AGC Partners 2012 Venture, M&A and IPO summary report

Here is the annual technology M&A report which highlights M&A volume was off 30%, and Q4 was particularly slow for IPO's and M&A. Not a good liquidity period for most. Some highlights:

• The most active acquirers stayed active, though seem to be doing many small deals
• The 25th cash richest technology company had nearly $2.5B of cash on hand
• The large VC's, many with multiple funds continue to build capital war chests
• Median acquisition premium was 33%

Though public companies continue to have hefty cash balances, it seems as if a combination of a mismatch between buyer and seller expectation of value, a concern over  government M&A scruitny, and an uncertain stock market has put a damper on activity. Though there is a way, the will is not keeping pace.

Justice department and M&A

Yesterday, the Justice Department filed suit challenging Bazaarvoice's mid- '12 acquistion of PowerReviews. If you blinked, you may have missed the transation as it's value was $168mm and PowerReview had revenues of $11.5mm.

Bazaarvoice offers a SaaS solution for customers to create and share ratings, reviews, etc and they syndicate these reviews across the web. Its clients more easliy create online social communities and have analytics to drive marketing and sales. PowerReviews is/was a competitor to Bazaarvoice.

I have not looked too deeply into the merits of the case, however, the low profile of the deal, the size of the seller, and the acquisition value seems to represent a very public statement by the government that they are going to be ever more mindful of the technology space for M&A and other anti-competitive actions. This suit, coupled with the FTC's recent review of Google's anti-trust position, and the FTC review of the Instagram buy should be a boon for lawyers.

Notwithstanding the merits of either of these cases, an active government oversight of the industry should mean that stakeholders should expect some dampening of  the M&A path to liquidity.

Customer lifetime value

The other day I attended a VC/Company founder seession at Lowenstein Sandler, where Devon Parekh, a partner with Insight Venture Partners spoke about customer lifetime value.While his presentation was skewed for enterprise type companies, the thinking has relevance for consumer companies too. In his view, it is one of the most important tools for estimating the value of a company, and as important, a means for management to manage and allocate assets.

Here's the summary of his thoughts:

• First they look at the size of the market (e.g. # of potential customers, number potential of seats, multiplied by average value/seat)
• Then they make assumptions, by distribtuion channel as to the number of seats a company may obtain (e.g. market share)
• Next is to look at the existing business, where they look at customer retention metrics by month of sign up. For example, they will assume that in the second year 90% of customers will renew, and in the third year, 85% of these will renew again
• They take these % and look at the components of customer lifetime value. They divide customers by market and simultaneously divide them by distribution channel (2 analysis)
• They determine revenue and gross margin by customer segment and by distribution
• Then factor in sales/marketing expenses (customer acquistion costs) to support the channel
• They use this information to reach a net contribution (pre-overhead allocation) by channel and by market
• They apply the customer lifetime value metrics to the potential addressable market
• They discount the future cash flows and apply a market multiple to reach a valuation conclusion

While I find this type of analysis incredibly useful for management and for later stage companies, I am not sure it's so relevant for early stage investors which tend to invest in companies which zig and zag before reaching their true market calling. Of course, this analysis does highllight how mature companies, who build their economic models around lifetime customer values can be blindsided when a new competitor, or way of doing business comes on the scene. Just think of the pain Enterprise software companies are facing as they now have to rely on the equivalent of their maintenance streams, without the initial 'pop' of large sales, to compete with SaaS vendors.

Search innovation

A few times each year I experiment with different search engines, yet have stayed with tried and true Google. Prior to looking at my latest nwe friend Izik,  I gave DuckDuckGo a whirl. I liked the clean interface, speed, and search suggestions for DuckDuckGo. While it's clear that the company has built a really nice product, it was not 'different' enough, nor, way 'better' enough for me to make a permanent switch.

Izik was built from the ground up for the tablet experience and offers a highly differentiated and intuitive search experience. The product was built by Blekko, which also offers a traditional desktop search experience "the spam-free search engine", as well as Rockzi, which is a highly visual (think Pinterest-like) social news/hobby board. According to Quantcast, Blekko has 1.8mm US unique visitors (Quantcast says DuckDuckGo has 248k monthly US visitors), so it could be called a large niche, or tiny mainstream player.

Unlike Blekko, Izik really is different; it saves clicks.

I suspect that if someone is going to really mount a serious search threat to Google's search position, it will have at its core a fundamentally different user interface. Microsoft won the application marketshare race by leveraging Windows, Apple's resurgance is, in a large way due to its smartphone's use of touch, and I am sure there are plenty of other examples, like Pinterest, where a fundamentally new approach to the user experience changes markets.

With Siri, Apple is betting that verbal commands will be at the core of a new user experience. Moreover, we are already seeing how mobile apps are changing the search paradigm as in-app search efficiency saves so much time/clicks that users don't think about exiting an application, such as Flixster, to search for movie or theater information.

Hopefully, for Google shareholders, the company is not getting too infatuated with self-driving cars, or with replicating many Kansas City wired experiments. It seems as if the times are changing in the core business.

Marketplaces

Bill Gurley of Benchmark posted to his blog a couple of months ago about a new investment his firm made in a new online marketplace, Dogvacy. Essentially, the company is similar to an Airbnb for pets. Here, people who are looking to board a pet are matched with individuals who would take it in, for a fee.

Along with his announcement of the investment (note, Benchmark was the first investor in the online marketplace Ebay), he posted the marketplace screen which the firm uses as a guide to determine if they are interested in an investment in the marketplace arena.

I am a big believer in marketplaces, especially ones where services are sold. I see a huge pool of underutilized talent (supply), available to meet the price and convenience needs of people who are increasingly comfortable with interacting online, have online payment capabilities and the infrastructure (e.g. broadband, VOIP, chat, and video) to effect online commerce (demand).

With one marketplace successful and a second now early in its launch, Bill's post gave me an interesting few minutes to look at what we are up to through another investor's eyes. So, here's his screen applied to our new venture:

Marketplace screen used by Benchmark

Rated (A-F)

New Experience vs Status quo

(  (A)   Users of GG reach counselors via the internet. It’s not simply cheaper or closer, it’s a whole new alternative. Location and identity are no longer tied together and this reduces anxiety about the timing to reach and a background to trust counselors dramatically. This should fuel word of mouth demand

Economic Advantage vs status quo

(  (A)   Economics are better for both sides of the equation; buyers and sellers. Prices should be better for consumers (can be 50% lower) as you are working with incremental time for counselors who alrady have practices and the rates should not upset local in-office billings. 

Opportunity for technology to add value

(  (A)   Offering a seamless, closed-loop, experience from search to trial to consult to payment should add great trust and transparency for the consumer

Fragmentation of suppliers

(  (A)   The American Association of Christian Counselors has grown from 15,000 to 50,000 members over the past decade. Specialized services from eating disorders to trauma or life coaches are under the umbrella of just this one organization. Other Associations exist specifically for Christian Coaches, Pastors and Mental health professionals. Perhaps, as interesting, is that availability of counselors should not be an issue since cross-time zones work in favor of finding someone who is available for a consultation.

Friction of supplier sign-up

(  (A)   All a supplier needs to do is to fill out a profile, download Skype, and attach their Paypal accounts

Size of market opportunity

(  (A)   According to Pew, nearly one-third of Americans identify themselves as Evangelical Christians, though the opportunity clearly spans a global market. This site sits at the intersection between religion, mental health, and coaching. The need spans all demographics, for example 46% of college students felt that ‘things were hopeless’ at least once in the previous 12 months and 31 million US adults received mental health services over the past 12 months  (NY Times survey)

Expand the market

(  (A)   Making it easier to find a professional to provide a service at a lower expense and from the comfort of your home should expand the number, and frequency, of consultations clients seek.  This is complemented by the mismatch in the professional training and client requirements. For example, the majority of traditional counselor training programs have no courses dealing with spiritual matters, while three-fourths of Americans say religion is critical to their life approach. Many Clients look for a faith based Advisor for two key reasons; one is faith perspective; they want a therapist who resonates with their worldview. The second is moral ethics; they want a counselor who understands what guides their decisions." It is incredibly difficult for clients to find counselors who are accessible, share their view, and are affordable. In one marketplace, GG bridges these difficulites.

This should directly impact the top reasons people don’t see counselors;  44% of people who are not getting help could not afford the cost, and 21% did not know where to go, 15% did not have time and 10% did not want their friends to know they were seeking help. (National Statistics on Mental Health)

Frequency

(  (A)   The frequency of Advisor visits varies by individual, requirements, and type of service required. Often counseling sessions are monthly, lasting for a period of years, while coaching may go for an intense, shorter duration, followed by quarterly check-ups.

Payment flow

(A) GG is in the payment flow and as the revenue represents a new economic opportunity for the caregivers, which can only be achieved by being on the system, the relationship is symbiotic

Network effects

(B+) Religious adherence is highly social as has been demonstrated via  early Facebook results. Caregivers develop a reputation and it’s transparent for all to see and reputation has real value in the marketplace. The best providers are rewarded with better placement and more business. Therefore, a high premium is placed on providing a quality service.

compensation

Around this time of year boards have recently, or are about to finalize compensation plans for companies. WilmerHale and Ernst & Young publish an excellent survey:

Executive Compensation: Insights from the 2012 CompStudy Survey of Venture-Backed Companies

The data is an important indicator for what is 'market' for employees of venture backed technology companies. Here's a link to the survey of 4,000 startups, 10,000 founders and 20,000 executives. It takes a look at companies who have raised zero to 5+ rounds of capital, are located in the US and looks at equity % held by founders and non-founders....by title.

Some of the numbers that resonated with me are:

• Non-founding CEO's have approximately 6% of fully diluted equity holdings (post round 2)
•  CEO direct reports are in the 1-2% range
• CEO base salary of $250- $267k (median and mean)

I am confident that every company is different in its philosophy and execution of their compensation plans. I am also confident that having good data and transparency gives people more comfort that fair dealings are taking place.

This study helps give that confidence.

Irving, Newton and Janis

I had the opportunity to spend some time with Irving Wladawsky-Berger the other day. He's been a forward thinker in the industry and, before retiring, led IBM's e-busineess and cloud computing strategies. Now, he is assisiting Citibank with their digital money strategy and, in his spare time, lectures at MIT.

Irving was sharing with me his insights into big data and the primary point he was making is that big data arereally HUGE data sets and it's still quite easy to make bad decisions using big data (note to self...think of this when folk cite the 'wisdom of the crowd' religion). We are still way early in providing proper toolsets to harness and highlight what's really important within these data sets. When we do, it will prvide huge value for users and corporations. I've seen the early value for customers of tracx.com and the prople there have great plans to take their social media management application deep within the Enterprise. In many ways fulfilling the promise CRM left unfilled.

This brings me to the deeper point which I later gleaned from Irving's blog. He spoke about the major change in scientific perspective from Newtonian physics, where objects exhibit deterministic behaviors, that is, if you apply the same forces to the same object, you should yield the same results to a new world where Quantum mechanics and relativity rule the day. In this bizarre world, counter-intuitive behaviors abound.

When you use these theories as a background, it seems as if investing in young technology companies is much more like embracing quantum mechanics than following Newton. Meteoric rises by companies such as Pinterest, Zinga and Groupon have not been duplicated and, I am confident, that duplicating most, if not all their 'magic' will lead far different results. Being a follower is fraught with danger in technology. Though, it's not the point of who gets to the market first, nor is it necessarily that the 'better' product wins. I do think, however, that the management of the companies, through incremental tweaking of their products can, and do, match their solutions with an unmet need/fascination which the market embraces. Or, bold entrepreneurs  go against conventional wisdom in designing their products in a way which people suggest are doomed for failure. For example, Google had a stark homepage while Yahoo embraced ad and content clutter (and early revenue). Today,  current darlings Box.net, Evernote and Dropbox were all founded when the conventional wisdom was that forcing the consumer to download a client was a non-starter and the kiss of death. I suppose that it was....until it wasn't.

We live in an era of uncertainty where the answers obviously change...as do the questions. Let's all try (just a little bit harder) to be just a little bit different.