My long-time Kellogg/BCG friend, Al Warms, has gone public with his latest effort, Appolicious.  Al sold his previous company, Buzztracker, to Yahoo and went on to successfully run & grow Yahoo News.
 Appolicious is a community for application discovery. You can upload your current applications (names only) and the site will begin to profile your interests and those of your friends and others like you. Unlike the one dimensional iPhone App store, Appolicious has a myriad of discovery methods for community members to discover new apps or to share feedback/commentary about existing ones. I have no personal stake in the company today but am a big fan of Al's and think that he is addressing an increasingly significant issue in mobile apps as the number of options for users grows exponentially. Give it a try and comment on your experience.

I remember a period in 2000 when I was stressed beyond belief, I was getting little sleep and I had lost 15 pounds. As my portfolio plummeted downward with all others, I envisioned myself working as an evening janitor in some office building. I wrote a post a couple of years ago, Resilience in the Storm, in which I laid out the a number of key lessons learned from VC vets like Roger McNamee on how to manage through downturns.

"He(McNamee) said that in times of massive macro change, there is little you can do as an individual to change your environment. You can respond by, like Homer, lashing yourself to the mast, and screaming at the on-coming storm. Or, you can use the time to truly understand what is important in your life…family and friends. In fact, he advocated that you will have limited influence on outcomes during macro setbacks, and that these are prime times to increase the amount of time you spend with your spouse and kids."

Meet Joel Bauer. His created character is a riot. I'm going to go one step better. 8×10 cards with music that plays when it opens (Rocky?)…Secrets for the New Normal 🙂

 Enjoy

There is no doubt that the venture industry is going through a major house cleaning right now. Much of the pruning that should have been done post Bubble is finally going on now as LP's start to wake up and pull back a bit from the asset class. One of the main challenges has been the mismatch between LP demand in the category and the declining liquidity of it. The main question people as is what is the right amount of capital that should flow into the business annually to keep it healthy. Let's look at the mathematics from the exit perspective:

"Even as I write I am watching the eunuchs now posing as Wall Street CEOs bend over backward before some congressional committee…We at Morgan Stanley are pleased by your investment. Now, if you ever want to see a dime of it back, go away. We’ll call you if we need you." — Michael Lewis

It boggles my mind how many articles I am reading that defend the short-sighted land grabs at our banks & insurance companies. Does Wall Street get it?  If you lose so much money from stupid & greedy activities that your firm is insolvent, you don't get to stick your hand in the piggy bank for bonuses. Show contrition, not indignation. The way that the rest of the world operates is you get to the end of the year, you look at your profits and your cash balances. If you have the cash to pay the bonuses, you pay them. If you don't have the cash, you don't. So, Wall Street, if your performance has been so strong that it deserves bonuses, pay them out of your cash. Oh, wait, you don't have the cash…

"A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be."
        — Wayne Gretzky

peHUB had a recent post by Connie Lolzos on Josh Lerner's recent research about serial entrepreneurs. There are two general camps. One states that success begets success and serial entrepreneurs are likely to repeat. Lightning does strike twice (or three, four, etc times). Another position is that success is driven predominantly by serendipity which greatly reduces the chance of serial success. Furthermore, once a founder has hit it big, is he/she as hungry the second time when their bank account overflows.

Josh Lerner looked at a cut of data around success rates of serial and first time entrepreneurs (Paper link: Download 09-028
). As Connie mentions:

This would support the serial entrepreneur camp's claims obviously. Furthermore, it also quantifies the chance of success for those first time entrepreneurs…around one-in-four. I would imagine that this number goes up significantly during downturns like today when competition is reduced and a likely liquidity event occuring during a market recover (in 3-4 years).  Timing of launch has a strong impact on venture success.  Lerner comments that great entrepreneurs are more likely to launch during these times and have the vision to see what could be versus what is.

Connie also pointed another interesting fact about how many venture backed deals involve serial entrepreneurs. It looks like only 13-16% of the time do VC's back serial entrepreneurs. So, 6 out of 7 times, a new entrepreneurial team (often coming from other start-ups though) gets the VC money. Another positive for emerging entrepreneurs.

"We must all hang together, or assuredly we shall all hang separately." — Benjamin Franklin at the signing of the Declaration of Independence

Dan Primack set off an interesting dialog around his article Radically Reinventing Venture Capital. There is a growing wave of articles about new or revised models and debate around what went wrong.  He described a suggestion by one Boston VC who proposes that LP’s think about funding individual VC’s as single partner entities. These are all interesting and thoughtful discussions, but I believe that they are over thinking things. I offer that the heart of our issues rest in our industry’s compensation incentives mixed with a fine market melt down.

Venture capital used to be a business about creating revolutionary businesses to change the world for the better. Wealth was driven by carry, the GP’s share of profitable investments. Investor, entrepreneur and VC were aligned, all focused on profitable investing. This has broken down.

The LP community has moved aggressively into alternative assets to kick start unfunded obligations. Furthermore, consultants, advisors and staff have concentrated this capital on a shrinking list of investment firms.

At the same time, market disruptions have basically shut down the IPO world and the VC’s main escape hatch. With public options diminished, acquisition multiples have declined, which has reduced the frequency and size of investment exits. For example, while investments normally take 3-6 years for exit, in this environment, only 20% of deals have exited since 2003. This had backed up VC’s portfolios.

The toxic result is that VC’s look increasingly to management fees instead of carry for compensation. This breaks the alignment between LP & GP. This incents & focuses VC’s on raising larger funds, more often and deploying it quickly.  If a group raises $800m every two years, it adds management fee in $20m per year chunks. Three funds, eight partners leads to $6-8m/yr per partner in just fees. Carry is a nice to have versus need to have.

As long as LP’s go along with this, things won’t change. Unless the money drives this, behavior & incentives won’t change. They need to regain the alignment between their interests and the VC’s.  One heretical idea would be to move current compensation from being based on assets under management to salary based with escalators. By relatively fixing the current compensation regardless of assets (increase it for new hires), VC’s will have less incentive to raise capital for the sake of driving current fee. Rather, they will be focused more on the carry. Granted, carry grows with fund size assuming returns are the same, but we all know that returns suffer when funds are too big and are deployed too quickly. So, there is some governing factor to imprudent asset accumulation.

I also liked the structure of Warren Buffett’s first funds. He established a base rate (say a 6% return) upon which no carry was charged. So, the first 6% of IRR is free which makes sense, as venture’s goal is to drive alpha above more conservative asset classes. Unlike with hurdle rates, he did not have a “catch-up” after 6%. Rather, he charged 25% of the profit above the 6%. So, a VC is worse off (from a traditional 20% carry) until IRR’s in the low teens and then better off above the low teens. This gave no bonus for poor results and superior compensation for strong results.

I don’t know if the LP community has the appetite for this kind of approach regarding fees. They are fighting to get allocation into a narrowing list of venture firms so are unlikely to rock the boat for fear of exclusion. They are, unfortunately, in for a rude awakening if they can’t find another way to align their interest with those they entrust their capital.

"The brick walls are there for a reason. The brick walls are not
there to keep us out; the brick walls are there to give us a chance to
show how badly we want something. The brick walls are there to stop the people who don't want it badly enough. They are there to stop the other people!"
                — Randy Pausch, The Last Lecture

I have always been interested in the studies on the "Expert". In these challenging markets, resilience becomes increasingly central to success. Why is it that the middle or high school star (President, etc) is usually not the eventual star in life from the class? How can two people grow up in the same environment and the one with less innate skill end up succeeding? How can 10 start-ups launch and one pulls away from the pack even though it did not have the "rockstar" team?

I have posted twice on the subject — The Expert Mind and The Passion for Greatness. With the publication of Malcolm Gladwell's book, Outliers: The Story of Success, there is increasing discussion around this topic now. Gladwell confirms previous research that lays out that success is not driven by innate ability (though "nature" does bracket how far "nuture" can go). He describes how "purposeful" hours of practice are a key driver (10,000 hour rule) and also concludes that environment & circumstances also play a considerable role.  This applies not only to athletics (Jordan/Woods are the first to practice and last to leave…obsession on improvement) but business as well. He describes how Bill Gates was able to launch Microsoft because his school had access in the late 1960's to mainframe computers when others didn't (environment gave him a leg up).

In a recent NY Times editorial, Lost in the Crowd, David Brooks takes exception with the over-emphasis on environment over initiative. One of our local entrepreneurial stars, Howard Tullman, emphasized one section in an email he sent around. I agree fully with the conclusion that success, while enhanced by environment/fate, is eventually driven by effort and passion. As Jim Clark, founder of Silicon Graphics, Netscape, Healtheon/WebMD & myCFO, once said, "Great companies are willed into existence". From Howard's excerpt:

"Yet, I can’t help but feel that Gladwell and others who share his
emphasis are getting swept away by the coolness of the new discoveries.
They’ve lost sight of the point at which the influence of social forces
ends and the influence of the self-initiating individual begins.

Most successful people begin with two beliefs: the future can be better
than the present, and I have the power to make it so. They were often
showered by good fortune, but relied at crucial moments upon
achievements of individual will.

Most successful people also
have a phenomenal ability to consciously focus their attention. We know
from experiments with subjects as diverse as obsessive-compulsive
disorder sufferers and Buddhist monks that people who can
self-consciously focus attention have the power to rewire their brains.

Control of attention is the ultimate individual power. People
who can do that are not prisoners of the stimuli around them. They can
choose from the patterns in the world and lengthen their time horizons.
This individual power leads to others. It leads to self-control, the
ability to formulate strategies in order to resist impulses. If forced
to choose, we would all rather our children be poor with self-control
than rich without it.

Tim Draper has recently launched his blog, titled "The Riskmaster" (http://theriskmaster.blogspot.com/).  He will post on the venture capital business, spreading entrepreneurship, interesting videos and inspirations on the economy.  This blog is guaranteed to be entertaining, informative and challenging. For those of you not familiar with him, Tim is the founder of Draper Fisher Jurvetson and backed such hits as Skype and Hotmail. He has a long-term perspective on the business as his father founded Sutter Hill in the early 1960's and his grandfather is considered to be the first venture capitalist in California. He is also a huge source of positive optimism which is a scarce resource these days. Well worth reading!

As the bad news keeps pouring in, a lot of people are wondering what we can expect in the coming years. Additionally, everyone is trying to figure out what hope exists. Well, I’ll give two thoughts on this (briefly).

First, the world of technology is driven by two factors: the laws of exponentials and the Black Swan. Progress does not occur linearly but exponentially. We can expect to see changes the magnitude of the past 100 years in just the next 20 years. This means a lot of people are going to a) be really busy and b) be dramatically better off. These changes will come from places you can’t predict (Black Swans). Market crashes and negative developments are not the only unexpected six sigma events.

Second, markets run in roughly 7 years cycles and technology in 15 year waves. Vacuum tubes to main frames to mini-computers (DEC) to PC’s (Apple/Microsoft) to the Internet. The next wave, then, should start in 2010-11 and hit full force in 2015-16. Many in the business (us, Kleiner, etc) feel this will be in Cleantech. The energy market is 10-20x the IT market. We are not talking about billion dollar markets but trillion dollar ones. There will be a lot of casualties but some enormous wins.

So, there us no doubt that life is really brutal today. But, prepare and get ready for enormous, explosive market opportunities. It’s going to be mindblowing.

So, I stick my neck out again typing on my small iPhone. I declared the old venture cycle dead last June. I am declaring the the next cycle, even bigger than the former, will kick in during 2010 with foundations forming by the end of next year. I also believe we will see 30-40% of remaining venture firms will not survive to see this through (food for another post)…