segment of the Internet, The Wall Street Journal is reporting that online sales were off by 2% from Nov 1 through Christmas Eve. Relatively, this was not so bad as overall, retail was down 6-8%. The sheer numbers of US shoppers who visit each of the major sites highlights a maturing US channel (per Quantcast):

Ebay 64mm
Amazon 54mm
Walmart 37mm 20mm

It seems to me that the 'advantage' to the consumer of shopping online vs physically is narrowing. Hand held smart devices going mainstream now gives instant access to verify pricing 'fairness' and the well known pro's and con's of physical vs online shopping seem to be heading towards a market share balance.

Overall, I sense a feeling, excepting Amazon, that innovation in online selling seems to have stalled. Looking at leading sites that included AAPL, Best Buy and eBay, I was struck by how little improved was the shopping experience. Moreover, the price advantage inherent in a business model where efficiencies in labor and real estate ought to translate into better pricing seems to have disappeared.

In my view, absent new innovation in the online experience/value, the halcyon growth days of explosive commerce growth are behind us.

Wednesday, December 24, 2008

Fun and creative video...from Truveo (click here)

Improv Everywhere also have a spoof where they filled a subway car with scores of identical twins...

Monday, December 22, 2008

Morgan Stanley's 08 Internet and Economy report (click here)

Mary Meeker, et al, recently published their year-end report for the state of the Internet...and the economy. Over the years, I have looked forward to reviewing the report as the data and perspective have been invaluable. Often, they showed a perspective that was unpopular, and right on. It's a long document and, surprisingly, I have not been able to find any real nuggets of gold that would add to or modify my venture investment thoughts...yet.

For those that want a guide, suggest you jump to:

p24 for a macro guide to US Advertising spending by Medium. Q2 Internet growth slowed to 10%, but was nicely ahead of all other major arenas which dipped into negative territory.

p26 highlights a regression analysis showing the 3x correlation of Ad spending growith to real GDP growth (not a good sign in a recession).

p38-43 is a major theme of the report. Relative to time on site, video and social are way undermonetized. Many slides highlight the value for users, no mention of the value for advertisers (who are the real customers).

p69 shows the growth of advertising inventory, and the slowing CPM's as inventory is greater than supply. They call this a short term issue...until the pace of new inventory slows dramatically, or engagement with viewers rapidly improves, I doubt they are right.

p78 details Mobile Internet growth (smart phones). With 5B page views, it's a dynamic 325+% growth rate! Expecting 3G critical mass in '10 (p81)

p93 presents the global trends for internet usage; 10 largest emerging markets surpass 10 largest developed markets in terms of number of users....not revenue.

p 105 their closing thoughts "Companies with cogent business models that provide
consumer value should survive / thrive – consumers need
value more than they have needed it in a long time" do the shareholders for many of these consumer facing companies.

Friday, December 19, 2008

The Rosenberg case (Click here)

Thanks to my smart friend Larry, who forwarded a report by David A. Rosenberg, an economist with Merrill Lynch. He shares a historical perspective of today's recession, followed by my thoughts on how this affects an investment perspective in the software/internet arena. His case:

1. Unlike each of the past 32 US recessions since the Civil War, this one is a 'balance sheet' variety, where households are rapidly reducing debt($29b in Q3)

2. Past recessions were influenced by the Fed tightening credit, inflation, and excess inventories. Leading up to this recession, each of these metrics were behaving in an anti-recessionary way

3. We are seeing a fundamental demographic shift with the average baby boomer nearing 50 years and in the natural life mode to delever liabilities. Therefore, it is not realistic to expect the consumer spending to cushion any downfall

4. The repeal of Glass-Steagall in the mid-80's fueled great competition by financial institutions to gain market share in the consumer sector. With the household debt/income ratio at 140%, and with the demographics noted above, we should expect deflationary times as consumers focus on debt reduction and not spending. Deflation is his major theme driven by (demographics, excess inventory, excess labor (unemployment), and reduced credit affecting CAPEX).

5. Expect the Federal government to jump in and try to fill the gap, to avoid deflation, with at least $600b of incremental spending. Especially in light of the Q3 numbers where household net worth contracted by an astounding $2.8 TRILLION! This far exceeds the $1.9 trillion loss seen during the break of the Internet bubble in Q3 '01.

What does this mean for Internet/software venture investing?

If the case he makes about deflation and reduced consumer spending is true, then the sector of investments that are advertising supported will suffer for the duration as the customers for these services will be balanced sheet constrained.

It seems to me that a more promising arena would be one where vendors offer product/services that EXACERBATE a deflationary outlook by enabling net short-term spending reductions, or a longer-term strategic cost saving shift gained by a shift in basic infrastructure that addresses labor or operating costs.

In the Enterprise and SMB environment, the combination of tight credit, and deflation should accelerate the move to SaaS and open source based solutions. For the consumer, where more $ is spent fixing PC's than purchasing them, look for outsourced support (iYogi or Reimage (I am on the board)), as well as a a shift away from premium priced brands....the premium for cool is moving away from the average Joe. Speaking of Joe, Frappacino's ain't so cool no more.

Wednesday, December 17, 2008

Lux et veritas- Light and truth

Yale University announced yesterday that the value of its liquid securities within its endowment dropped 13% during Q3 + October. More meaningful, the overall endowment, that includes 'Alternatives' such as Venture Capital investments, LBO's and Real Estate dropped by 25%. As the market continued to punish investors, and the Alternative category tends to report write-downs later than public valuations are reported, the news for the full year, will surely be worse.

It's clear that the primary source of funding for venture firms; endowments, family offices (hello Mr. Madoff), and pension plans are under tremendous pressure to meet current obligations. The TRUTH is that the private equity community, (including the fund of funds) will see a rapid trickle down effect from these mark-downs that will include sales to secondary funds who will continue funding LP obligations (best case), defaults of current obligations (worst case), and a shut-down of funding new groups (certainty).

Companies are only as healthy as their customers. The customers for venture funds are their LP's that entrust their precious capital to firms in an effort to mitigate risk and seek healthy returns. If the customers (LP's) are not healthy, there is less funding, and a contraction of fund sizes, coupled with the gross number of firms who receive capital.

Unlike real estate and the LBO world, in the venture business, this may ultimately be good news as the thirst for capital, from a per company perspective, from early to mid-stage companies, appears to be diminishing as the recipients of their capital harness capital efficiency garnered from just in time infrastructure (Amazon's EC2), just in time sales, and just in time development.

Similar to the secular alignment during '01-'03, when many funds reduced their size and raised smaller successor funds, we may be at the verge of a similar, but horizontal shift throughout the industry. The TRUTH is that this painful ecosystem environment may align the business models of mainstream venture with the trend for capital demand by its constituency. If so, all this pain will give us a healthier ecosystem.

A return to 'little game' venture, coupled with the entrepreneurial spirit of self-exploitation by building equity through working insane hours at below market rates, is what brought us MSFT, AMAZON, Ebay, LINUX, ORACLE, DELL, etc. The foundation of the venture industry has been paradigm shifts started by small disparate groups of entrepreneurs, and initially supported by no or little capital, often disparaged by large organizations and too small for large venture to properly deploy capital 'efficiently' for their business model (notable exception is Kleiner Perkins).

I believe the Grateful Dead said it well; 'Once in a while you get shown the light in the strangest of places; if you look at it right'

Tuesday, December 16, 2008

NY Angels investment details

I have been involved with a local group of Angel investors (New York Angels) led by its Chair David Rose, and Executive Director, Paul Sciabica. Mirroring the local deal flow, and general paucity of local early stage investors, the group has been an active investor in software/internet companies. It's 70+ members include savvy folk such as Gideon Gartner (Gartner Group), Scott Kurnit (, Howard Morgan (First Round Capital and idealab), Alan Patricoff (Apax and Greycroft)and Esther Dyson.

During the past 5+ years, the group has been an active investor in NY with more than $35mm invested in 54 companies. This year looks to be similar to '07 with nearly $8mm invested (40% in add-on rounds). Different from VC's, and keeping with the pattern of many Angel investors, nearly 60% of the capital has been invested in the initial financing round, with 40% allocated in follow-on's (where, upon success, professional capital usually comes in to lead).

The deal flow seems strong with 10-15 new prospects screened each month, and 3-5 presented to the group for consideration. The NYA is primarily an early stage investor and has experienced 3 recent exits.

Monday, December 15, 2008

Peer to peer pay to play paradigm

One of the greatest challenges for entrepreneurs and early stage investors is betting on an early paradigm shift; you never really know if it's a deep market, or a drip of water till you dive in. The venture business thrives on the turbulence and opportunities that paradigms offer entrepreneurs and their risk equity backers. But it's not a smooth line. Over the past 5 years we have seen a number of false paradigm waves that have consumed billions of dollars of capital and countless entrepreneurial cycles. Two of the largest faux paradigms that come to mind were RFID and WAP (mobile).

Moreover, despite great fanfare, it's still unclear whether stand-alone 'social' and 'video over the net transport/hosting' will prove to be faux or real self-sustaining markets too.

Another area that's received great attention is the great market disruption that can follow embracing peer to peer technology. BitTorrent was an incredible innovator that followed hard on the heals of Napster. Unfortunately, they also initially embraced the pirate aspect of Napster and, though attracting stalwart investors (Accel and DCM), they seem to have been unable to translate great download acceptance into a self-sustaining business.

Techcrunch posted a sad letter to shareholders from Bittorrent's CEO that details the terms of their most recent financing, which appears to be a rescission of their most recent $17mm financing round, replaced by a $7mm 'pay to play'...highlighting the desperation of the situation. The end of the post has the full term sheet.

The peer to peer paradigm has many niches (full disclosure that I am on the board of Pando ) that are performing well, though it's clear that eyeball aggregation, based on purloined content, though it worked at YouTube, is not working here.

Friday, December 12, 2008

Q3 2008 Inernet advertising report (Click here)

Pubmatic, a company that specializes in Ad optimization for publishers, recently published their report on Q3 pricing trends in the Internet. Some highlights/comments below:

1. Social remains the lowest priced category coming in at 21 cents....with the continued explosion of pages and the reticence of brand advertisers to embrace this category, tough sailing is ahead.

2. Q1-Q3 saw an average display ad (CPM) drop 27%

3. Small sites, probably due to more effective targeting, enjoy a CPM nearly 3x that of large sites

I am not sure small companies can 'cut their way' to prosperity. Unless this negative trend is arrested, get ready for a wave of closures of venture backed firms leading the way, with video a close second.

With data such as this, probably no surprise that Eyeblaster just announced a RIF....

Thursday, December 11, 2008

Google expands its ecosystem (click here)

Previously, I commented about the difference in the MSFT and GOOG ecosystem. Thousands of companies support and enhance the Windows OS, and over at GOOG, thousands of companies try to break their foundation (SEO).

Domain Parking, where folk own domains with wonderful traffic, due to search engine optimization and wonderful names ( comes to mind), primarily earn revenue, not by adding incremental value, but by referring this traffic to other sites; effectively exploiting a search loophole that adds clicks between users and their desired destination. Therefore, you can think of Parking, in part, as a bane of search engines with a continued cat and mouse battle between the sites and the engines. As you would expect, many of these sites are often masters at SEO to maximize rankings to capture first time surfers.

The other day, Google announced Adsense for Domains, to assist the parkers with maximizing their revenues. Historically, Yahoo has been the largest supporter of Parkers, who often go directly to parking aggregators such as Sedo, GoDaddyand DomainSpa.

It seems as if the contraction of GOOG's growth has them 'shining the light in the darkest of places'.

Wednesday, December 10, 2008

Where for thou exits? (click here)

Updata Advisors and Morrison & Foerster have just published a survey, conducted during Q3, of senior executives in the software, internet and related services industry about their M&A interests. The survey covered executives in the US, Asia and Europe.

This is a topic that keenly interests me as, over the past few years our industry (internet and software), has experienced an uneven exit environment; with windows opening and closing at an ephemeral pace. I have found that keeping current on the M$A environment is a critical element towards appreciating the window of opportunity to reap rewards for many years of hard work.

Key findings:

1. Buyers expect to remain active (45% expect M&A to increase or remain the same), as the economy gives many players the ability to grow global market share at more reasonable prices.

2. Large-cap buyers are expected to lead the way. Unfortunately, if true, this will probably continue the trend of reducing the number of public companies in the industry and, unless refreshed, result in a smaller universe of buyers.

3. In the Internet sector; security, e-commerce infrastructure and content providers are the most interesting to buyers. Interestingly, social and shopping sites were laggards. If the intentions of the survey bear out, it seems there's a mis-match between many of the internet investments over the past 3 years, and buyers intentions.

4. Nearly 70% of transactions are sourced from internal sources...not introduced by bankers. Again highlighting that effective Business Development/partnerships is the most reliable way to a positive exit.

Tuesday, December 9, 2008

What is the customer thinking?

In the Wall Street Journal, Peter Whatnell, CIO of Sunoco was interviewed about how the economic downturn is affecting his department and the company's use of technology.

Here's a link to the article

Though I have a great deal of respect for his comments, from a business perspective, I have been reticent about investing in companies that build direct sales forces to sell to organizations such as Peter's. The appeal of investing in companies that provision customers remotely, with salesfolk who can demonstrate the benefits of the product/service without SE's, or investing in consumer facing solutions, is much more appealing than the front loading of expenses to build, train, and support direct field sales efforts. Of course, selling to Enterprise customers via indirect channels, maintains some allure.

In the interview, Peter says that one should 'never waste a good crisis' to rethink your business and cites having 'interest' in looking at new applications if they offer 90% of the functionality at 10% of the cost......

Monday, December 8, 2008

Wonderful post from Redfin's CEO (click here)

Many jewels....of note:

1. Get a board you can connect with (not just one with connections). As a board's role is primarily provide advise and consent, it's essential for a CEO to have a trusted relationship with his board. They don't have to be best friends, but knowing that your board members are committed to the company's success, is a wonderful start.

2. Create simplicity. Cut through the long-winded discussions and make a decision.

3. The journey is the destination. Each and every day...bring it, you don't get do-over's.

Worth a read for entrepreneurs and VC's alike

Marketing...the Evil Empire vs MSFT?

In a recent board meeting a fascinating discussion took place where the ecosystem around MSFT and GOOG were contrasted.

MSFT built/attracted an ecosystem keenly interested in promoting, fixing, and supporting their OS. On the other hand, it seems as if the GOOG ecosystem (SEO) is keenly interested in breaking the 'OS' rather than supporting it.

Effective SEO breaks the user experience, and the cumulative damage to the ecosystem is tantamount to the anti-virus vendors encouraging folk to write viruses, thereby increasing their own revenues....but with huge unintended consequences.

The daily cat and mouse game between SEO and the GOOG (and other search players) highlights the frailty of the system. This could be a Black Swan in the making, with dramatic and unforeseen consequences.

B of A's latest Internet report (click here)

I think that one of the most useful metrics when looking at public valuations is the P/E to growth ratio. It just makes so much sense that faster growing companies would have higher P/E's and the contrary, as we see in recessionary times, is just as true.
Over the years, I have seen this ratio, on a normalized basis, approximate 1.2. As an illustration, if a company is projecting 20% growth, you would think the market would reward the firm with a P/E of around 24x.

The latest B of A Internet report has a some nice data (p 12-13) that looks at their coverage universe, segmented by large and mid-cap and advertising and commerce that shows which of the covered firms would be above the valuation line (more than fully valued), or below the line (less than fully valued). From the charts, it seems as if advertising is about fairly valued today, and with a limited universe, e-commerce is not significant enough to note.

From a macro industry view, unless we see a continued deterioration of expectations, it seems as if we have achieved a reasonable balance between valuation and growth.

Friday, December 5, 2008

Exactly not the way it was

I was speaking with a CEO yesterday about his perspective on the sales environment in his SaaS company today vs prior stressed economic environments. When he said 'today, it's exactly like selling software to the enterprise, but without the enterprise', it caught my attention.

While he mentioned elongated sales cycles, due to expense caution, as evidenced by contracts 'caught in legal' before PO's are issued, he also highlighted the fundamental difference in implementation of his SaaS service offering due to:

Zero customization and minimal integration and, little or no end-user training that substantially reduces the time to revenue/cash; while enabling him to much more effectively match expenses with cash.

When I thought he was done expressing himself, he then concentrated his thoughts around the capital efficiency promulgated during the firm's early adolescent stage that's now especially vivid in this down market where the real-time matching of sales and marketing expenses (SEO, PPM, CPA etc) limits the 'spend and pray' budgets where, paraphrasing John Wanamaker's view of bygone days where "Half the money I spend on advertising is wasted; the trouble is I don't know which half."

The consequences for this CEO is that he's more confident with spending more (or reducing less) than in previous downturns, because he has more instantaneous access to the knobs and levers to shift/reduce expenses when returns under perform expectations.

Thursday, December 4, 2008

Angels marching along

University of New Hampshire's Center for Venture Research has posted its 2008 1H summary of Angel investing statistics. The key points for me were:

Angels, as an investing class, put more money to work in first and second round investments than VC's

At least during 1H of '08, Angels were investing more dollars than in '07

As expected, and quite different from the venture business, Angels do not invest deeply (multiple rounds) in companies they fund. Preferring to spread the dust wide, rather than deeply. I have not seen any studies showing returns for the Angel class, but suspect the unwillingness to pile capital into the winners (and having full exposure to the losers), greatly hinders overall returns.

Call in the reserves

Jeff Bussgang, a Partner at Flybridge Capital Partners (and former co-founder of Upromise), wrote an interesting post about the thought process that many people in the venture community are going through right now regarding the level of reserves necessary to support existing investments.

The post highlights that the amount of capital in each fund is a definitive sum though the application of the dollars is shifting. It's simple math, if the capital held in reserve to support existing portfolio companies are greater than forecast, you make less investments....or change your model and invest lesser dollars in the same amount of companies. Given the uncertainty of add-on financing many firms are opting for the fewer investment perspective.

Recession usually means that company revenues will grow slower than planned and reducing expenses is usually less than half the equation to having a self-sustaining company. Critically, slowing spending usually means deferring the growth that leads to timely exits. The combination of slow growth and deferred exit translates to more capital required to support an existing portfolio, and less new investments.

Longer term, deferred exits will slow VC fund raising, cause more 'annex funds' to be raised to support companies in a capital starved environment and shift funding from 'A and B' rounds to later stage opportunities where the magnitude of capital required is more certain.

As this perspective seems to be emerging as the current 'wisdom of the crowd' in the VC community, it's also probably a recipe for great opportunistic early stage investors who should see great deal flow and pragmatic terms.

Wednesday, December 3, 2008

Feeling social?

With all the talk about declining CPM's (and related metrics)... and a son who is taking High School economics, where he's been exposed to the dreaded supply/demand curve, I decided to look at the deal flow we have seen over the past 18 months (nearly 600 companies) and look at the % that were intending to build/grow companies that had banner/social advertising (supply of pages) at the core of their business models. With the sector's torrid growth, I suppose it was no surprise that nearly 60% of these reviewed companies had advertising based models that were reliant on CPM's or similar variants for revenues.

The industry has seen a massive expansion of inventory (pages) available for advertising, with some estimates touting that, in a scant 3 years, social pages now account for nearly 50% of all ad based inventory. With signs that, in a general sense, social inventory reached equilibrium with advertising spending sometime in late '07-early '08, it's not surprising that the unabated growth in pages, coupled with a stagnation (decline) in spending has shifted the CPM pricing curve for many of these firms in a negative way.

This is a natural supply/demand ebb and flow. But what I am watching is the impact the funding environment has on the success of these entrepreneurial ventures. Building social networks is a bit like building a proprietary information database where it often takes 2x the planned time and money to critical mass, but when you do, it's like owning gold mining rights into perpetuity. Today, building companies, such as Twitter, is akin to flying a plane and adding components in mid-air. You must have great faith, leading-edge innovation, or a serious safety net (capital) to achieve a critical mass substantially larger than originally planned to reach self-sufficiency or to build meaningful shareholder value. I think at least two of the above conditions are necessary for survival...three to prosper.

The natural outcome of this rationalization will be a reduction of inventory, via shuttering companies, to a level where we have market forces again in alignment with demand. From what I have seen, it will be a tall order for many companies to cross today's economic chasm. I am afraid the outcome for these businesses will be akin to the cold freeze when the 'dot bomb' imbroglio was mostly confined to the Internet. True the burn rates are lower, and management is more focused on sober business metrics, but it's a tall order to fight the broad economic tape.

M&A activity will not alone solve the economic equation shareholders find themselves in today, where they have the option to fund companies with declining asset values, hoping for a greater payback tomorrow. Chris DeWolfe, of MySpace, was quoted here that they are being approached by companies willing to sell themselves at a fraction of the value of a scant few months ago as capital to fund loss making operations is now scarce.

If past is prologue, many entrepreneurs are already making a 'left turn' and are busy building companies that leverage areas (like where end-user prices are inflated to support brick 'n mortar sales/marketing) where a great price reduction will encourage demand to outstrip available supply.

Grand Canyon University IPO

Well, there is a Father Christmas....

Grand Canyon University
NASDAQ "LOPE" priced 10.5mm shares at $12/share day (vs. a filing range of $18-$20). The Company offers a blend of brick and mortar university level education, with a fast growing online component.

The combination of good comparables to price off, as well as strong top line growth of 50+%, with 20% margins are the honey that always attracts investors. Interestingly, most of the proceeds from the IPO went to shareholders.

Post offering, the stock is holding well around $15/share, which is around 2.75x next year's sales. Credit to Merrill Lynch and Credit Suisse for leading the effort in an environment where, according to Renaissance Capital, IPO's are off 75% from last year's pace.

Monday, December 1, 2008

Minding your P's, Q's and insights into T's

One of the beauties of the Internet are the wonderful niche markets that rapidly develop into viable nationwide and global businesses due to the low cost of distribution and harnessing the creative talents from many corners. Often, many in the venture community only stumble upon these situations when they have reached a nice critical size that raises their visibility to the general public.

Recently, Wired Magazine had a nice article by Clive Thompson on: How T-Shirts Keep Online Content Free where he noted that a myriad of folk have set up companies to hawk T-Shirts with monikers from bands, politico's, TV characters, or other sundry sources.

CafePress , drives a reported $100mm of '07 revenues, with $20mm in profits and 60% growth by creating a community of nearly 7mm people who create, buy, and sell custom T's. Social, commerce and content all meet at CafePress. Below are numbers for CafePress, as well as one of the competitors, Zazzle, courtesy of

Now that we have the T's covered, I am sure entrepreneurs will find great equity building opportunities in the P's and Q's.

Friday, November 28, 2008

Stars, Planets and moons

I suppose, similar to the Thanksgiving meals enjoyed by most of you, the center topic of conversation moved from last year's 'gee, Bear Stearns looks in trouble' to 'man, my portfolio is down 40%'. The painful shift from 'them' to 'me' highlights 'our' recession.

I've been thinking about the sage advice for our CEO's to 'get profitable' ASAP and 'cut expenses across the board' and continue to be troubled by such blanket statements. It seems to me that triage is the order of the day where deeper investments should be made in companies doing well and decisions to stop funding laggards is the way to go. Business decisions, such as this, should not be across the board socialistic share the pain missives(though we may be heading towards such an economy).

This is really a preamble to the criticality of agreeing on, or reinforcing, the objectives that shareholders expect from the business and management. It's impossible for a CEO to run a company serving too many conflicting simultaneous masters (growth, profitability, reduce expenses, etc.). Over the years, massive returns have inured to shareholders backing firms that became the stars of their solar systems (MSFT, Oracle, Google, Yahoo, Ebay). Fine returns have been earned by planets who, lacking the mass and energy to be stars, still have sufficient weight to capture satellites and enjoy unfettered orbits (Adobe, Intuit,Symantec, etc.). With the seismic market shifts that has limited access to capital across the board, all stakeholders ought to understand what are we building or funding towards?

As a venture community, unless we provide clarity of direction, we will be on a collision course with our CEO's. On one hand, we invested with the objective of helping them create planets, and just maybe, stars. In an environment suffering spasms of dislocation, we have asked for a change of direction. Now, we are asking them to scale back and defer building stars, even to simply go for the moon. Beware what we ask for, too many moon shots does not reap portfolio returns that justifies the risk of our asset class that is littered with black holes.

It seems to me that existing portfolios ought to be 'rationalized' with all resources going to the 'feeders and growers'. New portfolios can still gain the benefit of diversity across many promising investments,with the day of reckoning delayed. But, most of all, alignment with the CEO's and shareholders is critical. It's not the time for ambiguity of direction.

Wednesday, November 26, 2008

Birds vs. Words

Most of us knows someone who is larger than life itself; my buddy Igal only does things grandly. Whether its his 260+ lb dogs, which can handily sport saddles, lunches that never lack just one more course, or seemingly more children than fingers. He is also one of those people that has an old world expression for every life experience, that would have your granny nodding in agreement.

When I began blogging, he took me aside and asked 'why is a bird different than a word'? Before I could stumble out an answer he lowered his booming voice and responded to his own query 'when a bird is released, you know where it goes, but words, once released, have no master and travel so far, you can never track it'.

I am thankful to have many friends and family who, in many quiet ways, share their thoughts and friendship.

Have a great Thanksgiving,


Tuesday, November 25, 2008

The VC landscape

Mark Peter Davis, of DFJ Gotham posted in the Silicon Valley Insider excerpts from his speech about 'why VC's aren't investing anymore'. He was clearly exaggerating for effect, as we are in the midst of a slowdown, not meltdown in the VC space.

The capital allocation issue, where institutions seek to diversify their investments into various buckets, is a big problem. Ironically, the decrease in the value of public stocks, means they are under allocated to this area, and many are seeking to lessen their investments in 'alternatives (including venture) to re balance. This macro situation only partly masks the micro effect....returns in the venture market have disappointed many institutional investors. Over the past 5 years, the Venture market has been a bit constipated as many dollars were invested, but too small a % were returned. Positive net portfolio returns are a different, and more difficult, story. The economic situation, 'the denominator' problem highlighted in the piece, clearly exacerbates an already difficult environment.

The only long-term solution is around innovation that opens new markets, or fundamentally destabilizes an existing one. Only by pushing the envelope (yes, taking risks) will investors and entrepreneurs garner the type of sweet returns that justifies investment in the asset class vs alternatives, such as 'vulture' investing (downtrodden public companies), 'secondary' investing (buying LP interests from individuals/institutions interested in reallocating), or 'value' investing (low p/e stocks). An arch focus on profitability, at the expense of innovation, is a path that surely leads over a steep cliff.

Despite a terrible economic environment, in the midst of the early 80's we saw the IPO's of Oracle and Microsoft. Two companies that were riding fundamental paradigm shifts that brought institutions running to the venture asset class as tangible returns were available in the dawn of a new paradigm. Capital efficiency in the internet area is clearly important, but alone, is not sufficient to drive stellar returns necessary to support investments at the pace of the last decade.

Monday, November 24, 2008

Web based services...ready for hyper growth?

I was listening to the quarterly report from Liveperson (LPSN), a micro-cap stock that has not been a strong performer in the public market (I am not a shareholder). The article in Sunday's NYT that highlighted the positive trend in the Spirituality market piqued my interest.

The Company provides an on-line service that facilitates real-time assistance and expert advice. Essentially, they are in two businesses; a platform that assists their customers provide on-line support (chat and CRM) for consumers. More recently, they acquired Kasamba, an Israel based firm that offered a marketplace for consumers to directly connect to thousands of experts online.

One of the gurus of the online market business is Jeff Leventhal. Jeff, is the founder of Onforce, a stunningly successful marketplace for contract service professionals (primarily IT). Jeff is someone who is best known for solving the age old 'which came first, the chicken or the egg' question. In marketplaces, the question is referred to as 'do you build the sellers or attract the buyers first? As we tout the capital efficiency of building internet and software companies, it seems to take twice the time (and more than that in capital) as expected to build a viable, self-supporting community.

Services now represent more than 50% of the GNP, but only a fraction of on-line commerce. Think of the metaphor of building an 'Ebay for services'. Essentially, you sell/buy time and expertise, not physical goods. It's a tricky issue as trust is paramount to success.

My experience is that the buyer trust issue has held back success. If you have happy buyers, sellers will flock. It seems to me that the rise of trusted payments, video cams, and instant reputation measures, that buyers will get far more comfortable using these services. Probably with pure consumer activities first, then with a move to the mainstream. Fortunately, hundreds of vertical markets exist for such services, ranging from the 'pure' consumer (porn, health and spirituality), to more business oriented services (e.g. programming, IT support). Each of these markets represents potential revenues in billions of dollars.

Recessions force folk to do things more efficiently; whether buying physical goods, or, perhaps, expertise.

As my friend and fellow investor, Howard Morgan says, he named his blog WaytoEarly, because he works with companies, and markets, that are mostly early in their life cycles. In such instances, backing people who you trust can get the job done is paramount. This is one reason I have always been intrigued with my investment in Bitwine.


Waking this morning and being greeted with another multi-billion dollar bailout was shocking. Not that another financial institution was being rescued from gross mismanagement, but that this particular institution was, a scant 6 weeks ago, with the government's assistance, at the doorstep of acquiring Wachovia Bank's banking business for $2.2B.

So, what new information came to light for management and the government in only six weeks that caused the stock to crater (down 2/3 before the open)? The government and management teams supporting this massive transaction had ample knowledge of the dangerous ecosystem, and logically should have had access to Citibank's data. Information that logically was available even last week when Citibank suddenly announced a RIF of 52,000 employees.

It is unlikely that markets should improve, nor should they, when stakeholders have such poor transparency to make rational decisions.

Sunday, November 23, 2008

The Role of the Angel Investor (click here)

From the Tech Crunch 50 conference earlier this year.

Jason Calacanis (founder Weblogs, Inc sold to AOL) is the moderator for a panel that includes:

Ron Conway- (Uber Angel investor). Involved with, Google, Facebook, Paypal,AskJeeves etc.
David Kidder-(Clickable, where he raised $22mm). Also, works with companies to help them raise Angel and venture capital
Chris Sacca- (ex-Google employee) Twitter investor
Matt Coffin- (LowerMyBills), Mahalo,Demand Media etc.
Yossi Vardi- (ICQ co-founder), 'go to' Angel for Israeli consumer facing internet entrepreneurs


1. The only effective way to reach Angels (or VC's is via introduction). Cold pitches just don't work well.
2. Yossi is not interested in the business model as 'the more attractive the business model, the higher your losses will be'. He invests in people...
3. Investing local is important as unexpected issues happen that can best be dealt with 'over a few beers'.
4. A recognition that good is good enough, and that they will miss 'great' investments. A portfolio approach, across sectors, is an important first step, that leads to picking the best one's available in each sector. Perhaps a more disciplined 'spray and pray'.

Interesting that no one highlighted a drive for market leadership, innovation, or 'business model'. In fact, business plans were derided as a waste of precious time.
Just one of the many cultural differences between Angels and 'Pros'

Saturday, November 22, 2008

Survival is not a strategy (click here)

Wonderful post by Anand Rajaraman of Cambrian Ventures on the importance of growth, for young venture backed companies; especially in difficult times.

Friday, November 21, 2008

The lost generation only takes a few months

Per the Wall Street Journal, Citibank seems to be next up; or rather down.

The incredible turbulence in Financial Services brought me to look back at the software and internet worlds. Areas that, until recently, we thought enjoyed turbulence as a way of life.

In 1999, ranked by market cap, here were the top 4 Internet Companies:

1. AOL $150B
2. Yahoo $35B
3. EBAY $24B
4. Amazon $24B

The recent big news was that, in late 1998, Netscape, the great pioneer succumbed as an independent entity, for an acquisition price just shy of $5B.

Today, the top pure plays (ignoring MSFT) are:

1. Google $82B
2. Amazon $15B
3. Yahoo $14B
4. EBay $14B

The big news is the Yahoo/MFT soap opera.

What's interesting is that, outside of AOL, leadership has been remarkably stable. True, on either ends of these stats is our lost generation known as the Internet Bubble. These statistics are remarkably similar in the software/services industry where:


Have led the rankings for each of the past 6 years and the big news is that Larry Ellison emulated Charles Wang and led a massive, and timely consolidation play of second tier vendors.

Lost Generation is a term coined by Ernest Hemingway in The Sun Also Rises and referred to the generation between the Great World Wars. The massive dislocation in this arena is tantamount to a lost generation where Merrill, Wachovia, Bear, Lehman, Goldman, Morgan are all gone or faced with fundamental change.

We know what was on one end of the Financial Services lost generation, and will shortly know what's the other bookend. Hopefully, it's a wave of innovation that spurs us on to great heights, and not a morass of regulation that only a great bureaucracy of titans can navigate.

Thursday, November 20, 2008

The End- By Michael Lewis (Liars Poker fame) click here

A long read, but the best article I have seen that details the culture and motivations around the sub-prime/CDO meltdown....its like in spades.

Free, commoditization and Microsoft

Yesterday, Microsoft announced plans to offer free internet downloads for a fully configured (e.g. not a freemium service dependent upon a scaled down free version upsold to a full-featured service) anti-malware service; Morrow.

Great news that will, hopefully, spur Symantec, Trend, Mcafee to embark on an innovative path to offer great(er) protection, tuning, and remediation. Entrepreneurs, and their venture capital backers should be encouraged that a slow growth AV market will face greater commoditization than AVG or Avast could hope to accomplish and the established players will turn to M&A to ameliorate this meteor strike.

One Company, Reimage (where I am an investor), is clearly heartened by the news as they anticipate their rapid revenue growth will be buoyed by:

1. The cost of embedding AV in their offering has now dropped to close to zero
2. The opportunity to continue to build their affiliate network has now dramatically increased, while the cost should decrease.

The view from on high- New York Angels meeting

Yesterday, I attended the monthly meeting of the New York Angels, a group of 75+ Metro New York investors that fill the gap between friends/family and venture capital financing. Members include Esther Dyson, Gideon Gartner, Josh Kopelman, Scott Kurnit and Chris Anderson. (I have been a board member for 3 years). As background, over the past 4 years the group has invested more than $20mm in 50+ young companies. The companies mirror the Metro NY landscape with many investments in the internet arena, a smattering of retail, and a respectable share of medical oriented firms.

David S. Rose, the Chair is well plugged into the Angel investing activity around the country, through his investment in Angelsoft and he began the session with a perspective of the way Angel investors seem to be reacting to the market downturn. He sees Angels taking a 'new approach to investing' whereas, despite continued innovation, follow-on rounds for seed investors will be mostly problematic as the venture community is hoarding capital to support their existing portfolio companies; leaving diminished resources for new investments.

From a deal overview, he sees valuations plunging in the 40% range to a pre-money in the $1mm range for seed investments. Moreover, the business objectives for stakeholders will place a premium on getting to self-sustainability, at the expense of growth. This shift is directly tied to his perspective that scant resources will be available from professional investors, so it's better to own a grape than to throw out a rotten watermelon (my words, not his).

One of the beauties of Angel organizations is the diversity of backgrounds, thought, and opinion; sort of like going to the in-laws for Thanksgiving. As such, let me share why I disagree with some of the sentiment expressed by David:

1. I don't think professional investors are interested in small companies that have reached break-even and 'with fresh capital' have the potential, but not the record of seeking break-out growth. The environment is littered with firms that have great potential, but limited growth that a VC simply does not have the time to filter all the coal dust to find the diamond. The math for early stage venture investing success dictates that each portfolio of an early stage investor should have at least one 10x that returns most of the fund. Each investment ought to have that potential.

2. I don't see a plunge in seed stage valuations. Depending on which side of the field you are sitting on, it's a shame (or a virtue) that investors can't own more than 100% of a Company. Realistically, the market dictates a healthy balance between greed and avarice whereas early investors, post-investment, ought to leave a healthy amount of equity in the entrepreneur's pocket. After all, these are the folk whose passion will drive them to 24/7 company commitment, who will face multiple rounds of later dilution and are the glue that will make your investment more valuable. Owning too much, too early is a Faustian bargain.

Instead of a plummeting prices (ok, there will be some moderation), I see a 'right shift', whereas seed investors who put money behind ideas, will now look for a finished product. Those seeking a finished product, will look for some measure of market acceptance. And each will invest at their historic valuation levels for an investment that has now been measurably de-risked.

Entrepreneurs seeking seed capital will revert to cold garages. Prudent investors will have wonderful opportunities to participate in a changed risk/reward environment. One, whose later returns, will depend upon participating in investments that are showing signs of attaining, or have reached market leadership.

Tuesday, November 18, 2008

Goldman Sachs analysts feel growth is oversold in the market

Goldman Sachs technology analysts hosted a call today where they made the case that technology growth companies are trading at a relative discount, approaching 30% to 'defensive' companies with many EPS growth levers. outside of incremental margins garnered from revenue growth. Here is the link Goldman Presentation 111808
Get your own at Scribd or explore others:

Public company valuation is an underpinning of private company liquidity events, and a benchmark for investments too. This market reality seems to correlate pretty well with the advice many VC's are giving their portfolio companies to contain expenses, even at the risk of giving up market share.

The advice works well in the public markets, where it's easier to rotate in and out of your ownership position. In Venture, we tend to see a move of investment stage to the 'right' as a way to ameliorate risk profiles (where early investors seek to be adequately compensated via a risk premium) for their efforts. Other VC's remain true to form and concentrate on funding innovators (Union Square, Spark, First Round)

Pro forma disease

Last night I attended the Fall New York Venture Edge Dinner attended by nearly 50 members of the NY venture community. In ad hoc remarks, Alan Patricoff expressed concern about the misalignment of the venture model (I assume he was referring to large funds chasing small(er) opportunities), Sita Vasan of Intel thinks there is great opportunity in front of us, and Venetia Kontogouris, of Trident Capital, is deeply worried about the economic environment.

The guest speaker was Daniel Gross of Newsweek, author of "Pop! Why Bubbles Are Great for the Economy" who gave a fascinating, informal talk about the election, bubbles and the general economic environment. On the election, he mentioned his recent article 'What's the matter with Greenwich?' where he cited that Mr. Obama carried the wealthy enclave of Greenwich, Ct. in the recent election, despite his intention to increase taxes for many households. He reflected that people were voting against their self-interest, then went on to observe that, in economic matters, Obama was shown consulting with luminaries such as Warren Buffet and Bob Rubin, while McCain had.....Joe the Plumber. Though they did not like the message, it seems they trusted the messenger more than his rival.

Mr. Gross's remarks about the economy were equally interesting. His last book examined the impact of past bubbles on our economy. Opining that bubbles are logical events in a world where human behavior suffers from episodic spurts of irrationality, he went on to explain that the net impact is not necessarily all bad. The past 150 years brought us Telegraph, Railroad,Internet and housing bubbles. Though investors who hung on too long, or entered too late, suffered great pain, the resulting infrastructure (rapid communications, seamless transportation, instant information) left our nation better off.

Towards the end of his conversation, a throwaway line really caught my attention. He said that we (I think he meant the general financial community) suffers from "pro-forma" disease. Pro-forma Wow! He sayeth the truth. We are in the time of year where CEO's and their management teams have put together neat budgets for board examination and approval. Each of these have bottom-up and top-down assumptions that are based on market dynamics, experience, and industry rules of thumbs. From a pro-forma perspective, they look great and from a governance view, are critical in a Company moving forward with a united front between investors and management. The problem is that we don't live in a pro forma world. Exogenous factors nearly always interfere with these best intents. Whether outside disruptions caused from competitors, markets, or technology shifts; or internal disruptions, emanating from personnel upheavals or process interruptions. It makes no difference, pro forma planning may be the best we have, but it's broken.

Monday, November 17, 2008

Google's slowing growth

Google's slowing growth, was highlighted today in Silicon Alley Insider where Henry Blodget noted that the bloom has fallen off the GOOG rose.

The slowing growth seems to be a natural outcome of its massive market share, in a time when its customers are slowing their growth in related spending; thereby slowing the shift from off-line to on-line. Unlike folk such as Yahoo, it's nothing personal. No doubt that when the sun comes out there is still plenty of hay in GOOG's fields, to be harvested when days are sunny again.

But, the overall message is right, secular growth is slowing, and it's not a one quarter event. It seems to me that re-accelerating growth for GOOG will depend upon the combination of two factors:

1. Short term- continue to add value to the basic product; thereby encouraging more people to use it. In the Companies I have invested in that use GOOG as a key component to their marketing efforts, these investments add incremental gross margin, therefore, we continue to make them. Provided that their return is above that of alternative uses of marketing/sales capital. If they added more margin, no doubt management would allocated more dollars to their GOOG campaigns. The added transparency in Analytics, SEO primers and Trends absolutely helps create a win/win.

2. Longer term (and riskier)- continue to make bets in emerging areas where they can lead a paradigm shift. Schmidt was on Apple's board before the iPhone was released, and a scant couple of years later, it's a totally different company. These investments must be in large markets that can move the growth needle AND could be accelerated via acquisition.

It seems to me that the moribund Enterprise market would be ripe for the type of innovation Google could bring. Perhaps, Chrome is a toe in the water that gives them more comfort that the waters are fine for a full dive. Combining with 'CRM' would give it a fine base of corporate customers which they could immediately add tremendous value to by integrating more value WHILE lowering prices AND INCREASING gross margins.

While we are at it, these factors also could be exploited by entrepreneurs in young companies who, via riding a new paradigm, may create massive customer value, the same way GOOG did/does.

Sunday, November 16, 2008

Decision Speed

In a recent board meeting, a healthy discussion ensued around the trade-off between growth and prudence (e.g. spending reduction) in turbulent times. In the aviation world, it's known as decision speed, whereas an aircraft (plane or helicopter) needs to reach a certain velocity to get airborne. Moreover, for safety sake, critical abort alternatives present at various levels of velocity.

Unlike aviation, such decisions in Company building involve the construction of such a multivariate equation that decisions are not always clear and evident. In the software/internet spaces, we live in a fluid environment where the execution of strategic objectives is seldom a straight line and Decision Speed often feels like a way of life. For sure exacerbated by broad market conditions.

To provide a framework for thinking re-investment considerations, I look at the following guide (not covering all alternatives):

1. Company in a growing market, growing market share, and path to self-sustainability. Starting with an easy one; action.....continue to invest, and go for it.

2. Company in a static market, growing market share and path to self-sustainability; action... examine if ecosystem partners are interested in a combination. Market will probably shake out; action;'s the time to be a lead player, or exit to one who will lead.

3. Company in a nascent market, unproven business and market share irrelevant; action; share the pain (mgm't and investors) if knowledge gained support initial investment hypothesis.

Our industry has fresh memories about dealing with such turbulence, as well as operating in high velocity environments.

Many other scenarios exist, only limited by your imagination. I have found that devising the best plan lays with a candid assessment of your position, then taking action. Sometimes this action is not governed by the academic perspectives of what is best for all stakeholders, but the unique situation individuals or organizations find themselves in.

I have heard it said that now may not be a time for heroes; but it's also not a time to defer pursuing a definitive course of action; based on the facts, not what's popular. This may indeed be heroic.

Freemium business model

In a number of internet market segments (gaming, content distribution, security, performance enhancement), participants seek to lower the cost of customer acquisition through giving away a starter version of the product and offering a paid enhanced version. Often the board room debate centers around the cost to provide the service (bandwidth, storage, support), marketing, and the conversion rate to an enhanced version that is a gateway to the paid model.

It's important to differentiate between companies that focus their energies around the conversion from free to paid, vs. vendors who concentrate on 'free' to use, but are advertised supported. The later really support themselves via an attention tax that users pay each time they use the product. The beauty of this tax is that, for vendors such as Google, the tax, when properly implemented is not too obtrusive, and adds to the overall user experience.

Chris Anderson posted an insightful article in Wired that discusses his views, with a link to MMMPOW that cites statistics in the gaming market. Per MMPOW, here are conversion rates from free to paid for select successful vendors in the casual gaming arena:

* Club Penguin: 25% monthly uniques pay, $5/mo per paying user
* Habbo: 10% monthly players pay, $10.30/mo per paying user
* Runescape: 16.6% monthly uniques pay, $5/mo per paying user
* Puzzle Pirates: 22% monthly players pay, $7.95/mo per paying user

These are way higher than my experience in horizontal business segments, which mostly do not have the benefit of strong community (anyone know LinkedIn conversion to paid?), where a 2% conversion rate is considered successful.

For awhile, the software and internet industry went through a phase where vendors placed an 'annoyance' tax on users of the free product by bombarding them with pop-ups and other annoyances as a way to improve the conversion percentage. Thankfully, competitive realities have minimized this practice as building negative brand equity is ultimately a poor practice (I wonder if today GM feels their planned obsolescence was a good thing?).

Overall, many mail vendors have done an outstanding job of striking a balance between value offered for their free products and garnering revenue for themselves. In their business, it takes a tremendous amount of capital to subsidize horizontal and global applications, before the business can generate positive gross margins through advertising and upgrades. So much capital that the innovation bar is now so high that entrepreneurs must really be doing something special to succeed here.

I am intrigued by the free/paid line in the security and performance enhancement market where Anti-virus, firewall, registry cleaners, disk maintenance vendors, amongst others, have mostly embraced a free to paid model. Sort of like going to the dentist for a free cleaning, with expectations that they will garner the later root canal work.

Friday, November 14, 2008

Innovation Presentation (click here)

Earlier this year, folk from SonyBMG gave this presentation that speaks to the accelerating rate of change and the global opportunity brought on by the ensuing disruption (Jeff, thanks for the heads-up on it).

They highlight that we are living in 'exponential times' where new explodes across the globe at a dizzying pace and we can expect innovators to come from anywhere.


Makes me hope an ember of innovation glows at Sony.

Keeps me excited about the opportunity we have before entrepreneurs, angel investors and venture capitalists.

Thursday, November 13, 2008

Is the Venture model broken?

TheFunded - Canarie
View SlideShare presentation or Upload your own. (tags: lp investing)

Is the Venture model broken?

A flurry of thoughtful debate has rightfully begun around a speech and presentation given by Adeo Ressi of TheFunded at Harvard. His presentation argues that the venture model is broken, as evidenced by his belief that the wrong companies are being funded, too much entrepreneurial time is spent raising capital and missteps have brought on the poor returns generated by the industry over the past 5 years. He offers a number of suggestions, with varying degrees of merit, that I won't go into here. But will proffer that, unlike the auto industry, as well put by Thomas Friedman's great op-ed, How to Fix a Flat, the industry is not fundamentally broken, but in the midst of a transformation.

The National Venture Capital Association is celebrating its 35th year and. per the Association, its members have backed companies accounting for 10.4 million jobs and $2.3 trillion in revenue in the US in 2006. As you would expect for an industry that's been around for awhile, is geographically dispersed, and consists of thousands of firms, there is no monolithic venture capital industry. Instead, it's populated by a rich mosaic of niche specialty firms. Some like First Round Capital Capital focusing on the earliest stages of innovation, others like Carmel Ventures successfully concentrate on a fertile geography. True, concentrations exist, but like Judiasm, no centralized authority dictates how to prosecute the business. As was vividly brought home by the performance in the financial and political arena's, diversity is good.

But all is not well in VC land. The exit environment can charitably be called anemic. The lack of IPO's (one last quarter, representing the lowest volume since 1977) has caused a consolidating stable of ready willing and able acquirers who, in a less competitive M&A environment, coupled with diminished multiples will slash their valuation models.

The underpining of our capitalistic economy is that dollars flow to opportunity; where investors can earn favorable risk adjusted returns. Entrepreneurs strive to create companies that build equity value through creating meaningful market share, or through creating an engine that throws of growing cash flows. Venture capitalists seek to invest in these companies and reap a portion of these rewards. It's been that way for more than 40 what's the problem now?

Netscape enjoyed its explosive IPO on the same day that Jerry Garcia passed away, August 8th 1995. The opening of a global market opportunity, mostly unencumbured by geographic borders, presented an historic opportunity for wealth creation (returns to stakeholders) that now strives to maintain double digit growth, mostly through exploitation of niche arenas. A few faux markets have been offered as 'the next internet' but nothing has arrived that replaces the heady decade of 20+% growth. I don't believe 'mobile' is the answer. Not because the growth of subscribers, or the need, is lacking. But, investing in an industry where a small number of gatekeepers controls the distribution channel exposes entrepreneurs, and investors, to a level of risk that is simply too great to bear. Love the milk, but please keep the cow.

Positive trends are nonetheless afoot. Brought to us, not by the monolithic gatekeepers, or the venture industry, but where you would most expect, and hope for it. The entrepreneurs are speaking.

"I need less capital" In software/internet Big Venture Capital is gone. Small markets are best served by small investments.

"I need less people" We will stand on the shoulders of the open source community, use 3rd party distribution (affiliates) and SEO our way to brand building.

"I will innovate" The IT industry has 3 legs that move independently. Software, communications and hardware provide the foundation for value creation. Parodying the parable of the 3 Little Bears, one is reaping the benefit of years of investment (communications), one feels about right (hardware) and the last is ripe for a fundamental shift (software). None of the past shifts were the derivative of big capital (corporate or venture). No reason to expect it will be the next time.

Reminder to self, keep an open mind to the geeky looking/sounding person you meet. They just may be the game changer.

Wednesday, November 12, 2008

Budget slashing

It seems as if the first, and perhaps, last wave of systemic budget cutting brought on by the collapse of the financial services industry and pronouncements by stalwart venture firms, led by Sequoia are now behind us. Balancing the rush to preserve equity, often at the expense of equity creation, was a more balanced view expressed by Alan Patricoff.

In the venture business, there is always merit to surviving for another day. However, it's my experience that this is not the way to earn consistent returns for LP's, but a way to minimize capital exposure to under performing investments. Prudent companies, especially in our industry, led by folk who experienced the nuclear events of '01- '03, for the most part are not living way beyond their means today. One can always cut expenses, but our industry has consistently shown that creating equity value is most closely aligned with market share leadership. Moreover, the foundation for creating sustainable value, certainly in times of questionable exits, is by earning a volume of revenues, greater than your expenses.

Try as you may, but no young company, founded with a growth oriented DNA, that I remember, has ever slashed their expenses to victory. Many companies appropriately encouraged to slash budgets find themselves with now unproven markets, or a value proposition which has not yet resonated. Nevertheless, if a company has momentum, this environment presents an incredibly capital efficient time to garner market share as distribution, R&D and customer acquisition expenses are in a deep downward spiral.

The balance between growth objectives (often cash consuming) and balance sheet maintenance is what just shifted as the cost of capital soared by at least 30% in the past month. It takes a brave soul, full of passion and confidence to unabashedly continue with the leap into the unknown.

No doubt that some stakeholders will be massively rewarded for this confidence, it will take a few years to know just who...

Tuesday, November 11, 2008

Acorns to Oaks

More often than we realize, singular people, or small passionate groups do things that change the world in positive ways for the rest of us. Many times we don't realize the magnitude of the change till the wave rises up like a tsunami, ignored till it hits the beach.

In technology, we are accustomed to seeing these waves and now expect them every decade or so:

Joe Ossanna, Ken Thompson, Dennis Ritchie and Doug McIlroy brought us Unix

Richard Stallman and Linus Torvalds stood on their shoulders and brought us Linux

Dave Winer, Ramanathan Guha and Dan Libby birthed RSS

Bill Gates and Paul Allen created MSFT

Don Chamberlin and Raymond Boyce created SQL, which brought us Larry Ellison and Oracle

Tim Berners-Lee, Vint Cerf paved the way for Jim Clark/Marc Andreessen and the commercial Internet.

In politics, we have President-elect Obama, and in Jerusalem, my former Partner Nir Barkat looks to be the Mayor-elect. Both bringing fresh ideas to troubled areas with breathtaking potential.

It starts with an acorn....

Monday, November 10, 2008

Endowments cutting back on PE?

According to PrivateEquityOnLine, Harvard University is in the process of looking to sell $1.5B of PE investments in the secondary market. With nearly $40B under management and 11% invested in PE, this represents around 1/3 of their PE stakes.

I am not sure this action has the hallmark of a hasty panic as indicated in Silicon Alley Insider. Following are comments to Henry's post earlier today :

1. While the PE market always has some defaulting LP's, and no doubt the % of defaults will rise in '09, it should not reach the epidemic proportions witnessed in '02-03. Many vintage '00-'01 funds had abnormally high % of investors as individuals/small family offices that were unable to meet capital calls or were margined too high due to lack of diversity of their portfolios. Professional institutions are indeed suffering today from being suddenly overweighted in PE (due to the 'denominator problem' that occurs when PE is tracked as a % of total portfolio value). If the portfolio value decreases, while the PE value remains constant, targets are overshot. By charter, this often triggers events to re-balance within proscribed formulas; which include sale of PE stakes and lower commitments to new managers. Institutional thinking often leads to a belief that the current pain of selling a portfolio at a 'discount' is less than the pain associated with being out of charter.

2. As for Harvard, I don't have any insider knowledge, but they have a reputation for being a market leader due to their early support of VC, and bold actions in the VC market. The later includes a proactive approach to limit exposure to VC funds that, in their view, grew too large for a market opportunity where their target companies (entrepreneurs) preach capital efficiency. I would not be surprised if they forecast the rates of return in buy-outs and real estate, which have traditionally been the largest component of the Alternative investment basket declining substantially. The prospect of these asset categories experiencing fundamentally declining returns, due to the prohibitive state of the debt markets, and deleveraging causing prices to drop, signal a prudent change in portfolio approach, not a panic.

3. Fund of funds, long a source of capital to the VC market are also experiencing long closing cycles. This will hurt PE and VC fund raising.

4. Today's exit environment is truly hostile. Other than hindering fund raising (a big thing), I am not sure it augers poorly for VC firms where we can 'buy low' and hope to reap returns through participating in equity value building by entrepreneurs building companies that will save their customers time, proffer revenues, or offer good old plain fashioned fun. The exit events for these investments are years off; who knows , we may have a President Bush in the White House when this happens....

The Facebook Effect

David Kirkpatrick is writing a new book about Facebook.

FB is much in the news as one of the market leading social applications; privately held so it does not report its financials, only spurs more comments/speculation. It seems there is a growing, age old debate, between growth and profitability in a time of scarce (expensive) capital.

Healthy debate....

My posted comment is below:

Facebook, similar to many now public Internet companies is in a race. Sprinting towards the market leadership cliff while hoping to cross the profitability threshold before cash gives out, or the public markets support the growth. Scores of companies navigated this course in the time of cheap and plentiful capital 10 years ago. It's a road well worn by entrepreneurs and investors.

With hundreds of millions of dollars still in the bank, even with a net burn rate of $15mm per month (assume that at least 50% of that is variable costs), 'going for it' seems like a reasonable course of action, and one that should not put the Company's survival at risk. Albeit, if they don't initially succeed, the downside will be huge dilution, but not survivability. At their size, I suspect, with a downsizing, FB can always be forced into profitability. But why now?

In venture backed companies, management and investors are paid to try to create market leading disruptive companies, then strive for an exit when this goal is accomplished, or on the way to being met. Seems to me that folk are acting rationally here when rational ('forgiving'?) markets will accord successful, growing, market leaders a 10x on the last private round.

Friday, November 7, 2008

Let's be reasonable

One of the smartest guys I know, who would never admit it, is Larry Wagenberg. Usually a market sober person, he's just turned bullish about the prospects for making money through investing in the public sector (that complements his venture activities); it's not that he's optimistic about the economy, just that he sees good long term value to be gained by investing when he sees a sudden buy/sell imbalance. His points about the yield curves, hedges gaining their footing, and consumer indexes are all well grounded and got me thinking about some fundamental points in the venture market.

For some perspective, here's numbers from Goldman Sachs reflecting on public valuations:

Software median expected 3 year growth in earnings: 12.2%
P/E to growth ratio for software: 1.2x (which means that if a company has a 20% growth rate, you would expect a 24x P/E multiple

These numbers highlight the steady, yet unspectacular growth in an industry commonly thought of as a 'growth' market. I suppose there's no better tell tale sign of a mature market than analysts tracking valuation as a multiple of maintenance revenue (5-8x)! Having grown up in the 80's, isn't it striking that they now track a mere 3 desktop software companies; Adobe, Intuit and MSFT? Game over.

This highlights when the turbulence caused by hyper growth settles, customers always anoint 2-5 'winners' from the scores of participants (as Geoff Moore would say 'Gorillas, Chimps and Monkeys'). The enterprise market is well along on the same path and we are seeing accelerated market concentration, where the number of vendors is in steady decline, valuations are based on maintenance revenues, and the best acquisitions are around cost reductions. Charles Wang (CA), you were way ahead of your time.

Expectation of growth has always been a key driver for valuation and the positive liquidity events that are the hallmarks of our industry. Mary Meeker recently cited interesting data in Morgan Stanley's latest Technology/Internet Trends publication:

2002 2007

Broadband growth(%) 78 23

Mobile user growth (%) 20 20

Internet user growth (%) 26 16

With the Internet phenomenon, at least the public companies, entering their 13 year, with revenues and users measured in the billions, it's clear the expectations for gross market growth have slowed and are factored into public valuations. Even given the suddenness of the adjustment, it's hard to find a great deal of fault with today's valuations when compared with expected growth. Per the folk at B of A (Brian Pitz), the P/E to Growth ratio in the Internet segment, based on '09 earnings, looks to be about 1x. Google comes in at .7 and Yahoo at 7x(small e)! They are expecting online advertising to grow at a steady and unexciting 14.6% CAGR (search, display, lead gen, classifieds, etc).

So, why am I an optimist at the prospects for venture investing in the internet, software and technology enabled service arenas?

1. The multi-billion dollar internet industry consists of a myriad of niches; many are emerging each year with hyper growth characteristics. Most will plateau when generating revenues in the sub-billion dollar range and will lead to companies that, when successful, will generate revenues in the hundreds of millions of dollars.

2. These companies have the potential to be created in an incredible capital efficient way. Just in time bandwidth and storage, administrative applications paid per user/month, open source tools and instant metrics for PPC/CPM enable instant adjustments.

3. The capital required to create a self-sustaining market leading player (albeit beginning in a niche) is a fraction of what it once was. Therefore, if a Company reaches a self-sustaining run rate at, after consuming a modest amount of capital, and is executing within a growth segment, it has the potential to handsomely reward its shareholders. Additional capital raised in these circumstances, will be done so at favorable terms to the existing stakeholders.

4. Reaching customers (to sell and support) anywhere in the world, at low price points, can now be profitable at prices that are staggeringly low. Moreover, the drive by entrepreneurs to pass along these cost savings to customers via low prices creates huge opportunities for sustained growth.

5. Customers expect the industry to 'eat its babies'. Out with the old and in with the new only accelerates in turbulent times when folk are forced to save costs, or lose jobs. When the stock shock passes, look for accelerated opportunity for companies with compelling cost saving metrics. Robert Levitan of Pando (I am on the board) leads with the message of 'we will cut your bandwidth costs by 75%, and keep your existing SLA's'. Hard not to listen.