"Pigs get fat, hogs get slaughtered" — old folk saying

What a two weeks it has been. Who knows what firm will be the next victim of Darwin.  I told you all to buckle up last June because things were going to be interesting. With the Fed letting Lehman go down, now everyone is starting to wonder about whether their bank, brokerage firm, etc be next. Confidence in the system has taken another hit. Lot has been written on this, so I will not jump in other than to say that this is what happens when the pigs become hogs (e.g. greed takes over).  While it is the investment banks and such getting taken out back to be shot, it could be any of us. Lose your moral compass and you will eventually hit the rocks.

What the heck does this have to do with VC and entrepreneurship (this time)? Well, it's a great reminder to be your own moral compass. What I mean by this is that when you create and sell something to someone else, look yourself in the mirror and do a reality check. Just because someone might be gullible enough or uninformed enough to buy something doesn't mean that you should sell it. I have seen way too many portfolio companies fail to live up to their potential, too many entrepreneurs fail to deliver what they promised to investors or customers and too many VC's not bring the value that they claim they will.  I understand everyone has to sell and that we are, to a great degree, in the dream business. But, if you know that your portfolio company is overvalued on the LP quarterly report or that your product doesn't really do what you claim with the customer, these will eventually come home to roost. Demand excellence from yourself and from your companies and if you come up short, find ways to continually improve to be what you want to be versus pushing harder sell the pig with lipstick.

Buffett's sidekick, Charlie Munger, said it best recently:

In my mind, money earned in this way (whether Ibanker, VC or entrepreneur) is Blood Money and relies on the Greater Fool theory. That is not how great companies are made gang. So, look in the mirror tomorrow and do a gut check…

"It was the best of times, it was the worst of times, it was the age of
wisdom, it was the age of foolishness, it was the epoch of belief, it
was the epoch of incredulity, it was the season of Light, it was the
season of Darkness…"
— Charles Dickens, Tale of Two Cities

While I wrote about my concerns on the coming part of the business cycle, I am actually quite positive about the flip side of this coin. These periods are not kind to existing portfolio companies, but create a very attractive environment for new venture investments. I believe that 2008, 2009 and possibly 2010 will be good VC vintage years. Some of the crazy pricing and activity we have seen over the past year or so disappear and more rational investing takes its place. These times are actually, I would argue, also positive developments for well managed companies.

1) fewer competitors are started
2) weaker competitors go out of business
3) Darwin forces efficiency and laser like focus in your business
4) this discipline continues on when markets open back up, making for more profitable exits
5) less capital consumed means more equity for the founders in the end

Sectors that do well are those with low average burn, those focused on performance (e.g. pay for performance models) versus "productivity" or intangible benefits, and those selling into less recession sensitive customer bases. Life is tough if you sell capital equipment, have asset intensive businesses, have high burn, have impression based ad models or sell into recession sensitive industries. You are going to see a lot of dead Web 2.0 companies that rely on advertising for their revenue.

Jerry Mitchell, who is a special guy here in Chicago for his decades of helping entrepreneurs, just had his 70th birthday. He recently told that Teddy Roosevelt said one of his favorite quotes about perserverence and effort which I really liked:

“It is not the critic who counts; not the man who points out how the strong
man stumbles, or where the doer of deeds could have done them better. The
credit belongs to the man who is actually in the arena, whose face is marred
by dust and sweat and blood; who strives valiantly; who errs, who comes
short again and again, because there is no effort without error and
shortcoming; but who does actually strive to do the deeds; who knows great
enthusiasms, the great devotions; who spends himself in a worthy cause; who
at the best knows in the end the triumph of high achievement, and who at the
worst, if he fails, at least fails while daring greatly, so that his place
shall never be with those cold and timid souls who neither know victory nor
defeat.”
— Teddy Roosevelt

Eric Olson and Frank Gruber are launching their first TechCocktail conference in Chicago this week on Thur, May 29th at Loyola University. You can register by clicking here. They have pulled together a great set of panelist including Dick Costolo from FeedBurner/Google, Jason Fried from 37Signal and a host of other luminaries. They have also thrown in a VC panel which I’ll be on with Brad Feld, Kirk Wolfe, Rob Schultz and Bruce Barron. If you can make it, it is definitely worth attending.

"…it’s more about people skills and the ability to assess whether there’s a market for something."
  — Dick Kramlich, co-founder NEA

I was cleaning out my files the other day and came across a 2005 NYT article by Gary Rivlin on the venture industry titled "So You Want to Be a Venture Capitalist". It is well worth a read for any of you inspiring investors. Couple of takeaways from it:
— "Below the surface, there’s a huge amount of turnover."  I did not realize the degree of turnover at some firms, including 70% partner turnover at NEA (1997-2005) and 70+% partner turnover at Kleiner (1997-2005). Some is due to poor performance and other is due to strong performance and retirement.
— Up or out. A large share of a fund’s profits are often driven by 25-30% of the partners. This is a true meritocracy and the results are clear to quantify. Over half the partners will fail in the bigger picture.
— Entrepreneurs have a hard transition to the investing side despite the large trend towards this.
— Success is driven by being a good judge of people and for understanding when markets are getting ready for inflection. "you’re a natural athlete or you’re not"
— It is a mentoring business with a long gestation period…"probably 6-8 years and you should be prepared for losses of about $20 million (per person)".

One last point that the article doesn’t mention is that the entry period can be grueling. It is not as rosy as most people on the outside assume. 60% of a good fund’s deal will lose money or breakeven. The losses come early and winners take time to compound. So, sometimes you have years of carnage while being out in the wilderness hoping for the hits to come through.

"By all rights Stewart Alsop should have been a terrific venture capitalist. So why did Mr. Alsop, long considered a cyber-prophet among technology leaders, wash out in a profession in which he seemed predestined to succeed?

In recent months, as venture capital firms have announced the formation of new investment funds, a hot topic among the Silicon Valley cognoscenti has been the exodus of "tourist V.C.’s," as people from nonfinancial backgrounds are known here. Some have left the field because they did not pick enough winners; others have gone on to pursue different projects. Whatever the reason, there are hundreds fewer venture capitalists around today than just two years ago…." (click here for rest)

The nice thing about doing angel investing on the side is that I can invest in fun, if not wacky, ideas from time to time. I put a little money into a friend’s (John Funk, wonderful serial entrepreneur) IP incubator called Evergreen IP. His partners come out of the CPG world and they have licensed an array of innovations/patents and are now bringing several to market. One of these is the Dog Pause Bowl (www.dogpausebowl.com) which is targeted at obese dogs or dogs that eat too quickly. Look out Weight Watchers… He describes this better than I in his post "We Have Liftoff!".

There seem to be two styles of bloggers. Those that drop shorter snippets into posts but do so once or twice a day and those that like to write longer posts but do so once a week/month. While I have always assumed that the former better fits people’s consumption behavior, there have been a variety of studies that confirm this. In "Not Quite the Average: An Empirical Study of Web Use", the researchers concluded that the average web page has around 600 words and the average reader only spends time on around 100 of them (about 20-30%). So, keep the posts to under 100 words…(note to self!). We’ll see if I can do it…whoops, I just hit 119 words.

I was looking at the global statistics page at the back of the most recent Economist Magazine and noticed that it had a chart laying out the % of households in each country that use IPTV (internet) as their primary means of getting their television services (vs. cable, satellite, etc). Below are the top 7 countries on the list:

Hong Kong 31%
Iceland 27%
Estonia 10%
France 10%
Cyprus 10%
Sweden 8%
S Korea 7%
(US <1%)

Much like cellular has leapfrogged land lines as the primary telecom pipe in developing countries, many countries are going with IPTV as a prominent source of distributing content. Homes can get both internet access and video/TV delivered through one pipe. We have seen this phenomenon up close through our Growth Fund’s investment in UUSee, the leading IPTV P2P provider in China with over 30 million users.

In addition to this IPTV trend, we are also seeing videos come at us from the hosted video sites like YouTube, Metacafe and specialized channels like Celebtv. My kids are watching entire episodes of their favorite shows on the show’s website. While people complain about having too diverse a choice through the hundreds of cable/satellite channels, imagine the complexity when thousands of IPTV channels emerge. With the low cost of production and low cost of distribution, people will be able to set up extremely niched “channels”.

This will create quite the challenge for advertisers, who are still trying to figure out how to use banner ads. Instead of a simple decision of what image to put in a banner that is broadcast out, they will have to figure out if they want to use pre/post roll advertising, sponsored advertising, contextual text links beside videos, overlays on top of videos or jump into the creative game and produce content itself. The permutations of types of content with types of channels is becoming mind boggling. However, for creative lead gen players, this will present a terrific opportunity to capitalize on the complexity and the glut of ad inventory arising.

Of course, this doesn’t begin to get into the challenges of integrating cross-media promotions (text/SMS, website, etc) or the rise of mobile advertising. It’s going to be a great couple of years here as the IPTV revolution swings through!

Following up on my post on the buyout world, the VC world has also experienced valuation inflation over the past year. As more and more liquidity comes into the sector (mostly acquisitions), VC’s are beginning to feel bullet proof again. We are starting to see VC’s promising entrepreneurs $80m and $90m pre-$ valuations if they can get some proof points in a given area (we’ll see if they come through). Since venture does not use much debt, the debt crisis has not hit home yet (it will should the economy go into recession and ad budgets and cap-x budgets get slashed). If you want to get a sense of what is driving the increasing craziness, check out some members of the asylum. Slide at $550m and Rockyou at $325m??? While we have several on here (and fingers crossed they hit Henry’s values!), I scratch my head a bit. While not the extremes of 1999, there are a lot of $’s for eyeballs (or "attention" as it is now called these days). Here is Blodgett’s estimates of property values:

THE SAI 25: THE WORLD’S MOST VALUABLE STARTUPS

Rank
Company    Valuation
1.    Facebook $9 billion
2.    Wikipedia $7 billion
3.    Craigslist $5 billion
4.    Betfair $5 billion
5.    Mozilla Corp $4 billion
6.    Yandex $3 billion
7.    Webkinz $2 billion
8.    LinkedIn    $1.3 billion
9.    Habbo    $1.25 billion
10.    Oanda    $1.2 billion
11.    Linden Lab $1.1 billion
12.    Kayak $1 billion
13.    QlikTech $850 million
14.    Ning $560 million
15.    Slide $550 million
16.    TheLadders $500 million
17.    Stardoll $450 million
18.    Ozon $450 million
19.    Thumbplay $400 million
20.    Glam Media $400 million
21.    Rock You $325 million
22.    Tudou $300 million
23.    Efficient Frontier $275 million
24.    Zazzle    $250 million
25.    Spot Runner $250 million

Contenders
Federated Media    $245 million
Yelp    $225 million
Meebo    $220 million
Indeed    $200 million
Zillow    $200 million
LoveFilm    $200 million
Metacafe    $200 million
Adconion    $200 million
4INFO    $175 million
Photobox    $150 million
Vibrant Media    $150 million
Gawker Media    $150 million
Mahalo    $150 million
56.com $150 million
Youku    $125 million
Digg    $125 million
Etsy    $115 million
LinkExperts    $100 million
Powerset    $80 million
Trialpay    $80 million
Huffington Post    $75 million
Associated Content    $65 million
Live Gamer    $60 million
Twitter    $75 million
Mint    $50 million
Prosper    <$50 million

JB Pritzker sent this over to me recently. Shades of reality but tons of humor in this…

How to manage your company’s board of directors:

1. Meet by phone whenever possible. Most of them will be doing their email or goosing their admin or something and not paying any attention at all. They’ll just vote when you ask’em to.

2. Never distribute anything in advance; they might read it and get themselves all confused. Just present it all: gets you through most of the meeting.

3. Never number the pages of what you are presenting. Lots of time can be used constructively figuring out what page everybody is on. If you email the material (preferably just after the start of the meeting), send lots of separate files. Turkeys’ll never know what to look at. Bonus suggestion: send slightly different copies of files with different pagination to everyone; it’s a lotta work but it’s worth it.

4. Have your CFO present numbers, lots of numbers. Make sure they get a chance to go over variances in the pencil budget.

5. If you have to meet in person – it is gonna happen sometime – use food. Any discussion you don’t want input on should be right after lunch. No one’s gonna be awake then.

6. Speaking of lunch, you can play this for lots of time. Have your dumbest admin take orders off some huge takeout menu. Get what type of bread they want, dressing, meat, lettuce, all that. Then have a smart admin shuffle the list so NO order is right. Wrong bread with wrong filling etc. No veggies for vegetarians (they tend to be nitpickers anyway). Kills lots of time and helps make sure they meet on the phone next time. BTW, they’ll pay no attention to anything between when lunch is ordered and when it comes so minimum of an hour.

7. Do bring up board comp and director’s liability insurance. Sure to get their attention and won’t interfere with the real business of the company.

8. Have a nine person board with three insiders, four VCs and two people who don’t have a clue. Just four VCs alone should guarantee gridlock.

9. Every meeting should run way over schedule. You control the agenda: presentations up front; substance in the third overtime period.

10. If they’ve gotta discuss something, get’em down in the weeds. Color of the office; words for the new ad campaign; what bank to deposit tax payments in. That keeps everybody out of trouble.

11. If you’re public and their questions are going where you don’t want to go, tell them you’d be glad to answer but that’ll make them insiders for the next two years. You can also tell by who squirms who was planning to sell.