March 31, 2010

Term Sheet Terms Explained

My friend, Dave Broadwin of Foley Hoag, has a blog post today which is the first part of his discussion of venture capital term sheet terms that are worth negotiating over.  Dave discusses dividends, partcipating preferred, founder representations, option plan and founder vesting, Board of Directors, and 'drag along'. 

Dave's descriptions are clear, and his advice is sound.  There are very few hard and fast rules about the structure of terms in a venture deal.  Some of this comes down to firm style -- firms tend to like some of these structures, although exceptions can always be made if necessary to win a deal.

The best defense an entrepreneur has is to have options -- alternate offers, or a strategy, perhaps less desireable, that lets you put off fund raising.  You can get VCs to make changes to their standard terms if they have competition.  In the absence of competition, it could be tough.

One of the best arguments against terms like dividends and participating preferred in a series A financing is that it will probably be in the interest of the series A investor to keep these terms out of later financings when more money comes into the deal.  If these terms are in Series A, they'll almost certainly be in later financings.

Dave didn't mention that one pressure that VCs face in eliminating these terms from their deals is the internal partnership dynamics.  Although, in theory, everything is negotiable, if a firm normally gets participating preferred and you want it out of your deal, this may make it harder to get the deal approved by the partners who are on the fence.  Don't assume that every partner in the firm has done a detailed analysis of the pros and cons of your deal and all the terms.  Instead, a reluctant partner may vote No based on something simple like less favorable terms.

I always preferred the cleanest possible deal structure, baking everything into the valuation.  Rather than paying a higher price for a deal and compensating for it with fancy terms, it's better to keep the price a bit lower and keep the deal as clean as possible.  In the end, this works out better for both sides, particularly as more rounds are raised.

In the end, the best an entrepreneur can do is to understand all these terms and do their best to get the best deal they can.  But, it's rarely worth letting a financing fall through because of a stubborn investor on these points.

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March 18, 2010

Who's Looking Out for You?

Dave Broadwin of Foley Hoag's Emerging Enterprise Center has an interesting blog post about the legal aspects of a company director's fiduciary responsibility.

The key to this issue is that VC investors who take Board seats at small companies have an inherent conflict.  As a partner in a venture fund with compensation tied to the performance of that fund, they are financially motivated to maximize the value of their investment in the company.  As a corporate director, they have a fiduciary responsibility to look out for all the stakeholders in the company.  And, as the Trados case indicates in Dave's blog post, corporate directors should be leaning in favor of looking out for the common shareholders over the preferred.  The preferred shareholders have their rights defined in their stock purchase agreement and, from what I understand of the Trados decision, don't need the additional protection of directors looking out for them.

This creates an obvious conflict, particularly when a company is facing tough times.  What if a company is struggling but has an opportunity to raise money on terms that may be adverse to the existing preferred shareholders?  You can imagine a scenario where, as a Director, a VC votes in favor of this tough financing as it preserves some value for the common stock but, as a preferred shareholder, they vote against it.  That may meet the fiduciary obligations defined in the legal precedent, but sets up weird dynamics.  It's difficult for one person to have two points of view.

What is more likely is that a conflicted director will steer the company away from such a financing because they know that as a shareholder they can't support it.  Is that protecting the interests of the common shareholders?  Unclear.  I was involved in one company that during the 2001 meltdown had to raise an inside round of financing.  It was on tough terms and was structured to motivate existing investors to participate -- put more money in, and you can keep more of what you already have.  Don't put more money in, and you get wiped out (if you are interested in more of the mechanics behind these types of things, say so in the comments.  I'll explain).

One of our large investors made it clear that they had no more money for this deal on any terms.  They were a buyout firm that had been trying their hand at early stage VC.  It wasn't a good fit, and the meltdown confirmed this.  But, even though they weren't going to invest, they were also going to block any sort of financing that diluted their interest.  They were willing to let the company go in order to protect their interest that, without additional financing, would be worth nothing.

We had very complicated discussions at the Board level where each of the VCs was probably thinking more about their firm's stake than about what protected the common shareholders.  Luckily, we were able to convince this firm to let us go ahead with the financing as they were going to get zero one way or the other, unless they changed their mind and participated.  But, the conflict of interest didn't feel good.

Although it's good to have the legal aspect of the conflict clarified -- directors need to protect the common shareholders regardless of what class of stock they hold themselves -- I don't have a good answer for the human side of these conflicts.  The best advice to an entrepreneur is to make sure you go into business with investors and directors who you know, from their past track record, will balance the best interests of the common with their own financial best interests.

Another take on this comes from one of the favorite sayings of one of my former partners (unclear whether the original source of this is John Doerr or Dick Kramlich):

No conflict, no interest!

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February 22, 2010

High Risk ≠ Innovation

My friend, Chris, sent me a link to Why Venture Capitalists Avoid Innovation: They Like Making Money, written by Andy Singleton.  It was interesting reading, but I don't agree with many of the conclusions. 

One of the author's complaints is that VCs "claim to be in the business of innovation, but they also talk constantly, often in the same paragraph, about how much they want to avoid innovation."  However, Singleton is confusing 'innovation' with 'risk.'  There are lots of types of risk with any new venture:  technology risk, team risk, market risk, competitive risk, development risk, sales and marketing execution risk, financing risk, etc.  A brief word on each:

  • Technology risk -- The risk that some fundamental new innovation just won't work.  This tends to come up more often with 'hard' technologies like semiconductors, energy, drug development.  This is different from development risk.
  • Team risk -- The risk that you either can't build a team with suitable skills or that the team you build won't work effectively together.
  • Market risk -- The risk that the market for your product won't appear.  Perhaps you are counting on some market shift in the future.  If it happens, you'll be the big winner because you saw it first.  If it doesn't, you may be dead.
  • Competitive risk -- The risk that existing competitors in your market can fill the need that you are trying to fill more quickly than you can.
  • Development risk -- The risk that your development team will be ineffective and fail to build a product that works well and/or is done on schedule.
  • Sales and Marketing Execution risk --A set of risks ranging from getting the product requirements correct so that engineering builds the right thing to the ability to generate sufficient awareness and demand for the product to the ability to actually get customers to part with their cash in exchange for the product.
  • Financing risk -- The risk that you can convince investors, now and/or in the future, to invest in the company in light of all these risks.

There are probably other risks (add in the comments), but these are the main ones I think about.  One problem in Singleton's post is that he equates innovation to risk, and most likely technology risk.  I look at it differently.  I think that an investor looks at any early-stage company and weighs the risks versus the potential upside.  If they can mitigate the risks and the upside is big enough, they invest.  If the risks look too big and the upside doesn't justify them, they pass.

How would you mitigate some of these categories of risk?

  • Technology risk -- Is there a proof of concept or prototype that demonstrates the technological achievement?  Has the team demonstrated the ability to project the technology advance in the past?  Is there independent diligence that validates the planned technological advance?
  • Team risk -- Have you worked with the team before?  Have some of them worked together before?  Does that validated track record give you the confidence that they can execute the plan?
  • Market risk -- Are there early market trends that will tell you if the market is shifting in the direction you are hoping for?  Is there a fallback or interim plan that will keep the company going if the market shift happens later than you predict?
  • Competitive risk -- Can you gather some competitive intelligence that will give you a hint of what the competitors' plans are?
  • Development risk -- Similar to team risk: Does the technical team have a validated track record of developing similar projects with high quality and on time?
  • Sales and Marketing Execution risk -- Another team risk:  Does the Sales and Marketing team have a validated track record in specifying the product correctly, building awareness and demand, and closing profitable business?
  • Financing risk -- Does the plan give the company sufficient cushion to ensure that they can get far enough to attract additional investment?  Will an objective new investor be attracted to this opportunity?  Is there room for a reasonable valuation step up in valuation while still leaving room for a new investor to make sufficient money?

From my experience, the most common reason why a venture-backed IT company fails isn't technology risk but sales and marketing execution risk.  Products are poorly specified, requirements aren't honed sufficently, products are positioned poorly and undifferentiated, sales teams are ineffective, etc.  It's hard getting all this right.  If you don't, even the best product won't sell.  In fact, great sales and marketing execution can make a success out of a mediocre product.

The second most common reason is market risk.  Oftentimes start-ups are projecting that a new market segment will open up that they can capture.  If it doesn't happen, or doesn't happen before the start-up runs out of money, you are in trouble.  Hopefully, there is some sort of fallback plan.  If not, you are probably dead in the water.

Most VCs take on some level of technology and development risk as history shows that many times these can be overcome.  In fact, the first thing I read after reading Singleton's post was about Bloom Energy.  If that's not VCs backing innovation, to the tune of $400M, I don't know what is.  Of course, I am sure that these VCs see gigantic potential upside and had plans on how to mitigate the risks before they invested.  And, there are many others in clean tech, drug discovery, etc.

Some of Singleton's comments on the state of the VC business are accurate, but don't impact the calculus around these risks.  Some firms are more risk averse, but they still evaluate deals along all these axes.  An innovator has creative ways to mitigate these risks.  That's the type of innovation that VCs are looking for.  There are very few deals with no risks and big upside.  Instead, most VCs are looking at how some or most of these risks can be overcome.  It may be a high bar and may not always sound reasonable.  Perhaps they are looking for business innovation rather than just technological innovation.

Before you present your company to an investor, make sure you have thought through all these risks and what you would do to mitigate them.

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February 15, 2010

Moving Forward Full Speed

As mentioned in my previous post in this series, now that I have told the story of the wind down of our investment fund, I'm now moving forward by going back to my earlier background in an operating role.  My investment career spanned almost 11 years, and I learned an awful lot during that time.  But, I think it's time to go back to an operating role.  Here's why.

First of all, the investment world, particularly things related to venture capital, is a shrinking one.  It's well documented that the number of venture funds in the US is dropping, and the funds that are surviving are raising significantly less money than before.  So, like a game of musical chairs, there are just fewer possible jobs in venture capital.  Since I don't have a firm hold on an existing VC job, it's not likely that one will be available for me somewhere else.

Second, I've joined two existing venture firms in the past.  No matter how good the firm is, it's always different on the inside.  Partnership dynamics are much different than corporate politics.  In a company, you clearly know who your boss is.  And, it's easier to move around the company, or even leave if you choose to.  In a partnership, you have a dynamic of shared management and, often, unclear hierarchy.  That can be part of the attraction as you can join and be a partner.  But, some partners are more equal than others.  And, large partnerships are more difficult to manage than large companies.  More importantly, it's not clear that the best investors, who tend to rise in venture capital firms, make the best managers.

For all these reasons, I'm not interested in joining an existing investment firm.  And, I just spent 2+ years trying to start my own.  So, even if I wanted to remain an investor, it may not be possible.

More importantly, I'm not interested.  It is attractive to be an investor for many reasons: 1) potentially high current compensation, 2) spreading your risk across multiple opportunities, 3) challenging and broad work, etc.  But, it's been very tough to be a successful investor in the past decade.  Even many of the best venture capital firms have had few distributions to their partners due to their few successes being diluted by the larger number of meager returns.  There hasn't been as much money made in this business over the past decade as your friendly VC may lead you to believe.  If you've been an investor in a VC fund, you've probably seen this first hand.

I'm much more excited about taking on an operating role and getting something done.  I'm being highly selective about opportunities I consider, but I have seen quite a few very interesting projects in a short amount of time.  I think that right now the best entrepreneurial opportunities are better bets than the best VC jobs.  And, three VC friends of mine agree, telling me that it's better to be an entrepreneur right now than to be a VC.  We'll see, but it sure is energizing.

I've committed to one opportunity with a business partner.  The details are still being kept under wraps, but we've received fantastic customer feedback and some strong investor interest.  When we're ready, I'll talk about that opportunity here.  Until then, I'm sure I'll find some inspiration from my travel through the fund raising process as we get the company off the ground.

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February 03, 2010

Undaunted by the meltdown

Here's the next chapter in my 'What happened to Sempre' series.  If you haven't been reading along, the previous posts described why we decided to pull the plug, a look back at how we got started, building the team, and a discussion of our initial strategy of VC-style investing in public microcap stocks.

Once the market melted down in September 2008, we had to re-trench.  Our investor traction was gone, and we felt that we had to re-examine our proposed strategy in light of changing times.  As you may recall, there were a lot of people thinking that our economic world was coming to an end in the fourth quarter of 2008.  We decided to not do much fund raising during this time due to the high level of uncertainty.  Instead, we thought about alternative strategies.

First of all, our strategy of investing in microcap stocks had to go.  Although still economically viable (and remaining so today), there was no appetite for this type of strategy on the part of investors.  They were worried about continued downside risk and didn't see a lot of upside in a straight equity-only strategy.  That was coupled with increased risk aversion on the part of investors.  If we continued to pursue that strategy, we were dead in the water right then.

As some of our potential investors pointed out, one of our partners, Tim O'Loughlin, had an extensive background with venture debt.  This type of financing was very much lacking in the marketplace, particularly for later stage companies that may have trouble borrowing from banks.  We spent some time investigating this strategy and decided to pursue it.  Here's why:

First of all, most venture debt funds focus on lending to very early stage companies that have strong VC backing.  As a company, I never understood this.  If I am so early that I have no revenues, why would I borrow money to finance my product development?  Shouldn't my equity investors put more money into the company rather than use their funds to pay interest on a loan?  Here's the rationale that a venture debt firm will give you:  We will give you additional money so that you can get more work done on your Series A funding, hopefully earning you a higher valuation on Series B.  In exchange for that, we'll earn some interest and take a small warrant (option) position in the company in preferred stock.  If everything works out fine, that's all true.  The initial investors and management team will end up somewhat better off in this scenario.

But, not enough people think about what happens if things don't work as planned.  And, how often do things work as planned at a start-up?  If you fall behind plan, your lenders will get nervous and perhaps consider taking your last amount of cash in order to satisfy their loan.  At the least, they'll take up a lot of management and Board bandwidth getting reassured that additional capital will be coming into the company to service the loan.  Hopefully, the investors will realize that the lenders are expecting to get repaid and won't try to force them to convert their loan to equity.  This can lead to a game of 'chicken' being played with the company.  No one really wins these games. 

Why do venture debt players do this?  Because they are essentially loaning money to the venture capital firms and not the individual companies.  This 'off balance sheet' leverage can be helpful to a VC firm, and the risks are pretty low as long as the lender and VC investor have a good working relationship.  Despite this, I don't think that companies should borrow very much money until they have revenues to pay the loans back.  The issues and risks of the downside scenario don't balance out the upside opportunity.

That's where Sempre's Capital Access strategy fit in.  We were going to loan money to companies that had revenues and were at or near cash flow break even.  Most venture debt firms don't loan to these companies because they perceive the warrant upside to be smaller than with the early stage companies.  However, because capital is scarce, the interest rates you can charge are very attractive.  And, the risk of loss is likely to be lower.  Even if the company fails, they have a real, revenue-producing business that is more likely to have salvage value than an early-stage pre-revenue start-up.  Tim's track record bore this out, with consistent IRRs that would rival that of any tippety-top tier venture fund.  The money is returned to the investors (or recycled into new investments quickly), so the investment multiple might be lower than a venture fund.  But, assuming you can put the money to work again and again, an high IRR is the way to measure investments.

I won't go into the nitty gritty details of our strategy, but we certainly found a very strong deal flow of companies that had $4-$40M in annual sales and were at or near cash flow break even.  They were, in most cases, 'equity worthy' but couldn't or didn't want to raise additional equity capital.  Maybe their exsiting synidcate didn't have sufficient capital reserved for the deal.  Or, maybe the company had never raised venture capital and didn't want to start now.  In any event, we proved to ourselves very quickly that this was a viable strategy, and probably with higher caliber companies than we had at first anticipated.

Fund raising in 2009 was, of course, difficult.  Most investors had very limited liquidity to allow them to make new commitments.  And, first time funds always come under scrutiny.  We did find some investors who liked and were looking for venture debt, liked our strategy, our team, and our track record.  But, as chronicled in my 'pulling the plug' post, we couldn't get this over the finish line.  Traditional venture debt strategies tend to have returns that go up and down with VC returns.  They have been out of favor for many investors.  Sempre's strategy has been shown to be much more consistent, but it turned out to not be a benefit to be in the venture debt bucket.

The last chapter of my Sempre story will cover what I am thinking of doing next and why.  Stay tuned.

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January 28, 2010

Looking at microcap stocks

Back to my series documenting the story of how we tried to raise a new, innovative investment fund in a historically bad climate.

I wrote earlier about how we got started and how we put our team together.  After a short time, we settled on a strategy.  We decided to do something that hadn't really been done before:  we would take the venture capital model to the public stock market.

What does that mean?  First of all, I think of the venture capital model as one of being an active, engaged investor who works with a company to build value.  You need to have a significant stake in the company and perhaps a board seat to ensure that your interests and the company's remain aligned.  This is usually applied to private companies where the VCs own a controlling stake in a company.  They usually buy a preferred class of shares to ensure that they get their money out first in the event of a sale or liquidation.  Most of these private company ideas wouldn't work in the public markets.  More on that below.

Our targets were public information technology (IT) companies that had market capitalizations between $50M and $250M.  These stocks are largely ignored by public market investors and have low trading volumes.  Until a company is worth about $500M, most money managers won't buy the stock.  Public investors value their liquidity -- the ability to sell quickly.  Like venture-backed private companies, these smaller public companies were not very liquid.  You could definitely get in and get out, but you had to do it carefully and over time.  Too much buy side or sell side pressure, and the stock could move a lot.  Not good for your investment strategy or your reputation.

We wanted to be constructive and have a positive reputation with companies.  Our approach was to identify companies that we felt were significantly undervalued in the public market as measured by both their financial metrics and their product offerings.  This required more than typical public market diligence -- you had to evaluate their financials and look at their business and how it could be restructured or improved to increase value.

Once you find such a company, you have to approach management to see if they were receptive.  Since we were 'constructive activists', we needed to get management, the existing board, and perhaps some of the larger investors to buy into our strategy for the company.  We generally found a very positive reception, but sometimes the companies wanted to keep doing what they were doing, despite the lack of appreciation by the public market.

The companies we liked best usually didn't need more cash.  So, we didn't invest directly in the companies.  Instead our plan was to purchase shares in the company in the open market to build up a position.  We found that we would have to work with trading partners who specialized in this type of transaction.  They could buy stock in illiquid companies without driving the price up (or sell without driving it down).  If we liked a company, our strategy was to buy 5-10% and perhaps take a Board seat.

We were planning to be long-term owners.  We'd own the stock for 2-3 years.  We didn't plan to short stocks -- we were 'long only.'  This kept us on the same side as management and differentiated us from hedge funds.  In fact, we were more like a late stage VC -- buying a position in a company that had revenues but had the potential for significant value creation. We'd hold onto the stock until we had built some value, which helped all the stakeholders.

The benefit of doing this in the public market was that you always had the opportunity to change your mind if you wanted.  Although not always easy to sell your position, it was sellable.  VCs generally can't sell their position in private companies at prices near the market value.  When they do sell, there is generally a significant discount.  Being able to control the exit timing was a critical element to this strategy.

Another benefit of investing in public companies is that you could chat with other investors to get their thoughts on a company.  This isn't collusion, just a discussion of what you thought of a company's public information.  We learned a lot by talking to other public market investors, particularly as we were new to the game.  Our VC skills would help us once we invested, but there were nuances of the public market side we had to learn.

Our historical analysis showed that there have always been significantly undervalued public IT companies, independent of the overall market cycle.  During down markets, there are just more of them, and they are even more attractive.  We did put some money to work in some companies we liked, and we did very well.  We struck up some constructive relationships with some management teams, but without outside capital, we couldn't build up a big enough position to have a real say in the companies.  We'd need about $12-15M per deal and a $250M fund to make it work.

It was tough getting investors to appreciate what we were doing.  One of our biggest problems was the 'bucket' problem.  Most institutional investors have buckets, or categories, for their investments -- venture capital, buyouts, international stocks, real estate, etc.  Our firm was a cross between late stage venture capital and public market investing.  Some investors couldn't do any public market investments.  In other firms, the two buickets were managed by different people.  And, our public market strategy was different than what they wanted -- they valued liquidity in public stocks even while they tolerated illiquidity in private company holdings.  It was rare to get an investor who understood VC and was willing to consider public stocks.

We did start to build some traction but were stymied by the market maltdown in September 2008.  Our traction went to zero, and we waited out the worst of the market to evaluate our plans.  Even so, it was frustrating to not get further before the meltdown.

In addition to the bucket problem, we also faced the first-time fund, first-time team problem.  Investors are very wary of backing new teams (will they stick together?) and new funds (do they know what they heck they are doing?).  These are valid concerns, and we had our strategy for overcoming them.  But, it took a long time with each investor, and we didn't make it over the finish line before the race stopped with the market meltdown.

In looking back, perhaps we were wrong to try to do something new.  However, it was also clear that investors weren't looking for 'more of the same.'  That fickleness was frustrating and explains why it's so tough to get a new firm off the ground.  There is still an opportunity for this type of microcap venture-style investment.  Some VC firms dabble in this now, and perhaps someone will take our strategy and make a lot of money with it.  That would be satisfying.

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December 17, 2009

Pulling The Plug

As some of you already know, a couple of weeks ago my partners and I decided to pull the plug on our investment firm, Sempre Management.  This post will include the short version of the story, but over the next few posts I plan to tell the story from the beginning in more detail.  There are good lessons here for any sort of entrepreneur.

The bottom line for us is that this is a horrible environment for raising investment money, particulalry for "first-time" funds.  While we were raising money, we followed the standard advice of not publicizing what we were doing.  The SEC worries about raising money from the general public.  Since we aren't raising money any more, I can talk about what our strategy was.

We were raising money for a variant of a venture debt fund.  Venture Debt means loaning money to companies that would typically be backed by venture capitalists.  In practice, most venture debt loans are made to very early stage companies.  These companies often don't have revenues to pay back the loans.  Instead, the venture debt firms count on the investors to put additional capital into the company to pay back the loan.  The hope for the company is that the company will make more progress with the borrowed money and will therefore earn a higher valuation for that follow-on investment.  More on that when I get to the chapter on venture debt.

Sempre was targeting companies that had revenues and were near break-even.  We were not looking for investors to put in additional capital.  Instead, we were looking for good businesses that were trying to cross the threshhold from losing money to making money and needed some additional cash to do it.  Most would be worthy of an equity investment but, for a variety of reasons ranging from investors out of money to not wanting to suffer additional dilution, the company would prefer to borrow money rather than take on more equity capital.

To cut to the end, we found out a few weeks ago that our potential lead investor had to delay their commitment to us for another six months due to issues around the timing of liquidity in their own fund.  They decided that they needed to raise a new vehicle in order to invest in Sempre.  Our other potential investors couldn't step up in their place and were likely to wait for some other lead to emerge.  This additional time and risk on top of everything else we've been through in this crazy time was the last straw.  We decided that we would stop now rather than carry on for 6+ more months with an (always) uncertain ending. 

Although we had a great strategy, a solid and current track record in implementing that strategy, had worked together as a team for more than 2 1/2 years, and were willing to fund the start-up of the fund out of our pocket, we still couldn't get over the bar in this tough fund raising environment.  Being a first-time fund is very tough -- many investors refuse to consider you.  And, we believe that 2010 will be even worse for first-time funds as many big name VCs will be in the market and the availability of capital isn't likely to improve.  The first-time funds will continue to get squeezed out.

Each member of our team is now embarking on their own path.  For me, I plan to return to an operating role.  I'd like a senior management position in a young company, ranging from a company about to collect its first revenue to one that is looking to add to its management team in order to scale.  I'll stick to the information technology and clean tech sectors where I have the most experience.  Likely titles for me would be CEO, COO, or VP of Sales and Marketing.  If you know of something that looks like a fit, let me know.

We plan to keep our Sempre Management contact info alive, so no need to update your contact info on me.  I look forward to reconnecting with many of you soon.

Over the next week or so, I plan to tell the story of how our team came together, how we chose our strategy, how we dealt wtih the market meltdown in the midst of fundraising in 2008, and how we revised our strategy and continued fund raising in 2009.  This won't be any sort of 'tell all', but will focus on lessons that apply to any entrepreneur.  I look forward to your feedback.

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November 24, 2009

No one looked under the Canopy

A very interesting story has emerged in the last few days about a venture-backed company called Canopy (coverage from TechCrunch and peHUB).

It looks like management defrauded the investors by lying about the company's financials.  There was an auditor hired, but no audit done.  Now the VCs have all pulled the company from their websites, which is never a good sign.

This is a company that raised a lot of money and, until recently, employed a lot of people.  Now it is likely to be stuck in a lot of litigation in and among investors and employees.

I don't know anything about this situation, but I've been on enough boards to know that if management wants to fool you, you can be fooled.  Board members rely on what they hear from the management team and, unless they slip up, you can be fooled for a while.  The surprising thing is that, if this is the level of fraud that's alleged, you'd think that someone at the company would have spoken up long ago.

One key thing I have learned over the years is to maintain casual contact with employees at all levels of a company.  It's great to be able to stop by to ask them how it's going.  This is particularly true for key people in finance and engineering.  Both groups tend to be honest and direct.

Secondly, I always maintain direct contact with the service providers used by a company, particularly lawyers and accountants.  They tend to have a good sense of whether or not things are on the up and up.  In the case of Canopy, one call to the auditors would have determined, allegedly, that they never did an audit!

I'm not picking on the VCs involved as I don't know the whole story.  But, there is no substitute for 'management by walking around', or the investor equivalent.  Be present, and talk to the people on the front lines.

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November 03, 2009

Re-matching expectations

Every time there are new venture capital performance statistics announced, lots of people, including me, decry how over-funded the segment is and claim that it has to shrink.  And, over time, it will shrink.  But, what does this environment mean to entrepreneurs?

The fundamental problem with the venture capital business is that the VC investor's expectations are no longer aligned with that of an entrepreneur.  According to the latest statistics on exits from venture-capital backed companies, the average merger exit this year is $92M (and that's only for the ~25% of the deals where the transaction size is announced).  I'm willing to bet that the unnanounced transactions average a much lower price, although there are always some significant deals where the value isn't announced for various reasons.  Let's be optimistic and assume that the average for ALL venture M&A exits this year is something like $70M.

Now, if you and your co-founders could start a company from scratch and make it worth $70M, you'd think of yourself as being pretty successful.  But, to a VC, that's a marginal return.  Assuming that the VCs own 75% of the company by the time of the exit, they would take $52.5M of your $70M exit.  If the total investment in your company was $25M, the VC's profit would be $27.5M.  20% of this goes toward the VC's carried interest (assuming that their overall fund was in the black), leaving $22M for the LPs (the VC's investors).  That's a 1.88x multiple for the LPs.  Not what the VCs are shooting for, but not a disaster.

If you look at the historical returns I linked to above, you'll see that, on average, the VC industry has delivered a less than 1x return to LPs year after year from 1999 on.  They've lost money for a decade, so the average deal is worse than what I described above.  It's worse because there has probably been more money poured into the deal.  Maybe the real average exit is less than $70M.  And, my analysis above doesn't include the VC's 2%/year fee which also drags down returns.

What most VCs do to combat this is either 1) raise a lot less money and invest only in very capital efficient deals or 2) take really big risks that have a chance to deliver gigantic returns.  One huge return can overcome the losses of many deals.  But, if you aren't lucky enough to be part of one of those big wins, your returns (as a VC and an entrepreneur) suffer.

As an entrepreneur, your interests are more directly aligned with the VC that raises less money and is careful about the capital that they invest.  When your revenue-stage company gets to the point where it needs some additional capital to get over the 'cash flow break even finish line', you won't want to take that in as equity capital.  That's what pushes you into the overfunded category and lowers your return.  Instead, you may want to consider some venture debt that is tailored to meet the needs of companies at this stage.

The benefit of this type of debt is that it doesn't really change your share (or the VC's share) of the upside proceeds when your company achieves its exit.  The venture debt typically includes some warrants (or options to purchase shares in the company upon exit), but not a large stake.  If your company grows as planned, you should make more after repaying this venture debt then if you sub-optimized your growth without the debt.  The downside is that you have to service this debt which adds to the short-term cash burn.  As long as your company is growing faster than the added burden of the debt service, you should be able to repay the debt and capture the upside.

Of course, if you've never raised venture capital money, this type of debt instrument is just as applicable.  You may not want or have the option of taking additional equity investment to finance your last stage of growth.  Venture debt gives you the capital you need while allowing you to maintain control of your company.

In another case of mismatched expectations, most venture debt firms don't want to invest in revenue stage companies.  They prefer to invest as early as possible when the top-tier VCs invest.  Essentially, they are loaning money to the VCs, not to the company.  That can make sense if you have a new company with top-tier venture backing.  But, for the other 99% of the private companies out there, venture debt isn't really available.

There's clearly a nice opportunity here for both the private companies and the right venture debt investor.  More to come soon.

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October 27, 2009

Small VC is Beautiful

I've written many times about the impending structural challenges in the venture industry.  There is too much capital hoping for huge outcomes in an environment where a modest win should be considered a big win.  It's critical that VCs be careful with the amount of capital they meter out to portfolio companies, and, for larger funds, this makes it tough for them to participate in these capital efficient deals.

The folks at Industry Little Hawk agree.  They've written a white paper that describes why smaller venture funds (<$150M) offer the best returns.  They have historical numbers to back it up. 

The big question is what will happen to the big funds out there?  They have too many people who make salaries that are too large and spend too much money on fancy offices.  Limited partners in these funds are figuring out that these fixed comforts misalign interests between the General Partners in the venture funds and the Limited Partners who invest in these funds.  Look for continuing pressure on these larger funds and a steady exodus of partners from these funds as they attempt to get closer to 'right-sizing'.

Although I hear LPs talk about this quite a bit, it will take years for this to ripple through the venture industry.  For now, most venture funds will wait on raising a new fund, hoping for a better environment in a year or two.  The industry won't really shrink until these funds give up on their existing model after failing to raise funds.  5-10 years from now, the venture business should look much different than it does today -- smaller firms with more nimble partners.

Another shoe to drop will be the fee model that is employed by venture firms.  The more they can align their compensation with the LPs interest, the better.  LPs will insist that VCs can't get rich off of high fees and will instead have to deliver significant returns in order to make some serious money.  Look also for certain fund strategies to employ a very different fee structure when they can ensure that they only make money when the LPs do.  I'll write more about that in the future.

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October 16, 2009

Venture Capital's Structural Mess

There have been a few more posts recently describing structural problems in the venture capital business.

Fred Wilson called out VCs who claimed that they need to own at least xx% of a company to justify an investment.  xx is usually 20% or more.  Most VCs think this way because they have a large fund and want to have a manageable number of investments to worry about.  Each deal may need to ultimately represent $10-15M over time.  In order to justify that, you may need to own 25% of a company (or invest in much later stage companies).

Josh Kopelman explained why big funds will have trouble generating strong returns for the large bulk of money they have.  Here's a great quote:

Take a $400M venture fund.  In order to get a 20% return in 6 years, they need to triple the fund -- or return $1.2B.  Add in fees/carry and you now have to return $1.5B.  Assuming that the fund owns 20% of their portfolio companies on exit, they need to create $7.5B of market value.  So assume that one VC invested in Skype, Myspace and Youtube in the same fund - they would be just halfway to their goal.

Both of these posts are worth reading in full.  I'm going to cover some trends from the VC's investors on down that highlight structural problems in the industry.

Most VCs raise money from ranges of institutional investors (endowments, 'funds of funds' which manage large pools of capital for other investors, pension funds, wealthy individuals, etc.).  Collectively, these are the Limited Partners in a venture fund, which is managed by the General Partners.  There are several issues impacting LPs these days:

  • There has been a long term trend of lots of capital being available to invest, and therefore a desire to invest more into venture capital.  As every LP increased their allocation to venture capital, they ended up increasing the amount they wanted to invest in a fund.  Some LPs have minimums of $20M up to $50M (present economic difficulties excluded).
  • LPs often don't want to be more than 10% of a fund.  So, their minimum investment levels imply fund sizes of $200-$500M, at a minimum.
  • However, LPs also don't like large fund sizes because they think that the VC General Partners make too much money from their fees (typically 2% of committed capital per year).  So, here's the first conflict -- we have to invest $20M or it isn't worth our time, but we don't want you to have a large fund (or at least not a large fee income).
  • As Josh pointed out, it's hard to make money with a big fund as you need many big exits.  This gets easier with a small fund as the sizes of wins required goes down proportionally.  But, small funds aren't interesting to many LPs as they can't invest money in them to be worth their time.
  • And, in today's economic climate, there is a shortage of liquid assets available for LPs to use to meet their existing fund commitments let alone make new ones.  That's one reason why new fund commitments are so low.  Also, with VC returns being fairly low for the past decade, many LPs are moving out of venture capital or lowering their allocation, except for commitments to proven very top-tier funds.

There is also a structural problem with compensation.  As you might know, VC General Partners get a salary from their management fee and then a piece of the upside on the aggregation of the deals in the fund.  Typically, the partners would split 20% of the profits in the fund (not in each deal).  The whole fund has to be above water for this to happen, and some top VCs have a 'carried interest' of 25% or even 30%.  LPs are trying get everyone pushed back down to 20% if they possibly can.

Many LPs are compensated in the same way.  They get a management fee from their investors and then get some level of 'carry' if their fund is profitable in the aggregate.  If you think about this, it compensates everyone for achieving fund multiple, regardless of how long it takes to get there.  You might think that an LP would be thrilled if they could send you all of their money and you could reliably return 1.25x their money in 12 months.  Logic would assume that they would do that year after year.  But, their compensation system keeps them from doing that.  They'd only make 6.125% of the committed capital as a profit (you'd have to generate a 31.25% return, keeping 20% of it, 6.125%, and sending them the remaining 25%).

They'd rather let you hold the money for 5-8 years in hopes that you can return 2-3x their money, even if it means that you might lose half their money.  That doesn't make much sense, but that's the basis of LP and GP compensation.  If you generate a 2x eventually (to net 2x, the VC has to generate 2.25x and keep .25x for themselves as your carry), and raise a new fund that tries to do this every few years, you can eventually earn more money.  But, chances are something that can generate a 2x return can also lose half its value.  And, that's what's been happening in the venture space.  LPs and GPs are trying to generate high returns and living with the losses.  The glut of capital in the sector is one factor in driving down returns.  For the VCs and LPs, their high management fees buffer this for them, but their ultimate investors are getting tired of it.

I expect there to be lots of changes.  Foremost, capital will continue to drain out of the venture capital space.  Second, there will be pressure on the venture fund terms, pushing down management fees so that the GPs only make significant money if the investors are also earning a profit.  This will force the GPS to do the math that Josh Kopelman did and raise a smaller fund.  That will force many funds ts close and many people to leave the business.  Ultimately, it will be a healthier market, but it will take some time and a lot of gnashing of teeth before it gets sorted out.

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October 12, 2009

Beyond Venture Capital

There has been a lot written lately about the shrinking of the venture capital market.  Here are some stats from recent posts across the web:

US Private Equity fundraising plunges 70%

Only 17 venture capital firms raise money in Q3 — fewest in 15 years

Some of this is cyclical.  VCs usually only raise a new fund once every 3-5 years.  So, one slow quarter or even a slow 3 quarters doesn't foretell the end of venture capital.  But, it's clear that the VC business is shrinking in several ways:

    • LPs (limited partners or investors in venture capital funds) are commiting less money to the venture capital sector.  This means that there will be fewer funds and those funds will be smaller than before.
    • LPs are getting tougher on the terms that they pay to VCs, particularly on larger funds.  This is affecting the fixed management fees, which pay VC office rents and salaries, and the carried interest (share of the upside of the investments), which is how VCs used to make most of their income.  LPs don't want VCs making big salaries off the management fee and want some level of return for themselves before sharing with the VC.
    • VCs are slowing down their investment to push out their fund raising into the future when, hopefully, things will be better.  Also, some LPs are asking their venture capital funds to slow down their investment as the LPs are short of cash from liquid investments to use to make their capital commitments to the venture funds.  Even multi-billion dollar endowments can have a cash crunch!
    • The old guard VCs are having an easier time raising money than upstarts.  Much of the money being raised is by brand name funds or brand name investors.  Innovative new funds are getting pushed aside due to the cash crunch at the LPs.  And, poor performing funds will struggle to raise money.
    • Due to the slow exit environment, more companies are having to fund their growth internally or with their existing investors.  As those investors old funds start to run dry, it will become difficult for even good companies to get access to the cash they need to grow.  Some will sub-optimize their growth and others will be forced to sell before they would otherwise want to.

What does this mean to an entrepreneur?

    • You need to get your company to revenue faster and close to cash break-even faster.  VCs are still going to be needed to get companies off of the ground, but it could be tougher to count on them for expansion stage capital.  Of course, there are still other ways to get a company off the ground -- bootstrapping it, angel financing, etc.
    • Choose your syndicate carefully.  VCs who are unable to raise a new fund will slowly whither away.  The lack of sufficient new capital to invest and the associated management fees will cause partners to leave.  Old investments in old funds get put into caretaker mode and will have trouble squeezing new capital out of the investors.  Make sure your investors are healthy and have a long runway.
    • Look for other sources of capital as you get closer to break-even.  If you have revenues and hard assets, you can consider debt to fund your business rather than equity.  Don't over-leverage your business, but a modest amount of debt in a growing company is a good thing as it preserves the existing equity structure and is a source that can be tapped again as the debt is repaid.  However, too much debt or debt in a non-growth company can be a killer.  You need growth to repay the debt or the debt service will crowd out your operating expenses.
    • Don't count on your investors or board to solve this for you.  They can be helpful, but the company's leadership needs to ensure that the company is financed, in partnership with the investor base.

Overall, I think that the start-up financing arena will be a place for innovation.  There will still be plenty of venture capital for the best ideas and teams, but entrepreneurs will also be challenged to get their companies going without venture capital or plentiful late stage financing.  One of the keys to success is keeping your company financed, and those who do so have a big advantage.

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August 25, 2009

Steering clear of the rocks

Q: What's the one thing in common among every business plan that has ever been pitched to an investor? 

A: The plan is wrong.

Don't worry about the plan being wrong.  The plan represents a set of assumptions that hang together to produce a business venture that, if everything went according to plan, will generate positive returns for the investors and other stakeholders.  It's impossible to get all of the assumptions right.  It's management's job to adjust the plan as the assumptions don't line up.  Somethings go better than you expect.  Other things go worse.  And, there will be factors which emerge that you never considered.  That's what makes being an entrepreneur fun (and stressful!).

One of the most common mistakes that entrepreneurs make is failing to recognize that things are going off track until it is too late.  Entrepreneurs are optimists, generally.  You need that optimism or you'd never try to get a venture started.  Objectively, the odds are against you.  But, it's the thrill of the opportunity that motivates most entrepreneurs.

You can't panic when you miss your first milestone or your first assumption turns out to be false.  But, you should objectively analyze the impact.  If your development project is starting to fall behind, can you really make up time in the coming few weeks?  Or, should you re-adjust some of the features and change priorities to add more slack in the schedule?  If your revenue generation is behind schedule, can you realistically make that up in the remaining months of the year?  Or, should you ratchet down your initial assumption to match the reality.

There is no easy answer for this.  But, here are some things to keep in mind as you analyze.

  • Don't dismiss any missed milestone or projection as 'no big deal'.  You need to find the root cause and assess whether other assumptions you have made are wrong.  One of the most common occurrances is the cascading of missed objectives.  An optimistic assumption in one area is usually coupled with optimism in other areas.  Even when you re-double your efforts, it can become hard to avoid falling behind faster due to the inherent optimism in the original plan.
  • Get objective input.  It's very hard to avoid drinking your own Kool-Aid as an entrepreneur.  You are the visionary that sold everyone on this plan.  You convinced everyone that you could overcome the obstacles.  So, as the new obstacles appear, you still believe you can overcome those, too.  I'm not saying that you shouldn't try.  But, you need to get someone outside the daily fray (board member, advisor) who can assess the situation and give you objective feedback.
  • Listen!  Your board members, advisors, and team members are probably trying to give you some subtle messages about adjusting the plan.  There's a fine line between giving up on the plan and making the right adjustments.  A key skill for the CEO is to be able to listen objectively to all input, question their own assumptions, and then make the right decision.
  • Act early, act often.  Early action when a plan is going off track is your best friend.  By taking early action (adjusting sales plans, reallocating resources, cutting expenses, etc.), you are buying yourself the most time to get back on track.  If you make up your shortfall or catch up on your project plan, it's not hard to ask the resources back that you may have given up.  Or, you may find that you can get by just fine with less.
  • There's no shame in adjusting the plan.  The real shame is in failing to adjust the plan.  Again, here is where the entrepreneur's passion can become their weakness.  You've overcome so many obstacles to get your business to this point.  Of course, you can overcome the current obstacle, too.  What you have to think about is, what if we can't?  Am I spending too much money for the case where we don't get back on track?  Chances are, the answer is yes.  Way more companies have gone out of business by spending too much money than by spending not enough.  Keep the odds in your favor by adjusting your spending as quickly as possible when you start to go off track.
  • Don't wait for the Board to force you into making changes.  Most times, the Board will defer to management as management has much more detailed information.  So, if you believe that you can make up for a miss, the Board will usually give you a shot.  But, just make sure you aren't fooling yourself first.
  • Most of the 'misses' with a plan are negative, but you may also exceed aspects of a plan.  This is great when it happens.  Don't be afraid to adjust a plan updward if you are really confident that you are ahead of the curve.  If you really are growing ahead of plan, no one should object to ratcheting up the spending proportionately, too.

I'd be interested in other approaches that people have taken when your best laid plans go astray.  Please share them in the comments.

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August 24, 2009

Dinosaurs aren't going anywhere

Scott Kirsner has a very interesting blog post today entitled "Why Waltham Doesn't Matter."  His opinion is that most of the local VC's (particularly those with offices in Waltham in what Scott calls Mount Money) are dinosaurs that are out of touch with the latest happenings in the local tech community.  They don't pay attention to young entrepreneurs and don't fund ideas in the coolest new technologies.  Like a bad doctor, Scott has the symptoms correct but the diagnosis wrong.

Most of the more established VCs do tend to focus on areas that have been successful for them in the past.  And, they'd prefer to work with entrepreneurs who have been successful in the past, too.  There are so many risks with early-stage start-ups, why not increase the chance of success by limiting the places where you will fail?  And, there have been plenty of strong returns in recent years from following this formula.  I'd submit that the list of local IPOs and large acquisitions is dominated by companies in this category.  There are exceptions, but this is where the money has been and, for many, continues to be.

There are other VCs who can't break into this space successfully.  Or, perhaps they decide that to make their mark, they'll venture into some riskier waters.  The jury is still very much out as to whether they'll make money from these deals.  There are some good exits to date, but not enough to prove the point.  The contrarian in me will argue that they have a better chance of long-term success as these areas should be less crowded and will attract less capital in the short-term.  In fact, if every local VC flooded these new areas, they'd probably overfund a lot of mediocre companies, which would hurt everyone.

I've focused on the exits because that's what VCs and their investors (limited partners) care about.  Market development, fostering young entrepreneurs, networking events, etc. are nice.  I actually like them and have participated in more than my fair share.  But, they don't pay the bills unless they lead to deals that generate big returns.  Some VCs may feel that they do.  Others may feel that they can generate large returns without them.  I don't see the point of bashing one strategy over the other, particularly when I think that the old-fashioned way is still generating stronger returns.

I like Scott.  He's on a mission to have us all invest more in developing our local market.  Many of the VCs he's bashing do that, but perhaps not in the way he'd like.  They sponsor entrepreneurial events at MIT and elsewhere.  They've all done at least some deals in newer technology categories (even if they don't take the brave step of having the recent college grad run the company).  It might be nice if more of them did even more.  I think that seeing strong returns from the upstarts will make that happen.  Until then, Scott's 'dinosaurs' will continue to do pretty well for their investors and themselves.

And, don't be blinded by all the market development activities that Scott mentions.  At least some of those firms do these mostly for marketing appearances.  They want to appear to be more 'early-stage' and 'leading edge' than they really are.  Check out how many of these early-stage, seed-stage, wet-behind-the-ears deals that these firms really do.  Some, but not a lot.  Just like the dinosaurs.  They just do a better job marketing themselves doing it.

I'd love to see more VCs networking with young college students and entrepreneurs.  I've done a lot of mentoring of first-time entrepreneurs.  Although they are passionate, most of them don't deserve to be funded (just like most business plans put forth by experienced entrepreneurs).  It's a very fine sieve that filters out most of these unworthy ideas and leads to the small number that do get funded.  There are also a bunch of interesting ideas that don't fit the 'venture model' and have to get funded by other means -- angels, bootstrap, etc.

I think Scott would be more successful if he was less harsh.  He can heap praise on all the nice market development activities that he is in favor of.  But, he should also recognize the deals that become the strong exits that pay the bills.  Once some of the upstart firms that back upstart deals generate outsized returns more consistently, you'll see even more activity, even by the more established firms.  Until then, the dinosaurs and the evolving new species will co-exist.

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August 11, 2009

General Partner math

I chuckled when I read this entry on PEHub today.  According to a study done by Peracs, 77% of private equity funds could manipulate the benchmarks they compare themselves to in order to claim to be in the top quartile (25%) of all funds.  I guess just about all the funds are way above average.

If you read this carefully, it doesn't say that 77% of funds do this, just that they could.  But, most VCs do claim that they have strong performance.  And, of course, many of them can't.  I remember my first day at MIT when then President Paul Gray said to the freshmen picnic "all of you were in the top 10% of your high school class, but 50% of you will finish in the bottom half of your graduating class at MIT."  It wasn't exactly a pep talk, but it was a dose of reality for many students who had never finished anywhere but on top.

And VCs have some of the same issues.  Most are bright and high-achievers.  But, if you face the reality of the low VC returns from this decade, half of them must be below that.  So, unless they monkey with the benchmarks as Peracs suggests, half of the VCs would have to admit that they are below average.  And, the average isn't very attractive.

All of this means that the VC industry has to contract.  Limited Partners are figuring out that they can't keep pumping money into this asset class.  Some firms have strong performance and a good reason to believe that they'll continue to do so.  Others have niche or regional strategies that aren't over-crowded.  But the rest may have to come up with some creative mathematical marketing to justify their existence.

I think it was George Carlin who said something like "Imagine the average American.  The scary part is that half of America is dumber than that!"

Update: Shortly after I wrote this, the NVCA released their latest VC performance numbers.  Not very pretty.

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August 06, 2009

Board Meeting Thoughts

Both Fred Wilson and Brad Feld have written recently about Board meetings.  Having been to many Board meetings myself, from both sides of the table, I thought I would weigh in, too.

I totally agree with Fred on the value of face-to-face meetings.  I also admire Fred's determination to be at out-of-town Board meetings in person.  To me, that is a must.  I have been in many Board meetings where someone was on the phone.  It's a distraction, and you know that they aren't paying 100% attention.  I don't blame them.  It's hard to follow a multi-person conversation over the phone.  Of course, you miss out on the body language, too.  My own personal attendence record at Board meetings is above 95%.

Just as VCs tend to have a higher hurdle for out-of-town deals, I think that entrepreneurs should have their own higher hurdle for an out of town investor.  What evidence is there that an out-of-town investor will put in the face time to get to know the company?  Do they have a network that can be helpful to you?  Many times, non-Silicon Valley companies try to add a Bay Area investor to get some visibility and access to contacts in the Valley.  That makes sense to me, but most of your Board members should either be local or have a track record of showing up.

I also liked Fred's comment on putting in time beyond just the meeting to get to know the company and the other directors.  I have seen others do the same.  One person I brought in as an independent director at a past investment flew in to every meeting and planned to spend about one full day beyond the meeting with the company -- meeting with management, having dinner with the CEO, one-on-one meetings with other directors either before or after the formal meeting, etc.  This made them a much more effective director.

I'm less in synch with Brad on his point of 80% of the meeting being forward looking.  I think that some directors gravitate to that -- they don't have the patience for operational details.  I haven't been on a board with Brad, so I'm not describing him.  But, I have been on boards with other directors who only pay attention to the big strategic points.

I'd favor more of a 45% operational, 45% forward looking, and 10% administrative split.  I think that there is a ton to be gained by looking at how the CEO and management team are running the company.  You can spend a lot of time discussing strategy, but if the company is dysfunctional, it will never be able to execute against these great strategies.  I believe that more companies fail due to poor execution than due to a failed strategy.

One good approach is to have an operational overview at each meeting, with an emphasis on different departments on a rotating basis.  This also gives the Board a chance to see some of the other executives in action as each executive should present their department details.  You can also learn something of the team dynamics to see how all the executives interact.

Another lesson I have learned is that the CEO has the opportunity to control the meeting and the agenda.  Only a weak CEO loses this.  The best CEOs keep the meeting on track and communicate surprises in advance.  This allows the directors to get their emotional reaction out of the way in advance of the meeting.  The focus of the meeting should be to build consensus among the board members, or at least have a discussion which leverages their broad points of view.

One last thought -- there should be detailed action items captured in a Board meeting, with reporting back at the next meeting on the status of these action items (even if the CEO decides to abandon a particular item).  Don't lose the decisions that are made at these meetings.  Early stage companies probably have board meetings once per month, so there are probably a lot of short-term decisions made.  Later stage companies slow down to once per quarter, and the decisions probably have more long-term impact.

I'd be interested to hear in the comments about other things people like or don't like in Board meetings.

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July 20, 2009

Non-compete non-starter

As Bijan wrote, the Massachusetts House was greatly watered down House Bill 1794 which was written to make Massachuseets law on non-competes similar to the law in California.  The new version, which Bijan describes, restores much of the effect of non-competes.  These stifle innovation and mobility of entrepreneurs in Massachusetts.

When this issue first came up in 2007, my initial reaction was to oppose the change.  As a VC, I saw how non-competes gave us piece of mind that our entrepreneurs and other employees couldn't leave our companies to start a competitor.  As someone who was actually sued under one of these agreements in 1990, I understood this from the entrepreneur's point of view.  So, I always made sure that our non-competes were narrow and targeted.  I initially thought that narrow and targeted non-competes should be allowed.

I was wrong.  When I read all the arguments in favor of eliminating non-competes in Massachusetts, I was convinced.  The most compelling argument is that entreprenurship and successful VC-backed companies abound in California where such agreements are not allowed.  Note that agreements protecting intellectual property and prohibiting people from soliciting employees once they leave are enforceable in California and would be in Massachusetts.  We are just talking about the ability to leave and practice your employment at a different company in your field.  As long as you don't solicity your fellow employees and protect your former employer's intellectual property, I think it is healthy to encourage such movement.

Massachusetts employers who oppose the elimination of non-competes are being disingenuous.  They have significant presences in California where these agreements are not enforceable.  And, they thrive there.  Bijan includes some examples, such as EMC.

If you agree, you should join the list of supoprters.

There are some Boston VCs on the list, but not many.  I'd love to hear the arguments from those who are against making this change.  If you know where some of these arguments are posted, please put a link in the comments.  Otherwise, I think that all Boston VCs should take a stand one way or the other.

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July 07, 2009

Corporate Cult of Personality

Back from Japan, I'm finally able to look around and see what's happening in the world.  I came across this great article about AIG Financial Products Group in Vanity Fair by Michael Lewis.

The article was spurred on by Jake DeSantis from AIG's Financial Products Group, whom I previously wrote about when he wrote an op-ed for the New York Times.  It describes how things evolved at AIG's Financial Products Group and now the risk level grew so large that it dragged down the company and many of the large Wall Street banks.  Behind this increase in risk was group head Joseph Cassano.  In Lewis's article, you can read how Cassano's lack of understanding of how their underlying business worked and his over-aggressive personality drove AIGFP to take on way too much risk.

There is an important lesson here for any executive and board of directors.  Companies take on the personality and the ethics of their leaders.  If you have an executive who will 'win at all costs,' you will end up with a company that will also win at all costs.  And, the costs may be more than you are willing to bear.  When I hired CEOs, I always focused on ethics and responsibility since those were characteristics I wanted to see throughout the organization.  Being aggressive and driven is also very important, but you have to keep those in check with some responsibility.

No one in the article accuses Cassano of being corrupt.  But, he didn't understand the risk he was taking, and didn't seem to care when it was pointed out.  That's when the greed overran the responsibility.  That's a bad trade-off.  But, that's what you get when that's the personality of the person running the company.

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June 10, 2009

VC discipline

I've written many times about the size of the VC industry.  There is lots of data to show that the returns don't justify the current size of the industry.  Too much capital in the hands of VCs have led to companies being overfunded, which lowers the returns.

The latest data set comes from Paul Kedrosky of the Kauffman Foundation.  Paul confirms some of the thoughts above, and postulates that the core business that has driven venture capital, information technology, may have matured too much to justify so much VC investment going forward.  New sectors need to be exploited.  Perhaps clean energy is one of them.  The challenge is that the investment models in new sectors are not was well known, and there will invevitably be some trial-and-error until it is figured out.

PEHub wrote about this today, with an interesting example.  They used the comparison of three companies in the same space to illustrate what happens when a niche gets overfunded.

[Note that my former firm, Venrock, was an investor in Vontu (but in a fund that was invested before my time there).]

PEHub suggests that the Vontu syndicate did well and, therefore, the other two companies shouldn't have been funded.  But, the real problem in this chart isn't the existence of the other two companies but the amount of capital poured into them.  Obviously, Vontu could justify significant investment given the size of the outcome.  If somehow they could have gotten there with less capital, everyone would have done even better.

But, the other two companies were way overfunded.  They were all probably optimistic at the start of the investment.  Perhaps they had to keep up with Vontu.  But, the VCs who kept putting money into those companies were only focused on trying to get a big win and not protecting their downside.  I don't know anything about the operations of these other two companies, but you almost always know that you aren't heading for a big outcome long before it happens.  If the VCs had the discipline to turn off the flow of capital and push the company to an exit, they may have done better in the case of Reconnex and could have limited their losses in the case of Tablus.

It's the lack of discipline in the business that is causing the problems.  VCs have big funds which generate big fees.  Therefore, they are motivated to deploy large amounts of capital in hopes for a big win (with little regard for the losses).  And, in the Don Valentine quote in the PEHub article,

Don Valentine asked his limited partners why they invested in other venture firms they knew were unlikely to make money and came back with a candid assessment, recorded in the book Done Deals: “They think it’s fun.”

I don't think that LPs think it's "fun" now to over-invest in venture capital due to the low returns this decade.  Maybe, with the fun now over, some discipline will return.  And, LPs will also start to look for some more innovative models as ways to make some money.

The last thing that has to happen is for VC compensation to get more aligned with their investors making money.  The 2% fee and 20% carry model can provide too much current income for VCs with little regard to capital loss.  That doesn't work for LPs except for well-established funds that have a high likelihood of doing well.  In addition to looking for some unique investment strategies, LPs should also look for some innovative compensation models from their venture funds that align everyone's interests more directly.

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June 08, 2009

How much rope?


Whether you are a manager, Board member, Advisor, or a parent, you always wrestle with the question of how much rope to give someone when they are making decisions?  Do you keep them on a tight leash, or give them enough to hang themselves?

As a manager, where you own direct responsibility for the outcome, you can justify a tighter leash.  You want to encourage the people on your team to take risks.  Failure is the best way to learn, and most people fail before they succeed.  But, if failure has a big consequence, or your own success depends on the success of the people you manage in this instance, you may want to closely monitor what is going on and keep them on course.  Let the innovations be their idea, but don't let them drive into the ditch.

In a situation where you don't have such direct managerial responsibility, this is a tougher question.  As a Board member or Advisor to a company, you can't jump in an run things, unless you are explicitly asked.  The company needs to stand on its own, and the company's management needs to make the final decisions.  You can give input, make suggestions, and provide strong debate, but you can't overrule the team.  About all I ask for in these instances is that they listen to me (if they don't want to do that, why have you as an advisor?).  If I'm heard, it doesn't matter as much if I'm heeded.  In fact, as a Board member, I prefer that management make their own decisions.  Then they can be held accountable if their decisions are wrong.

If you are an advisor or Board member and act very heavy-handed, you can probably convince management to do things your way.  But, you'd better be right.  If things don't work out when you have 'overruled' management, you can't really hold them accountable.  The dynamic I prefer is to start off trusting management's judgment.  If they do something I don't agree with, and it works out, then I've learned something.  If it doesn't work out, I lose some faith in their judgment.  If it happens a few times, then maybe the company needs new management.

Your approach also haas to be moderated depending on what the stakes are.  If the company is going to go over the cliff and its survival is threatened, then maybe a heavy handed approach is required.  And, replace the management for almost taking the company down with them!  But, most decisions don't have that level of impact.  You need to let the people closest to the situation make the decisions, and then measure them accordingly.

As my kids have grown up, I see parallels with parenting.  Every kid is different than their parents, and they make their own choices about how hard to work in school, pursuing job opportunities, and taking part in extra activities.  You can't make your kids act the way you would.  Just try to get them to listen to you and learn from your experience.  That can be a big enough challenge sometimes!  But, if they make a few mistakes and learn from them, they'll have a stronger foundation on which to succeed in the future.

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June 01, 2009

Nothing Like Building Stuff

Today, Boston-Power announced that it plans to build a state-of-the art battery manufacturing facility in Auburn, MA, near Worcester.

Like many companies these days, Boston-Power has applied to the federal government for a grant of about $100M to help build the factory.  The facility would be used to build a new product, Swing, to be used in hybrid electric vehicles.  If the federal government is going to spend money to subsidize industry, this is the type of thing the taxpayers should be funding.

First of all, we need new batteries to power hybrid electrc vehicles.  These vehicles lower our dependence on imported oil.  And, we need to build these batteries in the US to be close to US manufacturer supply chains.  Also, we can export these batteries to international manufacturers.  Lastly, Boston Power plans to hire 600 people at a factory in central Massachusetts where new jobs are generally lacking.  Getting good jobs building stuff is a key to our economy.

We need to continue to develop new technology that we can manufacture here and export elsewhere.  It's so much harder to solve our employment problems with service jobs, which generally are lower paying.  Instead, our economy needs to find high-margin, innovative products that we can build here.

One key part of building them here is that the rest of the supply chain needs to be here.  Boston-Power also manufactures laptop batteries, including supplying batteries for the HP Enviro Battery.  But, these batteries are manufactured in Asia to be close to the rest of the laptop supply chain.  Even if we could build laptop batteries more cheaply in the US than in Asia, you'd lose money shipping the batteries from the US to where the laptops are built.

Let's hope Boston Power is awarded these grants so that we can start to build more high-tech stuff in the US (and Massachusetts).

Disclaimer: I was a board member of Boston-Power for several years and am currently an advisor to the company.

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May 30, 2009

We're #59!

Despite putting no effort into promoting The Fein Line, this blog ended up being #59 on the list compiled by Larry Cheng of the most read VC blogs (ranked by Google Reader subscriptions).

Thanks to all my readers for taking the time to follow this.  And, thanks particularly to those who comment and contribute to interesting discussions.

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May 28, 2009

More than the money

With the advent of lower capital intensity business models, there are more entrepreneurs who are building their businesses without venture capital.  This gives them the ability to hold on to more equity and more control.  In the most likely event of a modestly priced exit for the company, they'll keep more of the upside.  That all sounds great, and, if you don't need much outside capital to get your business going, it could be attractive.

But, there are things you get from venture capital beyond the money.  You can add these to your business without a VC investment, but you have to work at it.  Here are some:

  • Independent perspective -- As an entrepreneur, you have to drink the Kool-Aid.  You think that what you're building is great, and you look past all the problems to see the possibilities.  But, some of the time, you need a dose of realism.  You need to find a way to hear the outside perspective on your company.  You can achieve that with one or two independent directors on your Board, or an active advisory Board.  Go beyond your friends and current stakeholders.  If you can't attract an industry insider from your segment to work with your company, you may not be good enough at networking, or have a strong enough value proposition, to be successful.  And, that's the kind of 'tough love' feedback you should expect from an independent perspective.
  • Deep contact network -- You also need to be able to attract talent who really knows your marketplace.  Most VCs have great contact networks that they have developed over years (or decades).  You need to be a great networker to find this talent for your own company if you aren't getting value-add from a VC.  For some, networking comes naturally.  For most of us, it takes work and attention.  That may mean carving time away from other things to go to an industry event, conference, or meetup.  As an entrepreneur, it's essential.
  • Relationships with key customers and partners -- After you have sharpened those networking skills to bring talent into the company, you'll need to make contact with more customers and potential partners.  No company has enough of these.  Business people you add to the company should come with some of these contacts, but there is always the potential for more.  Another value-add you can get from independent directors is access to their contact network.  I like having an independent director that is a recently retired senior executive from one of the big customers or partners in your sector.
  • Keeping you honest -- I like people with attention for detail.  At least one Director of your company should be motivated to go over everything you are doing with a fine tooth comb.  They can give you feedback on how to improve and be a sounding board for future moves you are considering.

Whether you are going it alone (without venture investment) or evaluating whether a particular VC really brings something more than money to the table, think about these types of value-adds for your Board.  Your company won't improve with a Board full of your biggest supporters.  Mix in a couple of independent, well-connected, detail lovers.  You'll be glad you did.

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May 15, 2009

Plan for yourself, not the VC

There have been a few VCs writing about whether or not you need a business plan to make a venture capital pitch in response to an artilce in the New York Times.  As Angelo points out, most VCs focus on the team and the market, not on the detailed plan.  I wouldn't advise an entrepreneur to develop a full business plan in order to raise money.  Normally, a good PowerPoint presentation with some projected finances is enough formal material.  Also, be prepared with a good market and competitive analysis.  The VC will learn alot about you from how well you prepare this information.

An early-stage investor knows that the market will change a lot before a new company's product is available.  It's impossible to anticipate what will happen.  So, most investors focus on how you approach things.  How do you react to the suggestion of competitive threats?  Are you overly optimistic?  How customer focused are you?  Do you realistically assess the risks in the plan?

You'll have to do a lot of planning to produce the slides and financials.  You will need to understand the market well, even if you don't do formal market research.  You can learn from customers and other market participants.  You'll have to have a development plan, a sales and marketing plan, and an operational plan.  You don't have to pull them all together into a glossy document with lots of prose, but you better be able to talk about it as if you've written one.

And, once you have funding, you'll need an updated operating plan.  This will keep your team coordinated, make priorities clear, and make sure you have enough money to get it all done!  Don't wait for your investors to ask for a plan.  Produce a plan for yourself, and keep it current as the world around your company changes.

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April 29, 2009

Macro VC Math

Fred Wilson wrote a great post today that summarizes, at a macro level, the VC Math Problem.  If you are interested in the math behind venture returns, read this whole post, including the slew of comments.  Great stuff.

I could quibble with some of Fred's assumptions, but the fundamental message is right on.  He describes the likely distribution of exits of technology companies (Fred says that this is about $100B of exit value in a year).  If you crunch through the numbers through how much of this VCs end up with, net out their fees and carried interest, it shows that this is sufficient to justify something like $16B of venture investment in a year.  That's about 60% of what is raised in recently times, providing more evidence that the venture business must shrink.  More money doesn't create more exits.

One of the comments to Fred's post ask if there was a limit on entrepreneurship in the same way that Fred argues there is a limit on venture math.  I think that the venture limit derives from our economy's ability to absorb new technology offerings.  As the economy grows (or returns to growing some day soon!), we can absorb slightly more new technology.  I think that this does impose a limit on the technology entrepreneurship we can justify in this country, at least the type of entrepreneurship that is aimed at getting some sort of venture return.  But, there are many types of entrepreneurship that are really aimed at having a business throw off enough cash to pay all the employees a healthy wage.  Those are sustainable businesses that may never exit.  And, they are great.  I don't see a similar limit on these, many of which are service businesses.

All of these macro approaches are somewhat flawed.  I think that it is mostly important to look at them as directional, rather than precise.  Whether you think we can justify $15B or $20B of VC investment, it's hard to look at the NVCA returns and think that investors will feel that these are strong enough to justify the risk.  And, eventually, those investors will move away from VC, hopefully rightsizing the amount of capital available.

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April 13, 2009

Keep Wringing

My friend (and lawyer for Foley Hoag), Dave Broadwin, wrote today that he is optimistic, and we shouldn't be wringing our hands about how bad things are for startups.  He's got some evidence, some of which he got from me, that the pendulum has swung too far in lamenting how bad things are, particularly for venture capital-backed startups.

Well, the numbers that Dave cites from me are correct (9000+ venture backed startups in the US today and only 30 M&A exits in 2008 at prices of $150M or more).  I got these numbers from VentureSource.  They may not be perfect, but they should be pretty close.  There are many, many VC-backed companies in all different industries.  And, no surprise, the exit envionment is weak.

But, I'm not ready to stop wringing my hands.  Slowly but surely, the number of VC-backed companies will drop.  There are a small number of new companies being funded, and there is a greater number, I believe, in companies being sold or shutting down.  Only a small number of exits are 'successful' -- the investors make some decent money.  What's that, 2x or greater?  That's probably not enough to make the VCs or their investors happy.  But, doubling your money is a good starting point for successful investments.  There are also successful investments that sell for less than $150M if they haven't raised too much capital.

Quick VC math refresher:  If there are no recaps or wash out financings, here's how the math works.  If you assume that VCs own 75% of a company at the time it is sold, the company has to sell for 2.667x the invested capital for the investors to make 2x their money.  Now, that's a simplification as it doesn't take into account some VC terms that sweeten their outcome (dividends, participating preferred).  Also, it doesn't reflect that early investors may have a better multiple than later investors as they may have paid a lower price.  Or, later stage investors may make more than early investors if they add complicated structures to the deal.  In the end, each deal is structured differently.  But, If a company hasn't sold for at least 2.5x the invested capital, it's not successful.

There will be successful deals, and some very successful ones in this environment.  But, as a limited partner (LP) in a VC fund, you need the whole fund to be successful, after fees and carried interest paid to the general partners.  That requires a lot of successful exits, and some very successful ones.  I don't think that there are enough of those out there to keep LPs happy and to justify the fees that many GPs charge.  And, that has a lot of VCs and their LPs wringing their hands for the foreseeable future.

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April 09, 2009

US Treasury: Stay away from Venture Capital!

I don't often agree with the editorial page of the Wall Street Journal, but yesterday they got it right.  There is no reason for the US Treasury to regulate the venture capital industry.  As the editorial points out, VC is too small to create systemic risk for the US economy.  If you look at the industries that have done so (banks, investment banks, insurance, perhaps), they all have the common thread that they are funded with debt.  Their actual equity capital is a small portion of their holdings.  When they have to write down their assets by more than the value of their equity capital, then the banks are insolvent.  This is explained very well on NPR's This American Life if you feel like you need a primer on why banks fail.

Venture funds, and their investments, don't have this problem.  Venture funds take on very little debt, if any.  Usually, they may take on some short term debt to pay expenses between capital calls.  It's pretty minor.  And, their portfolio companies also take on only modest amounts of debt, as described in the editorial.  The loss rates in this type of debt is very low, probably 1% or less.

So, you have investors, entrepreneurs, and bankers that are working with risky companies with their eyes wide open.  If the company fails, the investors lose their money, the employees lose the time they have put in, and, rarely, the banks lose a portion of their debt.  This sounds like good old American risk taking, with the hope of big rewards in the case where the company is successful.  There are some very poorly performing VC funds that have lost most of their investors' money.  It's too bad for them, but this doesn't lead to systemic risk.  Even if all the start-ups failed, I don't see how it can bring down the economy.

I think that the regulators don't understand the VC business and are lumping it in with hedge funds (which can employ significant leverage and can lose much more money much faster).  I don't like the idea of the government regulating either one, but a fair question for the government to ask is about leverage ratios.  It would be reasonable to ask VC funds and hedge funds how much they have borrowed against their portfolio, and the cumulative borrowing of their investments.  I don't think we should keep people from borrowing, but some level of borrowing is excessive and should be made transparent.

Venture funds would definitely be under any reasonable threshhold of risk.  So, they could check that box and be on their way.  The government shouldn't then have to worry about them.  Perhaps some major hedge funds could be big risks depending on what they invest in.  If your whole fund is in credit default swaps or other toxic assets, maybe that should be made more transparent.

All of this goes to say that if the government is going to put regulation in place, I'd like them to start with reporting and transparency, rather than restriction.  If AIG had to report the level of risk they were taking with the credit default swaps, their stock price would have taken a beating.  And, the executives wouldn't have gone down that path because they would have feared the disclosure.  That's a healthy form of regulation that doesn't try to anticipate all of the reasonable ways that people can make money.

Thanks to Jeff Bussgang for being the first person to point me to the WSJ editorial.

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March 01, 2009

Shrink It Must

I've written before about the overfunding of the VC business.  The fundamental problem is that high-tech entrepreneurship doesn't scale with more money.  There are limits to the number of deals that deserve high-tech venture capital each year.  These limits are based on the number of sound teams and ideas that exist, as well as the amount of new technology you can push onto customers at once.  I've felt that, for the long-term, VC funding can't grow much faster than GDP.  And, with a shrinking GDP, that highlights the VC over-funding even more.

Scott Kirsner wrote about this in today's Boston Gobe, including a quote from me.  He also includes this quote:

"Last year, our industry raised about $28 billion in new investment capital," says Michael Greeley, chairman of the New England Venture Capital Association and managing director of Flybridge Capital Partners in Boston. "I think we'll raise between $8 billion and $12 billion this year, nationally. That's a dramatic reduction. My sense is that the average fund size will be cut in half, and they'll have to cut the number of partners who work for them as a result."

I think it will take a while, but this sort of shrinkage in the VC business will be a good thing.  The best ideas will still get funding, although it will be tougher.  And the weaker ideas that may get funding now, will not.  This will lower the noisy competition for the better ideas and allow them more time to flourish in a capital efficient manner.

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February 23, 2009

VC can't bail us out

Starting with a Tom Friedman op-ed piece in the New York Times on Saturday, there have been a steady stream of VC bloggers who have pointed out why Tom's suggestion of the government pouring $20B into venture capital is a bad idea.  I agree.  Here are thoughts from Fred Wilson, Don Dodge, and Jeff Bussgang.

Venture capital is a business that can't scale with more dollars.  No matter how vibrant our economy is, there are only so many ideas that are worth funding each year.  Having more money available doesn't mean that more ideas are worth funding.  Quite the opposite:  having second and third-tier ideas funded as well as top-tier ideas dilutes the market opportunity for everyone.  It forces every start-up to raise more capital in order to compete.  It lowers the financial return for the entrepreneurs and for the investors.  And, as venture returns are lowered, limited partners begin to scale back their commitment to venture capital for the long-term.  So, a flood of government venture money in the short-term can lead to a scarcity of private venture money in the long-term.

Most top VCs will agree that there is too much money in the industry.  If you look at venture returns, you'd conclude that perhaps half of all venture funds should go away.  So, putting more money into venture capital clearly isn't necessary.  And, although Tom Friedman points out that some of the institutional investors who invest in venture capital are short on cash, you can be sure that there is no shortage of funds available for any top or second quartile VCs who are raising money.  The cash crunch is much more likely to begin the squeezing out of some of the poorer performing venture funds.  But, because of the huge amount of capital still out there and the long time constant on venture funds (funds are committed for 10 years, typically), any venture scale back will take a long time.

So, can the government do anything to help new technology business grow?  Well, I don't think that real early stage businesses can bail us out in the short-term.  This shouldn't be considered part of an economic stimulus, but, instead, part of a longer-term plan to build new industries.  In this light, the government has a great role as a funder of primary research.  Clean energy is one obvious place for this type of funding, but it can be done across many sectors.  It was government funding that got the Internet started (with our without Al Gore).  Government funding through organizations like the NIH still fund many of the initial developments in biotech.

Only the government can justify the initial research funding that may have no economic return.  This investment will instead help create research positions at our universities and will, ultimately, lead to companies spinning out of those schools.  I'm actively involved in the Deshpande Center at MIT, and that's a great model for assisting the most commercially viable research projects move toward becoming companies.

If you think of the funnel of potential businesses, I think that the bottom of the funnel (venture funding) works pretty well and is probably over funded.  Where we should be spending more resources is in testing out new ideas at the top of the funnel.  Although the government needs a good system of evaluating the ideas it funds (perhaps modeled on DARPA, but without the millitary ties), I wouldn't mind some overspending on basic research that may lead to the next big thing.

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February 12, 2009

Ciclon Semiconductor acquired by TI

I've been traveling this week, so this post is coming one day late.  Yesterday, Ciclon Semiconductor was acquired by TI.  Ciclon manufactures MOSFETs, components used to build power supplies.  Ciclon's technology allows power supplies to be made more efficient (less energy loss, and therefore less heat given off) and in a much smaller size with fewer components (cheaper, more reliable).  The purchase price of Ciclon wasn't announced, but suffice it to say that it was a very nice multiple on the total amount of capital invested in the company.  TI is serious about selling these products as a full information page was prepared before the announcement.  I invested in Ciclon while I was at Venrock.

The Ciclon story is very instructive for today's entrepreneurs.  The CEO, Mark Granahan, identified Ciclon's core technology and orchestrated a spin-out from Agere where it was initially developed.  Mark was very scrappy and negotiated a very attractive deal with Agere.  This technology and equipment gave Ciclon a head-start on product development and allowed a Series A financing to happen in a market segment that is generally viewed as being low-margin and commoditized.

However, despite having two successful financings, Mark kept the company with a very frugal spending plan.  They leased space from Ben Franklin Technology Partners at Lehigh.  This gave them affordable office space and access to additional resources.  As they developed products and captured initial design wins, Mark built a very strong management team without over spending.  Although their customers are not yet announced, I can tell you that they have design wins in very visible products from some of the leading consumer electronics and computer vendors.  The company was able to get to revenue very quickly, including leveraging some legacy products from the Agere spin-out to lower their cash burn.

Some key takeaways from the Ciclon success story:

  • A very clear definition of the market opportunity, validated by customers at the start of the project.  It helped that they were targeting a commodity market with a disruptive technology
  • Defensible technology, with a roadmap to extend it.
  • 'Unfair advantage' derived from Agere spin-out.  Every start-up needs some key advantage in order to counteract the fact that they are a new company with relatively little money
  • Maintained frugal mindset despite initial funds raised and commercial adoption
  • Hire a world-class team.  Even a company like Ciclon faced many challenges along the way.  Their team was strong enough to overcome technical and manufacturing challenges that might have derailed weaker companies.
  • Get to revenue quickly, even if it is with an interim product.  This helped offset some of the cash burn, which benefits both the investors and the entrepreneur.

Congratulations to Mark and the team at Ciclon.  I am sure that they'll be very successful getting these products further into the market while at TI.

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February 05, 2009

The Public Company Discount

Don Dodge wrote recently about public company valuations vs. private company valuations.  This is a subject that is near and dear to my heart.

You can find many examples of public companies that have solid businesses and very low valuations.  Most public tech companies that are financially stable and have enough revenue to be sure to be around for a while are valued at less than 1x revenue these days, plus cash.  Think about that in terms of a start-up:

What's a start-up worth that has $15M of revenue, runs at break-even, and has $5M in cash?  In more typical times, you might expect this company to raise money at $40-70M pre-money, depending on what the long-term upside is.  Currently, a public company with this financial profile is probably valued at less than $20M, including the cash.

This class of public companies are really forgotten.  They are too small to be tracked by most analysts.  They don't trade at very high volumes.  They sound a lot like private companies, but they have the transparency, and costs, of being public.  Investors can probably get a venture-type multiple on these types of companies, with less risk than that start-up.

I think that these types of opportunities will definitely compete with private companies for capital.  In fact, I'm betting on it...Limited Partners of venture capital and private equity funds are starting to see that this is an interesting complement to their usual investing.  They do have the asset allocation issue that Don mentioned since their alternatives are a higher percentage of their portfolio than they would like.  But, as that returns to normal, I expect some capital to flow toward more VC-like investing in the public market.

And, what happens to that start-up that has the attractive financials?  They'll get financed, but they may not get the valuation that they would like.  If they are really cash-flow break even, they'd be better off tapping some debt until better valuation times return.

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February 02, 2009

Overreaching Regulation

The government has to demand accountability and frugality from those receiving our tax dollars as loans or equity, such as the automakers and financial institutions.  And, we need to make changes to Wall Street to lower the chance the excessive risk taking can bring down our economy again.  My first choice for Wall Street changes is more transparancy.  I

f the volume and nature of the credit default swaps on the balance sheets of financial institutions was more widely known, perhaps that would have increased the pressure on such institutions to lower their exposure or ensure that they have more capital to back up their risks.  However, it's clear that there was a regulatory lapse here since the credit default swaps should have been considered insurance, which would have demanded the right capital structure.

As I read on PE Hub today, a bill introduced in the Senate would require additional disclosure from private equity and venture capital funds, in addition to hedge funds.  Ropes and Gray has issued a preliminary legal opinion on the bill.

I think that this type of broad regulation goes too far.  I am all in favor of requiring disclosure of funds with excessive leverage or derivative trading.  Of course, any fund with public investments is already required by the SEC to meet various disclosure standards.    Leverage and derivative (and credit default swap) trading can cause a lot of damage if done to excess because a small amount of capital can lead to huge losses (or gains).  These types of investments shouldn't be eliminated, of course.  They have a place.  But, we should require more transparency so that the market will help limit the risks that are being taken.

However, 'long' investors who own vanilla equities (public or private) are only risking their own money.  They can make money when the equities go up.  And, they can lose the money they invested when they go down.  Without leverage, they have all of their investments backed up with capital.  So, I'd be in favor of requiring VC or PE funds to inform their investors of the amount of leverage they are employing (they probably already do that).  But, I don't see why we need more disclosure of venture firms who are investing in private companies alongside other qualified investors.

Although probably harmless, what good will it do to require VC and PE firms to list their investors?  Or, to publicly list the value of their funds?  These funds are not publicly traded, so the public doesn't really gain with this information.  I am very wary of the SEC pushing regulation into areas that don't need it.  We need regulation to protect the public good.  But, we don't need regulation for regulation's sake.

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January 05, 2009

The diligence never stops

Reading about the SEC's many fruitless investigations of Madoff over 16 years has me thinking of due diligence this morning.  It's easy to criticize the SEC in hindsight for not finding anything.  Obviously, Madoff was a master at covering his tracks, making any diligence process difficult.  He also played off of reputation and trust to swindle his clients.  This probably worked on the SEC as well.  I'm guessing that they cut corners on the investigation because of who (they thought) Madoff was.

As an investor, I never stopped the due diligence process, even after making an investment.  Pre-investment, I would try to do 360 degrees of diligence, talking to anyone I could find who knew the people, market, or technology involved in a prospective new investment.  I would try to get them to meet first-hand with the company to get their direct impressions.  I would also talk to previous employers and investors from the founders' companies.  As is the case with anyone, no one gets 100% scores.  You have to weigh issues and risks with the potential upside.

People learn from their mistakes, and I tend to be a forgiving guy (one of my weaknesses, some may say).  I wasn't necessarily put off by a failure in a previous situation, but I wanted to learn as much about it as possible.  It's startling to hear the different perspectives that multiple people can have on the same situation.  On one company, I had one board member tell me that a key person was barely involved with the company while another said that this person was chiefly responsible for the company's success!  How do you know who to believe?

If you talk to enough people, you can form your own opinion.  If you weren't there yourself, you can be like an investigative reporter, digging up as many facts as possible and stitching the story together.  You can listen to your own instincts and see how they line up with what you've heard from others.  But, there are some things I'm not very forgiving on -- honesty and ethics.  If someone lied once, they'll certainly do it again.  That's an almost impossible habit to break.

I'm always amazed at the lack of diligence that some investors and entrepreneurs do.  I've seen some investors back entrepreneurs from failed companies without talking to any of the previous investors.  Maybe they wanted to keep the new deal to themselves, but is that worth the risk of missing out on the other investors' perspective?  And, very few entrepreneurs perform diligence on VCs.  Those investments are two-way partnerships.  If you have a choice of investors, shouldn't you do your homework on them?

As I mentioned before, I don't stop this process after investing.  If I am working with a CEO and I come across someone who knows them well, I'm going to ask a lot of questions.  This has bothered some people who thought I was 'going behind their back'.  But, I just want to continue to learn as much as possible about the people I am in business with.  I always put a much greater emphasis on my first-hand interactions because they are only colored by my own judgment, not someone else's, too.  However, if I can learn how to help a CEO be more effective by understanding a past situation they were in, it only helps all of us for me to take advantage of that.

Also, be very wary of someone who doesn't want their background to be an open book.  I've encouraged people checking my references to call anyone.  And, I don't feel I need to prep my references on what to say about me.  I've got nothing to hide and am happy to discuss any situation I've been involved with, including those that haven't worked out.  I'm guessing that Bernie Madoff didn't consider his fund to be an open book for the investigators.  He certainly controlled the information that anyone could find out, much to everyone's dismay.

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December 17, 2008

A Holiday Smile

Here's a great holiday video from First Round Capital.  The story behind it is on Josh Kopelman's blog.  I challenge you to watch this and not smile.  It's a great way to cheer up in spite of the difficult market.  Happy Holidays!


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October 20, 2008

Median is worse than mediocre

Today's VentureBeat had an article pointing out that the uptick in some of the macroeconomic factors won't translate quickly into an uptick in the venture capital economy.  Of course, there are some links between the overall economy and the VC world:

  • Late stage investors are heavily influenced by the public stock markets.  They have to calibrate the higher valuations they pay with the exit timing and ultimate exit valuation that the company will earn.  This applies to companies going public (not any time soon) or companies being acquired.  Public acquirers obviously worry about their own stock price when determining what they can pay for an acquired company.
  • Buyout firms are like late stage investors, but also tend to finance a significant portion of their deals with debt.  Obviously, the debt market is incredibly tight these days.  Not much of this type of deal activity here, although you may see some debt free deals such as small public companies going private to avoid the cost of being public while they regroup.
  • Early stage VCs shouldn't worry about the public market too much.  The deals they do now won't exit for 5-8 years.  Who can predict the exit environment then?  Early stage VCs should worry mostly about uniqueness of the opportunity, target market size, team strength, and capital efficiency.  However, early stage VCs also tend to get skittish during these times.

The most interesting statistic in the VentureBeat article is in the following:

But most venture capitalists will remain under considerable strain. Even when they invested during the last down cycle of 2002 and 2003 — when valuations were lower, letting them get a larger ownership stake in companies they backed — VCs didn’t do well. The median internal rate of return (IRR) for a 2002 vintage VC fund (a fund that began investing in 2002, when the stock market was rock bottom) is -1.2%, according to PE Wire, citing Thomson Reuters data. That means they’ve lost the equivalent of 1.2 percent every year over the past six years, even though VCs have had about that long to grow the companies. With the market turning downward now, it’s unlikely that number will increase significantly, as firms may have a tough time selling companies and locking into profits.

The median IRR for a 2003 vintage VC fund is 0.9 percent.

These performances are worse than many expected. The question is whether VCs will do as poorly with their 2009 funds. Uncertainty about this will only cloud the outlook for startups going forward.

The problem here isn't that a down cycle is the wrong time for an early stage investment.  In fact, I think that it is the best time as many investors are on the sidelines, lowering the competition for the new company.  However, I think that the reason why the median returns for these funds is so low is that there are just too many venture funds with too much money to invest.  By the time you get down to the median fund, you are much closer to the bottom of the barrel than you would like to be.  If the current top quartile of venture funds were all that existed, the category would look pretty strong.  So, that means that VCs will only be able to deliver the returns that their investors expect if the number of funds is cut by 75% and the amount of capital by about 60% (many of the top funds are also larger than the average).

LPs who invest in venture funds have figured this out, but the exodus from venture is slow.  And, there are many more LPs who have been waiting to get into the category who may be propping up funds that should otherwise be going away.  Over time, venture can only be a healty category if it takes a haircut just like the Dow Jones Industrials have.  Unfortunately, I don't see that happening any time soon.

PS - This is one reason why my new fund will be doing something different than traditional venture capital.

Update - Just after publishing this, I found this report from Silicon Valley Bank that includes lots of details on venture fund performance on page 9.  See the table below from the report that shows that even the top quartile VC fund hasn't done extremely well lately.

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August 11, 2008

A123 -- Ready for an IPO?

Disclaimer:  Although I am not an investor in A123, I am on the Board of Boston-Power, a battery company that does not currently compete with A123, but may in the future.

Last week, A123 filed their S-1 in preparation for a potential IPO.  A123 is an innovative company that spun out of MIT.  They have battery technology that is currently used today in DeWalt power tools.  They are also working on projects for hybrid electric vehicles and other applications.  The company has raised at least $133M of venture capital and has generated lifetime revenues (through March 2008) of about $72M.

I've spent a lot of time over the past year looking at public companies.  Although A123 looks exciting for the long-term, I have my doubts about their ability to either go public or, in the near-term, be a successful public company.  Their business just hasn't developed enough to sustain value in the public markets.

If you study their financials, you'll see that they have approximately zero gross margins.  That means that their selling costs don't quite cover their material costs and manufacturing overhead.  Low gross margins are not surprising for early stage manufacturing companies.  They are not yet selling at high volume and are investing in manufacturing capacity for the future.  But, it's disconcerting to me that even at $10M in revenue per quarter that they have slightly negative gross margins.  On top of that, the company has a significant rate of spending for engineering, sales, marketing, etc. at $13M in the March 2008 quarter.

Clearly, A123 is trying to go public based on their future potential.  And, that potential could be very high.  But, I find the public markets to not be very forgiving of these types of companies.  In fact, it could be tough to go public at all right now.  Now, perhaps the company has some additional deals and information up their sleeve that they would only release when they update their S-1.  Perhaps they are the rare company that can pull off a high-promise IPO in this environment.  If they do go public, they'll have to convince investors on an ongoing basis how they will build into a sustainable business.  Any missteps along the way will likely result in significant stock price punishment.

Ultimately, I wish A123 the very best.  If they can go public and sustain their value with this type of profile, it will bode well for Boston-Power, too.  But, don't be surprised if they proceed with caution toward an IPO.  The market is not a forgiving as it has been in the past, even for companies with interesting technology in a hot space.

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July 28, 2008

Late Stage or Too Late?

The Boston Globe ran an article today about the venture capital environment and late stage VC investing.  Basically, because the exit environment is uncertain (very few IPOs, M&A exits are at low prices, etc.), companies are raising more late stage capital in order to remain private longer.  Although it can seem nice when a company raises a large round of financing (the companies cited in the article raised $40M+), it also changes the equation for everyone involved.

Even if these rounds are done at pretty high valuations, they still represent dilution for the management team.  And, for the existing investors, they have to commit capital to the company that they were hoping to keep in their pocket for other deals.  You can argue that this is balanced out by the ultimate exit being higher as the company will be even more mature, but I am skeptical of that for most companies.  The slow exit environment can also mean a slow customer spending environment, which can delay a company's growth.

Instead, many companies raise more capital than they should, which dilutes the exit returns for everyone.  What can you do about this?

The most important thing to do is to get to profitability as quickly as possible.  By being very cautious about what you spend and matching it with your revenues, you can minimize the amount of capital you need.  This will improve the investment return for everyone involved.  Of course, you shouldn't starve the company for capital, but it is much more common for VC-backed deals to be overfunded vs. underfunded.

The worst situation is the company where the investors are reluctant to put in additional capital because they don't see incremental return.  They are more likely to pressure the company to sell, even though it may not be the best time.  Being forced to sell a company too early can be discouraging for everyone, but, to the investors, it may make sense economically.  What can you do in this situation?  Make sure you don't get there by ensuring that your investors all have sufficient investment capacity for your deal, that they remain enthusiastic about your prospects, and that you carefully monitor your spending.  Am I sounding like a broken record?

I think that the late stage VC market is pretty challenging right now.  There is a lot of capital out there searching for deals, and valuations on good deals are going up.  With the exit environment remaining very tight, many good companies will struggle to raise capital because their company progress hasn't kept pace with their capital spending rate.  In other words, it's hard to justify further investment in the company as the upside looks limited.  Existing early-stage investors may be forced to provide additional capital to companies to keep them going until the exit window re-opens.  And, this is not helpful to entrepreneurs as they see their future returns going down.

The moral of the story -- spend slowly and get to profitability quickly.  That give you the most choices.  And, as a VC, keep plenty of dry powder and make sure your companies develop at a rate commensurate with their spending.

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July 23, 2008

Plan to Transition

Yesterday, Fred Wilson wrote about Transitions in start-ups.  In general, I agree with Fred that transitions in companies (start-ups or otherwise) are better if they come from within rather than being forced from the outside.  However, in my experience, many times transitions have to be forced.

One question that VCs often ask entrepreneurs, particularly technically-oriented and/or first-time entrepreneurs, is how they would react if a professional CEO is needed at some point when the company grows.  The best entrepreneurs define themselves by the company's success and will want to bring in whatever new management becomes necessary as a company develops.  Companies go through stages where the needs are different.  The professional CEO could rarely start a company from scratch and the technical founder usually can't run a $50M company.  The companies change, and therefore management probably has to change to deliver the optimal outcome.

Some entrepreneurs get this.  I've worked with quite a few who knew what their own strengths and weaknesses were.  They realized that, if they were successful, the company would need more experienced management.  That didn't indicate weakness on their part, but rather success in that they had moved the company from a standing start to some level of success.  Overcoming those odds is the first victory a company must achieve.

However, it's often difficult for an entrepreneur to see this from the inside.  Even if they indicate that they are open to this type of change at the onset of the company, once they are in the heat of the battle their objectivity is compromised.  Many times founders will point to the fact that they haven't made a significant mistake as a reason why they should continue to run the company.  I remember telling one entrepreneur that if I waited for him to make a mistake before we made a change, then I would have made one, too!  The Board's job is to be proactive in assembling the right team around the company, rather than reactive.

These can be some of the most difficult decisions that a Board can make.  Usually, the Board prefers to have the founding CEO continue in some other role at the company.  Sometimes, the founding CEO poisons the ground with their actions, forcing them to have to depart.  This is always bad for the company as the founding CEO is often greatly responsible for the success that gets a company to this transition point.

This is why having an active, engaged, and objective Board is critical to a company.  Generally, VC's bring this to a company.  Non-VC backed companies often make a mistake by not bringing on outside directors who are truly objective.  Also, these types of directors rarely will take action against the founder who brought them in.  And, many public company boards are populated with people who either don't want to rock the boat or are beholden to the CEO.  This creates opportunities that many activist investors try to take advantage of.  For the company's sake, they are much better off with a constructive or operational activist than the alternative.

Companies and Boards should take a hard look at themselves to make sure that there is a truly objective view on the company and the management team at the table.  And, they have to plan on transitions.  Companies should be frequently changing, and that may mean occasional changes in management, too.

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July 11, 2008

Contrarian is the way

Wee Willie Keeler - "Hit 'Em Where They Ain't" 

Whether it's in private company investing or public market investing, I have become more and more of a contrarian as time has gone on.  Certainly you can make money as a momentum investor following the herd, but you also have a big risk of crashing hard when the bubble bursts.  It took most VC firms years to dig themselves out of the tech bubble crash (and some are still digging).

As a contrarian, I look for opportunities where others aren't looking.  Sometimes you can be the first one to start a new trend.  Once the new trend becomes a tidal wave, it's time to get out...The beauty of being a contrarian is that competition is less, valuations are lower, and it's easier to build relationships as people are appreciative of the rare attention.

On the other hand, when you are part of the herd, you can more easily get caught up on group think, missing key issues.  Also, you have tons of competition and will definitely pay a higher price for a deal.  The upside can be high, but, as in musical chairs, when the music stops some people will be left out.

Being a contrarian brings up its own issues.  Other investors will wonder why you pursue out of favor opportunities.  You may have to wait for your target to come back into favor to have the best chance of an exit.  But, when it is time for an exit, there will likely be fewer competitors vying to be bought.  The scarcity factor can be significant.

As is the case with any type of investment strategy, the most important thing is to stick to your principles.  Don't let the market dynamics convince you to compromise your investment criteria.  Strategy drift is a big source of mistakes.

Also, I don't think I could be a day trader, moving in and out of positions very rapidly.  I focus on the long term and patience is required.  Since I'm investsing other people's money, I need them to be patient, too.

Convincing someone to go along with your contrarian strategy can be difficult, but when you turn out to be one of the only people who was right, it's all worth it.

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June 10, 2008

What a difference a Board makes

I recently caught up with a couple of CEOs I know.  Both are at companies that are about the same vintage and have spent about the same amount of money over that time.  They have different amounts of progress, but both companies are at least somewhat behind the plans that they had pitched to investors when they last raised money.

However, at one company, the Board is very supportive of the business and, although concerned about some of the progress issues, is sticking with the company and working hard to make it successful.  At the other company, at least one member of the Board has lost patience and is pushing for an exit at a pace that doesn't feel natural to the CEO.  Of course, there are always two sides to each of these stories, and I am just hearing from the CEO in each case.

The CEO of the company under pressure was wondering why their Board member had changed his attitude about the company so quickly.  I don't really know, but one issue that most entrepreneurs overlook is internal firm dynamics.  It can be hard to tell from the outside, but many times decisions at VC firms are influenced by the status of the particular fund the investment is in, the status of the partner at the firm, and partner-to-partner dynamics.

If a particular fund won't return all of its capital to investors, or the deal in question can't make a big difference one way or the other, the VC firm may be ready to give up on a deal just to free up the partner time.  This can happen with an older, small deal in a big fund.  The outcome just won't move the needle, and the VC firm is probably focused on newer funds that can generate carried interest income for them.

If a deal has lost its initial sponsor, or a partner at a firm sees some other deal as being the key for his or her ascendancy, it's possible that deals can get ignored by the partner on the Board.  Also, if partners are being tough on each other over deals in internal discussion, there may be retaliation where other deals are targeted to get even, rather than to maximize returns.

The fundamental issue is with deals that don't turn out to be as large as first thought.  However, these can still make some money for the firm and the entrepreneurs.  This kind of deal may not matter in some cases to the VC firm, but will matter a lot to the entrepreneur.  This misalignment of interest can cause problems.

What can an entrepreneur do about it?  First, do your best to know the people who will be involved in the deal, as well as to know the reputation of the firm.  Some people and firms can separate internal dynamics from how they manage deals.  Others can't.  Second, keep communications open so that if you sense these types of problems coming up, you can try to bring them into the open.  Most VCs won't acknowledge internal issues, but may be willing to minimize their time by appointing someone outside their firm to their Board seat.  This isn't ideal, but is better than getting pushed prematurely to the exit.

Also, you may be able to use other Board members and investors to keep each other honest.  No VC wants to look like the one who is the weak member of the syndicate.  Don't let a VC ringleader emerge if you can help it.  Instead, keep everyone engaged and have a lot of one on one conversations so that each person has to express their own opinion.

VC deals are like marriages, except that it is even more difficult to get out.  So, choose your partners very carefully!

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April 19, 2008

Less is More

Today's Boston Globe has an article on the drop in VC funding both in the US and especially in New England in the first quarter of 2008.  We've been conditioned to think that when some number goes down, it must be a bad thing.  In this case, I don't agree.

Sure, it's nice when the number of start-ups and the amount of funding goes up and up.  But, that only works if the number of successful exits is also going up and up.  I've been concerned for some time that the amount of funding and the start-up valuations have been rising much faster than the number and size of the VC exits.  It's healthy if there is a breather.  It's a good thing for existing start-ups as they'll have to learn how to make less money go farther, a healthy dynamic.  And, it's a good thing for new entrepreneurs looking for money.  Having the bar a little higher means that entrepreneurs have to have a better story, a more refined plan, and a more compelling advantage in order to get funding.  Not every start-up and every entrepreneur deserves to get money.  In fact, when they do, it waters down the results for everyone.

Given the high levels of funding for the past year or so, we need a breather.  To really guage the health of the start-up world, you need to look at the health of the portfolio companies, not the amount of new money funding new start-ups.  I see more start-ups finding ways to stretch their cash and generate revenues from innovative business models and interesting partnerships.  That's the real health of start-ups.

After the dot com and telecom meltdowns, start-ups found it almost impossible to get anyone to buy anything.  That made a bad situation even worse.  Customers didn't want to bet on start-ups with uncertain futures.  These days, I am seeing a resurgence of start-ups being able to sell products and services to both consumers and enterprises.  And, with increasing capital efficiency, that revenue can go farther to help a start-up grow.  In fact, if start-ups find ways to be more efficient, they need less cash, which also puts downward pressure on the aggregate funding numbers.

So, unless there is a huge long-term drop-off and start-ups find it difficult to get customers to adopt their products and services, I'll continue to think that less funding is more.

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April 10, 2008

Finding the Exit

Fred Wilson wrote this morning about finding a "new path to liquidity" for start-ups.  He is fundamentally conflicted between being a VC and being a user of web services.

As a VC, Fred makes his money by either taking his companies public (harder and harder to do, particularly in the Internet sector) or by selling the company to some sort of acquirer who can pay cash or liquid securities.  Fred needs this liquidity to deliver a return to his investors.  By all accounts, he has done a great job at this.

But, since the IPO market is very tight, most companies get sold.  And, most acquirers don't realize the initial vision that the start-up had for its service.  Maybe they just want the technology and not really the product or service.  Maybe they lose focus and move onto the next corporate priority.  Or, perhaps they just can't execute well because of their size.  This doesn't always happen, but Fred reveals his frustration as a user of services that have been bought, and sub-optimized, by big acquirers.

Fred also mentions some new liquidy options for private companies, Goldman Sachs's GS True Market and Opus-5.  While I don't have any direct experience with these, the idea is that these are marketplaces where private company stock can be bought and sold between qualified investors.  Private equity firms can buy start-up positions from VCs, for example.

This type of exit can provide some liquidity and get a VC out of a position that they no longer want to hold.  But, I am skeptical that it will provide the high-multiple returns that VCs need to deliver the results that their investors expect.  Private equity firms like to value companies based on cash flow.  Most private companies that can't go public or be sold at a nice price to a strategic buyer probably don't have financials that will support a high exit price.  So, this may be liquidity, but it isn't a substitute exit that VCs really need.

And, the private equity buyers may allow the stand-alone services to grow on their own longer, perhaps realizing the vision that Fred the user is looking for.  But, if the company can't generate sufficient cash, it will go by the wayside.

On a cynical note, one point that Fred missed is that he needs the big strategic buyers to sub-optimize their acquisitions.  That creates gaps in the market that become opportunities for the next wave of start-ups to capitalize on.  If the big companies did a great job, then start-ups wouldn't thrive.  An example might be Cisco.  Although far from perfect, they did such a good job in the enterprise router market that there just wasn't much business left for anyone else.  Now, start-ups really struggle in that space and only a few get funded.  If Cisco screwed it up, there would be plenty of opportunity.

In the end, the only real exits that deliver VC returns are ones where the hype exceeds the reality, at least temporarily.  This would either be a nicely priced IPO, where the price is baking in a lot of future growth, or a sale to a strategic buyer who is willing to pay much more than what the financial statement justifies on its own.

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March 28, 2008

Board Skills and Personalities

I really enjoyed Jeff Bussgang's post about American Idol in the Boardroom.  I think that he cleverly captured the personality types you need on a Board -- domain expert, cheerleader, and truth teller.  The truth teller is usually the person who the entrepreneur gets mad at the most.  But, they are the most valuable -- you need people on your Board who will bring objective input to the company from the outside and who will challenge assumptions.  You have to remember that investors and Board members are not your friends.  You want to have a good, open relationship with them, but you don't want them pulling any punches or worrying about your feelings.

I've often thought that investors tend to bring three types of skills to a company, each person with their own combination.  Note that this is different than the personality types that Jeff described.  In general, when you finalize outside investment and put your Board together, you want to get representation from all three personality types and all three types of skills below.

Skills from VCs:

  1. Raw intellectual horsepower.  There are many VCs who are just super smart.  They can connect the dots faster than anyone else and think through the outcomes of various courses of action.  They often may be linked to the truth teller as you want the smartest person to not pull any punches.
  2. Deep contact network.  Most VCs have deep rolodexes and close contacts with people in the industry -- potential partners, acquirers, other entrepreneurs, other investors, etc.  You should certanily expect to leverage these networks from your VC.  Make sure that the individual you bring on the Board has these connections directly, rather than representing connections that their firm has.  Most entrepreneurs will tell you that VCs are generally poor at leveraging relationships that their partners have.
  3. Attention to detail.  You want to have an investor or Board member who will read everything and try to understand everything.  A lot of VCs are so busy that they don't have time for the details.  But, the management team needs to focus on the details, and, hopefully, one investor or Board member will be digging into these details to make sure that management stays on track.

As you put your Board together, make sure you have a good mixture of these skills and the personalities that Jeff Bussgang described.  Think about each prospective Board member along these dimensions and make sure you know how you score them on these scales.

These days, many entrepreneurs are raising angel money rather than VC money.  That's a good thing, but it doesn't mean you shouldn't think about your Board.  You can still put a Board together with some angel investors or industry people to give you an independent, outside perspective.  Too many times I see very early stage companies that don't put a real Board together.  These companies tend to 'breathe their own exhaust' for too long and lose site of where the real market opportunity really is.

Are there other styles or skills that you would like to see from Board members and VCs?

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March 13, 2008

Entrepreneur means you can't give up

Jeff Bussgang from IDG Ventures wrote recently about a breakfast sponsored by AlwaysOn to promote their upcoming AlwaysOn - East conference.  Jeff points out that many entrepreneurs play 'Blame the VC' when their business plans don't get funded.  It's true that some entrepreneurs are so enamored with their business plans that they feel that the VC who passes on the deal must be stupid.  And, if 50 VCs pass on the deal, they all must be stupid.  But, I haven't found this view to be very prevalent in the entrepreneur community.

I was at that breakfast, too (and had the pleasure of sitting next to Jeff).  My view of the entrepreneurs' tone was slightly different.  There were quite a few entrepreneurs who spoke up about the fact that their business plan had been funded, but not by Boston VCs.  Perhaps their plan was funded by angel investors, corporate investors, or the ever looming West Coast VCs.  I have some expereince helping out entrepreneurs whose plans I think deserve to be funded by VCs. Some of them have a lot of commercial traction.  Despite some introductions, Boston area VCs haven't moved ahead and funded these entrepreneurs.

But, these entrepreneurs aren't deterred.  They have raised money from angel groups and individual investors.  They are courting VCs that are out of town.  And, they have modified their plans to take less initial capital in order for them to prove some commercial viability before they go try to raise more money.

If these entrepreneurs succeed, it doesn't mean that Boston area VCs are dumb.  Maybe they are too conservative.  Maybe they don't understand the market segments that these entrepreneurs represent.  Maybe they are unwilling to back first time CEOs or willing to build out a team after they fund the company.  Maybe they can't justify a small initial investment.  The best entrepreneurs won't let this stop them.

Instead, these top entrepreneurs with their strong plans will let the marketplace show who is right.  There is a lot of capital out there from many sources.  A great entrepreneur has to be a great sales person.  If you can't sell your plan to anyone, then either you aren't good at sales or the plan really is flawed.  The whole world can't be dumb, can it?

Since we are raising money now for our new investment fund, I have a front row seat for these types of meetings.  Some of our target investors have strategies that don't line up with ours.  Others only look for funds with a certain profile that perhaps we don't meet.  It's our job to find investors who are the right match for our fund.  There seem to be more than enough out there of this type that we can get our fund off the ground.  We're very encouraged by the response and optimistic about our success.

But, if we aren't successful, it will be because of a shortcoming of our team or strategy, not the fault of our target investors.

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February 26, 2008

Funny WSJ Cartoon

I've been in some negotiations like this:

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February 25, 2008

Sempre Management Web Site

Our new firm, Sempre Management, now has its first web site.  It's only a splash page, but it gives you a sense of our look and focus.  In the coming months, we'll add some real content.
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Good old days of venture

I've been going through my track record as we put our diligence materials together for our new fund.

One stark fact is how the venture business has changed.  My last two operating jobs were at Shiva and New Oak Communications.  Shiva raised a bit more than $8M in four rounds of financing from 1989 through 1994.  That small amount of money came from two blue-chip investors -- Greylock and Kleiner Perkins.  In those days, you dripped the money into the companies (the biggest round was $4M).  Shiva went public in late 1994 with a $200M+ market cap and had a $2.4B market cap at it's peak in June 1996. 

New Oak raised just under $12M in two rounds (including seed capital) in 1996 and 1997.  When we sold the company in January 1998 for $156M, we still had $6M in the bank.  So, in about 15 months we spent almost as much capital as Shiva spent in 5 years.  Things were already accelerating, but no one complained about the outcome.

In looking at the venture deals I have been involved with since 1999 (14 deals), they have averaged $52M+ per deal!  Unfortunately, not all of these companies had a successful outcome, and some of them may require additional capital.  So, significantly more capital has gone into deals since 1999.  Now, that is not a big surprise, but it is still stark to see the contrast.

Of course, the problem is that with $12M of capital per deal, a $75-100M outcome is a very significant win.  With $50M of capital per deal, you need a $300-400M outcome to achieve the same multiple.  I think that there were proportionally many more $75-100M exits in the early to mid 90s than there are $300-400M exits today.  So, it's much tougher for VCs to make the same type of returns now than it was before.  And, that's a good reason why my new firm will be doing something different!

PS - Inflation is a small factor here.  According to my quick check, there has been about 31% inflation in the past 10 years.  So, it does make a difference on capital per deal, but not that big of a difference.

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February 15, 2008

More Money for VC

This week got away from me as we were on the road raising money for our new fund, Sempre Management.  Meetings with prospective limited partners went very well, and we have many weeks and months of fund-raising ahead of us.  It's very exciting, especially when we continue to get such positive feedback on our strategy.

One LP told us that he expects a lot of money to shift from buyouts to venture capital in 2008.  This may be good for funds like ours that have a VC-like strategy, applied to a different market.  But, it also means that there will be a lot of investors looking to raise their exposure to more typical venture capital.  Although this may sound good for VCs, I think that it actually isn't.

Too much money in the VC segment means that investors will 1) overfund existing companies, 2) fund more marginal opportunities in order to put more money to work, and 3) be more content to live off of their larger fee base rather than focus solely on making strong returns for their investors.  This also, in the long-term, is bad for entrepreneurs.

Entrepreneurs may have more VCs willing to fund their companies, but those companies are more likely 1) to face increased competition from more well-funded start-ups and 2) to be over-funded themselves, leaving less room on the upside for the entrepreneurs, except in the cases of the largest outcomes.  Entrepreneurs don't start companies for the salary -- they start them for the equity upside which only comes from great exits.

In general, I think that over-funding the VC segment flattens out the distribution curve representing the outcomes of start-ups.  With increased capital, there will be some even bigger wins that could only happen with a lot of capital available.  There will be fewer mid-level outcomes and just a broader range of outcomes, including bigger, more spectacular losses.  If you happen to be at a company that ends up a the high-end of the curve, this is a good thing.  But, the curve probably also shifts to the left, meaning that the average return drops significantly.

I have long felt that the venture capital segment can only productively absorb a fixed amount of capital.  That amount slowly grows over time, perhaps just a bit faster than GDP growth (this is my guess -- no numbers to back this up!).  Like most investment segments, over-funding the segment leads to lower returns for everyone.  The only saving grace for VC is that most other investment segments are over-funded, leading to lower returns across the board.  This is why the big institutions are looking for more alternative investments in segments that are less well-funded, hoping for bigger returns.  At least until everyone else follows them and over-funds these segments, too.

Luckily, we feel that our strategy is unique, at least for now.  It seems like our prospective investors agree.

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February 07, 2008

MicroHoo! -- Good for start-ups or not?

Alot of people are talking about whether the potential acquisition of Yahoo! by Microsoft will be good for the start-up world or not.  Some say it's bad.  Others say it's good.

I'm in the latter camp.  I think that these types of big combinations are much more likely to produce opportunity than to shrink the number of buyers that start-ups can sell to.

In fact, I think that this will increase the number of buyers for start-ups in the online space.  Google is already a big media company.  So is Yahoo.  Microsoft wiould become an even bigger media company if it is able to buy Yahoo.  But, there are plenty of other media companies that are smaller players or almost non-existent players in the online world that we think of as Google and Yahoo -- IAC, News Corp., Disney, NBC-Universal, Viacom. 

I think that all these media types will continue to converge, meaning that these big media companies need to bulk up their online offerings.  So, there will be at least as many acquirers out there, if not more, as there are today.

Second, a big merger like Microsoft/Yahoo will take a long time to complete and optimize.  Development will slow down in these two big companies as everyone worries more about their job than their product or service.  After the dust settles, there will be gaps in their offering that will have to be filled in order to catch back up.  Again, start-ups are likely to fulfill these needs.

Last, the convergence of all this media is bound to create more new opportunities.  Start-ups are more likely to identify these and capitalize on them quickly than big companies.

If Microsoft/Yahoo created a real monopoly, that would be bad for start-ups.  But, then again, everyone thought search was 'over' when Google started.  In technology, things are never done, you just have to look a bit further ahead.

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December 18, 2007

Snoman's Question Answered

If you enjoyed the adventures of Gary Snoman last year, you'll be glad to know that this year's holiday card from Blueprint Ventures answers the question "What about India and China?"  Happy Holidays!

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December 17, 2007

VC Outlook

The National Venture Capital Association released the 2008 Predictions Survey recently (powerpoint slides here).

There were some interesting tidbits in here:

  • VCs think that cleantech will be the fastest growing sector in 2008 for new investment, but will also be the most overpriced.
  • Semiconductors and software will be undervalued in 2008 (good fodder for my fellow contrarians).
  • VCs are optimistic about their returns in the future (or at least think that they will be better than they have been recently).  Given the amount of capital out there, I think that this is overoptimism.
  • However, returns in the past 12 months are ahead of historical 10 and 20 year returns.
  • Early stage venture capital, historically the strongest investment category, still has not recovered from the bursting of the bubble.
  • VCs think that Hillary Clinton will be elected President!

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December 03, 2007

The Non-Compete Clause

There has been a flurry of activity in some blogs about whether it is worthwhile for employers to require employees to sign non-compete clauses as a condition of employment.  Bijan Sabet, a VC at Spark Capital in Boston, had written about this a couple of times before.  Over the weekend he said that he didn't believe in these clauses and said that Spark would not longer require companies to have these in place for their employees.  I wonder if Spark's co-investors in future deals with agree.

Fred Wilson from Union Square Ventures disagrees.  Both posts have lively comments which are worth reading.

Having been an operating guy and a VC, I've seen both sides of this issue.  Also, I was once personally sued under a non-compete clause as one employer tried to keep me from taking a job at another company.  It's nice to be wanted, but that wasn't a lot of fun.

In my case, the non-compete clause of the first employer was very broad, making it almost impossible to enforce, even in Massachusetts.  And, my new employer, although in the same industry as my first employer, was also a partner that we had a cooperative relationship with.  So, it was tough to make the case that it was a pure competitive issue.  The case didn't last long in court (15 minutes on a hearing for a temporary restraining order), but I did have to reaffirm my commitment to the confidentiality of the information I had from my first employer.  I'm a strong believer in that.

Clearly, a non-compete clause, if well crafted and enforceable, protects the interest of a company.  VCs have a responsibility to protect the interests of their companies, so they should ask for such clauses.  But, these clauses should be narrow and fair.  If someone leaves voluntarily, they should be able to be restrained from joining a direct competitor of the products they worked on.  This can apply to big companies and small. 

Since these laws don't apply in California, investors there can't get such protection.  I agree with Bijan that this hasn't hurt entrepreneurship in California, but it has probably spawned more lawsuits from companies that may have started with or benefited from information gleaned from someone hired from a competitor.  I know that these are really issues of confidentiality, but they start from the fact that the there is no non-compete clause which is restraining job transfers.

I don't agree with Bijan that the presence of a non-compete clause has significantly impacted the development of start-ups in Massachusetts.  It may be a small factor, but I think that the issue is more of the overall attitude about starting companies.  Here's a comparison:

In Silicon Valley, when you tell your boss that you are leaving your job to start a company, they say "Great, I want to invest!"  In Massachusetts, they say "You can't', we'll sue you!"  This story works even if the start-up isn't a direct competitor.  No one wants to go to court, so the threat of the lawsuit is a big issue.

In summary, I'd like to see the courts require that non-compete clauses be narrow and fair.  If you really do restrain someone from working, you should pay them for their time.  But, these clauses have to be narrow enough to give the employee freedom without harming the company's interest.  I also think that it matters how you leave the company.  If you leave voluntarily, then you should be more constrained.  If you are fired, laid off, or forced to leave for "good reason", then you should have fewer shackles.  If you are so valuable, then they shouldn't want to see you go.

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November 21, 2007

When they say No...

Brad Feld wrote a post entitled "Don't Ask for a Referral If I Say No."  Good insight there into the mindset of a VC who tries to do an entrepreneur a favor by giving them a rapid 'No', but is then conflicted when asked to give the entrepreneur some additional help with VC introductions.

Too many VCs are hesitant to say No to an entrepreneur.  They prefer to preserve the option to invest later if the deal starts to look better (or if others get interested).  It's much tougher, but better for the entrepreneur, to give a No once you have decided to pass.  This saves the entrepreneur time.  I always tried to give feedback when I gave a No to a deal.  Maybe the target market wasn't interesting to me.  Maybe the deal didn't meet my firm's investment targets.  Maybe I didn't believe some of the assumptions behind the plan.  I try to be as open and direct as possible, probably only holding back when it was the entrepreneur themself who is the problem.  Maybe I'd say -- the team needs strengthening...

All of this feedback is my opinion.  Maybe I'm wrong.  But, if a VC says No, they have made up their mind.  It's not productive to try to change their mind through lots of follow-up.  If you want to keep me posted via an occasional email about your progress, that's fine.  Maybe we can meet again in six months or so.  But, don't try to overcome my feedback as if they were sales objections.  That's not the dynamic that is in play.

Also, as Brad says, asking for an introduction to another VC is a bad idea.  Unless the deal just isn't in a sector where my firm invests, I have to tell the VC that I passed and why.  I need to be honest with them as it's part of my relationship with them on sharing deals.  Instead, try to improve your plan and presentation first, and then get a trusted introduction to other VCs from their own non-VC contact network.  That's much more valuable.

You can get a lot out of a No from a VC.  Just not introductions to other VCs.

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November 19, 2007

Thanks, Scott, but...

Scott Kirsner from the Globe has done a great job writing about the start-up and VC scene in Boston for the Globe.  I always enjoy talking to him.

Although I haven't mentioned it here, I am in the process of getting a new investment firm off the ground.  But, we are still in stealth mode for a variety of reasons.  Today, Scott wrote a blog post about our activities that is directionally correct, but not totally accurate.  I very much appreciate the interest, Scott, but can't comment further until we are ready to be more public in our activities.

In the meantime, how about making a donation to Globe Santa?

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October 29, 2007

Angels and Early-stage VC funds

The Boston Globe writes today about the local venture capital market and the impact of angel investors and organized angel groups.  As the recent numbers show, VC activity in New England is on the upswing in terms of dollars invested, but this is skewed by larger, later-stage investing.  It's still pretty challenging for early-stage companies, and particularly first-time entrepreneurs to raise venture capital dollars.  The angel groups have filled the gap here somewhat, but there is still a mismatch between the appetite of angel groups and the number of early-stage companies seeking funding.  As the Globe reports, the amount of angel funding has stayed steady, which indicates that they are fully deploying the dollars available even though there is a growing market opportunity.

One way that this gap gets filled is with smaller VC funds that are willing to fund early-stage companies.  As I have been advising some early stage start-ups, I have found that three newer funds in town have been receptive to early-stage companies.  If you are an entrepreneur with an idea in the IT sector, it's worth getting introduced to these firms.  In alphabetical order:

.406 Ventures

Dace Ventures

Kepha Partners

Check out their web sites to see the backgrounds of the partners and their areas of interest.

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October 09, 2007

Repeat Performance?

When I wrote recently about Backing into 20%, or why big VC funds face challenges in getting big returns while they want to own as much of a company as possible, I missed one obvious point.

When I compared the kind of returns that a smaller fund, like Fred Wilson's Union Square Ventures, needs to have versus those that a bigger fund needs, I skipped over another solution.  Why can't the bigger fund just do what the smaller fund does many times over?  A $750M fund can just do what a $125M fund does six times.  That means that the bigger fund needs to have six times the partners finding six times the number of great opportunitites.  Each of those opportunites can have the profile of the returns that I described for the smaller fund.

Mathematically, that all works.  But, the math doesn't map to reality.  The scarce resource is the entrepreneur who can build a company that delivers the great returns.  It's a competitve market out there for these entrepreneurs, and if your firm has to find 6x as many of them as a smaller firm does in order to have a similar return, your firm is bound to lower the quality bar in the name of putting the money to work.  And, you need to put the money to work in order to justify taking a management fee on the big fund.  And, that's the dirty little secret of today's large venture funds.  It's almost impossible for a big fund to repeat the success that smaller funds can have with early stage deals.

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October 05, 2007

Business Week Points out VC issues

Business Week's Sarah Lacy has an article that reinforces some of the structural VC issues that have been discussed here regularly.

There's simply no big overall tech movement getting Wall Street revved up, and among entrepreneurs, the feeling is mutual. Sarbanes Oxley and other regulations have made the prospect of going public far less appealing.

The picture looks worse among acquisitions. Sure, the usually sleepy third quarter saw $10 billion come in acquisition proceeds, but that was spread among 90 deals. Companies like TellMe, the voice recognition software company founded in the late 1990s that snagged $800 million from Microsoft (MSFT), are in the minority this year. Far more common is the tech company that plodded along for more than six years, chewing through some $30 million in venture cash to eventually get bought for $50 million or so. Indeed, the median length of time it took companies to get bought was the longest Dow Jones VentureOne has seen since it started measuring the industry 20 years ago. Meanwhile, valuations keep rising, as billions of dollars in VCs’ coffers fight to get in what few great companies are out there.


Internally, many investors are worried that only a handful of firms will break even on the current crop of funds, much less post stellar returns. In hushed conversations over breakfasts at Buck's and lunches at the Sundeck, VC veterans are wondering aloud whether they should get out, or, after years of playing boardroom quarterback, whether they've still got the chops to actually build a startup.

However you slice it, unless something changes, venture capital is in for upheaval. Some venture capitalists are going to find themselves out of a job. Overall, the industry may become more the font of outsourced research and development for big firms and less the breeding ground for the next great tech powerhouse. And returns will be lackluster for the majority of firms left out of the best deals.

Yikes.  That's pretty pessimistic.  I don't think that it is quite that bad, but I do think that LPs are resigned to the fact that returns won't be as strong as in the past and great returns will be even more concentrated in fewer firms than in the past.

If I could wave a magic wand, I would make at least half of the committed funds to venture capital go away.  Even though that would lead to there being many fewer VC firms and VC partners, it would also mean that funds were smaller, investment decisions were more disciplined, and capital would be doled out much more parsimoniously.  That's good for entrepreneurs who can get funded and very good for ultimate returns.  There might be fewer start-ups, but I also think that there would be more small scale financings to give company concepts a try.

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October 04, 2007

Backing into 20%

Fred wrote today about the mytical 20% ownership threshold that most VCs have when they make early-stage investments.  As he points out, there is no investment reason why a VC needs to own 20%+ of a start-up.  The reason they want to own this much is that they want to put more money to work and have significant large dollar volume returns that are significant to their large funds.

The fundamental problem is the large size of early-stage VC funds.  It makes it difficult for a VC to do a small early-stage deals.  Each deal takes more or less the same amount of time.  So, if you have to put in the time, you might as well put more money to work to try to get a bigger volume return.

The problem with this is that VCs should be in the business of generating a significant multiple on an investment.  But, with a large fund, you tend to focus on the total dollar return so that it 'moves the pile', or makes a difference in a fund.  Putting $2M to work and getting $20M back (10x return) doesn't matter that much to an $800M fund.  It would be more significant to put $25M to work and getting $75M back (3x). 

Take a look at the numbers at the end of Fred's post:

Don't get me wrong, I would love to own 25% of a company or more. But we don't make it a requirement. Our requirement is being able to get into the best deals, work with the best entrepreneurs, and be able to generate $40-50mm in proceeds when a deal works and return the fund, $125mm in our case, on the very best deal in the fund.

If Fred gets a $40M return on a company that they own 15% of, that implies (more or less, depending on deal terms)  a $267M exit value.  That's a pretty successful company, and I'm sure that Fred has had a bunch of those.  If they get $125M (their fund size) on a 15% ownership, that's a $833M exit, which doesn't come along too often.  If you change these exit values to be the same percentage of an $800M fund, that would imply a $256M return and a $800M return.  Even with 25% ownership, these imply $1B+ and $3B+ exits.  Don't hold your breath waiting for those.

You can see from this example that a smaller fund has a much better chance of generating a significant multiple than a big fund.

The fundamental problem is that there is much more money being put to work in the early stage space then there are great entrepreneurs that need that volume of money.  This leads to three problems -- 1) too many copycat deals get funded as the money burns a hole in the VCs pocket, 2) VCs end up pushing more money onto entrepreneurs to raise their ownership and put more money to work and 3) smaller, very early stage deals have a hard time raising money because no VC wants to make a $1M investment.

The big funds force those investors to back into the 20% requirement, instead of making it a 'nice too have'.

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September 23, 2007

Scott Krisner Column on VC Blogging

Scott Kirsner of the Globe has a great column today on VC blogging.  He also has a blog post and video.  The video includes interviews with VCs and entrepreneurs, including me.

Scott's column does a good job capturing all sides of this discussion -- the views of VCs who blog, those who don't, and the view of the entrepreneur.  In the end, I think that a VC has to do what fits with their personal style.  Blogging doesn't necessarily give you an advantage over those who don't.  But, if you don't blog, you need to figure out what other means you will use to stay connected to the Web community.  One thing is for sure -- the market is changing and historical methods for marketing a venture firm and connecting with entrepreneurs won't continue to work in the future.

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September 18, 2007

Boston VC Partners and Networking Events

I wrote recently about the small number of Boston VC Bloggers.  I received some comments from some Boston VCs (who preferred to remain anonymous and to respond to me directly).  The consensus I heard from them was that they weren't comfortable blogging or posting public comments.  They preferred to communicate one on one to control their communications.  There was also a theme that many blogs (not mine, I hope!) included a lot of personal ranting which wasn't that useful.

I don't agree with this, but my view is shaped by the positive feedback I get from entrepreneurs who discover me through my blog (or from a friend who reads my blog).

Another form of participating in the Boston entrepreneurial community is to attend some of the networking events which happen regularly around town.

Some events are sponsored, like Web Innovators Group (sponsored by Venrock).  Although this event is open to all, perhaps some VCs stay away because they feel it is Venrock's event.  Other events become associated with a firm, perhaps because a partner at that firm started it or promotes it.  An example here is OpenCoffee Cambridge, with Bijan Sabet of Spark as one of the founders.  Although Bijan is welcoming, perhaps some VCs stay away because they want to do their own thing.

There are even big, occasional events like Tech Cocktail, where North Bridge was one of the sponsors.  I've gotten a lot out of attending all of these events, so thanks to all the sponsors!

Like blogging, I don't see enough of the senior people at the big Boston VC firms at events like these.  Now, maybe I'm going to the wrong events.  But, in general, I see a lot of the more junior VC people at these events that are primarily aimed at the emerging Web 2.0 world.  I like the junior people, so don't get me wrong.  They are smart and high-energy.  But, you can't delegate your interest in a new market to your junior VC staff.  Many of the firms around town which claim to invest in Web 2.0 companies don't have senior partners who show up at many of these events.

If you want to understand a new market, you have to participate directly.  So, I hope to see more of my senior VC friends at some future events.

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September 14, 2007

Why Don't More Boston VC's Blog?

As entrepreneurs give me feedback on my blog, they often ask me why more Boston VCs don't blog.  Of course, there are quite a few who do (these are the ones I read most often and is not a complete list):

Jeff Bussgang

David Aronoff

Mike Hirschland

David Beisel

Bijan Sabet

I wish there were more.  There are some firms that have no one who blogs, but they still claim to invest in the Web 2.0 market.  I don't get it.  I don't see how you can do that without being part of the community.  Without that, you just won't be able to understand these deals.

Some possible reasons why many VCs (particularly more of the 'older' ones, like me) don't blog:

1) They are very busy.  Hey, who isn't.  That's not a good excuse.  If you thought it was important, you'd find the time to do it.  This reasons is really 'I don't think that it's important.'

2) They don't want to be wrong.  I think it is risky putting opinions out there.  You may be wrong, or someone important may disagree with you.  So what.  As long as you are not confrontational, it's just a discussion.

3) They don't want their LPs to find anything that isn't totally buttoned up when they do their diligence.  Smart LPs will know that you can't invest in this space if you don't participate.  Just keep your sick hobbies out of your work blog...

4) They don't want to share their opinions with the rest of the world and lose their competitive advantage.  Come on.  Most VCs are pretty smart, but there are very few unique thoughts in this world.  By participating in the conversation, you'll have better opinions.  Of course, you have to be careful in talking about new spaces and companies you are looking at, but I think that blogging helps your deal flow so that you'll see more new things anyway.  And, we need to collaborate more in the Boston market anyway.

5) They have nothing to say.  I don't think that this is true, but if they really don't understand the space, then maybe they'd learn by trying.  See #2.

It took me a while to commit to doing a regular blog.  And, it's hard to carve out the time to write something sometimes.  But, I get so much great feedback from people who read The Fein Line that it's addictive.  I'd like to not be Boston's oldest VC blogger much longer...If there is someone else out there who deserves that title, let me know.

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September 10, 2007

You can own too much

I was getting an update on a company I know recently when I realized that the investors owned too much of the company for their own good.

Now, as an investor, you might think that you want to own as much as possible.  And, of course, the entreprenur wants to hold on to as much ownership as they can.  If the VCs do own too much, you can run into several problems:

  • The more commonly known issue is that if the investor owns too much of a company, there isn't enough equity left to properly motivate the entrepreneurial management.  If you are asking management to work start-up hours and forego market rate salaries and compensation, you probably have to offer them reasonable equity stakes so that they can share in the upside that they help create.  If the investors own too much of the company (maybe more than 80%), there is no way to have enough equity left to motivate the team except in very rare situations (companies that have raised huge amounts of cash where everyone agrees that the outcome is also very huge).
  • A separate issue has to do with large investor ownership getting in the way of follow-on financing.  A mature company (in terms of investment and age) that is a bit behind in terms of company development (maybe because a business model was switched one time along the way) may be in the situation where the investors own too much.  In this case, the investors own enough of the company (and probably at too high of a valuation) that it is hard to attract outside capital.  If there is investment interest, it may be at a lower valuation than the previous round.  The existing investors won't be happy about that.  However, if the investors do an 'inside round' and invest in the company without a new investor coming in, their ownership may not go up a commensurate amount because they hit the ceiling where they dilute management's upside too much.  Nothing is worse than doing an inside round at a company and, due to option pool expansion, owning less after the round than you owned before.

These types of situations often lead to companies being sold 'before their time.'  As a VC, you may prefer to sell the company rather than do one of those inside rounds where your ownership drops.  The only thing which may keep you from this is if you believe that the future upside is so big that it is worth the short term hit on ownership.  But, you have to convince your skeptical partners of this as well.

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Tough time dealing with a VC?

Once again, Ask The VC has a great post on the VC business.  This one is Why are Venture Capitalists So Hard to Deal With?  I direct people to Ask The VC all the time as I think it is a great resource.  I also like the model of submitting questions to be answered by the authors.  If you have a question about venture capital, ask them!

One additional comment I have on the content of this post is that VCs often behave badly because entrepreneurs let them get away with it.  If you behave like a jerk and entrepreneurs continue to come see you with new business ideas, then you get positive reinforcement on behaving like a jerk.  So, check the reputations of the VCs you want to approach and avoid those that are hard to deal with.  Check out The Funded for more (probably biased) feedback on how VCs treat entrepreneurs.

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August 31, 2007

Actually, you can hire a CEO

Marc Andreessen has written a great series of blog posts about startups.  But, his most recent about How to Hire a Professional CEO is too cute or just wrong.  To save you the trouble of clicking, here is what Marc says about How to Hire a Professional CEO for your startup:


If you don't have anyone on your founding team who is capable of being CEO, then sell your company -- now.

I don't agree, although I will concede that it is far better to already have a great CEO than to have to go hire one.

I think that most start-ups are in a more nuanced situation than this.  Here are the most common scenarios:

  1. There is an experienced CEO with the right market experience on the founding team.  You are done and can pass Go and collect your first VC investment check.  Maybe.
  2. There is a strong manager on the founding team who can run things for a while as you get the company off the ground.  For many high-tech startups, this can be someone who ends up being a strong CTO, VP of Engineering, or VP of Marketing.  The risk is that, as an investor, you know you'll have to remove this person from the job of running the company at some point.  Even if the Founder agrees up front, when the moment of truth comes for them to help hire a true CEO, they may resist or, even worse, become obstructionist.
  3. You have a great technical founder but no business person to get things going.  Usually, as a VC, I'd try to match up this great technical founder with a start-up CEO from category 1 above.  If you can't get one of 3 or 4 qualified CEOs to bite on the opportunity, perhaps there is some fatal flaw with the idea or the founder.  Think very, very hard before you go ahead and fund this kind of company without the CEO in place.
  4. Even scarier is the situation where you have a person with the CEO title on the founding team, but you don't think that this person is qualified for the job or should even have a role at the company.  There is no way you should fund this opportunity until you get the right person in the CEO slot.  Anything else is just asking for trouble.

In some of these scenarios, you may need to hire a CEO, either at the beginning of the company's life, or after it has grown and matured a bit.  It is very, very common for start-ups to outgrow the initial management and have to add more experienced management as it progresses.  In these cases, you'll have to hire a 'professional' CEO, as Marc calls it.

I've had some luck finding CEOs through my own network of contacts.  It is definitely worth doing this at the start of a search, but don't delay for too long.  I'd recommend trying up to 4 people from your network that you think would be a good fit.  Beyond that, hire a recruiter.

I've had good success with professional search firms.  I prefer smaller, boutique firms that focus on particular market segments.  The partners at these firms are hungrier and tend to do all the work themselves, rather than delegating it to less experienced associates.  Although the best search firms do a good job on referencing checking and thinking about fit within the organization, I think you have to really do that job yourself.  Make sure you spend hours and hours with the candidate, in both business and social settings.  Make sure you do many, many reference calls (at least 20), including many people not on their formal list. 

I always go out of my way to talk to what I know will be negative (or less positive) references to hear their perspective.  We all have people that we have crossed at some point who won't be glowing in their feedback on us.  They may be biased, but I want to hear what the biased people say.  Find someone who decided not to promote the potential CEO sometime in their career.  Find someone whom the CEO had to fire.  Find the investor who passed on their previous deal because of concerns about the CEO's experience.

You have to have the management team be part of the CEO interview process, but don't let them be obstructionist.  In the end, the Board hires the CEO.  You want the new CEO to fit in with the company.  But, I have seen situations where the existing management, which may be weak, fears the new CEO being brought in because they know that some or all of them will soon be out of a job.  In addition to just hiring the wrong person, this is probably the kind of situation that Marc is wary of.  And, rightfully so.  But, as an investor, you have play the cards you are dealt.  And, sometimes there is some breakage in these management changes.

It's definitely possible to hire an experienced CEO later in a company's life.  It is an element of risk.  But, you also need to match the CEO to the stage of the company.  A boot-strapping start-up won't be able to attract the CEO who can run a $50-100M business.  As you go from one phase to the next, you'll have to make changes.  Proceed with caution.

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August 27, 2007

Interview on Intruders.TV

Bruno Langlais interviewed me recently in, a video blog. 

They've had a recent theme about the Boston VC scene and the differences between Boston and Silicon Valley.  Given my 'years of experience', I tried to give a bit of a historical perspective.  I also highlighted two of the start-ups I work with in the Web 2.0 space, Geezeo and Good2gether.  You may have figured out that I am an unabashed shill for the companies I work with!

I like the video blog concept.  You get a lot out of watching the video versus reading an article or even hearing a podcast.  I've never been comfortable watching myself speak, but I've reluctantly gotten used to it.  I hope you like the content, and I'd appreciate seeing your comments here.

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Entrepreneurs can step up, too

I've written regularly about how Boston-area VCs need to step up and take some risks in order to foster some market segments, such as Web 2.0 (posts here and here).  Many entrepreneurs have told me that VCs in the area aren't willing to back them unless they have a team that has done it before with a site that has a lot of traction and already generating revenue.  That doesn't sound like real early stage investing to me.  And, I hope to see it change.

But, entrepreneurs have to be willing to take some big risks, too.  There are other ways to fund a start-up besides a VC.  Maybe venture capital is the only way to raise millions at once, and that kind of investment can only be justified in something that has a chance to scale rapidly and build significant value.  But, plenty of start-ups have gotten going with other forms of financing:

  • Angel investors -- in Boston, the angel groups are very active.  They don't move any faster than VCs, but they are willing to fund riskier ventures than typical 'early stage' VCs.  Also, there are many entrepreneurs who can find individual angels from their industry who are willing to back their ideas.  Geezeo and Good2gether are examples of this.
  • Friends and family -- this is probably the most common way that start-ups get going.  Who knows the entrepreneur better than their family and friends?  While not every entrepreneur has friends and family with the resources to back them, a scrappy entrepreneur can do a lot with a modest amount of capital.  Earlier in my career, Cayman Systems started this way.  Also, CircleLending has formalized many business loans between friends and families to get businesses off the ground.
  • Do some other work for funding -- a lot of companies get started with the team doing related work for pay (consulting work, licensing software, selling something related, etc.).  This may divert some attention from the core business, but it does keep people paid.  This will require extra effort on the team's part to do the revenue generating work as well as the 'new business.'  But, it gets you going.  Not many people know that one of my former companies, Shiva, was originally funded by doing driver work for a hard disk company.
  • Fund out of your own pocket.  This is the riskiest form of financing for the entrepreneur, but it is done.  Some people have some resources from previous success that can provide them a financial cushion.  Others are willing to make a big bet on themselves and their idea.  GateRocket and MyDesignIn are examples of this.  GateRocket went on to raise formal angel funding afterwards.

Many times when I meet with entrepreneurs, they won't get going unless a VC gives them money.  Now, for certain businesses, this is wise.  A business that has to compete with venture-backed direct competitors who are ahead of it, or one that will need millions of dollars for R&D (like a semiconductor start-up) may very well have to raise venture capital to get going.  But, most Web businesses don't need large amounts of capital to get going.  Some money is needed, but a lot of work can be done on more of a bootstrap basis.

Although the most committed entrepreneurs are willing to do whatever it takes to get their business off the ground, others are too willing to accept a 'No' from a VC.  This is a good test of commitment.  I am always impressed by entrepreneurs who have pulled off amazing things on modest amounts of capital because they were determined to get it done.  So, don't let a VC's 'No' slow you down.  Find another way to fund your business and prove the VC wrong.

If you don't have the guts and determination to do this, maybe the VC was right after all...

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August 16, 2007

VC Customer Serivce

Jeff Bussgang had a good post today about the tension between VCs and entrepreneurs which sometimes lead to VCs being branded as arrogant.  There is no question that many VCs treat entrepreneurs poorly, which is why things like this really resonate.  And, if web sites like help increase transparancy in the VC-entrepreneur interaction, then I am all for it.  Unfortunately, sites like this tend to capture much more of the negative feedback than the positive.

However, I don't agree with Jeff that brusque interactions are important for VCs so that they don't waste time that can be spent on more productive projects.  I see no reason why you can't treat entrepreneurs with great 'customer service.'  At Venrock, we actively discussed customer service and how we treated entrepreneurs when they came in to pitch us.  I thought that this was very healthy.  Part of good VC customer service is not wasting the entrepreneurs' time, in addition to not wasting our own.

But, every interaction with an entrepreneur can be a value-added one.  You can always give feedback, make an introduction, and offer advice.  You don't have to extend the meeting to do this, and you should always be direct about your reasons for saying No.  Saying No should be done live (in person or over the phone), but a direct email or voice mail is still far preferable than radio silence.  And, you can cut short debates about whether your feedback is right before they get out of hand.  I usually did this by starting with "I never change my mind about these decisions once made."

I always got feedback from entrepreneurs about the direct communications I had with them.  Giving them a clear No and some good feedback can help the entrepreneur.  I found that many times these entrepreneurs came back to me with updated plans or with their next plan.  And, they referred other entrepreneurs to me, too.

In poking around, I was happy to see that entrepreneurs took the time to post positive comments on some VC interactions.  I hope that these positive comments become a nice benchmark for other VCs to aim for.

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August 09, 2007

Will Web Entrepreneurs Stay in Boston?

Scott Kirsner wrote about the Y Combinator event today in Cambridge.  I wasn't there, but I've been to similar events.

Scott pointed out that several of the entrepreneurs planned to move to Silicon Valley to get funded.

Now the bad news... several of the enterpreneurs I talked to who have connections to the Boston area are planning to move their companies out west. The Y Combinator network is perceived to be stronger out in the Valley (the firm does a winter program in Mountain View). The VCs more adventurous. The partnership opportunities more plentiful. The potential for generating buzz better.

Is it hopeless to think about trying to change some of these dynamics?

I think that the only way that this trend changes is if the VCs start backing some first-time entrepreneurs in this segment.  The VCs are going to have to roll up their sleeves to find some business talent to help get the companies going.  The VCs are going to have to help the companies get some partnerships done with the Big Guys in Silicon Valley.  But, the payoff will be worth it.  We'll create some 'been there, done that' CEOs and VPs of Marketing who can start and run the next wave of companies.

I've met several interesting entrepreneurs over the past six months who can't get the time of day from Boston VCs but get lots of attention from West Coast VCs.  As Scott said, we need more adventurous VCs to break this cycle.

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August 01, 2007

More on Lumpy VC Fund-Raising

VentureBeat has some updated numbers on VC fund-raising.  I agree that you can't read much into these numbers on a year to year basis.  VC funds are raised once every 3-4 years at each firm.  So, the fund-raising can be pretty lumpy.  And, some firms raise very large funds which skew the numbers.  I think it is good that fund-raising has slowed down as there is a lot of money in the market right now chasing VC deals.

As for China, that feels like a bubble to me.  There certainly are plenty of opportunities in China, but the large volume of dollars raised now is mostly late-comers to the market.  As in the Internet bubble, those who got in late lost their shirt.  I don't know if it is already late, but the clock is certainly ticking.

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July 25, 2007

Is Your VC Crazy?

Bill Burnham has a great post which tries to explain the sometimes irrational behavior that a VC can exhibit on a Board.  Definitely worth reading if you've thought this to yourself during a Board meeting...
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July 23, 2007

Venture Bubble

As VentureBeat reported yesterday, VC investing is at a six-year high.  Yes, things have 'recovered' back to pre-9/11 levels.  I don't think that this is necessarily good as there is lots of evidence that the venture industry is in a bubble, particularly in Silicon Valley.

First, some good news:

  • Cleantech seems to be one of the growth areas.  I think that is a good thing, overall.  There are some subsectors of cleantech, like solar, that are overheated.  But, overall, this is a new sector that deserves some new investment.  Every VC firm I know is thinking about investing in cleantech if they aren't already.
  • It's also good that some of the big overhang of funds raised gets invested.  As there has been so much money raised, it's better to see VCs making some bets rather than sitting on the sidelines.

The bad news:

  • Silicon Valley grows while most other regions are flat or down.  This makes me think that the Valley has to be in a bubble.  Anecdotally, I see quite a few Valley start-ups getting funded that seem to be the 8th or 10th players in their market segments.  That can't be good.
  • New England is down dramatically, which is consistent with how this region feels.
  • Company creation is down and later stage investing is overheating.  The average deal size is now the highest it's been since 2000.  That also can't be good.

I would hate for another VC bubble to burst as cycles in the venture business are long -- it takes a while for a bubble to inflate and the impact of its bursting is also felt over years.  We need a VC Greenspan to give us a soft landing.

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July 18, 2007

Whither early-stage VC?

PEHub has a blog posting on the shift to late stage investing by VCs.  However, the data in this posting is really about funds-raised, not funds-invested.  I've always been wary of measuring the VC industry by quarterly fund-raising.  I think that you have to look at annual trends.

Fund-raising is a very lumpy process.  Firms can spend 6-18 months raising money, and the market is still relatively small that you can't read too much into quarterly ebbs and flows.  Also, it's no surprise that on a dollar basis that late-stage VC is dwarfing early-stage VC.  Later stage rounds are bigger, so the funds that invest in them are likely to be bigger.

I think that it is more interesting to look at new company creation.  There is some sort of lag in reporting to things like VentureSource, but you can look at this retrospectively to find some trends.

I did a quick search on VentureSource for all types of IT companies in New England.  Here is the number of companies reporting a first financing in each year:

2007 (to date)       17

2006                    38

2005                    39

2004                    34

2003                    40

2002                    36

Now this isn't 100% comprehensive or precise, but I believe it to be directionally correct.  And, it says that early-stage IT VC investing in New England is pretty steady. 

Remember how dead it felt in the market after September 11, 2001?  The number of new companies created has been steady since then.  It may be pretty scary to think that this is the total number of deals done per year given how much money and how many 'early-stage' VC firms there are in the area.  That is probably why these funds are now doing more later stage investing and sometimes raising separate later stage funds.

What does this all mean?  There is quite a bit of late-stage money being raised, but who is funding lots of early-stage companies for these late-stage investors to pick?  It seems to me that this is out of whack.  I continue to think that despite there being lots of money out there, very few New England investors are willing to do early-stage deals.  The number of early financings done in the past few years seems to back this up.

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June 25, 2007

The Taxman Cometh for VCs?

The tax structure that applies to VCs is under great review right now.  Fred Wilson is one of the few VCs that has come out in favor of taxing a VC's carried interest at ordinary income rates rather than capital gain rates.  Fred's never been afraid of controversy.

I think that capital gains treatment should apply when the investor risks their capital (time or money) in order to try to create a gain.  A VC's carried interest has no downside risk -- if they lose money on the fund, they don't have to repay investors out of their own pocket (nor should they).  They get a share of the profits, and not losses.  The limited partners in these VC funds have clearly risked their capital as they may not get their money back.  There isn't risk in the VCs carried interest, which is part of Fred's argument to tax it at ordinary income.  Note that this clearly should not apply to a VC's personal investment as a limited partner in the fund.  That investment clearly risks capital, and has to maintain capital gains tax treatment.

Don't assume that the tax code is consistent, however.  There are thousands of inconsistencies, exceptions and incentives in the tax code which encourage and discourage certain types of behavior.  Ask anyone subject to the creeping AMT if the tax code is fair.  So, although I think that consistency should be a goal, it obviously isn't a tax rule.

Also, VCs in smaller funds that don't draw big fees are risking their time to try to build companies in order to create gains for their investors and themselves.  If a VC earned zero salary and only made money if their investors made money, there might be more sympathy to keeping capital gains treatment for their carried interest.  Or, is this similar to a commission-only sales rep who pays ordinary income tax rates?  With huge private equity funds making tens of millions of dollars in risk-free fees for their partners, it's hard to see the risk that those general partners are taking in any case.

In addition, I don't like changing the rules on an investment vehicle once it's in place.  That deal was done with a certain set of tax structures, and it isn't fair to change the rules.  So, any tax changes should only apply to new fund vehicles put in place after the changes take effect.  Existing funds should be grandfathered, but care should be taken that these funds can't be extended in order to preserve the grandfathering.

So, what to do?  I think it is hard to make a blanket change.  Risk needs to be rewarded, whether it is time or money risked.  And, the system shouldn't be changed without ensuring that the venture capital and private equity models are preserved.  They add a lot of value to the economy and have created wealthy investors, VCs and entrepreneurs.  So, I hope Congress proceeds with caution.  Let's hope something comes up to take the heat off this issue in the public eye so change can be more deliberate.

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June 22, 2007

Summertime Blues?

A lot of entrepreneurs think that venture capitalists take the summer off.  That's not exactly true.  But, there is no question that things slow down.  With summer starting yesterday, I thought I would explain some of these dynamics.

First of all, VCs do tend to take some amount of vacation during the summer.  Those of us with kids tend to take big trips with our families, sometimes to exotic places.  And, to maintain sanity, you need to unplug, at least somewhat, when you take time off.  So, communication with entrepreneurs that you are working with can get interrupted (but excitement about a deal tends to override the need to unplug!).

But, it's rare to take more than 2-3 weeks off.  So, where does the impression that VCs take the whole summer off come from?  One thing to remember is that VCs work as individuals most of the time, but investment decisions are made by the team.  Depending on the partnership, there may need to be a complete consensus on a new investment.  Or, perhaps one or two key partners have to see a deal before it can go forward.  In a bigger partnership, there may never be a time during the whole summer when all the key players are available at once for a final presentation or a full discussion.

So, the individual VC partner is working, but the partnership may be very slow, or stalled, during the summer until all the key players are back at work.  A smaller firm will have much less of a problem here.  Although at a small firm an investment decision is likely to require unanimous approval, there are likely to be many more weeks when all the partners are in the office simultaneously.

If your company's progress or financial situation dictates that you are going to try to raise money during the summer, make sure you give yourself plenty of time to deal with these timing issues.  Ask the Partner that you are working with exactly what the summer schedule is likely to be.  Make sure you understand who will have to see your deal in person during the diligence process and get these meetings scheduled in advance and around people's vacations.  And, there is nothing like competition with another firm to get someone to move faster and bend the rules.

The Who plays Summertime Blues

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June 20, 2007

It's all in the letter

An angel investor friend of mine told me recently that he has heard of several angel deals in Boston where a VC coming into the deal after the angel rounds had been done had required that the VC round be labeled Series A, the typical designation for the first investment in a company, and that the angel rounds be re-labeled starting with Series B.  No other economic changes happened.  It was purely a name change.

Why would a VC worry about this?  It has to be because they are worried about marketing to their investors, to other entrepreneurs, or perhaps to themselves.  Many firms that have built their reputation on being 'Series A' investors (the first money into a company) have now moved to being later stage investors so they can put more money to work faster.  With larger funds to invest, it has become more difficult for some firms to justify doing early stage deals.  But, they still want to position themselves as such with their investors and other entrepreneurs.  Being a 'Series A' investor is a point of pride.  So, I guess that VCs are now writing some revisionist history so they can still claim to have invested in Series A.

I think that this is kind of crazy.  LPs won't be fooled because in the end all they care about is how much money goes into an investment and how much more comes out.  If someone else invested first and lowered the risk, fine.  Maybe it is marketing to other entrepreneurs that is what these VCs are worried about.  If word gets out that they don't do real Series A deals, entrepreneurs will go elsewhere with their deals.  That hurts VCs in the long term.  But, just changing the letters around won't solve this problem.  They are only fooling themselves.

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June 13, 2007

Massachusetts Billion$?

Jeff Bussgang has an excellent post on what it takes to build a billion dollar company in Massachusetts.  I've written and spoken for a while on the lack of 'anchor tenants', or successful big companies that act as a hub of activity, in Massachusetts.  EMC is certainly a big player in the storage market, and they have been very active in expanding their company through acquisition.  But, there are very few others.

In earlier times, companies like Wang, Digital, Apollo, Wellfleet, Cascade, Shiva, and many others either sold out or collapsed.  They weren't willing or able to lead for the long-term.  There are also a host of successful but smaller companies, like Analog Devices and Avid, that haven't expanded their business more broadly to truly become an anchor tenant.  This analysis is focused on IT companies.  I think that the Life Sciences sector in the Boston area is stronger and more vibrant in this respect.

We need these types of big companies, as Jeff notes.  Perhaps the clean energy sector will be a source of a new wave of companies that can anchor this segment for Massachusetts.  I hope that some of these companies have the fortitude and good fortune to become the new pillars of industry in our region.

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June 12, 2007

One more from Marc

Marc Andreessen wrote a bonus 3rd post on venture capital.  I recently posted on his first two excellent writings.

This post from Marc does a great job explaining why there will perpetually be too much money in venture capital.  With a fixed asset allocation for venture capital, institutional investors will continue to allocate money to VC even as returns continue to be sub-par.  At some point, there will be a good year, and there will always be some number of funds who do well (or get lucky, depending on your point of view).  Investors are willing to do poorly for a while in order to capture these outsized returns.

I think that this trend is exacerbated in the Boston market where there have been proportionally many fewer very large VC returns since the telecom bust.  Boston will need to be strong in a new sector (perhaps clean energy?) in order to be a hub for outsized returns.  Without some of these, a disproportionate share of the disproportionately large VC allocation will continue to go to the West Coast.  That might make investment sense, but it isn't great for the future of Boston.

I would have hoped that the big Internet and Telecom busts would have scared away enough capital to make venture investing seem more rational, but that hasn't been the case.  There is so much money around to be invested that these losses are still mostly noise to institutional investors.  So, smart investors have to find segments that are underserved.  Perhaps early-stage VC in Boston is one area that is underserved.  Most existing VC funds are hesitant to invest so early nowadays.  A few new firms are trying to capitalize on this opportunity, including .406 Ventures and Kepha Partners, both good friends of mine.

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June 11, 2007


I've reviewed a lot of early stage business plans over the past few months.  All of them are for companies that are looking for their first capital, many times from friends, families, and angel investors.  Some of them are also targeting early-stage VCs.  One thing missing from most of them are suitable comps (or comparisons) to help a potential investor compare the prospective investment with past successful investments.

Comps are helpful in several areas.  First of all, it's important to show how the business model of the prospective investment mirrors a successful business model from some other company.  Maybe that company is in the same segment and the new company will be a direct competitor.  More likely, the new company is trying to displace existing competition with a more efficient business model.  In that case, look for other market segments where a similar shift has occurred.  Also, show why the stakeholders in the new company's market are likely to be receptive to this business model shift.  Who wins?  Who loses?  Those 'losers' are the new company's competitors, even if they don't make the same type of product or service.

Another important comp is one that shows that a company with this type of model and in this type of market can scale rapidly.  Generally, markets that are growing rapidly are ones that are ripe for new entrants to take some significant market share.  Sometimes, a new company with a disruptive technology can drive the growth in a new market.  Occasionally, markets are efficient enough that a new competitor with a strong proposition can steal market share in a commoditized market.  With a new company, you need to figure out which of these dynamics apply to your situation.  Provide some evidence and provide a comparable growth situation as an example of rapid growth.

The most common type of comp that entrepreneurs focus on is the exit comp.  When you look at what the exit can be worth, make sure that you are comparing apples to apples.  Compare public companies to other public companies, or discount the earnings or revenue multiple when comparing a public company to a private company.  When looking at M&A exit multiples, you need to make sure that your comps are ones from recent times in a similar environment.  Make sure that the companies are at similar stages (profitability, revenue growth, etc.).  The more different a comp is from your new company, the more you have to discount the comp to cover the level of risk in the comparison.

One of an entrepreneur's most common complaints is that the investor or VC doesn't 'get' their opportunity and doesn't see the  big potential.  Effective use of comps can make your exciting story easier to understand.

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June 10, 2007

Marc Andreessen on VC

Marc Andreessen, founder of Netscape, has a couple of interesting posts on his blog about venture capital.  I agree with just about everything he says.  Of course, he has the perspective of someone who has delivered great successes to top-tier investors.  I am sure that someone else could be more jaded.

Part 1

Part 2

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June 06, 2007


I met with an entrepreneur recently who wanted to get my feedback on his business plan.  I meet a few new entrepreneurs every week, so this wasn't unusual for me.  We didn't know each other well beforehand, so we spent a few minutes getting to know each other.

He asked me Why?  Why do I take time voluntarily to hear about plans from entrepreneurs.  I don't have a fund to invest, and I can only do so many advisory boards.  I am not looking to charge entrepreneurs for my advice, but I do end up taking some formal advisory board positions which include modest stock option grants.  I don't really need a job in order to live the lifestyle I want.  Why don't I spend my time playing tennis or hanging around with my kids?

My answer was that I want to stay involved in the high-tech community.  I might become a VC again.  I might go back to being an entrepreneur or start-up executive.  No matter what I do, I need to stay fresh in this market.  The technology space is moving so fast that if you don't stay current, you quickly become a dinosaur.

I learn something from every meeting I have, even if I don't end up being that interested in the company or don't continue working with them.  So, I want to keep meeting with interesting people who have interesting ideas.  I get 'freshness' out of these meetings, so I think that that's a fair bargain for my advice (hopefully good advice).

By the way, here are the lyrics to a song by the old musical comedian, Allan Sherman.  This song, Good Advice, gives the appropriate caution to someone who listens to free advice.  I wish I could have found an MP3 of this to link to.

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June 05, 2007

Christina as Finalist for Entrepreneur of the Year

Congratulations to Christina Lampe-Onnerud, CEO of Boston-Power, on being named a Finalist for the prestigious Ernst & Young Entrepreneur of the Year Award in the New England region!  Good luck on June 14th.  The list of finalists is pretty impressive.
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May 30, 2007


It was several years ago when my friend, Russ Gocht, started Mobot.  They started with an interesting idea -- have consumers capture images on their cameraphones and use image processing technology to determine what was in the picture.  Then, send the consumer an appropriate marketing message that is tied to what they took the picture of.

Mobot may be a bit ahead of its time, but you have to admire the persistence of the team.  They have found opportunities to deploy their technology and have built up great real-world expertise in deploying innovative mobile applications.  I think that the market is maturing and these types of capabilities will be in greater demand.

Part of the challenge is consumer education.  The graphic above certainly looks and sounds simple enough.  But, who is going to educate consumers about this capability?  That takes time, money, and a compelling reason.  And, what happens if I take a picture of my big toe and send it to Mobot?

It's clear to me that there will be more and more marketing to consumers through their cell phones.  Mobot may be part of that mix.  They're certainly staying close enough to the market to be sure that they have a good shot at it.

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May 22, 2007

The Enterprise Strikes Back

There is a resurgence in enterprise purchases of IT products from start-ups.  The WSJ has an article today (subscription required) that describes this.  For those of you without a subscription, here are a couple of highlights:

Big businesses and institutions have always been somewhat hesitant to buy substantial amounts of tech gear from small companies. But they grew even more averse after the dot-com implosion: Many enterprises got left in the lurch after they purchased from small equipment makers such as Caspian Networks Inc. and Procket Networks Inc., onetime successes that went bust in the downturn. As a result, many businesses began shying away from tech start-ups and instead turned to stable suppliers such as Cisco and Alcatel-Lucent.

Now corporate tech managers are once again starting to buy equipment from small networking businesses with little-known names such as Riverbed, Aruba Networks Inc., Isilon Systems Inc. and BigBand Networks Inc. Many of these small firms make products that solve new corporate-technology problems, such as how to most efficiently store new corporate data like video, or how to best improve the transmission of information across networks that have been weighed down by multimedia applications.

While some of the big tech firms also offer similar technology to deal with such issues, tech managers are finding that the start-ups often have more cutting-edge products that are cheaper than the big suppliers' offerings. "The old guard equipment guys are having to think about more than just equipment [and] they're having to think about software and video," says Joe Skorupa, a research analyst with Gartner Inc. "They aren't used to thinking in those terms."

The upshot: a surge in business for many small tech companies, which is contributing to an overall boom in the tech-networking industry. Riverbed, which makes products to speed up corporate networks, saw its 2006 revenue more than triple to $90 million from a year earlier. BigBand Networks, a Redwood City, Calif., firm that increases corporate-network bandwidth, nearly doubled its revenue last year to $176 million. Many of these start-ups have recently staged successful initial public offerings, with Riverbed's stock jumping more than 50% on its first day of trading in September, while Isilon's rose 77% on its debut in December.

Businesses and institutions aren't over all their start-up fears, however. Many are putting their new small suppliers through a far more rigorous inspection process than in the past before deciding whether to buy from them. Among other things, they are consulting industry research firms to vet the start-up's financials and are talking with other customers to see how the start-up responds to problems.

There have been several IPOs of tech companies that made it through the bubble and sell to the enterprise.  With enterprise IT spending on the rise and a general dearth of innovation from many of the big vendors, there certainly are some start-up opportunities.  But, start-ups have to be smart to build trust with enterprise customers and develop cost-effective sales channels.  This usually begins with some sort of OEM partnership with a bigger vendor to get initial sales and establish credibility.

In addition to the types of networking and storage gear that is mentioned in this article, I think that enterprise infrastructure to roll-out and manage wireless applications across a wide area network should become a hot area.  With enterprise profitability strong and ROI from IT roll-outs easier to measure, spending in many of these segments should remain strong.

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May 21, 2007

Keep It Simple

One of the start-ups I work with received a term sheet a few days ago for a first round of financing.  As a very early stage company, this was not a big round nor was it at a high price.  But, this is the type of financing that early stage companies need to get going.  Up until now, this company had raised a few hundred thousand dollars of angel financing.  If this new round closes, it will allow the company to launch its new Web service.

As I was helping the CEO review the term sheet, I was surprised at some of the bells and whistles that the venture firm had put into the financing terms.  Without going into all the details, I would say that the venture firm had pushed toward some of the limits on what they could expect in an early stage round.

One reason why I like clean and simple terms for early stage financings is that terms for later rounds always get 'worse'.  Later stage investors, who generally pay a higher valuation for the company, feel that they should get some nicer bells and whistles than the earlier stage investors.  Rather than no dividend on their preferred stock, they will ask for an 8% dividend.  Rather than having a capped participating preferred, they will ask for an uncapped participating preferred.

[By the way, if you are baffled by these VC terms, you should read the Term Sheet series on Ask the VC.]

Another reason to have clean terms is that it gets the VC onto the same side of the table as the entrepreneur as quickly as possible.  As an early stage investor, you only really make money when the company has a nice exit.  You can't do much by trying to juice up the downside with a few nice financial terms.  And, certainly, you don't want to do this by taking away the upside from the entrepreneurs.  This leads to the start-up employees defaulting to the 'living off the fees' mentality that I described here.  This is the antithesis of what start-ups are about.

So, what's the right structure for an early stage deal?

  • Convertible Preferred Stock
  • Simple 8% dividend
  • 1x Lquidatoin preference
  • Participation after the liquidation preference, but cap that at 2x the original investment
  • Weighted average anti-dilution protection
  • Keep the Board small

There may be other questions on terms.  Put them in the comments, and I'll respond.

I like the structure above because it is clean and simple.  It gives the investors the preferred treatment they deserve for putting up the money.  It gives the investors a modest 8% return via the dividend.  It gives the investors preference in getting to a 2x return, which is very modest for an early stage VC.  But, for outcomes bigger than that, the investors and entrepreneurs are directly aligned as the investors would convert to common rather than take their capped preferred return.  Most importantly, you can push later round investors to stay close to this structure, which keeps some upside for the entrepreneurs.

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May 15, 2007

Living off the Fees

There has been a lot written lately about VCs living off their management fees (I mentioned it here).  This is a side-effect of large fund sizes which throw off 2+% management fees per year.  The bigger the fund, the larger the fee.  And, the VC partners of large funds tend to keep any 'excess' fees (beyond operating expenses) as a 'bonus.'  The problem is that VCs make a lot of money each year from their fees, significantly lowering their motivation to drive value in their investments (which would reward the VC in carried interest).  This is an even bigger problem in buyout funds, although they have had good performance lately.

This morning at breakfast, an entrepreneur told me that he felt that a lot of start-up executives were inheriting the 'living off the fee' mindset from their VCs.  Because many serial entrepreneurs have not made money from their equity in their recent companies, or have had their equity squeezed from multiple rounds of capital, executives are focusing more on getting 'market' salaries and on having job perks (flying business class, etc.).  They also see the lifestyle that the high VC fees have provided for their board members.

To me, this totally destroys the start-up model.  One of the main advantages that a start-up has is a highly motivated workforce.  You really can't afford to pay in cash to compensate a start-up executive for the high-level of work they have to do.  But, if their equity pays off, they could end up doing very well.

The key is to make a lot of progress on a little capital.  That's the only model that ensures that the VC gets a good multiple on their money (which they and their limited partners require) and the entrepreneurs still have a lot of value left over to divide up between them.

If a company can generate an exit value of $100M on $8M of total invested capital, that's a 12.5x multiple on capital.  If the VCs owned 67% of the company for their $8M, the VC would make just over 8x on their money (they're happy) and the entrepreneurs still have $33M to divide up between them (they should be happy).  This is a simple analysis assuming no bells and whistles on the VC terms.

It's much worse if the company has to raise $25M to get the same result.  By this time, the VC's probably own 80% of the company.  So, they make just over 3x while the entrepreneurs and employees (and there are likely many more of them for a company that has raised and spent this much money) will split up $20M.  This might seem like a lot of money, but chances are that this kind of deal also has some VC bells and whistles which suck another $5M out of the entrepreneurs pockets.  Not much of a payout for a $100M exit.

The lessons: Clean deals.  Simple terms.  Raise only what you really need.  Be frugal.  Stretch your cash.  Get to break-even as quickly as you can.  And we should all have our compensation dependent on the upside.

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May 09, 2007

Trolling the College Halls

There is a good post on VentureBeat today about finding investable opportunities in college labs.  The clear message of this post is that you have to take a long-term view in university relationships.  You have to be willing to invest time far in advance of finding a deal.  And the volume of deals to consider is very high.

Building trust with the faculty is a key factor, too.  I've tried to stay engaged at MIT over the years by teaching a few class sessions, participating in some entrepreneurial workshops, and serving as a Catalyst for the Deshpande Center and the i-Team class.

I just finished up mentoring an i-Team looking at a technology from the Media Lab at MIT.  The process of working with the students was great.  We had a team of Sloan students who were highly qualified for this project.  They did a very thorough job analyzing various market approaches, did significant customer diligence, and came to reasonable conclusions.  One of the students is likely to spend some time with the technologist to see if this can become a stand-alone business.

As a VC, you have to be willing to put in this type of effort with university students to build trust and to eventually find a deal worth investing in.  By building up a good reputation at MIT, I found some deals there over the years.  This past semester, I also taught a class session at Babson, in my friend Angelo's class.  Students there are just as sharp.  It would be great to be more involved there over time.

So, if you are interested in finding deals in university halls, be prepared to put in a lot of time first.

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May 08, 2007

VC's Not Yet Big on Cleantech

I think that within the next five years, 'cleantech' will be a significant investment sector.  I also think that it is a critical area for Massachusetts investment.  Massachusetts has the technology source (places like MIT), entrepreneurial talent, many industrial companies that have executives with skills to build manufacturing businesses (Millipore, Waters, etc.), and a trained workforce hungry for manufacturing jobs.

However, according to this report from Lux Research, VC's are not yet a significant funding source for cleantech start-ups.  VC's accounted for $2B of the $48B in cleantech funding in 2006, but that was more than double the dollar amount of 2005.  The balance of the funding comes from government and corporate investors.  VC's funded about one-quarter of the start-ups.

I expect this will change soon.  Unfortunately, many existing venture funds aren't looking actively in this space.  You don't see a lot of the 'usual suspects' as investors in cleantech companies.  These firms are going to have to dip their toes into these waters in order for them to position themselves for what is likely going to be a big increase in opportunities in this sector.

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May 02, 2007

It's impossible to raise $2M

I have heard from entrepreneurs over and over again that "it's impossible to raise $2M!"  This amount is too large for most angels and angel groups.  They are more likely to want to invest $250K - $1M or so.

For most VC funds, an investment of $2M is too small for them to bother.  As they have a $300M - $1B fund to invest, a $2M investment doesn't put enough money to work to take up a precious time slot.  Every investment, regardless of size, takes some time to mentor, monitor, and add value to.

But, $2M is just about the right amount for most early stage companies as a first investment.  Perhaps a company has raised $250K-$400K in angel money.  This gets the company up and running, but is not enough to move toward scaling the business.  $2M should be enough to get to the initial revenue stage and to show exactly how the business scales.  The product should be in its first release, and the initial revenue model should be validated.  A sales pipeline or steady source of sales traffic should be in place.  An initial team is probably in place.

In the Boston area, there are very few firms that will really invest only $2M in a new company (excepting situations where a VC firm is providing seed funding to a known successful entrepreneur).  I can direct early stage companies to the same 5-6 firms, but the other 10-15 'name' firms haven't shown an interest in looking at early stage companies that have modest capital needs.

Some of these companies may turn out to be big outcomes.  Many of them will provide a very significant multiple return to their investors.  But, none of them are likely to require much capital.  That sounds like a sound investment recipe to me, but if you have to put a big fund to work, you may miss the chance...

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April 23, 2007

Catch and Keep

Josh Kopelman has a good post today on Redeye VC on the interaction models of social networks.  Josh calls these business models, but this post isn't about monetization.  It's about how you interact with a site and how that predicts ultimate value.

The more valuable model is 'catch and keep' (vs. catch and release).  This means that once you start interacting with a site, you keep coming back and deepening your interaction.  Obviously, this is worth a lot more than a less regular access pattern.  When you become a significant part of a user's life, you have their attention on a regular basis.  This is worth money.

What attributes determine whether a site is 'catch and keep' vs. 'catch and release'?  Some thoughts I have:

  • The site needs to move an existing regular user action online.  You are much more likely to communicate with your current friends than your high-school classmates every day.
  • The site needs to provide you value on a stand-alone basis with information that is important to you.  You should have a reason to go there beyond just checking in with your friends.
  • The site should build value as the numbers of users grow, delivering leverage from the aggregate information.  The site should be able to allow the user to act on the aggregate information rather than just on their own information.
  • The site should provide easy links and access to other related sites, becoming a portal for a whole host of user conduct in this area.
  • The area of interaction needs to stand on its own rather than being a subset of something covered in an existing broad site.  For example, Geezeo will build a social network around personal finances.  This isn't something you are likely to put on your My Space page.

What other attributes do you think make a site 'catch and keep'?

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April 11, 2007

Hook Mobile

Another company I have been advising is Hook Mobile.  I've been tracking this company for more than a year.

Hook is banking on the acceptance of collectible and unique mobile content.  Think of various offline models like trading cards, collect-to-win games, card games (like Magic the Gathering) where there are unique and valuable cards.  Hook believes that all of these models will move to the mobile phone environment.  Their infrastructure allows carriers and big brands to deploy these types of models in the mobile environment.

Hook has had great traction and interest from big media properties.  For example, Hook enabled a collectible trading card promotion for Survivor.  And, Hook recently announced a deal with Warner Music where they will power a mobile trading card collect and win promotion for rap artist Yung Joc.

I find Hook's application interesting.  As they work with more brands, they hope to refine the user experience and build more awareness for this type of unique content.  If they are successful with this, they will be in the lead to power many interesting mobile marketing programs.

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April 07, 2007

Is There Hope for Boston?

The Boston area has really been falling behind in terms of venture-backed activity.  If you click through some of the other reports on the site, you'll see that outside of biotechnology and later stage deals, the amount of early-stage IT investment activity in New England is a small fraction of Silicon Valley.

The Boston area was always some fraction of Silicon Valley, but I think that the environment in Boston is even more depressing than the numbers would indicate.  Several VC firms that had been very active in Boston have fewer active investment partners than they had previously.  And, very few VCs are interested in investing in some of the more interesting new market sectors (clean energy, Web 2.0 apps).  Some quotes I have heard from New England entrepreneurs when they try to raise money in Boston:

  • It's impossible to raise $2M in Boston.  It's too much for most angel groups, but too small for most VCs that are looking to put much more money to work.  But, it's exactly the right amount for my early-stage business.
  • My deal won't appeal to Boston VCs.  But, I am getting more interest from NY and definitely Silicon Valley VCs.  They get it.  I guess I have a Silicon Valley deal.

So, what will it take for the Boston area to become more vibrant in the venture business:

  • We'll have to work harder to build up deals in more interesting spaces.  They won't just be able to ride on market momentum.
  • Team building will require significant effort, particularly on sales and marketing
  • VCs will have to dip their toes in to the water in some new market segments.
  • CEOs will have to work hard to expand their skills into new market segments
  • Web 2.0 companies will have to work hard to stay relevent to the Silicon Valley Web giants.
  • Work harder to leverage outsourced technical talent from Eastern Europe.  I know several companies doing this successfully now.

Also, one challenge for Boston is that there are virtually no 'anchor tenant' big companies that provide a solid base for the high-tech community.  Most of our big exits have been companies acquired by Silicon Valley companies.  I am regularly working on convincing entrepreneurs to stay in Boston rather than move to California.  If they all leave, the environment will just get worse.

I am committed to the Boston area for myself and my family.  So, we need to rally all the stake holders in the area to make sure that Boston remains a key market for innovation in venture-backed companies.

This is a topic I'll write about from time to time.

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March 31, 2007


One of the companies I have been advising is GateRocket.  GateRocket was founded by friends of mine who took the chance of starting the company in their house with no income and no outside funding.  You've got to love entrepreneurs like that.  They're committed to the idea and willing to sacrifice alot to see it come to fruition.  Something every investor should look for.

GateRocket offers a hardware and software solution to greatly speed up the verification of FPGA (Field Programmable Gate Array) designs.  FPGAs are becoming increasingly powerful and complex.  They are the highly functional chips that power many of the electronic devices we use every day.  Although these devices are programmable, the complex designs can be challenging to test and verify.  Founder Chris Schalick developed some unique methodologies for verifying these designs, filling an important gap in the marketplace.

GateRocket is angel funded.  Many VCs are wary of investing money in the design tool space as the outcomes are generally limited.  Conventional wisdom is that you have sell these kinds of companies to one of the big players in order for revenues to scale.  That may be true in the GateRocket case, but I'm pretty confident that the angel investors will get a very nice return on their money.  The outcome may end up being too small for most VC funds, but this is a segment where angels can really do well.

I've known Chris Schalick (and co-founder Stacy Swider) for years.  They're smart and hard-working.  It was a lot of fun giving them advice in my living room as they were just starting up.  Now they've got a strong CEO, Dave Orecchio, who the angel investors brought in (nice value add!).  The company has very nice customer traction and should do well.

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March 25, 2007

Sowing Seeds

Fred Wilson wrote a nice post on seed investing this morning.  This is directly in line with my thoughts on the benefits of getting into an investment early.

One key discipline that you have to have in order to be an early stage investor is to know when to fold your hand (in keeping with Fred's poker analogy).  Although the decision to stop backing an investment is very tough, it's easier to do it with a real early stage company as fewer people are involved and less has been put at risk.  There's always the risk that the VC and the entrepreneur don't agree.  The VC may think that the business won't gain any traction.  The entrepreneur is usually an optimist.  In that case, the VC can back away gracefully and convert their preferred shares to common shares.  If the entrepreneur can get someone else to finance the company, the VC won't be in the way.

I always prefer to make my own mess than to inherit someone else's.  If you build a company from scratch, you know the risks and you know where the bodies are buried.  If you come in later, you have to build in financial protection mechanisms in case surprises come up.  Later stage investors often describe the "first board meeting blues" when you come back from the first board meeting after an investment is made, now finally knowing what the REAL situation is at the company.  As many have said, the vacation doesn't often match the brochure.

I also think that investment style has to match investor personality.  You can make money investing early and investing late.  Your feel for an investment very much matches your ability to tell in your gut if an investment is going well.  That's why it's important to stick to your knitting in this business.  There's a risk that many VCs are now getting away from what they know best.  That will almost certainly mean that their returns won't be as good as they where when they stuck to their sweet spot.

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March 21, 2007


At dinner tonight at a local Chinese restaurant, I received the following fortune:

A goal is a dream with a deadline

It reminded me of something I learned long ago about goal setting.  You should set SMARTP goals.  When done right, they really motivate you:

Specific -- Who, What, Where, When, Which, and Why

Measurable -- There should be no debate about whether or not the goal is achieved.

Attainable --It's pointless to set an impossible goal.  It's even demotivating.

Realistic -- Similar to Attainable, but also includes the balance of other commitments and constraints.

Time-based -- Must have a deadline!

Positive -- You feel better if this goal is something you achieve, rather than something you avoid.  "Don't miss our budget targets this quarter" is not a motivating goal.

This was originally SMART (no P) goals, but I liked adding Positive.  I use this rubric all the time to make sure that goals are more than just dreams with a deadline (which is better than dreams without a deadline).

All of this pales in comparison to my all-time favorite fortune:

 You have a tendency to be shy when undressing outdoors.

Yes, I really got that one.  They don't make fortunes like they used to.

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March 13, 2007

Free can create value

There has been some discussion in the blog world about how to create value when you give something away.  Josh Kopelman correctly points out that the hardest thing about offering a free service is getting users who pay you zero to make the leap to paying you something.  It was on Fred Wilson's blog where I first heard the term 'freemium', describing a service which is offered for free with the option for some users to upgrade to a premium, paying service.  I'm skeptical of high rates of conversion to premium, so free services need other sources of revenue.  Everyone expects that a free service will be supported by advertising.  And, that's not a bad way to make some money.  But, I would be worried that advertising on its own won't scale to be enough revenue to build a big business.

What is most interesting for me is when a free service can attract enough users that are qualified in some fashion and can be handed off to other services who will pay a bounty for a lead or a sale.  This allows the users to decide when they are interested in some new service.  When they are interestecd, they click.  The click should be worth something.  It's even more interesting when this click is tracked through to a sale which pays a nice bounty back to the original site.  This pay for performance model goes beyond just plugging in Google ads to your site.  You need to negotiate partnership deals with suitable partners.  But, your free customers can be worth more in this way than as viewers or clickers of ads or buyers of a premium service.

Like Josh, I am real interested in market segments that can be collapsed with a free model, and particularly those where you can get paid bounties when your users raise their hand to indicate an interest in a related service.

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March 05, 2007


One of the most important parts of any start-up's pitch is the competition slide.  This is where you both define exactly how you plan to attack a market as well as how you position the competition.  I think that it is almost impossible to really understand what YOUR business will do and how you will succeed unless you have a thorough understanding of the competitive landscape.

You need to think about competition broadly -- existing solutions to the problem you plan to solve, substitute solutions, start-ups who may be taking a similar approach as you, big companies, small companies, etc.  You have to think about all aspects of these competitors -- technology, financial strength, quality of backers, revenues, brand strength, customers, partners, distribution, etc.  One or two lines on strengths and weaknesses isn't enough.  Try to look at the landscape they way that a customer would -- why would they buy from them?  why would they buy from you?

In a business plan presentation, you'll have to abbreviate this to make it succinct.  But, be ready with a more detailed analysis early in the diligence process.  Most VCs will ask you about competition very early on.  Show them that you know your market.

Also, don't be afraid of showing that you have competitors or that there are other start-ups with similar ideas.  There are no interesting markets with few competitors.  The key is how you will target segments in your market, how you will tailor features and distribution partners to reach that segment, and how your unique insights and combination of skills give you some advantage in that segment.  Markets are rarely targeted and won horizontally.  So, initial segmentation is important.

As a VC, I was always wary when I started finding competitors that the entrepreneur either didn't know about or didn't know much about.  That made me think that they didn't know the market well.  And, there will always be smaller competitors that you don't find right away.  So, if you can find a few new ones, you can be sure that there are a few more.  A good entrepreneur will have their ear to the ground more closely than a VC and should know the landscape well.

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March 01, 2007

Not something to be proud of

My friend Fred has a lot of guts to go along with this. After all that, he had to lose, too.
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February 27, 2007

Time Management II - Touch it just once

Last month I started my time management series by writing about setting daily goals and making sure you get the most important things done each day.  However, we all deal with mountains of small things that have to get handled along the way.  Each one may not be high priority, but if you don't keep up with it, you'll soon be snowed under.

One technique that I use is to try to 'touch' each item only once.  Back in the world where everything was on paper, you could find yourself shuffling papers around on your desk, spending a few minutes on one pile before you moved onto the next.  However, this is inefficient because you have to remind yourself where you were on each item before you can make progress.

Instead, try to handle something just once.  If it's an email, read, resond and file (or delete).  Somethings require more review or a more detailed reply.  If so, schedule a time for you to do that and file the item until that time.  Don't keep going back to it, reading it, and saying "oh, I really need to work on that."  Instead, pick a time to do it, and stick to it.

Once you get caught up on the torrent of communications, it's easier to stay caught up.  I try to set service metrics for myself on how long I will go before responding to an email and for dealing with paperwork.  This may sound like overkill, but this is how you would do things if you were somehow able to outsource all this work (hmmm, perhaps a start-up idea).  I try to keep up with my email throughout each day.  I respond to every message within one business day (usually much faster).  If I can't really answer a question or provide a detailed response in that time, I set an expectation for when I will get it done (and then pick a time on my schedule when I'll work on it).  If something comes up that keeps me from meeting that commitment, I let the requestor know.  If I know that I will be out of touch for more than a day, I set an 'out of office' message on my email.

I treat each of these interactions as a commitment, including a commitment to myself to keep up with communications.  Keeping commitments builds trust, and trust is the foundation of great business relationships.  So, keep in touch by just touching it once.

Here are some nice time management tips, along with the obligatory Dilbert cartoon.

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February 19, 2007

Venture Capital Network

I'm happy to say that The Fein Line is now part of the Venture Capital Network of blogs.  This network is a service of Feedburner and is run by Brad Feld.

Some features of this network are that you can easily find and search other VC feeds and you can advertise on network feeds (but not mine as I do not currently run any ads).  I am overdue in using some of Feedburner's features on my blog, so you'll start to see them appearing here, including FeedFlares on my site and in the feeds.

I hope you enjoy easy access to the extra content.  It's good stuff!

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February 15, 2007

More on energy efficiency

 The Wall Street journal reported today on a study commissioned by AMD (AMD press release).  Although AMD has focused on power savings with their processors, this study reinforces the point I made earlier today about energy efficiency being an area to focus on for new investment.

The key points:

Addressing the need for thorough, credible estimates on data center power use, the study found that in 2005, in the U.S. alone, data centers and their associated infrastructure consumed five million kW of energy, the equivalent of five 1,000 MW power plants.

The study found that in 2005, total data center electricity consumption in the U.S., including servers, cooling and auxiliary equipment, was approximately 45 billion kWh, resulting in total utility bills amounting to $2.7 billion, with total data center power and electricity consumption for the world estimated to cost $7.2 billion annually. The report also examines the growth in electricity demands since the year 2000, concluding that over the last five years server energy use has doubled.

So, there is a huge amount of money spent powering data centers.  Products which enable this to be cut should have a great market opportunity.

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Energy Time

As VentureBeat reported, there were a couple of positive financial events for some Massachusetts energy start-ups yesterday.  Celunol, a company developing a process to make ethanol from non-food plants and other waste products, was purchased (or merged with) Diversa, a modest sized public company.  Also, EnerNOC, a company which makes software to manage power grids more efficiently, filed to go public.

These may be some signs that the energy sector may be maturing sufficiently to justify venture capital investments.  I've looked at a lot of new energy deals, and many of them are still in the science project stage where they are trying to prove out the potential benefits of their technology.  Generally, technologies at this stage are too early to justify VC investment.  As I wrote earlier, VCs have a time frame that they attach to deals in order to achieve their investment objectives.  A science project will likely have a time frame that exceeds what most VCs can tolerate.  And, of course, there is an even higher level of technical risk.

There are some sectors which are maturing more rapidly, particularly energy efficiency.  The right products and services in this space can drop into existing infrastructure and designs and deliver power savings.  This can be done on a small scale or a large scale, and both areas are interesting.

Ethanol and solar power are too areas which are overheating quite a bit in the venture area.  Solar power companies have gone public with some high prices, and this drove a wave of venture investment where the valuations have exceeded in the value, in my opinion (an example of the hype being well ahead of the reality).  However, other areas in the energy space -- efficiency and storage are two of my favorites -- are able to mature on a VC time scale.

I am hopeful that Massachusetts can develop a cluster of companies in the new energy space.  That's an industry that will grow for a long time, and there is a lot of technology in our state that can be used to start some interesting companies here.

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February 13, 2007

Separating hype from reality

Eveyrone knows that "the hype precedes the reality."  Examples are here, here, and here.  Of course, there are millons more.  The Internet bubble may have been the ultimate case (or perhaps this is).  There was so much anticipation of the changes to our business and social worlds that the Internet would cause that valuations hit frothy levels and much money was made and subsequently lost.  Now, we are starting to see the real impact of the Internet on politics (check out some candidates Web sites here and here), commerce, and social interactions.  If you don't have time for a first life, maybe you have time for a Second one?

As an investor, how do you know when the gap between hype and reality has narrowed enough to make an investment?  If you are really ahead of the curve, you may be able to make money by anticipating the next hype wave, but you can get wiped out, too.  Remember Pen Computing?  If you invested the first time in the 1990s, you definitely didn't make money.  Now, it might still be too early for a new investment, but the gap has probably narrowed.  Of course, if you wait too long, you risk being one of many who follow the herd and probably achieve substandard returns (unless you come up with a new twist).

That's why it's critical to have a portfolio of investments.  As an investor in one or two companies, you should probably focus on things where the gap between hype and reality has narrowed quite a bit.  Look for leading customers who are already adopting something new.  Wait for integration issues to get worked out.  Then, find a team that really knows the space and comes up with a great next gen offering.

If you have the resources to have a portfolio, you can mix in some swings where you try to anticipate the hype.  Hopefully, some of these bets on hype, or before the hype, will become reality in your investment time frame.  If so, you may have some big winners which cover up all your other sins.  If not, the bread and butter investments will give you decent returns overall, and you can swing for the fences again next time.

In any event, leverage the talents of people who are smarter than you in the target market segment.  If you can't find these people, then you shouldn't invest.  There are always experts who can give you their opinion, and if you get enough of these that support the hype, it's time to take the plunge.  If not, you haven't dug deep enough.  Keep digging, or keep it real.

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February 07, 2007

Brave New Web

I spent the day today at the MIT Enterprise Forum's Brave New Web conference in Boston.  It was a great day of discussions and networking.  There's clearly a lot of interest in building companies in Boston leveraging the latest Web technologies and business models.

One recurring theme was whether or not Boston was a good place to start new Web businesses.  Is Boston overly disadvantaged compared to Silicon Valley?  Entrepreneurs said that local VCs tend to not be interested in Web businesses and aren't willing to take the same level of risk as their Silicon Valley brethren.  On the other hand, VCs say that they don't see enough business plans with big ideas in the Internet space.  I think that both sides are probably right.  Many local VCs aren't well-versed in the Web space and tend to stick to segments more in their comfort zone.  They don't have a deep enough rolodex to do suitable diligence and don't have a gut feel for these business models.  At the same time, very few entrepreneurs in the Boston area are well-versed in the nuances of Web marketing with a strong track record suitable for VC backing.

The solution is probably for VCs to dip their toe in the water and start funding some capital efficient Web businesses with the best teams they can find.  This will help them develop a feel for this market and will undoubtedly lead to some successful businesses.  If they watch the capital intensity, they can limit the losses from any of the mistakes.  This will also help some entrepreneurs cut their teeth in this market and develop a track record.

Jeff Taylor, CEO of Eons and former CEO of, had the best line of the day.  When he heard an entrepreneur say that local VCs weren't interested in Web businesses, he replied that it was up the the entrepreneur to find a funding source, even if that meant going to Silicon Valley VCs.  Don't let this kind of obstacle stop you.  If you are committed to your business's success, you'll overcome challenges even bigger than this before you are done.

It was great to see such a nice turnout for this event.  Between this and the strong crowd at the Web Innovators Group meeting on January 30, there is plenty of buzz about Internet businesses in Boston.  This market is healthier than most people think!

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February 06, 2007

Vicious Prioritizatoin

Focus, focus, focus.  Something I preach to entrepreneurs all the time.  The best entrepreneurs want to conquer the world.  They believe that their new product or service is going to have a huge impact and will change how many people work, play, or communicate.  They have to have this big vision in order to motivate them to put in the long hours with low pay that a start-up demands.  Who's going to work that hard to build a marginal company that will have little or no impact?  The prize has to be bigger than that.

But, entrepreneurs have to balance this vision of global domination with a focused effort that gets them started on their limited resources.  The challenge is to leverage your existing resources on the most highly leveraged activities that move things forward and keep you on the path to the big win.  If you spread yourself too thin to capture the big vision all at once, you'll fail to get the most important things done.

This is why big thinking visionaries have to be balanced by practical operating executives who can motivate and build a team to make daily progress toward a goal.  It is a very rare person who can bounce back and forth between these two roles.  And, both roles are critical.  Also, as a company starts to make positive progress, it will be presented with many more opportunities for expansion and partnering.  These can dilute what started off as a very focused effort.

As a Board member and investor, I demanded that CEOs exercise vicious prioritization.  Cut the list of tasks and cut it again.  Make sure you have sufficient resources on the most important tasks so that they are done successfully.  I use the word vicious to emphasize that most people don't want to let go of what are good ideas.  Don't let them go, just push them off to Rev 2 or next year's business plan.  If a particular idea is so fantastic, which of your committed plans would you drop to get it done?  CEOs have to be able to prioritize in this fashion to make sure they can achieve their most important goals.

Also, companies have to plan on having some slack capacity.  Product development schedules will inevitably fall behind.  Crises will emerge with key customers or partners.  Hiring may take longer than planned.  All of these situations will demand that existing staff step up their commitment to keep projects on schedule.  But, if you are already scheduling people for 14 hour days 7 days a week, you don't have any slack capacity.

One of the best Engineering VPs I ever worked with would never schedule engineers beyond 5 10-hour days per week.  That's already a heavy workload, but probably not a full start-up workload for an early stage company.  This Engineering VP was a thorough and meticulous scheduler, but he always left slack time in his schedule for critical new features, bugs that were hard to fix, or parts of the project that proved more difficult than planned.  The engineers never worked only those 50 hour weeks, but once in a while they would get a relatively easy week and a weekend off.  That kept them fresh for the start-up marathon.

If you have clear and vicious priorities, you can manage the slack capacity at your company to remain nimble and deal with the unexpected opportunities and problems that every start-up faces.

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February 05, 2007

Time Management I

With so much data at our fingertips and with so many interruptions in business today, it's real tough to stay focused and get things done.  We all have many web sites we monitor, news sources we scan, newsfeeds we browse, emails we need to read and act on, telephone calls we answer, and voice messages we have to listen to and return.  Sometime after we do all that, we have to get our job done.  I struggled myself finding time to start blogging.

Early in my career, I received some great time management training.  The guy who trained me at my first start-up has moved on to other things, so I don't have any recommendations for sources of good time management training.  However, the things that Ken Hecht taught me have stuck with me over the years.  I'll publish a series of tips on time management to pass on some of my experience.

The first thing that I learned about time management was to try to guess how you spend your time, and then figure out how you REALLY spend your time.  This is a good exercise for those of you who don't think you need time management improvement.  If you already know that you succumb to interruption and procrastination, you can skip this exercise.

Try this:  First, write down how you think you SHOULD divide your time between your major categories of activity.  Then, estimate how much of your time in a week you actually spend on these major activities.  For example, how much time communicating via various channels, reading and researching, creating content, working with customers, writing code, in meetings, etc.   Just guess some rough percentages.  Then, try to keep track of this on an hour by hour basis for a week.  At the end of each hour, estimate how much of the previous hour you spent on each of your major activity categories.  You'll be amazed at how far off your estimate is and how far off your estimate and actuals are from what you think you should be doing.  Of course, you have to honest with yourself...

Once you are convinced that you have a problem, the first thing you have to do is set goals for yourself each day.  Start small.  Pick one thing you know you have to do at the start of the day.  Maybe it is work on a major project and hit a milestone.  Maybe it is write a blog post on a particular subject.  Just pick your top priority item for each day first thing in the morning (or, ideally, at the end of the previous day).  Then, make an appointment with yourself to get this item done.  Put it in your calendar and don't double-book this time.  Avoid any and all interruptions during this time.  Just get this one item done.  Once you can do this consistently, try it with two or three things each day.  If you make a good list of your To Do items, you can start to pick these off pretty quickly.

In the future, I'll write about how to manage interruptions and avoid procrastination.  If you have any questions or comments on this subject, put them in the Comments or email me at

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February 02, 2007

Make sure the truth travels fast

Like a car wreck, I have trouble looking away from the marketing campaign gone awry in Boston yesterday.  Kudos to Turner for accepting responsibility and offering to make a payment to Boston to cover the real costs of this mess.  Scorn for the marketing firm, Interference, if they did indeed tell the two guys who put up the signs to keep quiet while the situation unfolded in Boston.  That may be the real criminal offense in this complicated story.

As both a VC and an entrepreneur, I've beein involved in quite a few 'crisis' situations.  These aren't crises when people's lives were potentially in danger, but perhaps where a company's or product's reputation was in danger.  To a start-up, this kind of damage can be fatal.  I think of start-ups as fragile flowers.  Too many mishaps or mis-steps can crush them.

One thing I have learned over the years is to get the truth out fast.  There is an old saying that "Good news travels fast, but bad news travels faster."  That's definitely true, which is why you have to get the truth out fast.  This requires fast action and decisiveness by executives.  It also requires the courage of your convictions.  If you are honest, it's easy to be courageous.

The truth is very powerful.  If Interference had called the Boston Police at 1:30 PM yesterday rather than emailing their helpers in Boston telling them to keep quiet, many hours of fear and disruption would have been avoided.  They may have been scolded for causing the situation, but that was going to happen anyway.  Getting the truth out fast would have also won them praise for doing everything they could to stop the situation from escalting.  These days, the truth comes out eventually, and usually fairly quickly.  So, to be proactive, you have to push out the truth even faster.

On one corporate Board that I participated in, we had a discussion about how to handle a tricky but minor situation.  What should we document in the Board minutes?  This wasn't even a matter that had significant ramificatioins, but we wanted to have a nice, clean paper trail for the future.  One of the Board members declared that he only wanted to document what actually happened.  We had acted in good faith, and if it was a bit messy, so be it.  He also pointed out that it's a lot easier to remember the truth and we'd all have a very consistent version of that, versus something that was not quite true.  As this was a very minor matter, we of course documented exactly the messy path that got the company to their situation.  It wasn't pristine, but it was done in good faith.  And, we all didn't have to take notes on what we agreed to.  It was the truth.

I also find that giving entrepreneurs your true reading of their company and your interest in it is very much appreciated.  People prefer a fast No rather than a long string of Maybes followed by an assumed No. 

Be direct, honest, and get the truth out fast.  It's liberating.

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January 29, 2007

Pet Peeves, Part I

Maybe I am old and set in my ways, but there are some things people do that really bother me.  I guess everyone has some of these, and it certainly helps if you understand that a VC has particular pet peeves before you go pitch your company.

This pet peeve probably shows that I am not just getting old but am also old fashioned.  I hate when people are late and don't call to give me a heads up.  Running late isn't a problem.  We've all been late, and in today's fast paced world, it's hard not to run late once in a while.  But, today is also a very connected world.  Anyone in business has a cell phone.  If you are running late for a meeting with me, please call to let me know.  I won't be mad.  In fact, I'll be happy that you respect my time as much as I respect yours.

If you don't call and are more than 10 minutes late, I'll probably cancel our meeting.  If you don't call and are more than 20 minutes late, I probably will be very hesitant to meet with you again.  If you call to let me know, I'll give you as much flexibility as you need.

20 years ago when I was in sales, it was very tough when you were running late.  You had to find a pay phone and make a call to tell someone that you were late.  I did a lot of international sales, and I soon learned the vagaries of various international pay phone systems.  But, I was never late without calling ahead first.

Of course, over the years, you get a lot of creative excuses for someone being late.  Here's the all-time champ:  A few years ago, I was stewing in my office waiting for someone who was 20 minutes late for a meteing.  My assistant finally tracked them down, and they said that they were "on their way."  When my assistant said that I would cancel the meeting because they were too late, they said that they were so late and couldn't call because they had been in a building that had a forced evacuation due to an anthrax scare and their cell phone had been trapped inside the building until the evacuation was over!  I still cancelled the meeting, but get a laugh about that one every time.

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January 25, 2007

Startups have Freshness Dating

One concept that many entrepreneurs don't really understand is that start-ups have freshness dating.  You know, "Best if Exited by 2010."  There is no explicit schedule for any one start-up, but once the entrepreneur takes money from investors, the clock starts ticking.

There are several factors that influence the end date and how fast the clock ticks:

  • How much capital is required to get to cash flow break-even.  The more capital required, the faster the clock ticks and the less time you have.
  • The pace of development of the market.  A fast moving market (one with high growth and/or increasing number of competitors) will have a fast-ticking start-up clock.
  • The monthly burn rate.  If you aren't burning much cash each month, investors will be more patient.
  • Each investor's situation.  Is their fund looking for a quick exit to help make their fund-raising easier on their next fund?  Does the partner need to put a 'positive number on the board' to enhance their standing in the partnership?  Is the firm looking to free up board slots among the partners to have more capacity for new deals?  These are the 'behind the scenes' issues which drive decisions that often befuddle entrepreneurs and cause tension in investment syndicates.
  • The age of the deal.  As companies raise multiple rounds of financing, investors get less patient.  There are some deals that manage to have multiple lives, with recap rounds of financing and the ability to continue to raise money.  But, these are often very circumstantial.  As an entrepreneur, you don't want to count on your ability sell the dream to an ever-changing syndicate.  As an investor, I always evaluated a company on the amount of progress they had raised vs. the amount of capital raised.  I would be drawn to deals where the entrepreneurs had gotten a lot done on a little capital.

I grew up with an exposure to the grocery business, but in my family and in my high-school job.  I remember working in the produce department when we had too much lettuce.  The manager was worried that it would start to rot in the back room.  So, we had to do whatever we could to 'move the lettuce.'  Don't let your start-up begin to rot -- keep it capital efficient, nimble, and moving forward.  If you sense things stagnating, be proactive about making changes.

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January 17, 2007

Right-sizing a VC fund

In my previous post on entrepreneurship in Massachusetts, I discussed the lack of 'anchor tenants' in the MA high-tech sector.  Another issue in Massachusetts and the rest of the industry has to do with the mismatch between the desired capital efficiency of a start-up and the ever increasing size of most venture funds.  It's very hard for a big fund to invest in an early stage company that may not require very much capital and may only produce a modest total outcome (although a nice multiple on invested capital).

This issue was also recently discussed on Venture Beat by Charles Moldow of Foundation Capital.  I agree with his analysis.  I think that there is an opportunity for small to medium size venture funds ($70-120M) with 3-5 partners.  Funds of this size can make investments in companies that do not require too much capital (maybe $6M from one of these funds over the life of a deal, perhaps two of these funds in the deal all the way through).  With this amount of capital, a $100M exit is a nice win.  If the amount of capital is moderated a bit with frugality, the average $72M exit on a total of $8M invested is also a very nice return.  Exits of this size can move the needle on a modest size fund, but don't get the attention of a bigger fund.

I think that there is an opportunity for funds of this size, and there are some existing and new funds which are targeting this market segment.  Venture fund limited partners are also starting to notice that they should look to smaller funds who can deliver a nice multiple on their money.  The challenge is that there is a lot of money in LP pockets, which tends to force up fund sizes (and push these types of investments out of the sweet spot).

There are other factors which have forced VC fund sizes and exist expectations so high.  I'll write about those in the future.

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January 15, 2007

The State of MA Entrepreneurship

As I am out trying to figure out what to do next, I know that I will be doing something involving entrepreneurship.  Maybe I'll stay in venture capital, maybe I'll join or found a start-up.  However, it's a bit depressing thinking about the state of entrepreneurship in Massachusetts these days (at least in the high-tech sector).

There are interesting opportunities.  I think that the Web is just beginning to show its promise in enhancing communications and commerce.  Mobile communications are also just beginning to move beyond voice and simple text messaging.  Also, I believe that energy and energy efficiency will be key investment and entrepreneurship themes in the coming years.

However, it's hard to see how the typical venture capital models can be applied to some of these sectors.  There are issues of capital efficiency and timing that make it difficult.  Also, Massachusetts doesn't have the anchor tenets and feeder companies to foster some of these industries.  And, that's the subject of this post which will be ther first in a series on the state of entrepreneurship today.

Many times people ask what it would take to replicate Silicon Valley.  I don't think it's possible, but some of the key factors are technology focused universities as a source of new ideas, a business school where entrepreneurship is a focus, sources of venture capital which are willing to take chances, and established companies in the key industries that are sources of partnerships and management talent.  You can also argue that you need an established community of companies that spawn more companies, but that's hard to have at the beginning.  Perhaps the way to start with that is to have entrepreneurs and VCs willing to fund a lot of opportunities before they see any initial results.

In Massachusetts, we don't have those anchor tenant companies that can be sources of management talent and partnerships.  EMC is the closest, but they are focused in just a few segments.  Others, like Analog Devices, don't lend themselves well to spinning off talent and ideas.  There aren't a lot of others that are big enough to be candidates.  Why?

I think that there are two factors -- companies that lack the vision to capture the market in the long term and VCs who decide to cash out instead of going for the long ball.  These issues are probably linked.  In so many industries of the past, the West Coast was 'open' and the East Coast was 'closed.'  Open always wins.  Now, the West Coast is 'consumer' (and 'open') and the East Coast is 'infrastructure.'  Right now, the consumer wins.  The consumer segment is where the spending is and where the innovation is.  Also, strangely, on the Web, it's possible for consumer uptake to be rapid (hard to do offline).

So, we need feeder companies that can help us build companies in the consumer, mobile, and energy segments.  If you are in a small company that has that potential, think about playing for the long ball rather than cashing in too early...

More to come in future posts.

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January 11, 2007

What ever happened to customer service?

As every market segment gets more competitive, customer service emerges as one type of differentiator.  It's why I always go to Starbucks instead of Dunkin' Donuts for coffee (or one of many reasons).  I find that I am incredibly loyal to vendors who give me great customer service.  Those who delight me with service get me as a customer for life.

My favorite ticket guy, Richie, once blew me away with customer service.  I buy concert and sports tickets from Richie.  He's not cheap, but he has access to the best seats.  A few years ago, during a Yankees-Red Sox playoff series, I was in NY for a Board Meeting and wanted to bring the founder of the company to the baseball game.  I had bought tickets from Richie and arranged to have him ship them to the company.  Unbelievably, Fed Ex lost the package.  Getting the tickets the next day was no good as the game was that night.  I called Richie, and he got me tickets to the game couriered to the company.  And, he didn't charge me!  Needless to say, I am Richie's customer for life.  If you ever need tickets, contact me at  I'll put you in touch with Richie.

So, why don't VCs give good customer service?  I have heard from so many entrepreneurs that VCs are horrible to deal with.  They never give straight answers to questions.  Entrepreneurs never know where they stand in the decision-making process.  Too many VCs like to 'hang around the hoop' in case a deal they are cool on somehow becomes hot.  Also, VCs don't treat entrepreneurs well during meetings.  They don't pay attention, they read email on their Blackberry's, and they are frequently late.  I'm sure you've seen the famous Gary the Snowman holiday video from Blue Run Ventures.  Entrepreneurs tell me that this isn't too far from true.

This is a sign of the arrogance and bloat of the current VC business.  I always believed in giving entrepreneurs good customer service.  I was on time, prepared, and attentive during meetings.  I tried to ask good questions, give good, honest feedback, and let them know what the next step in the process was.  I said 'No' when I had made up my mind.  I received frequent compliments from entrepreneurs who told me how refreshing this was.  Huh?  I couldn't believe that this was so rare. 

VCs who don't treat entrepreneurs well should prepare for a rude awakening.  They will eventually not have the best entrepreneurs to choose from.  The VC business changes slowly as funds are committed for years.  But, I expect some big structural changes in the world of early stage investing in the coming years.  As in any business, when it matures, premium providers will differentiate themselves with great customer service.

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