mbmccall, Author at SomethingVentured

The Siren Songs

05/18/2006 11/15/2019 by mbmccall

"History doesn’t repeat itself, but it sometimes does rhyme"
— Mark Twain

Here we go again. In Q1, we saw the highest median fund size raised on record according to Venture One (see the Venture Reporter excerpt below). It used to be said that an early stage venture group can’t deploy more than $300-400m and stay on investment style. The Siren Songs of large management fees are hard to resist.

In Greek mythology, the Sirens lived on an island surrounded by rocks. Their sweet songs would draw unsuspecting boats near, shipwrecking them on the rocks. Odysseus escaped this fate by tying himself to a mast and plugging the ears of his men. Unfortunately, most venture firms do not have masts readily available. During the heady bubble, at one point, there were over 30 venture firms with funds at or over $1B. During the ensuing crash, everyone repented and dropped either their current fund or their next fund down to a more manageable level. Venture Reporter recently published Q1 fund raising stats:

Though fewer VC firms, 17, closed funds in the first quarter of this year, they raised substantially more money, $4.26 billion compared to $2.5 billion by 22 firms for the same period a year ago. According to figures from Dow Jones & Co.’s industry tracker VentureOne, this quarter registered the highest median fund size on record, at $209 million compared to last year’s median fund size of $200.5 million.

Five funds, ranging from $400 million to $1 billion, were responsible for the bulk of the capital. Likely to sustain the growth are large funds still in the market like VantagePoint Venture Partners’s fifth fund and New Enterprise Associates’ next fund likely to close on as much as $2.5 billion in what would be the largest U.S. venture fund ever raised. And even if we’ve seen a few contrarian VCs launching small funds like Alan Patricof’s Greycroft Partners LP, only 31.25% of new funds raised in the past quarter were managing less than $100 million.

"Even in the heyday years of 2000 and 2001, there were at least 50% of the [venture capital] funds managing under $100 million," said Josh Grove, a research analyst at VentureOne

How quickly we forget. A few MySpace type exits and funds are back raising $700-$1B funds again. The good news is that most of the carnage was caused by a lot of small funds, run by inexperienced VC’s, that jumped into any deal they could find while paying irrationally high prices. This time, at least, most of the money is going to established funds. They are creeping later stage, either providing growth or founder buyouts on more significant companies. You see a lot of this in the interactive marketing space. That said, as I said in my "Black Art" post, their challenge is going to be maintaining adequate exit multiples on deals that they pump $20-30M into.

Quote of the Week

05/18/2006 11/15/2019 by mbmccall

I mispoke yesterday. Juergen Stark reminded me that his quote after one particular board meeting actually had some advice for VC’s as well:

"Yup, got it. Higher revenues and lower costs. Any more brilliant advice? How about some advice for you guys…higher returns and lower writeoffs.”

Maguire and VC Entitlements

05/16/2006 11/15/2019 by mbmccall

"We are losing our battle with all that is personal and real about our
business." — Jerry Maguire

I think that all venture firms should have a Mission Statement a la Jerry Maguire. We don’t have one nor do any firms that I know, but it certainly is worth considering. It would help entrepreneurs better understand the firm while also creating a "northern star" for the firm. A number of you emailed me after my Entrepreneurial Entitlement post. You had questions about what the top VC Entitlements were. Underneath the various comments, I could infer the normal questions about why VC’s have a poor reputation when, in fact, they enable significant value creation. I think part of the issue is that over half of venture deals don’t work out (either partial or complete loss). A lot of finger pointing occurs during these wrecks and, rightly or wrongly, VC’s are implicated by association.

However, I think that there is something else going on. It reminds me of the scene in Jerry Maguire when Jerry finally snaps under the cynicism of his business and he writes the famous Mission Statement that gets him eventually fired. (By the way, I actually chased down the original statement in its entirety for anyone interested…while quite wordy, there are some interesting parallels to the venture business Jerry Maguire Mission Statement).

One of the most difficult things about being a VC is in walking the fine line between being in the creation business and being in the money business. Without providing constraints and structure, a VC guarantees that his/her fund will under-perform. Many times, a company or entrepreneur needs to be saved from him or herself, to have the straw taken out of the proverbial Cool-aid. However, VC’s can often fall on the other side of the line, whereby it becomes purely a money game. It is around this issue that Maguire had an interesting quote:

"We are losing our battle with all that is personal and real about our
business….We are
pushing numbers around, doing our best, but is there any real
satisfaction in success without pride? Is there any real satisfaction
in a success that exists only when we push the messiness of real human
contact from our lives and minds? When we learn not to care enough
about the very guy we promised the world to, just to get him to sign.
Or to let it bother us that a hockey player’s son is worried about his
dad getting that fifth concussion."

So, with that philosophical ranting done, here are my candidates for the top 5 VC Entitlements:

1) Nonconstructive Criticism VC’s often find their portfolio companies not performing as expected or promised. We all have a knee jerk reaction to state the obvious and to apply pressure to the management team to change things. However, it is one thing to point out an issue. It is another to a) frame it within what is realistically doable and b) help think through options and solutions. As my friend and former portfolio CEO, Juergen Stark, used to sarcastically say "Great. I got it. You want me to do more, with less and deliver it on time. Any more helpful suggestions?"

2) Micromanage Following up on #1, VC’s can often begin to micromanage portfolio companies when things are not going well. Maybe it helps us feel like we are managing a situation or maybe we just feel entitled to muck around in the business. In reality, unless a VC has specific domain or managerial expertise that helps the business, this usually results in a frustrated CEO and a lot of wasted time on both the VC and company sides. It also brings into question how much trust exists between the two parties.

3) Introductions I violate this one much too often. VC’s legitimately want to add value to their portfolio companies. One clear way is to make helpful introductions to customers, partners, recruits and such. However, we can also often push introductions that are not relevant but yet take up management time and attention to follow up on. Just because I know someone that seems important or useful doesn’t mean that he/she is an appropriate introduction. The key is thinking about the introduction from the entrepreneurs perspective while taking into consideration their priorities and objectives.

4) Opinion Heard VC’s are obviously in a position of power because of the capital they can bring (or not bring) to a company. This gives us significant leverage. We also usually have an opinion or position on most areas of the company. These opinions are not always aligned with those of management (or relevant for that matter). Follow-up on #2 above, a VC needs to be careful not micromanage the business nor voice opinion frequently just to be heard. Entrepreneurs also need to realize that sometimes, a VC might actually have something useful or helpful to say!

5) Low Value Add Sometimes, what a company wants is just capital. However, more often, it needs help with strategic decisions, customer introductions, recruiting and such. Some VC’s are very good at rolling up their sleeves or in sharing their relevant contacts. There are other VC’s that see their roll predominantly as providing capital. This can be fine but the VC should at least make the effort to understand the business and industry.

Should all go well, we hopefully can deliver to our portfolio companies the Maguire utopia:

"I will not rest until I have you holding a coke, wearing your own shoe,
playing a Sega game featuring you, while singing your own song in a new
commercial starring you, broadcast during the super bowl in a game that
you are winning."

The Power of Exponentials

05/15/2006 11/15/2019 by mbmccall

Nothing is more powerful than the law of exponentials (Buffett refers often to the power of compounding interest). We all like to think in a linear fashion. If I work twice as hard, I will get twice the benefit. Products around me will continue to get incrementally better over time. The next version of software x will look like its predecessor but with added features and functionality. The biggest challenge with running technology firms is that technology advances exponentially. As a result, we get comfortable with a linear view of the world with a specific horizon, and our firm/product/service gets "curve jumped". Mainframes moved to mini-computers moved to PC’s moved to client/server moved to hosted solutions which is not moving to handheld/portable computing going to ???(bio computing). At each transition, the leader of the former (DEC, Microsoft, Sun, etc) wave is not the leader of the next. As Steve Jurvetson always points out, Disruption occurs at the Edges often out of the mainstream or at the interstices between disciplines.

So, what are examples of exponential advances:
— computing power & transistor density
— (heat emanating from laptops…)
— storage density
— bandwidth
— Internet users
— genes mapped
— proteins crystallized
— imaging resolution
— etc…

This makes the life of the average citizen better but the life of a Tech CEO rather difficult. There have been a host of suggested frameworks written about to manage this…Only the Paranoid Survive (Grove), The Innovators Dilemma (Christiansen), Crossing the Chasm (Moore), etc. Great reads if you are interested in this stuff.

What does this mean for a tech entrepreneur in a product business:
1) Be Paranoid. Exponential change hits very quickly and once it hits, it advances rapidly passing you by. Never, ever get comfortable with the notion that you "have no competitors".
2) Eat Your Own. This is a cliche, but yet firms do not do it. They get wed to their approach and their product. Use greenfield efforts or whatever it takes.
3) Plan Exponentially. If your product road map does not show exponential improvement in both cost and features, you are vulnerable. You often have to force your team into this mode by started with the end goal (10x performance) and make them show how it is possible.
4) Promote Out of the Box Thinking. Use off sights, consultants, brainstorming to create new ways at looking and addressing issues. How else can we solve problem A? Corporate inertia will perpetuate your current approach in a linear manner. If all you have is a hammer, everything looks like a nail.
5) Reality Check with Customers. Your way has to be the best way, correct? Firms spend a lot of time rationalizing why other approaches are getting traction and their "superior" solution is not. Be prepared to change or acquire as needed to stay ahead of the curve. Remember, the customer isn’t stupid (rationale #1).

What can we expect in the future? Snapshots from US News & World Report’s "Download us_news_report.doc

" has an array of very interesting statistics comparing 1900 to 2000. You should remember that with exponentials, the progress made in next 20 years will match the progress from the past 100 years. In 1900, homes with electricity (8%), miles of paved road (10 miles), farm population (30 million, about 45% of total population), births taking place at home (95%), homes with bathtubs (14%), adults graduating from high school (6%). Of course, while life expectancy has risen from 46 to 74 years, cancer deaths have risen from 64 per 100,000 to 200 per 100,000.

Buckle up for the future…

My 15 Minutes of Fame

05/12/2006 11/15/2019 by mbmccall

"In the future everyone will be famous for fifteen minutes."
— Andy Warhol

Thanks to Brad & Adam from ePrairie and Tim at StoryQuest for my 15 Minutes of Fame on their recent podcast. We talk about a variety of topics related to the general VC world and the Midwest entrepreneurial community. You can check out the ePrairie Podcast here.

Top Entrepreneurial Euphemisms

05/11/2006 11/15/2019 by mbmccall

About six weeks ago, I posted on 10 VC Euphemisms and had intended to post Guy Kawasaki’s corresponding Top Ten "Euphemisms" of Entrepreneurs. This slipped by mind until Steve Vivian from Prism Capital reminded me about it. It is hilarious yet should be taken seriously. I highly recommend you not fall victim to these claims. We have an informal policy that we will turn down any deal that has "conservative financials" and "no competition"… You’ll notice our fellow Chicagoan, Jason, is highlighted at the end.

The Top Ten Lies of Entrepreneurs
(Since I’ve antagonized the venture capital community with last week’s blog, I thought I would complete the picture and “out” entrepreneurs to begin this week. The hard part about writing this blog was narrowing down these lies to ten.)

I get pitched dozens of times every year, and every pitch contains at least three or four of these lies. I provide them not because I believe I can increase the level of honesty of entrepreneurs as much as to help entrepreneurs come up with new lies. At least new lies indicate a modicum of creativity!

“Our projections are conservative.” An entrepreneur’s projections are never conservative. If they were, they would be $0. I have never seen an entrepreneur achieve even her most conservative projections. Generally, an entrepreneur has no idea what sales will be, so she guesses: “Too little will make my deal uninteresting; too big, and I’ll look hallucinogenic.” The result is that everyone’s projections are $50 million in year four. As a rule of thumb, when I see a projection, I add one year to delivery time and multiply by .1.
“(Big name research firm) says our market will be $50 billion in 2010.” Every entrepreneur has a few slides about how the market potential for his segment is tens of billions. It doesn’t matter if the product is bar mitzah planning software or 802.11 chip sets. Venture capitalists don’t believe this type of forecast because it’s the fifth one of this magnitude that they’ve heard that day. Entrepreneurs would do themselves a favor by simply removing any reference to market size estimates from consulting firms.
“(Big name company) is going to sign our purchase order next week.” This is the “I heard I have to show traction at a conference” lie of entrepreneurs. The funny thing is that next week, the purchase order still isn’t signed. Nor the week after. The decision maker gets laid off, the CEO gets fired, there’s a natural disaster, whatever. The only way to play this card if AFTER the purchase order is signed because no investor whose money you’d want will fall for this one.
“Key employees are set to join us as soon as we get funded.” More often than not when a venture capitalist calls these key employees who are VPs are Microsoft, Oracle, and Sun, he gets the following response, “Who said that? I recall meeting him at a Churchill Club meeting, but I certainly didn’t say I would leave my cush $250,000/year job at Adobe to join his startup.” If it’s true that key employees are ready to rock and roll, have them call the venture capitalist after the meeting and testify to this effect.
“No one is doing what we’re doing.” This is a bummer of a lie because there are only two logical conclusions. First, no one else is doing this because there is no market for it. Second, the entrepreneur is so clueless that he can’t even use Google to figure out he has competition. Suffice it to say that the lack of a market and cluelessness is not conducive to securing an investment. As a rule of thumb, if you have a good idea, five companies are going the same thing. If you have a great idea, fifteen companies are doing the same thing.
“No one can do what we’re doing.” If there’s anything worse than the lack of a market and cluelessness, it’s arrogance. No one else can do this until the first company does it, and ten others spring up in the next ninety days. Let’s see, no one else ran a sub four-minute mile after Roger Bannister. (It took only a month before John Landy did). The world is a big place. There are lots of smart people in it. Entrepreneurs are kidding themselves if they think they have any kind of monopoly on knowledge. And, sure as I’m a Macintosh user, on the same day that an entrepreneur tells this lie, the venture capitalist will have met with another company that’s doing the same thing.
“Hurry because several other venture capital firms are interested.” The good news: There are maybe one hundred entrepreneurs in the world who can make this claim. The bad news: The fact that you are reading a blog about venture capital means you’re not one of them. As my mother used to say, “Never play Russian roulette with an Uzi.” For the absolute cream of the crop, there is competition for a deal, and an entrepreneur can scare other investors to make a decision. For the rest of us, don’t think one can create a sense of scarcity when it’s not true. Re-read the previous blog about the lies of venture capitalists, to learn how entrepreneurs are hearing “maybe” when venture capitalists are saying “no.”
“Oracle is too big/dumb/slow to be a threat.” Larry Ellison has his own jet. He can keep the San Jose Airport open for his late night landings. His boat is so big that it can barely get under the Golden Gate Bridge. Meanwhile, entrepreneurs are flying on Southwest out of Oakland and stealing the free peanuts. There’s a reason why Larry is where he is, and entrepreneurs are where they are, and it’s not that he’s big, dumb, and slow. Competing with Oracle, Microsoft, and other large companies is a very difficult task. Entrepreneurs who utter this lie look at best naive. You think it’s bravado, but venture capitalists think it’s stupidity.
“We have a proven management team.” Says who? Because the founder worked at Morgan Stanley for a summer? Or McKinsey for two years? Or he made sure that John Sculley’s Macintosh could power on? Truly “proven” in a venture capitalist’s eyes is founder of a company that returned billions to its investors. But if the entrepreneur were that proven, that he (a) probably wouldn’t have to ask for money; (b) wouldn’t be claiming that he’s proven. (Do you think Wayne Gretzky went around saying, “I am a good hockey player”?) A better strategy is for the entrepreneur to state that (a) she has relevant industry experience; (b) she is going to do whatever it takes to succeed; (c) she is going to surround herself with directors and advisors who are proven; and (d) she’ll step aside whenever it becomes necessary. This is good enough for a venture capitalist that believes in what the entrepreneur is doing.
“Patents make our product defensible.” The optimal number of times to use the P word in a presentation is one. Just once, say, “We have filed patents for what we are doing.” Done. The second time you say it, venture capitalists begin to suspect that you are depending too much on patents for defensibility. The third time you say it, you are holding a sign above your head that says, “I am clueless.” Sure, you should patent what you’re doing–if for no other reason than to say it once in your presentation. But at the end of the patents are mostly good for impressing your parents. You won’t have the time or money to sue anyone with a pocket deep enough to be worth suing.
“All we have to do is get 1% of the market.” (Here’s a bonus since I still have battery power.) This lie is the flip side of “the market will be $50 billion.” There are two problems with this lie. First, no venture capitalist is interested in a company that is looking to get 1% or so of a market. Frankly, we want our companies to face the wrath of the anti-trust division of the Department of Justice. Second, it’s also not that easy to get 1% of any market, so you look silly pretending that it is. Generally, it’s much better for entrepreneurs to show a realistic appreciation of the difficulty of building a successful company.

PS: here is an interesting commentary on this blog by Jason Fried.

Is Your AIM True?

05/11/2006 11/15/2019 by mbmccall

In 1995, the London Stock Exchange launched the Alternative Investments Market (AIM) to offer smaller firms a less regulated market upon which to float their shares. While initially viewed by many as a novelty, it has begun to gain scale and respectability as more and more international firms are using it for going public. While many firms listing there do not have the requirements to list on LSE or Nasdaq, an increasing number do but are electing to avoid the costs and SOX burdens associated with a US IPO. Should this trend (and similar ones in Asia) continue, it will clearly begin to threaten the US’s role as the financial market of the world.

Rob Schultz recently put up a great post on London Stock Exchange’s AIM market. He pointed out that pre-SOX, it cost his firm, DigitalWork, about $1M to go public. I believe that if the AIM can survive the next market down draft (emerging marketplaces are disproportionally hit), that it will increasingly become a major challenger to Nasdaq, especially for firms with market caps below $500m. Today, it is not even close to having the volume or number of investors that Nasdaq does. However, as more and more smaller, emerging US firms elect to by-pass our increasingly expensive and cumbersome IPO market, it will see a significant increase in its liquidity. Future regulation and bureaucracy in the US will dictate how large the AIM will become.

This movement is very similar to the threats the Chicago futures and options markets faced over the past decade. They moved aggressively to address concerns and weaknesses and are now stronger and more dominant than ever. How our markets and regulations adapt will determine the eventual outcome of this movement. As a VC, all other things being equal, I would much rather take a firm public in the US where we are more familiar with the legal system, institutional investors, etc. We will see…

Glory Road: Peapod

05/09/2006 11/15/2019 by mbmccall

Technology revolutions always have a boom-bust-rebirth-boom pattern. The key to this is surviving the down draft when it hits. Mary Meeker, whose career has taken a similar path, laid this out in a very powerful way. She aggregated the market caps of Google+Yahoo!+eBay+Yahoo!Japan+Amazon over time.
Pre-2000 IPO          = $2B
3/2000 Peak          = $178B
10/2002 bottom    = $32B
11/2005 value       = $262B (approaching 10x the trough and 150x pre-IPO!)

One of the most overlooked rebirths from this era is Peapod. Remember the $1B smoking hole in the VC road called Webvan? How about Kozmo or the array of other dead home delivery companies? Many started with low burn approaches but quickly ramped their burns in the hope of grabbing market share. My friends, Tom and Andrew Parkinson, founded Peapod in 1989, guided the company through the crash and now have, arguably, the most successful online home delivery grocery firm as part of Ahold. The May 1st Red Herring article "Life After Webvan" is a great article detailing this great story. I highly recommend it to all aspiring entrepreneurs. As I have written over and over again, controlling your burn equates to controlling your destiny.

Invasion

05/05/2006 11/15/2019 by mbmccall

If you work for one of the TV networks (or even the cable guys), you are about to have a really unenjoyable two months coming up. We are entering into the upfront ad sales season for TV and for the first time, internet advertising and, increasingly, IPTV are making things uncomfortable for the networks. Advertisers have much greater choice now and are moving increasingly large sums of money over. While the spending on traditional TV ads still dwarfs other media, it will feel the pain first in ad rates and later in total demand.

In a recent NYT article, MSN has announced a broad array of original content created just for the web. This stuff is the real deal. I has known actors, custom formats (shorter duration) to fit the web and real producers behind them. Steven Colbert’s recent roasting of President Bush was downloaded over 500,000 in 2 days before being taken down. Hollywood is going internet and the networks are stuck between a rock and a hard place. On one hand, they shun the internet with their own content and let MSN and other players siphon off ad dollars and market share or they can contribute their content and hope they can figure out a business model that works. In the latter case, they are accelerating the adoption of IPTV.

Meanwhile, there is a dramatic difference in ad rates between online and offline. This differential will close over time, but in the interim, it means replacing very attractive ad $’s with greatly reduced inventory as they move onto the web. Furthermore, their pricing power offline is going down the tubes as more and more alternative distribution alternatives pop up and Tivo obliterates their expected viewer behaviours. Jupiter Research estimates that DVR’s could cost the Networks $8B of the $74B ad market due to skipped commercials.

The networks are going to have to fight to stay ahead of the curve on this and most believe they won’t get out of their own way. They should be aggressively trying new formats and content (like MSN and others) rather than trying to milk their cash cows. This also includes embracing new advertising channels as well including interactive, RSS and other approaches. I predict that IPTV is going to explode onto the web in the next 2-3 years. This will create opportunity everywhere:
1) infrastructure will be strained…rebirth of the telco equipment world
2) distribution alternatives ranging from Youtube to Akimbo to CinemaNow
3) advertising infrastructure, services and models to meet the new formats and channels.

Exciting times unless you run ad sales for the Networks…

VC Feudalism: Extreme Entitlement

05/03/2006 11/15/2019 by mbmccall

"Be careful how you treat people because the toes you step on today may be
attached to *#s you have to kiss tomorrow"
— Aunt Scotti

I had an entertaining talk with Bob Lepowski today about the state of the VC industry. It is clear that VC’s do not have the best reputation in the world. Some of this is do to attitude and actions and some of it is due to misunderstanding and miscommunication. Way too often, VC’s will develop an excessive sense of entitlement. They feel their voice needs to be heard and their desires realized. Often there is a disconnect between reality (especially given the specifics of what a CEO is dealing with) and what the VC conceptually thinks should happen.

There is a clear contingency of our brethren who view themselves as being higher up on the food chain than others. We came up with the term VC Feudalism, to describe this perspective. VC Feudalism sounds much better than Den of Thieves or Sith Lord Counsel. Conceptually, the analogy is that certain VC’s see themselves as feudal lords. They strive to remain independent and to set up moats around their castles. They are to be obeyed by the vassals and serfs. For the sake of survival, they syndicate/partner with other lords to form alliances…some brief and some long-term. These alliances are key in helping them to hold off assaults and gain new territories. See the post on the Hochberg paper about venture networks. So, tongue-in-cheek, in the world of inflated VC self-importance: lord=VC, vassal=entrepreneur, serfs=employees,fief=company, barbarian hordes=competitors. There is a good reason Feudalism died out…

Michael Lissick recently wrote about the old "waiter test". It is a great way to understand what degree of arrogance or "entitlement" your lunch partner maintains (VC or other).

"Have friends and family observe your behavior while dining. How we interact with servers at restaurants is a clue to the state of our integrity. If you are treating these strangers as "subservient," it is a sign that compartmentalization has gone too far, cues are being overlooked, others are not being given their space, and that ethics issues lie in wait."

As I said yesterday, neither the VC nor the entrepreneur is entitled to anything that is not earned.

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