I watched the painful last gasps of the US soccer team on the World Cup stage this morning. They played poorly, with the greatest disappointment being Donovan. Sad but true article from ESPN sums things up. Not certain what the "entrepreneurial" angle on this is other than don’t hire an incompetent for a coach (Arena) or CEO as the rest take the lead from there…a sad day in US soccer history.
Bootcamp: Founders’ Equity
A while back, I asked for feedback from the community on potential topics of interest. One email had a host of questions around founders’ equity. I have been negligent in responding (I hope better late than never!). Great questions and ones that come up often.
1. How should founding teams allocate equity amongst themselves? What is the VC viewpoint on how this should be done?
I am not certain how other VC’s feel, but I like to see the various members of the management team have enough equity each that they a) think like equity holders versus just salaried employees and b) are excited to come into work each morning to build value for themselves. The core founders will clearly have the lion’s share of equity. A founder should think about carving out 10-15% in an equity or option pool for the first wave of hires. These shares can be either stock grants with reverse vesting or options that vest over 4 years. The core founders can divide the remaining portion equally or based upon perceived value being brought to the game. Equal division for the core allocation creates the most "egalitarian" approach though it might not be the fairest one.
2. Many software startup founders now do the seed round themselves
and get to a working prototype. How should the money invested be
treated?
A number of my friends have asked me this question when they are starting up. I would first divide up the equity pre-$ according to the discussions in question 1 above. Once that is set, determine a value for the company (most likely between $2-5m) and let the money buy an ownership stake. A simpler approach so as to avoid the potentially contentious pricing of the firm by founders is to have the money come in as a convertible note that converts at the same terms as the first professional money. This works if a venture or angel round is likely in the next year. Else, price it yourselves.
3. Any opinion on founders getting some (but low) liquidity at time of funding?
There has been a trend lately with late stage deals, for the founders to take money off the table during funding. These companies are usually cash flow positive and the only way for the VC’s to get enough money to work in the deal is to buy founders’ shares. Couple of things to note:
1) this stock is usually common and the new money coming in is preferred. If preferred is priced at $1.00, then common will be priced at a discount to this (often 20-50%) depending on the size of the preference stack (preferred money in). The more preference in, the greater the discount. Founders are often shocked by this discounting. Also, remember to keep this pricing of common consistent with how you are pricing your options. This common sale is a third party pricing of the common. You have to issue your options at that price as well.
2) VC’s generally don’t like to see founders take money off the table. Historically, it has led to founders losing drive and some motivation if they already have their nest egg and the rest is "house" money. Some founders remain equally motivated, but it is hard.
4. Is there such a thing as "deferred compensation" for the founders — and a way to recoup some of This at time of funding?
Founders equity is supposed to account for this. It is truly deferred comp in that you don’t get it until the company is sold and shares are liquidated. Some founding teams will put an IOU in place for a couple of themselves (like an accounts payable). However, new investors are keen on this. We want new money to go towards future growth, not to paying back wages. Also, we would like to see founders acting consistent with an equity culture versus a cash/current comp culture. When founders think and act like shareholders, their interests are much more aligned with the VC’s. Unless there are specific, unique family issues (three kids, etc), taking money off the table for past salary usually doesn’t play well with new investors.
Buzz: Are Acquisitions Replacing IPO’s
Tim Draper and Brad Feld have a variety of interesting observations in a recent Always On panel. One of the topics discussed is about the IPO/acquisition exit mix. Historically, this number has been around 20-25% IPO and 75-80% acquisition. Today, IPO’s make up less than 10% and dropping (and this includes overseas IPO’s). Tepid markets, SOX and other factors are really putting a damper on tech IPO’s. Since IPO’s are usually a great stalking horse for acquisition talks and they usually enjoy around a 50% premium to acquisitions, without them, exit valuations continue to fall. Do more with less capital since the exits aren’t as strong as they have been historically. Let’s hope things turn around…
Bootcamp: Strategic Investors
I was talking with a friend of mine, Patrick Dealy, who is at MaxMD about the pro’s and con’s of taking strategic money. MaxMD has an interesting business model, based upon their being the primary registrar for the .MD domain extension. Doctors and medical institutions can register for www.drname.md there while also beginning to sell a variety of ancillary offerings (HIPPA-compliant email, etc). It becomes a nice Trojan horse for them to penetrate the medical industry.
During the bubble, companies and VC’s actively sought out strategic investors for the "C" and "D" series of financings. They relied on the "irrational exuberance" along with strategics’s limited VC experience to get them to overpay (often 2x and 3x what a comparable VC would have priced the round at). Like any system based on poor, unsustainable fundamentals, this did not end well for the strategics and most shut down their venture arms. Those that stayed involved like Motorola & Intel, remained disciplined and are more active than ever, often getting invited in the first or second round.
While strategics are starting to come back into the market, we are not seeing the silly valuations of the past, though, because of the extra strategic value, they may pay a modest premium. More importantly, they are better educated and bring more to the table, often, than money.
Should you take strategic money? Negatives are: a) if they are a customer/partner, the investment may deter other customers from working with you, b) if they are a potential acquirer, it hinders your sale at the end since others will wonder why an insider did not buy the company first and c) strategics rarely invest across multiple rounds so not a good source if you are looking for investors with rainy day dry powder.
In reality, I have not seen (a) become an issue. In fact, I am seeing strategics (even competitors) coming in together on rounds. Since they are minority investors and often passive, this has not usually spooked other potential partners. This is not to say that it never happens, so evaluate your own situation. Every once in a while, (b) does become an issue. So, it is usually best to not take money from a potential strategic acquirer unless it is clear that they are the primary/sole acquirer.
The benefits are: a) you can often get a boost in credibility if a major strategic in your space takes an interest. If you are a wireless play and Motorola puts money into you, it signals to others that their tech groups canvassed the market and you had the best technology and b) they can often bring strategic benefits to you…access to their tech teams or channels, promotion to their customers, market insight, etc. Being fellow Chicago VC mafia members, we actively look for ways to work with Motorola Ventures.
So, I am generally supportive of strategic investors coming in assuming you have minimized the potential negatives of the deal. Make certain that the money brings with it enhanced value beyond the dollars. Talk with the relevant business units before closing to layout, if you can, a game plan for post investment.
Buzz: Is Printed Media Dead?
“The art of prophecy is very difficult, especially with respect to the future.”
— Mark Twain
As investors, we are continually trying to identify trends from fads and facts from promotions. If you can identify a trend early enough, you can do extremely well. For example, Sequoia’s initial investment (couple of million dollars) into Cisco, would have been worth nearly $170B at the peak of the bubble. Of course, they had long ago distributed shares, but it shows the power of compounding within a long-term trend.
However, the future doesn’t like to reveal itself to you as an investor. It has a rather random characteristic going forward and an annoyingly linear and obvious one going back into the past. One of the topics much discussed in paper and online is the future of printed media. Furthermore, what should traditional offline media companies be thinking about doing?
To get a better feel for these issues, I queries a host of friends in the online media world including Al Warms (Participate Media and RealClearPolitics) and a variety of folks at various magazine back east. Here is where I came out: the future trends for newspapers and general news magazines is not hopeful should they focus on proprietary content models. Open models and focused publications (Economist, etc) tend to have a much brighter future.
There currently is a natural tension between the papers, AP and the internet properties. It does not cost a great deal to get a feed from AP. It provides content (from papers) for sites that papers might view as competition. That said, it does greatly expand the reach of the paper’s content. Also, since most of the sites generally refer back with a link to the original paper’s site, it actually leads to traffic coming back to the paper. Some sites don’t do this and post entire text…which is clearly an issue from the paper’s perspective.
If the papers were to stop feeding content to the AP, then I assume the resulting business model would be either a) the paper would sell directly to the sites or b) the paper would keep its content in a walled garden. If it is the former, the paper would get incrementally more money as the AP cut would come out, but it would have the hassle of dealing with all of the sites. If it is the latter, then most of the sites would find other sources. There are a lot of reporters/publications covering the White House, Cubs, etc. So, I don’t know how much leverage the paper would gain. However, it would lose all of the traffic potentially coming in from those sites. Seems like a lose/lose. I am probably missing some obvious factors here.
The industry dynamics seem to be that content sources are exploding (traditional sources, user-generated, new virtual publications, etc). This is ratcheting up the noise level in the marketplace. So, brand and information filtering will be increasingly more important. This clearly plays to the papers’ strengths. However, consumers also want the most relevant & interesting information, so they want it from a broad array of sources. This does not play to the strength of a proprietary content model.
So, it seems that the model of the future is going to be a federated model. Users will most likely want to have a place(s) they go that pulls all relevant information to one location. Furthermore, it filters and prioritizes it according to the users preferences. Today, the AP editors (or paper editors) determine what is core and important. The communal filtering algorithms seem to work well here. Probably a stronger indicator is number of links to a given article or topic from various other sites (blogs, feeds, etc). It indicates that the topic was important enough for someone to link it to their own content (this is sort of how Google does its search algorithm).
I don’t know what this means for the print world. Specialized and non-traditional magazines (some of them) are growing in subscribers, but the newspapers and general news magazines are losing subscribers. This trend continues year after year. With the high fixed costs of the business, I don’t know how long it takes before the model breaks. Furthermore, I figure as advertisers get better at targeting ads online, there will ongoing erosion of offline ad rates (exacerbated by declining subscriber numbers).
Readers seem to want information around a topic, not necessarily a source. So, if a paper was able to aggregate its own content along with the best from other sources (including user-generated which is a heresy…) and provide an effective filtering mechanism that learns from past behavior, it seems like it would be ahead of the curve. However, if it goes deeper into its proprietary information/content model, I have to believe that it will accelerate the poor trends.
To get a rough sense of what is going on, go to www.alexaholic.com (a traffic tool…has sampling issues and comscore analysis can give you better #’s) and enter www.digg.com, www.memeorandum.com, www.chicagotribune.com, www.nyt.com, www.topix.net. You will see that Digg is closing in on the NY Times’ volume and just spiked (could be noise). Also, Topix and its partial parent, Tribune, seem to be converging in terms of numbers.
I don’t think this is the end of the branded media publications. They have brand, subscribers and presence. However, how they decide to move forward from this point will determine a great deal about their position in the media world.
Lingo: Shadow Tech
I was at the recent ITA dinner talking to Rob Harles from Comscore about how prominent or interesting technology firms are in the Midwest that no one knows about. My favorite example is SSA. A company that nearly no one, even folks in the tech community here, has ever heard of. SSA is a Software 50 company and has sold nearly $800m worth of software in the past 12 months, has 3,500 employees and a $1.4B market cap. Another company is Navteq. Most people a) can’t recall the name and b) don’t associate them with Chicago (even here). Where else but in the Midwest could a $3.92B market cap technology company that powers nearly every map on the web and auto remain hidden in the shadows of obscurity?
Nearly every week, I come across surprise after surprise. Few people realize Archipelago (merged with NYSE) is based in Chicago. I stumbled upon TicketsNow only after 8 years of 80-100% growth there. The Midwest is the largest medical device hub in the US (roughly $82B in annual sales). The list goes on and on.
Rob had a great term for this phenomenon…it is Shadow Tech. Midwesterners don’t tend to like to promote themselves and successful entrepreneurs tend to keep their heads down building their businesses. They hide in the shadows of the Midwest corporate scene. While this is admirable, it makes it more difficult to get critical mass and build out community when the "lobsters" are hold up in their caves.
The Midwest tech scene is much more vibrant than most people realize but, like an underground club, it is very challenging to find. This makes it ideal for venture capital (opaque, inefficient markets) but you have to work hard to uncover the opportunities.
I’ll write in the near-term about why traditional networking efforts don’t work well in this kind of environment. As a community, we need to experiment with different alternative models. The base is here but we need to connect the dots.
Buzz: Breaking Up Microsoft
The WSJ recently had an article discussing a notion that a number of value investors have been championing for some time now: breaking Microsoft up. Since each of the pieces seem to rely on each other (especially on the PC and mobile operating systems), this would be a very tricky proposition to pull off. Food for thought though…
Gates Should Weigh Microsoft
Breakup
Divisions
Would Aid Value,
Mere-Mortal Managers;
Good Timing for Bloomberg?
June 17, 2006; Page B14Bill Gates is gradually ending his day-to-day involvement with
Microsoft and focusing on charity. Because the move offers a time to
reflect, here is something Mr. Gates should ponder. His reputation as a software
developer is assured. But wouldn’t breaking up his creation be the best way to
secure his legacy?
Sprawling companies are difficult to manage. Microsoft’s
businesses stretch from its ubiquitous Windows software to videogame consoles to
an Internet portal. Moreover, the company seems to have lost its touch. It has
fallen behind Google in Web searching, and its latest operating system is
severely delayed. Microsoft may just be too big for Chief Executive Steve
Ballmer, or indeed anyone, to handle. Mr. Gates’s plans to step back may only
intensify managerial problems.
The company has three distinct businesses. Its operating systems
are growing slowly, but produce tons of cash. Its suite of Office software
products is in a similar position. Meanwhile, Microsoft’s other efforts are
potentially fast growers, yet mostly burn cash. Separating the company into
three businesses, or more, would make them easier for mere mortals to
manage.
Moreover, divvying up the company could help to secure Mr.
Gates’s reputation as a great philanthropist. He already plans to give away
nearly the entirety of his fortune. Breaking up Microsoft should mean he has
more to give away. Value investors think Microsoft allocates the capital
generated by its cash cows poorly. Growth investors think some of the company’s
efforts, like cellphone-software production, are smothered in such a large
organization. Both sets are unhappy, so Microsoft trades at a measly 16 times
next year’s estimated earnings. A breakup could raise this multiple.
Of course, the company is still earning billions of dollars and
has significantly improved operating results. But Mr. Gates was violently
against governmental efforts to break up his company in 2001. He may be less
defensive if he comes to the decision himself, especially once he removes
himself from the daily grind and potentially gains some
objectivity.
And there’s one last appealing point: No one would expect Mr.
Gates to be involved in every offshoot company to the same degree. He can
concentrate his efforts on the parts of the business he likes best. And who
knows, it may even bring out some youthful fire.
Bootcamp: Life Hacking
"The most important contribution of management in the 20th century was the 50-fold increase in the productivity of the manual worker."
-Peter Drucker
Drucker followed the previous quote by stating that the most important challenge of the 21st century would be driving similar productivity gain from the knowledge worker. I have had plenty of time to ponder this topic as I have suffered through a strong head cold at home. I have found myself increasingly enslaved to the information Samba. I go from my email to my voice mail to my in-box to RSS reader. By the time I have done one round of the dance, everything has filled up again. Furthermore, like quicksand, the more rapidly I move through this routine, the quicker they fill up from responses. Lord forbid that I have core projects to take care off outside of this dance. After too many 1 and 2am mornings, my body finally put the brakes on with the help of Acute nasopharyngitis (the common cold).
Between prolonged naps and chicken soup, I have pondered how this could be the basis of a post. Thoughts ranged from viral analogies (marketing, etc) to biology. In the end, the takeaway was the simplest of them all. The demands on entrepreneurs (and VC’s) are never ending and unless systematically managed, they spread, like a weed, and take over every waking hour (and even quite a few previously nocturnal ones as well).
One brain study used PET Scans to analyze brain activity in high IQ people. Rather than showing increased activity across the brain, it actually showed focused activity around the core topic. In other words, mental superstars did well not because they could process more (though many can) but rather that they isolate out the noise and focus only on what is essential.
The Economist recently published an article "Reprogram Your Life" that was the genesis of this post. The challenges and distractions we experience today take a very different form from those even 15 years ago…email being the most obvious. The article talks about "life hacking", tricks or "hacks" to reprogram your life. It mentions ideas like setting your email client to pull down email less frequently (say every 30 min) or having "vertical days" where you turn off all distractions (cell, phone, email, etc) and focus on a core task. It mentions two sites, www.43folders.com and www.lifehacker.com which have frequent posts on suggestions.
We fill our lives with urgent activities without fully thinking through what is important. These are Stephen Covey issues on steroids. I posted earlier about how critical balancing family and work lives…well, this is the battle ground.
Some suggestions:
— lay out your goals and core principals at the beginning of each year. these become the northern star against which you can prioritize. redress/modify from time to time.
— prioritize what you need to get done on a daily basis
— weave emails into your prioritized tasks versus responding to "action" emails immediately
— at the end of each day, look at what you did, what was of value, what was not and change future scheduling and time allocation. This works best around chronic time wasting activities
— if you have an assistant, have him/her prune your email for you, handling all scheduling activities
— when you find life spinning out of control, take some time off for Mindfulness (take a walk, clear your mind, meditate, etc). It will help put things into perspective and priority.
— if you procrastinate around major to dos, take 10-15 minutes to break them down into actionable sub items and weave them into your tasks
— militantly say "no" to task forces, committees or meetings that are not core or essential
— there are hundreds of books, blogs and articles around this stuff. Find an approach or set of strategies that work for you.
As with the PET Scan study, it really is about learning what not to do rather than doing things more efficiently. If you want to play in this world, you had better learn to "hack" or be prepared to spend many hours in bed with tissues and cold remedies…
Venture 101: That’s the Ticket
People often ask us what we look for in a company and entrepreneur before we will invest. The short list is:
1) company is or has the potential to be #1 or #2 in its space either nationally or globally.
2) either the CEO or CTO is well known, connected and respected in his/her industry (and experienced), is ethical and is someone we want to build a business with.
3) the business model is compelling and clearly scales. By compelling, I mean that we are happy with each dollar that comes in. We want to avoid the story: I am losing money on each unit, but I will make up for it with volume. By scalable, I mean that we can see the mechanism or approach by which the company can ramp to be a sizable business.
4) the company is rationally priced
It is a rare situation when we come across a company that is a leader in its space, is doing nine figures in gross revenue and has never taken outside capital. It is even more rare that such a company, given its size, is growing 70-100% a year. TicketsNow, located in Crystal Lake, IL, enjoys all of these and I am pleased to say that it is the latest addition to our portfolio.
Started on $100 by Mike Domek from his dorm room, TNow is the highest trafficked site worldwide in the premium ticket world. We could not be more excited about backing Mike and his team which includes Kenneth Dotson (formerly CMO uBid and co-founder CBS Sportsline), Mike Stein & Mark Hodes (formerly ran CRM and online marketing at Orbitz), Frank Giannantonio (former Land’s End CTO) and Sridhar Murthy (former CFO or VP/Finance at Ariba, Collabnet & Get2Chip).
All readers are encouraged to get their next premium sporting, show or concert ticket at www.ticketsnow.com!
Buzz: Music’s Future is Burning
One of the great emerging applications for FeedBurner (and RSS as a channel) is commerce. In the first wave of applications, publishers have used RSS to push content (mostly text like blog posts, news articles, etc) to feed readers. This past week, we got a glimpse of the future of RSS. Geffen announced a new rev of its website that embeds and leverages FeedBurner to link its artists directly to their fan base. Not only will this allow artists and the media companies like Geffen to push tour dates, photos and posts/news out to fans, but also songs and videos. Leveraging FeedBurner’s Feed Flare, they can also embed calls to action like buy this song, link to MySpace or rate it in iTunes. CNBC and MSNBC both ran stories on TV about how this new FeedBurner service was the label’s answer to iTunes disintermediating them.
Furthermore, Geffen is promoting their artists feeds in other FeedBurner feeds. So, they are using the medium to generate traffic while also using it to present commercial opportunities. Its a double feature…
Watch RSS jump out from being used for just static content distribution. You will see a rapid emergence of this medium for promotion, two way interaction (Microsoft plans to use it for synchronization) and commercial transactions. We are just coming out of the first inning. FeedBurner is in a great position at the center of all of this.
(disclaimer: FeedBurner is one of our portfolio companies…)