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.