Seeing Both Sides

In Over Your Head - The Life of an Entrepreneur

Being an entrepreneur means figuring out how to survive and thrive when you often find yourself in way over your head.  An ambitious entrepreneur is always pushing and stretching beyond their comfort zone -- creating a company from scratch, evangelizing a new category, taking risks way out of any rational person's comfort zone.  They rarely want to admit vulnerability, particularly to their management team or board, and so sometimes cover up their anxiety with bravado.  This is the exact wrong way to approach this common situation.

Believe me, I know the feeling.  In my late 20s, I was promoted to the executive team at Open Market -- a billion-dollar market capitalization, publicly traded company -- and found myself in way over my head.  I would come home at night, shake my head as I recounted to my wife the decisions I was responsible for making, and reflect that I really had no idea what I was doing.

But after a few years, I started to get the hang of it, gaining comfort and confidence in my position.  What happens to a passionate, ambitious entrepreneur who gets the hang of something?  They get bored.  They seek out the next big challenge.  I was fortunate to find it at Upromise, where I was asked to help start the company and serve as president and chief operating officer.  In our first 18 months, we raised $90 million in venture capital, hired over 100 employees, signed up partners and launched the service into the market.  During that period, I again often felt way over my head.  But that’s what made the experience so thrilling.  Whether it was pitching Citigroup’s chairman Bob Rubin to join our service (we were still operating the business out of my partner's house at the time – talk about “punching above your weight”!) or negotiating a board compensation package with former presidential candidate Senator Bill Bradley, being in over my head was one of the scariest and most fun parts of being an entrepreneur.

How do you know if you're in over your head in a healthy way as compared to an unhealthy one?  One entrepreneur gave me a good rule of thumb for this just yesterday.  He suggested that entrepreneurs follow an 80/20 rule - they should always feel in command of 80% of the business, but feel way over their head 20% of the time.  It's that 20% stretch that makes it fun and challenging.  But if an entrepreneur is on the wrong side of the 80/20 rule (i.e., are stretching 80% of the time and in command only 20%), then there is a deeper issue.

Here are a few recommendations for those who find themselves in that situation:

1) Be self-aware.  It's ok to feel as if you are in over your head as an entrepreneur.  In fact, it's natural.  Don't be afraid to recognize it, admit it, and talk openly about it with your board and management team.  Figure out which side of the 80/20 rule you find yourself.

2) Learn your way out...with help.  Seek the advice of the wise men and women around you to learn how to step up and grow into the situation you find yourself in.  Don't close yourself off to outside advice for fear of appearing weak.  Instead, embrace smart, diverse opinions to help shape your own.

3) Accept life preservers.  Many entrepereneurs are terrible at accepting help.  After all, the reason they're entrepreneurs is that they enjoy being their own boss and are passionate and often stubborn about following their vision.  It's hard for them to admit they need help and, sometimes, need a life preserver to pull them out of the situation.  It may mean hiring a COO, hiring a CEO and moving into a chairman role, or other big moves that risk giving up control.

When entrepreneurs are in over their head, it can be awkward.  But it doesn't need to be.  Be honest and open with those around you and keep an eye out to make sure you're not on the wrong end of the 80/20 rule!

Built to Last vs. Built to Flip

Fred Wilson wrote a blog last week on VC exits, bemoaning the lack of liquidity paths.  I admire Fred tremendously (both as an investor and blogger!) and think It's a great blog, but it only covers a part of the story.

First, a bit of background.  VCs need their start-ups to exit in order to pay back their limited partners.  The IPO window is effectively closed for VC-backed companies and even when it was somewhat open in 2006-2007, the bar was very high (typically you needed $100m in revenue, profitability and 7-9 years of operating history).  The practical path to liquidity for entrepreneurs, therefore, is to sell your company to a larger (typically public) company for cash and/or stock - an M&A exit.  Fred points out that, as a rule, Web start-ups simply do not thrive when snapped up by the (depressingly few) prospective acquirers like Google, Yahoo and AOL - leading to an unsustainalble cycle.

Why do I think Fred's blog only covers a part of the story?  Simply put, there are huge industries and parts of the economy where VC-backed start-ups are competing that are not covered in his analysis.  The life sciences industry, which has become a massive opportunity for entrepreneurs and VCs, has seen some terrific exits in both biotechnology (Flybridge Capital's senior advisor, Christoph Westphal's company, Sirtris had a strong IPO in 2007 and has a market cap north of $350m) and medical devices.  Our portfolio company, Brontes3D, was acquired by 3M for $95m after raising only $8m in capital.  Brontes, by the way, has indeed thrived under 3M's leadership.  Nearly two years later, the entire management team under CEO/co-founder Eric Paley is still there and 3M's resources and distribution channel has helped support taking the company's novel intraoral dental scanning device to market (as featured in yesterday's Boston Globe). 

The wireless industry has seen some nice exits for companies like Enpocket, 3rd Screen Media and m-Qube.  Enpocket's management team under CEO/co-founder Mike Baker remains at acquirer Nokia and has taken on responsibility for all of Nokia's mobile marketing initiatives.  Finally, the enterprise software industry (selling to, gasp, IT) isn't (as my partner Chip Hazard likes to say) dead yet.  Some strong exits in that market in the last few years include Outlooksoft and Virsa (both bought by SAP), AppIQ (HP) and IM Logic (Symantec).  IMLogic's CEO/co-founder, Francis deSouza, remains at Symantec 2 years later as an SVP running a huge part of their business (nearly $1 billion in revenue, last I heard).

A cynical observer might point out a sharp contrast here.  The "easy come, easy go" Web 2.0 start-ups may not be building real, sustained value and so vaporize under an acquirer as quickly as they appear, with "quick flip" entrepreneurs running off to do their next big thing.  Meanwhile, the "built to last" entrepreneurs across a range of "long-term value creation" industries -- life sciences, medical devices, enterprise software to name a few -- are more likely to stick it through and help their acquirers see real value through continuous improvement.

But then again, I'm a former entrepreneur.  Optimism wins out over cynicism every time.

American Idol in the Boardroom

It's taken me a few seasons and heavy lobbying from my wife, but I confess to finally becoming a convert when it comes to American Idol.  The show is simply mesmerizing when you blend the individual personalities and talents of the contestants with the judges.  In particular, I find that the three judges work incredibly well together to provide an entertaining banter throughout the show - Randy, Paula and, of course, Simon.  As much as I enjoy the performances, I enjoy listening to the judges' feedback on the performances even more.

As I was watching the top 12 contestants get winnowed down to 10 last night while catching up on email - many of which contained board packages and sundry portfolio updates - my mind drifted and I began to wonder:  if the contestants were entrepreneurs and the American Idol judges were VCs, which judge would the entrepreneurs want in the boardroom with them?

Let's examine the three candidates.

Randy is the Domain Expert.  His experience in the recording arts field is palpable when he speaks and presumably he is very well connected.  He displays great empathy with the contestants and often gives very constructive feedback that is relevant, albeit a bit narrow.  He doesn't focus on the overall strategy, typically, but rather picks out one or two small items to comment on.  Similarly, many entrepreneurs seek out VCs to sit on their boards who are deep domain experts and can provide them with vertical expertise relevant to their particular business.  But many entrepreneurs find the Domain Experts repetitive and overly formulaic over time ("I'm a hammer," confessed one to me the other day, "and everything I see looks like a nail to me").  At the extreme, these domain experts simply don't help the entrepreneur see the big picture in the value creation process.

Then there's Paula, the Cheerleader.  No matter how bad the contestant did, they can count on an encouraging word from gentle Paula.  Certain VCs display similar personas in the board room.  Missed the quarter?  Lost a key recruit?  "You're doing great," says the Cheerleader VC, "Atta[boy/girl] - just keep at it.  This is hard stuff and we love you."  I remember one of my board members used to systematically call me or email me with a "Nice job!" message at the end of every board meeting.  At first, I relished it.  After ten board meetings of the same formula, I realized I was the recipient of the auto-encouragement-message.  When you're feeling down and going through one of the inevitable troughs in the entrepreneurial cycle, you need that Cheerleader board member to pick you up.  But they lose credibility quickly because you're never really sure if they're telling you what they think, or just telling you what they think you want to hear.

Finally, there's Simon.  The thing you love and hate about Simon is that he tells it like it is.  He is the Truth Teller.  In the board room, sometimes the feedback is tough and hard to hear ("That really stunk - your sales presentation shows that you still have no idea how to articulate your value proposition").  But when the Truth Teller gives you that rare bit of positive feedback, it's all the more precious, because you know the Truth Teller doesn't sugar-coat ("Last quarter was awful, but this quarter you finally got your act together and executed flawlessly.  Well done.").

These archetypes - the Domain Expert, the Cheerleader and the Truth Teller - each have their pros and cons, but when I was an entrepreneur, I preferred the Simon-like Truth Teller.  It's the dead-on feedback from the Truth Teller that pushes a board and a company forward.  Even when it's painful to hear.  You can't solve tough problems in start-ups (and what problems aren't tough when trying to create a multi-million dollar business from scratch?) until you face up to them and articulate and explore them fully.  The Truth Teller doesn't let human nature's conflict avoidance tendency kick in, but rather pushes you to see the flaws and address them.

Which American Idol judge would you prefer to have on your board?

New Fund, New Brand: Introducing Flybridge Capital Partners

 

As my blog readers note (and appreciate), I typically don't write about my portfolio companies or fund.  But it's hard to resist on this one occasion.  Today we announced the closing of our 3rd fund at $280 million and a new brand:  Flybridge Capital Partners.

Our strategy and team remains the same:  5 general partners pursuing consumer, medical and information technology early-stage investment opportunities across the US.  But we wanted to eliminate any confusion that existed regarding our market position as a firm with a broad sector focus and a diverse, blue-chip Limited Partner base.  When some folks heard the "IDG" name, they thought corporate VC and media-only (for example, while we were flattered when AlwaysOn named us one of the top VCs in 2007, we were chagrined when they listed us in the corporate VC category!).

The word "flybridge" appealed to us because (in addition to being available, two syllables and easy to pronounce/spell) it represents a nice metaphor to what we do every day - give entrepreneurs (who are steering the ship on the main bridge!) a different perspective on the landscape and waters ahead.

Closing the fund in the context of the current malaise in the general economy is also a nice endorsement for the early-stage venture capital market - something that should give all of us some hope.

Let's Play "Blame The VC"

I attended a breakfast run by Tony Perkins and AlwaysOn last week in preparation for their upcoming, inaugural event in Boston "AlwaysOn - East".  I've attended the NYC event a few times and although they are a bit too buzzword compliant, they tend to attract a high-quality audience in the consumer new media start-up market.  Tony and team are now trying to bring the model to Boston (April 8 and 9) and broaden its market segments to appeal to players in enterprise IT, life sciences and cleantech markets as well.

Anyway, the breakfast was a group of 75 or so entrepreneurs, VCs and service providers gathered to give the AlwaysOn team some perspective on the Boston start-up community.  What really struck me was the nature of the dialog in the room.  It was almost as if the local entrepreneurs, bemoaning their lack of success in securing funding, rationalized that it must be due to the inadequacy of the Boston VC community.  In effect, they wanted to play the ever-popular game of "blame the VC".

Here's how the game is played for those of you not familiar with it.  First, assume you are a combination of Steve Jobs, Bill Gates and Larry Page rolled into one that your start-up idea will be worth somewhere north of $100 billion.

Next, approach a number of VCs to pitch the deal.  One favorite approach is the cold email (ask your VC friends how many "transom" or cold emails result in funded businesses and you'll probably hear that the typically long odds of 500 to 1 go to 50,000 to 1).

Then, when you don't get funding, play "blame the VC".  Tell all your friends that those risk-averse idiots wouldn't know a good deal if it hit them in the face.  And especially the ones in [insert your geography here].

By the way, this game is played by all entrepreneurs all over the world - new and old.  One of our portfolio CEOs, a successful serial entrepreneur, pitched 40 VC firms before securing his follow-on round.  It turns out, 39 of those VC firms were total idiots.  Only one had the keen insight to see the value in his company and fund it.  Another of our portfolio CEOs just recently complained to me:  "Silicon Valley VCs all fall into such groupthink.  I have no interest in working with them".  Funny enough, those comments precisely echoed the comments from the Boston entrepreneurs in the room at the AlwaysOn breakfast!

Now obviously I'm being a little cheeky here.  Passionate entrepreneurs should indeed ignore all the "nattering nabobs of negativism" (to quote Nixon's former VP Spiro Agnew in a line penned by William Safire!).  But let's tone down the blame game a bit, shall we?  If you don't get funded, there is probably some underlying, logical reason why beyond the fall back "blame the VC" game.  It's probably worth thinking deeply about what you can do to improve the idea, or modify your pitch, rather than whine about the unfairness of it all.  To quote Benjamin Franklin:  "Any fool can criticize, condemn and complain.  And most fools do." 

Now I do admit, that is an aphorism that cuts both ways!

It's Morning in America Again - Just Ask The HBS and MIT Sloan Kids

Reading the newspapers and magazines covering the US economy is downright depressing (today's Wall Street Journal is particularly depressing - hammering on both the worsening credit market problems and brain drain away from start-ups).  But meeting with fresh-faced MBA students is downright inspiring.

I had the opportunity to meeet with 100 Harvard Business School and MIT Sloan students over the last few days and was incredibly impressed with their optimism and energy, particularly as it relates to the entrepreneurial opportunities that lie ahead.

We host an event with the graduating students every Spring, inviting 100 of the most inclined to entrepreneurship (as opposed to...gasp...banking and consulting) in order to get to know them and see if there might be opportunities within our portfolio, learn about companies they are starting or joining, and generally build relationships with the next generation of talented entrepreneurs.

What struck me the most this year was that the students seemed oblivious to - no that's too harsh, let's say unaffected by - the global economic turmoil raging around them.  The collapse of credit markets?  Inflationary pressure tying the hands of Bernake's Federal Reserve?  Destruction of trillions in asset value as the real estate asset bubble deflates?  A weak US dollar impacting our competitiveness and purchasing power?  Not even a part of the conversation.

Instead, they wanted to talk about clean technology and sustainability, novel medical devices and sensors, Google vs. Microsoft, the opportunities represented by the emerging mobile generation, the shift of the nearly $1 trillion in global advertising to the Web, the emergence of global perspective on VC and entrepreneurship and many other topics bubbling with possibilities.  Recognize that all of these young men and women have the mission to find a job after business school over the next two short months, yet they didn't seem concerned with "a job".  They were focused on ideas, innvoations and opportunities.  It is no coincidence that the famous MIT $100k Competition - where entrepreneurs submit business plans and get judged by VCs and start-up veterans in the hopes of winning a little seed money and a lot of notoriety - had a record number of entrants this year.

With a nod to John Winthrop (oh, Ronald Reagan as well, I suppose), one can only observe that in the halls of the elite American business schools, it's Morning in America again and our entrepreneurial economy remains a city on a shining hill.  There is still plenty of hope to spread around!

Follow-On Financings: Act Like a Pro, Raise the Dough

With the capital market turmoil raging, many argue that 2008 is going to be a tough year for start-ups to raise money, particularly follow-on capital in the form of a Series B financing (not surprisingly to any veteran viewers of Sesame Street, Series "B" follows Series "A" rounds of financing).

Series B financing processes are all about credibility.  Does this management team have its act together to build a great, valuable company?  As such, behaving like a pro during the fundraising process is critical.  If the management team demonstrates they can run a great fundraising process, they can run a great company.  If they look like this is their first time through the process and they are scrambling to react to questions and requests for materials, their ability to successfully execute on the business plan will be heavily discounted.

For VCs, the Series A is a “hopes and dreams” investment thesis.  Do I believe the vision and this management team's ability to bring the vision to life from nothing?  The Series B investment thesis is all about “metrics and momentum”.  The management team needs to provide a compelling case that their company and their category has tremendous momentum, in fact accelerating momentum, and that the Series B money is going to be used to cement their leadership position in a valuable market.  It is not a speculative bet.

In a first meeting with a management team, typically lasting 60-90 minutes, a VC firm’s job is to decide whether to have a second meeting.  If so, the VC firm will typically articulate to the management team the key issues or concerns there have with respect to the business that they'd like to understand better and see addressed.

If a VC firm is interested in continuing the process after the first meeting, they’ll typically invite the team back for a second meeting with a broader group of the partnership and try to understand the business at a deeper level in the context of the key issues.  If there is interest in doing “real work”, the due diligence process begins and it is "game on".  Note to entrepreneurs:  if a VC keeps meeting with you and isn't doing "real work", it's a yellow flag that you are on the back-burner of their "top new projects" list, of which there are typically no more than one or two.  Typical materials that are asked for to assist in due diligence in a Series B process include:

• Capitalization table
• Management team bios
• 3-5 year Financial plan and model – the CFO should be prepared to walk through; which should include a 10-15 page PowerPoint presentation on the business model, key metrics and assumptions and how those metrics and assumptions impact the financial model
• Historical financials, audited and unaudited
• Note that the financial model should be packaged in an Excel file in such a way that can be send to VC firm associate/principal to tear through and tweak assumptions and run sensitivity analyses
• Sales pipeline – VP Sales should be prepared to walk through
• Management team references
• Customer references
• Partner references
• Technology review – VP Eng should be prepared to walk through, ideally with PowerPoint presentation as guide and architecture document as back-up
• Major contracts
• Product roadmap – VP Marketing should be prepared to walk through; ideally with PowerPoint presentation as guide
• Exit valuation comparables and scenarios – CFO should have matrix of public company and private exit comparables that show typical revenue and EBITDA multiples

A thorough but efficient diligence process typically takes 4-8 weeks from first meeting if everyone is focused on it.  A few pieces of good news should be sprinkled in during the process to underscore the momentum story (e.g., “By the way, we signed X” or “By the way, we were 50% ahead of plan last month”).

At the end of the day, the fundamental VC math a firm will need to be sold on for the Series B goes as follows:

• What is the post money valuation on this round?
• How much additional capital will be required, if any, and what’s my blended post money going to be across the two rounds
• Multiply that number by 5-10x. 
• Can I convince myself and my partners that I can generate that exit valuation based on the industry comparables during a rational market period over the next 3-5 years?

If the answer is "yes", you get the term sheet.  If no, rinse and repeat with next the VC firm!

Is the Exit Window Closed?

Microsoft's unsolicited $44.6 billion bid for Yahoo is an exciting, bold move for the Redmond, WA software giant who is desparately trying to compete with Google for the $800 billion in global advertising dollars, of which only $24 billion will be spent online in 2008 (a rate that is growing at over 20% per year).

But if VCs needed yet another signal that the exit environment is getting tougher, here is another one.
First, the IPO window is closed thanks to choppy stock markets and recession worries.  Then, some of the most popular technology company acquirers, like HP, IBM and Cisco, get battered in the stock market along with eveyrone else.  And now two of the most popular media and Internet acquirers, Microsoft and Yahoo, get frozen in their tracks as they try to figure out whether to combine.

What happens to VC-backed portfolios when the exit windows close?  We saw it occur in 2001-2003 and it's not pretty.  The companies who had the investment thesis, "if you build it, they will come", find that no one is coming to their party.  And the companies that had the investment thesis, "get a few leading customers and then let's sell to Yahoo/Microsoft/Google" are seeing two of the three candidates go into hunker down mode for the forseeable future.

Bottom line:  if you are raising capital and have the option, raise a bit more.  And if you have set your 2008 budget, reset it...a bit lower.

Who's Afraid of the Big Bad Recession?

With yesterday's 0.75% rate cut by the Federal Reserve, the press has been rightly focused on the ripple effects that the soft economy will have on the US and the world.  Amidst the high-level analytical fervor, the mainstream press has not probed on the implications to the venture capital/start-up economy, which fuels so much innovation, particularly here in Massachusetts.

There are two interesting competing forces at work.  First, venture capital investments are obviously negatively impacted by the down turn.  Start-ups that were funded during what will be seen as the "go go days" of 2005-2007 will struggle to maintain their growth and momentum through the economic head winds.  If VCs invested in these companies at inflated prices and, on the margin, over-capitalized these companies, their returns will suffer.

But on the flip side, looking prospectively at the VC asset class, one might argue that it is suddenly looking more appealing than ever, particularly on a relative basis (reminds me of the joke about the two "buddies" being chased by a bear realizing that they don't have to outrun the bear, just one another).  Over the last five years, our later stage private equity cousins benefited tremendously from cheap debt, a rising stock market and a robust IPO market.  Spectacular buyouts could be executed with modest capital at risk relative to the total deal size and then flipped for a nice profit 2-3 years later.

As a result, limited partners began to pour a greater share of their "alternative" asset class dollars in private equity and holding their venture capital exposure relatively costant.  But with a choppy stock market and evaporating IPO environment, suddenly those easy buyout returns don't look so easy any more, particularly given its dependency on the US banking system, which is the sector of the economy that appears hardest hit.

In contrast, the venture capital asset class is looking pretty good right now, with its 10 year window that in theory can skate through a few economic cycles and a sector exposure that's more dependent on IT budgets (which appear to be remain reasonably robust, with IDC forecasting 6% growth in worldwide IT spend to $1.3 trillion in 2008) and the shift of marketing dollars to digital environments such as the Web and mobile (which appears inexorable, with Internet advertising forecasted to grow to $24 billion in 2008, almost a doubling from $14 billion in 2006).  It is interesting to note that on the same day that the Fed announced its rate cut, the Dow Jones announced a modest increase in 2007 of VC dollars invested of $30 billion (8% above 2006 across the same number of deals) and a nice balance of fund flows with $32 billion raised.

The last economic cycle demonstrated an interesting lesson for VCs - start-ups that were created during the 2001-2003 downturn have proven to be terrific investments 5-6 years later.  Incubating small companies during economic downturns, forcing managers to be prudent with their capital and quietly positioning themselves for strong growth and leadership when the market turns, is an age old start-up playbook for success.

My advice to entrepreneurs - don't wallow in self-pity about the negative impact the economy will have on your 2008 performance.  Instead, this is a great time to hunker down, steal incremental market share and build a valuable company that will be poised to take advantage of the predictable upturn around the corner.

2008 Boston VC Blog Predictions

As I did in 2007 as well as 2006, I thought I'd throw out a few predictions for 2008.  So here we go, in no particular order...

1) No Recession. As Agent Maxwell Smart would say:  "missed it by that much".  I am short-term bearish about the US economy and, like many of you, have watched with great concern the emerging credit crunch, real estate asset bubble, US dollar devaluation, rising oil prices and inflationary pressures.  That said, I think the US economy will power its way through 2008 without slipping into a recession (which is technically defined as two quarters of negative GDP growth).  Yes, we'll see anemic growth and more stock market turmoil, but corporate profits and international markets remain strong and I believe consumer confidence will return, particularly with the completion of the presidential election likely to usher in a wave of hope and optimism - no matter who wins.  The implication in our business is that young start-ups will have a harder time accelerating revenue, but the fundamental pillars of the US entrepreneurial economy - VC capital, IT spending, advertising spending - won't radically dry up.  The CIOs and CMOs that I talk to and the survey data I read suggests budgets will be flat or modest growth rather than sharply down.

2) Web 2.0 - pop goes the bubble?  Billions of advertising dollars are shifting to new media venues, with online being the most popular.  This shift will continue to fuel speculation about what will be the most valuable online media properties and audience aggregation opportunities.  But although this shift represents a real opportunitiy for a few winners, I believe that the so-called Web 2.0 sector has been grossly over-funded over the last few years.  I think the weaker economy will cause this bubble to pop in 2008 when advertising budgets stop rising, there's more pressure on experimentation, and investors realize that customer acquisition economics are proving harder than expected.  The particularly strong inflation pressures on search engine marketing (SEM), as more advertisers direct their dollars to this performance-based category, will make this emerging problem even more acute.  Talk to any of the CEOs of the major SEM-based businesses and they will tell you about margin pressure due to the rising cost of traffic acquisition.  VCs who are over-exposed to the consumer/Web 2.0 sector may be in for a rude awakening.

3) Enterprise IT - the comeback kid.  Look at the last few IPOs and mega-exits in New England and you see a pattern:  the return of enterprise IT companies.  Acme Packets ($600 million market cap), Big Band ($300 million market cap), Bladelogic ($700 million market cap), Equallogic ($1.2 billion acquisition by Dell), Starent ($1 billion market cap) and Netezza ($750 million market cap) are signs that the post-bubble hangover IT departments have been suffering from has finally passed.  IT is willing to invest in young infrastructure companies and new technologies to improve efficiencies and modernize their capabilities.  These investment opportunities will continue in 2008, despite macroeconomic conditions exerting some pressure on IT budgets.

4) Wireless - slow and steady.  The chokehold that carriers maintain over the wireless market continues.  Meanwhile, advertising dollars are moving to mobile more slowly than expected due to ecosystem immaturity.  There is simply too much friction in the business for an advertiser to place a $1 million purchase (lack of inventory, fragmented and nascent ad networks, handset fragmentation - to name a few).  Thus, 2008 will likely be an incremental growth year for the wireless industry, not yet a breakthrough year.  Breakout conditions (pervasive 3G networks, video and rich content, a more mature advertising ecosystem) still feel 2-3 years away.  Good fodder for early-stage investors, but not an area of hyper revenue growth.

5) And our next president will be...who the heck knows??  This race is a toss up.  I would've predicted Clinton vs. Romney, with Clinton winning in a tight finish, but Romney has faltered despite all the money he's poured in and Obama and Clinton are neck and neck.  This will be an interesting race to watch, for sure!

That's it for now.  Let's see what 2008 holds for us all!

Serving as an EIR: The Inside Scoop

I am pleased to have as a guest blogger, Nitzan Shaer, who was an Entrepreneur in Residence (EIR) with us at IDG Ventures for the first half of this year.  Nitzan had previously started Skype Mobile and prior to that worked at Microsoft Mobile.  Nitzan recently left us to take the COO position at Mobivox, a mobile voice-over-IP start-up (sound familiar?) we funded a few months ago with Nitzan’s involvement in the company.  Since serving as an EIR is becoming a more common occurrence in the VC and entrepreneur community, I asked Nitzan to share some of his observations on the pros and cons of the job.

Nitzan’s submission:

The opportunity to explore your own business ideas, to gain access to top minds in the industry and to get paid for it all, sounds to many like a dream job. The truth is, if it plays out well, it probably is. However, not all EIR’s feel they spent their time wisely. Based on my personal experience as an EIR, and reflecting on talks with other VC’s and five EIR’s, I assembled my observations into a short 10 step guide for ‘would be’ EIR’s. Or in short, Shaer’s 10 points on becoming a successful EIR. Disclaimer: success is not guaranteed, but at the very least, I hope it will make for a good read. Advance at your own risk. 

The idea of becoming an EIR was introduced to me after I started considering my next steps at Skype. Following two adrenaline packed years at Skype (at the time the company stood for “The Whole World Can Talk for Free”), and almost a year post the acquisition by eBay, I decided it was time for me to jump on, yet again, to an early stage opportunity and help grow it to be mega big.

Three options were on the table: join an early stage startup, start a company of my own, or become an EIR. Honestly, there was no start up I found that excited me, but there were a bunch of ideas that I wanted to pursue – not all of them in my direct area of expertise, so I knew I would need time and advice. After living in London and Seattle, my network in Boston was limited so I set up meetings with Boston VC’s and listened to what they had to say.

The first thing I learned from meeting eight VC’s was that there were nine different definitions to the term EIR. Boiling it down, there are three areas EIR’s typically focus on: identifying new investment opportunities, helping portfolio companies, and ultimately launching or joining a new investment (the ‘Exit’ even for an EIR). Some VC’s expect you to bring your own ideas for a company, dig into it, and launch it. Other VCs have an idea they have been seeking to pursue and ask you to join up and build it out. Most, but not all, will offer a salary. Some will want the right of first refusal to invest in your idea if they like it. Others will let you do your own thing, even if they don’t like it (just for the benefit of having you hang your hat in their office and engage in constructive exchange of ideas). To succeed in the eyes of the VC, you would need to bring at least one investment into the company which they would not have made otherwise. [Point 1: whatever you do, be sure to bring at least one great investment to your host VC – that is what they live for]. If you think about it, with today’s competition on good teams intensifying EIR’s are a great way for VC’s to get first dibs into a great team and for that team to get to know, and trust their VC.  [Point 2: Be sure to meet A LOT of people. Soon you will be back in the trenches building a business, and times like this will be a vague memory].

However, the EIR role is not for everyone. Risk #1 is stagnation – after 12 or 18 months you may be empty handed and start to overstay your welcome. You will not have much to show for your time as you were not actually in a start up gaining experience. Even worse you may feel pressure to jump onto a company that you are not in love with. [Point 3: At any given moment, you should be working on at least two backup plans so you don’t have to start from ground zero if you hit a dead end]. [Point 4: have the drive to define your own path and the conviction to know what the right business is for you, even if your hosts do not want to invest in it].  If all does go well, chances are you are not only choosing an employer for six month, but also an investor and board which will be with you for years to come. [Point 5: Choose your host VC with the assumption you are entering a marriage – most likely they will be there for key decisions in your life for years to come]

I was fortunate to be introduced to IDG Ventures by two HBS classmates – one of which IDG invested in and the other who co-invested with them. After meeting all the partners, talking to their CEO’s and cross referencing them with other local investment professionals, I concluded that this was the perfect match for me. They had deep operational experience (i.e. they knew in practice rather than in theory how to build a company). Second, they took the approach of mentoring rather than instructing their portfolio CEO’s (not typical in VC land unfortunately). And third, they knew what seed investments were all about, and did not have such a large fund that a small investment would make no difference to them in the grand scheme. [Point 6: Find a VC that matches your personal and business goals: small vs large investments, involved vs. unengaged board members, expertise and connections in the industry you are seeking].   

For me personally, the EIR experience played off extremely well. As in any business, the outcome is defined by the people, the timing and a healthy dose of luck. During a period of six months I spent around half of my time sourcing investment opportunities (which means getting to know all the restaurants in Boston up close), [Point 7: keep close track of who you met and how they can help out in your new venture. You will rely on these meetings for years into the future]. The other half of my time, I spent working on three business plans which I was passionate about. I was privilege to get a look at inner workings of a highly talented investment team and at the same time spend quality time investigating some business plans. The GP’s opened up their personal network to me and helped set up meetings with the movers and shakers of the ‘direct to consumer’ market which I was after. [Point 8: Keep an open dialog on going with the GP’s. Meet frequently, solicit their advice, and update them on your observations. The last thing you want if for someone to ask ‘remind me again, what is that guy doing in our office’?)] [Point 9: Before you get started, have a clear definition of what mutual expectations are and how success is defined].

During those six months, IDG invested in two companies which I played a primary role in identifying and qualifying (for every two completed deals, I don’t have to tell you how many ‘almost’ make it to the finish line). The second of the two investments, was MOBIVOX, a company that provides free international calls from any phone. After the first few hours with Stephane (CEO), I realized this is one of those companies that does not come round the block every day. It has a practically unbound market potential, given the fact that it works from any phone – landline or mobile, globally, with no need for download of applications. People finally have the opportunity to make international calls from wherever they are no need for a PC or calling cards. After two months of detailed due diligence, both the partners and I decided we could not pass on this one. I joined as COO and board member and IDG Ventures brought in the rest of the family too. IDG China, IDG Vietnam and IDG Boston joined together to invest in a global opportunity which they all felt passionate about. Chapter one ended very happily for IDG Ventures and me. Now, we all have our eyes (and hearts) on making MOBIVOX a global success !

In conclusion:
1. EIR can be a dream job, but it is not for everyone. You need to set and adhere to your agenda. It could end up great, but it could also end with nothing much to show for.
2. Choose your VC firm well – they will most likely be your investors and partners for years to come.
3. And finally, Point 10: Have fun! If you do decide to do it, relish every minute. When else in life to you get an opportunity to work on your own ideas in such an environment?

Pencils Down, Your 2008 Plans Are Due

While many consumers are focused on the hectic holiday shopping season, many CEOs are focused on the hectic annual planning season.

Each of my eight VC-backed boards are in the throes of this annual ritual - trying to gaze into the crystal ball to divine what next year's results will look like and how to develop a plan to get there.

Having done this for a number of years, I'm struck by how similar best practices are across a range of companies - whether they're consumer Internet companies (note how deftly I avoided the tired label "Web 2.0"), software companies, medical device or something in between.  Since many companies are wrestling with this process as we speak, I thought I'd share a few thoughts on what I've observed to be useful tips and techniques.

Set one and only one plan of record.  Many CEOs like to get "cute" by having a "board plan" and an "internal or stretch plan" which are different (with the internal/stretch plan being more aggressive).  In the end, this tends to confuse everyone more than it's worth (yes, I used to do it, too, and I confused myself!).  The sales team will typically have a quota that in sum is greater than the plan of record, but there should be one and only one plan of record and it should never change throughout the year unless the board explicitly agrees to a replan, say midyear.  All performance during the year should thus be compared to the plan of record.

Set a 70% confidence plan.  When I was an officer at a public company (Open Market), we used to always set expectations with the public markets against a plan we were 90% confident we could beat.  In a venture-backed company, this is known as sand-bagging and it has a negative side effect, which is that you will tend to under-invest in future growth and infrastructure if you don't set a plan that anticipates faster growth.  Another common mistake CEOs make is setting an unrealistically aggressive plan - the "if everything goes right" plan.  I've often had companies see revenue growth of 3x year over year, but feel like they've "lost" because they set an unrealistic growth plan for 5x.

Articulate your strategic goals on one page, then cascade.  The financial numbers tell only a part of the story in a plan of record.  The important plan elements in a growing, VC-backed company are the strategic objectives that will position the company for value creation 3-5 years down the road, not just what happens next quarter.  These should be articulated at a corporate level on one page so that the board can track them alongside the CEO, and then translated by each VP/department head into their own set of summary objectives.  Only by linking the objectives from top to bottom with the financial numbers can you be sure that the plan "holds together" and doesn't have any conflicting assumptions or elements.

Make it count.  Assign CEO and executive team bonus dollars against achieving the financial and strategic objectives and measure them quarterly.  That way, it's more than just words on a paper, but makes keeping score a part of everyone's top-of-mind activity.  Some entrepreneurs find it funny to have $10-20K at stake against quarterly objectives when they're really aiming for a $5-20 million equity payout, but by putting some real dollars against the shorter-term milestones, it helps everyone focus their energy and attention to the small steps along the path to the bigger success.

Discuss the "what if" scenarios with the board.  In almost every board planning meeting I've been in, someone inevitably asks the "what if" questions - "what if revenues are half what you think?" or "double?" or "what if revenues are zero?".  The last thing you want to do as a CEO is get caught flat-footed mid-year when things don't go according to plan and the board hasn't agreed to a set of actions.  "I just assumed you guys would bridge the company", is the last thing a board wants to hear 60 days before running out of cash!

What are some of the planning techniques you're applying this year?

CyberMonday strikes again

As readers of my blog know, I never flog my portfolio companies, but tomorrow is CyberMonday and as a fan of e-commerce over the last 12 years in the industry, I find it hard to not do a little cheerleading in general and for Mall Networks in particular.

According to shop.org, 68.5 million people will shop for holiday gifts from work, up substantially from last year, and 30.2% of holiday sales will be influenced by the Internet.  It's an incredible transformation and it's hard to imagine what the next 12 years will bring given the pervasiveness of broadband, mobile and the forces of globalization.  It'll be interesting to see if consumer worries about the housing slump, mortgage crisis and other economic woes will slow down e-commerce spending tomorrow and beyond this holiday season.

TechCrunch comes to Boston

Before memories fade too quickly, it's worth noting what a great event we had Friday night when we hosted TechCrunch's inaugural Boston MeetUp event.  800 entrepreneurs, VCs, press and other industry players came to network and celebrate the beginning of the holiday season.  A number of local start-ups use the opportunity to launch themselves to the market.  Below is a pic of me with the ubiquitous Don Dodge from Microsoft.  Special thanks to Michael Arrington and TechCrunch CEO Heather Harde for organizing the event with us.

TechCrunch Party in Boston - November 16th

We’re pleased to be teaming with TechCrunch, to host their first ever meet up in Boston. Like their previous events, tickets are limited to the event, and being released on an incremental basis. The event information is as follows:

Friday, November 16th from 6-11pm.

Location:  The Estate at 1 Boylston Place.

Register here through EventBrite, based on availability.

Boston VCs to Google: Bring it On!

Rumor has it that we will finally hear the news on the Google phone today.  The search firm's every move is closely watched, but lately even the parochial Boston technology community is abuzz about what's happening in Silicon Valley.  For months now, both the Boston Globe and the Boston Business Journal have breathlessly reported Google's every move, including its real estate and hiring forays, with hundreds of engineers briskly hired and crammed into office space in Kendall Square - apparently nearly all of whom are working on its planned mobile offering.  When I was at the wireless trade show conference (CTIA) last week in San Francisco, there wasn't alot new to talk about, and so Google’s reported entry into the spectrum auction and top-secret efforts to create a phone operating system loomed particularly large.

And yesterday's Sunday NY Times raves about the gadget prowess of the executive in charge of the effort Andy Rubin.  Meanwhile, the stock price has never been higher, closing yesterday at over $711 per share with a market capitalization of $222 billion, surpassing even Cisco.

The parochial debate in Boston is whether Google’s presence is a net plus or minus. The grander debate on the world stage is whether Google is a Netscape-like flash in the pan or truly a history-making enterprise?  My vote on both accounts is huge "net plus" and "history-making".

Google’s vision is breath-taking: the company is after no less than the $800 billion of advertising dollars that are currently spent worldwide by giants like General Motors and P&G down to your local dry cleaners. With only roughly $20 billion in that advertising spend happening online in 2007, the data shows that online ad spending, although growing at a torrid pace, has not caught up with the time consumers are spending online as compared to other media (insert here the usual diatribe about the decline of the newspaper, network television and the like along with the required gratuitous reference to the "Long Tail" of content and entertainment). Its ambitious plans into the mobile market are merely a natural extension of this strategy. Google is following the consumer eyeballs – and consumers worldwide are more and more turning to their mobile phones as a source for news, information, games, entertainment and video.

What some people don’t fully appreciate is that Google is actually after more than the online and mobile ad market. They are after the offline ad market as well. The vision isn’t just about the transformation of advertising and content to digital media. It’s also about making advertising measurable.  Google is in the midst of a huge experiment in television advertising (thanks to its partnership with EchoStar), radio advertising (thanks to its acquisition of dMarc) and magazine advertising (through a strange reseller/price arbitrage arrangement that is merely an excuse to get down the learning curve).  And through this powerful connection with advertising and marketing as its core focus, Google is entering into technology arrangements and developing offerings that are threatening Microsoft’s core business of Windows, Office and the enterprise.

Can Microsoft stop them?  Consider this: at General Motors, I would venture to guess that the CIO has periodic meetings with Steve Ballmer to review strategy, future plans and important high-level requirements.  I would guess the CMO has the same meetings with Eric Schmidt.  Google apparently has hundreds of employees now based in Detroit servicing the auto industry marketers.

So should we welcome Google’s entry into the Boston market? With open arms!  We VCs may not like the impact of the added competition and downstream price inflation on Boston high-tech talent – the predictable result of Google’s giant sucking sound.  But having Boston serve as one of the talent hubs for Google will allow us to get a window into one of the most important industrial companies in the world, serving as a base grooming strong managers (which there is a dearth of in Boston) and a potential source of interesting M&A and partnership opportunities.

Thus, the message to Google from Boston VCs and the broader high-tech community should be:  "Bring it On".  Hire as many as you can.  Buy a few things while you're here.  And somebody should tell Eric Schmidt to spend as much time in Nantucket as possible!

Seeking Serendipity

As I was giving some career advice recently to a college class, I realized there was one important piece of advice that I never received, but now preach and try to practice:  as busy as you may be, always carve out the time to take random meetings.  Simply put, it pays on occasion to take meetings with high-quality people, even though you have no idea who the person is that you’re meeting with and why.

I have learned that in the world of VCs and start-ups, those somewhat random meetings with high-quality people can lead to interesting outcomes.  In fact, my career has been shaped by VCs I didn't know reaching out and having random meetings with me, leading to interesting outcomes.

When I was a student at Harvard Business School, at a time when I didn't even know what venture capital was, a VC firm called Greylock invited me to a dinner meeting on campus and, later, was kind enough to introduce me to one of their portfolio companies, Internet commerce start-up Open Market. I ended up joining the firm after business school and had the privilege of riding the Internet 1.0 wave as an executive there for five years, through an IPO and many exciting ups and downs.

In the middle of my time at Open Market, I got a random phone call from another VC I didn’t know, David Fialkow from General Catalyst, who wanted to have breakfast with me. I wasn’t looking for a job and didn’t really have any reason to meet with him, but I enjoy meeting interesting people and so took the meeting. Another interesting person was at that breakfast – a great marketing entrepreneur named Michael Bronner. Michael had an idea for a new company:  helping families save money for college by redirecting the billions of dollars they spend on marketing programs into tax-free college savings plans. I thought it was a brilliant idea and immediately agreed to jump on board to help found the company and serve as president and COO. Today, Upromise has over $18 billion in college savings plans under management across 8 million households in America. Sallie Mae purchased the company in 2006.

Three years into my tenure at Upromise, I got a random call from another VC - this time one I knew.  He and another friend were starting a new venture capital firm and wanted me to consider joining them.  I told them I wasn’t interested in becoming a VC – just like I wasn’t originally interested in a job at Open Market or helping Michael Bronner start Upromise – but they were interesting people that I knew and respected, and so took the meeting.  Shortly thereafter, I joined my partners Michael Greeley and Chip Hazard in starting a new venture capital firm, IDG Ventures Boston.

And now I’m the one on the other end of the phone calling up people I don’t know, and who don’t know me, and asking them to take a random meeting that may lead to an interesting outcome.

Everyone is super-busy and over-programmed, so it's hard to maintain that discipline, but I've always been impressed with those that block out the time to take a few random walks and seek out serendipity.

Scott Kirsner Stirs The Pot

Scott Kirsner is always good for a little controversy.  The Boston Globe reporter wrote an article in today's business section that talks about the VC blogging phenomenon with a Boston lens.  The article probably won't win him any popularity contests at the Bay Colony Corporate Center in Waltham, but that probably wasn't his point.

The Rebirth of Enterprise IT

My partner, Chip Hazard, has been an enterprise IT VC since he joined Greylock in 1994.  He and I have watched with some amusement as everyone and their brother in the VC community has been writing off enterprise IT as a boring industry and reinventing themselves as consumer VCs.  With some coaxing, he agreed to do an update on a guest blog he did a few years ago on the topic.  Here it is:

When Nicholas Carr wrote his now-famous Harvard Business Review article over four years ago, “IT Doesn’t Matter”, the most damning claim to our industry was that IT had become a commodity input – irrelevant as a source for strategic advantage. Many pundits, from Larry Ellison on down, began pontificating on the maturation, consolidation and eventual death of the enterprise software business – at least for companies whose names are not IBM, Microsoft, Oracle, SAP or Symantec.

The general thesis goes something like the following: 1) corporate IT departments are looking to reduce, not increase their number of vendors and are therefore not inclined to work with start-ups; 2) customers no longer are pursuing best of breed strategies, but instead want integrated suites to simplify deployment and operations; 3) the sales and marketing costs of large enterprise software solutions are extremely high and drive a need for significant investments that are beyond the capabilities of many early stage companies; 4) the overall rate of growth of the software industry as a whole has slowed and there are few areas for innovation. Common analogies used by these pundits include the maturation and consolidation of the automobile and railroad industries in the early to mid 1900s. Pretty depressing stuff.

In the last six years, many venture capitalists are submitting their own vote on this debate with their feet, as the percent of funding dollars to software companies has declined from 25% of all venture disbursements in 2001 to 19% in the first half of 2007. Anecdotally, when you walk the halls of VCs around Sand Hill Road and Route 128, you hear a similar refrain: “We’re diversifying away from software... we are experimenting with consumer-driven business models... we like Web 2.0/new media plays”.

So where does that leave a talented entrepreneur (or VC, for that matter) with deep experience in this now passé field? While challenges remain, we submit that there remain numerous glimmers of hope in the enterprise software market – and certainly the recent reopening of the IPO market and the more robust M&A environment has brought some of these to light. If you look at some of these recent successes, themes and strategies emerge that entrepreneurs can adopt to drive the creation of successful companies:

• Innovate to drive efficiency. For many times over the last decade, enterprise software companies positioned themselves as automating certain functional departments of corporations. First it was manufacturing, then financials, supply chain, sales, marketing etc. If this is your view of the enterprise software environment, then by and large Larry Ellison is right – there is little room for new categories and innovation. That said, if you spend time with the average CIO, you will hear a different story. In today’s “post-bubble” environment, CIOs have seen their staff and capital budgets cut back, but the demands on their organizations from business executives have continued to increase as companies seek to have a more flexible and cost-effective IT organization to support their business plans. CIOs have gotten their much sought-after “seat at the table”, but with that seat comes the pressure of accountability to deliver bottom-line results. Compounding this challenge of doing more with less is the sheer magnitude of the accumulated applications and technologies that have been deployed by enterprises over the last 20 years. The number of lines of code, disparate pieces of software, and points of integration has exploded exponentially. As a result, there remains a robust opportunity for focused vendors to drive innovative technology into enterprises to drive efficiency in IT operations. The bar, however, is quite high. If you can’t drive a 5 to 10 times reduction in key metrics, the status quo will prevail. A recent success story is Bladelogic, which went public in July of 2007 and trades at 13 times trailing twelve moths revenue, primarily due to the company’s success in automating data center operations, a key means to drive efficiency in IT operations. Opsware, which HP just agreed to acquire for $1.65 billion, is another example and also demonstrates there is a relatively healthy M&A market, as these innovative companies fill key product gaps for large acquirers, such as IBM, Microsoft, Oracle, HP and EMC, as well as mid-sized public companies such as BMC, CA and Symantec.
• Wrap your software in commodity hardware. One of the complaints you will often hear from IT departments about working with a new vendor is the challenge of integrating their solution into their already complex environments. The mundane, manual tasks of requisitioning and provisioning the necessary hardware to run, or even pilot, the shiny new piece of software slows the path to adoption. As a result, a number of innovative software companies don’t appear at first blush to be software companies at all. Instead they sell pre-provisioned, plug and run, hardware appliances. Companies that adopt this model are not only able to leverage Moore’s law to drive performance, but also can ship their customers a unit that can be slotted into a rack and up and running in hours, not days. This allows customers to trial the solution and see the benefits immediately, mitigating the long sales cycles that plague many traditional enterprise solutions. Further, the appliance approach tends to lead to easier adoption by channels that are better suited to selling hardware than complex software. This appliance strategy was seen initially in the security software industry, but has since spread to other areas such as storage back up solutions from companies such as Data Domain, which recently went public and currently commands a $1.4 billion market capitalization on trailing twelve months revenue of $76 million.
• Dominate a niche. Start-ups are often caught in a quandary. To raise money and hire the best people, they need to convince VCs, employees and other supporters of the company of a big vision and the opportunity to capture a billion dollar market. To do so, however, they run the risk of going too broad, too quickly and losing the laser focused approach that allows young start-ups to win against large, incumbent vendors. A better strategy is to instead think about climbing a staircase. You know you want to reach the next floor, but you don’t do that by trying to jump up 13 stairs all at once. Ask yourself, “What can I uniquely do today for a customer that solves a real problem and also provides a link to doing more things for those customers in the future?” In today’s age of rapid development, componentized software and offshore resources, software code is relatively easy and cheap to write, and is no longer the “barrier to entry” and source of competitive advantage it was ten or twenty years ago. Instead, what matters to customers (and potential acquirers) is the deep, domain-specific knowledge instantiated in that software. For an early stage company to build this knowledge, they need to be incredibly focused in a given domain and make sure they have people on their team who understand a customer’s business better than the customer does themselves. Unica, a recently public $80 million in revenue marketing automation company in Boston is a good example of this. When they first got going, they had the best data mining tools for marketing analysts on the planet. Not a huge market, but one that valued innovation and provided a logical steppingstone to campaign management, lead generation, planning and the other marketing tools that the company sells today.
• Explore SaaS (software-as-a-service). If the key barrier to success for early stage enterprise software companies is excessive sales and marketing costs, adopting a software-as-a-service model may be the right approach. This is more than just selling your software on a subscription versus perpetual license basis. Instead, SaaS is all about making it easy for customers to understand, try and, ultimately, gain value from your software. In 5 minutes and for no up front cost, I can become a user of Salesforce.com. Within the 30 day trial period, I can self-qualify and decide if it is the right solution for me and worth the on-going subscription cost. Most importantly, I can potentially do this without consuming a single dollar of their sales and marketing spend. None of the airplane trips, four-legged sales calls, custom demos, proofs of concept or lengthy contract negotiations that lead to the 6 to 12 month sales cycle that costs a traditional software firm 75% of their new license revenue in a given quarter.
• Consider Open Source. Open-Source is not about free software, but rather products that have seen, or have the potential to see, widespread grassroots customer adoption. A passionate end-user community has the benefit of driving a development cycle that quickly surfaces key product requirements and needed bug fixes. Further, the grassroots adoption of the product provides a ready installed base of early adopters who will promote the product across their enterprise, purchase professional services and acquire more feature rich versions of the product. Like SaaS, this is a way to mitigate high sales and marketing costs. When My SQL looks for customers for the enterprise version of their open-source database, they have to look no further than the estimated 11 million active installations of their software or the 750,000 plus people that subscribe to their email newsletter. RedHat’s version of Linux, Jboss’s version of the application server and Sugar CRM are three other well-known open source success stories, but other opportunities abound.

Enterprise software entrepreneurship and investing is certainly not for the faint of heart, but when pursued with some combination of the strategies above, we believe interesting opportunities remain for innovative companies to make their mark in the world and have a positive impact. Contrary to the claims of many, it is still possible to build these companies in a relatively capital efficient manner. Sticking to some of the examples cited above, it is illuminating to note that Bladelogic raised $29 million of venture capital before its IPO, Data Domain $41 million, Unica $11 million, Red Hat $16 million and Jboss (pre-acquisition) $10 million. Only Salesforce.com raised a lot of capital - $64 million – although almost 75% of that came in their last round when one would assume there was evidence the model was beginning to work.

In the end, we believe the analogy to the automotive industry is flawed. The manufacture and distribution of cars is fundamentally different from the software industry. In auto industry, there are tremendous benefits of scale, the underlying platform (tires, chassis, internal combustion engine, frame and skin) has remained the same for decades, and there is little room for small players to access end-users. Software, on the other hand, is a digital good and an information business. Innovation is limited only by the creativity of the author. Small teams can be extraordinarily productive - often times more so than larger teams and organizations. The underlying platform and architecture has changed several times in the last 30 years, and there is no physical product to distribute, thus end-users can be accessed much more directly. Is there a benefit to the incumbency and distribution might of IBM, Oracle or EMC? Absolutely. Does that mean there is no place for creativity, innovation and entrepreneurship in this industry? Absolutely not.

TheFunded.com and Aretha Franklin

There’s a new VC-entrepreneur newsletter that has been getting a lot of attention lately called TheFunded.com.  The Wall Street Journal had a profile of it last week and I find more and more entrepreneurs and VCs talking about it.

The concept is quite simple.  It’s a bit like what TripAdvisor is to travelers – entrepreneurs go online and report on their impressions of working with this VC or that one and the reviews are broadly posted to the community.Why is this gossip column cum feedback site so popular?  With a nod to Aretha Franklin, I think it simply comes down to one word.  RESPECT.  Entrepreneurs want to be treated with respect.  As the holders of the money and, often, power, VCs are often labeled as arrogant know-it-alls – one of the most consistent criticisms you hear in the industry and see from the posts.  TheFunded.com provides an open counter-balance, requiring VCs to be on their best behavior, else they are “called to carpet” in a semi-public forum by entrepreneurs.  Can anyone say:  VC accountability?

Why are VCs often arrogant?  Is that what they teach us at VC breeding schools?  I think some of it is just the nature of the business.  As I mentioned in my post “Dr. Seuss and The Land of No”, VCs have the job of saying “no” hundreds of times for every “yes” that they fund.  To be efficient, they are trained to say “no” quickly and not waste time on projects they simply don’t like or don’t believe in.  Whether you believe in a project or not is such a subjective standard, that it can always be open for debate and argument.  But VCs can’t afford to have debates and arguments about projects they don’t like, they must quickly, unemotionally move on to the next one.

Entrepreneurs, on the other hand, are emotionally attached to their projects and wired to believe that what they are working on is the absolute best thing going on – after all, they chose to work on it at the expense of every other new start-up or job they could have pursued.  Thus, it is hard for them to contain their natural enthusiasm over why what they’re doing absolutely deserves to get funded.  And nothing is more frustrating for a “walk through walls” entrepreneur than to be dismissed by a VC, no matter how graciously. 

Many VCs find it particularly hard to provide the follow-up “no” (should I call?  Leave a voice mail?  Send an email?  How to make it more personalized?  But if I spend all day explaining to entrepreneurs why I’m saying “no”, I’ll never have the time to get to “yes”).  On the other hand, entrepreneurs take particular offense if the follow-up “no” is curt and impersonal.  It’s a bit of a joke on both sides of the fence.  “Dear X, thank you for your time, but we are not going to pursue the investment opportunity at this time.  Best of luck and keep in touch.  When you are worth billions, we will post you on our 'missed deals' website”.

All joking aside, the tension between the two world views of the skeptical VCs and the optimistic entrepreneurs is inevitable.  You see this tension playing out in board rooms and pitch meetings every day.  To be clear, though, it’s a healthy tension.  If it weren’t for the walk-through-walls optimistic entrepreneurs, companies would never get started.  And if it weren’t for the cynical, blasé VCs, a lot of precious capital would be inefficiently wasted on tilting at windmills. 

The trick, therefore, is for VCs to simply treat entrepreneurs with R-E-S-P-E-C-T.  That’s all entrepreneurs are askin’ for.  Just because a VC may not like the idea, or even the person hawking the idea, doesn’t mean they shouldn’t treat them with decency and respect.  On the flip side, the entrepreneurs should remember that it’s the VCs job to sift through hundreds of opportunities and spend time only on very few.  If it’s not a good fit for them, move on.  That’s why TheFunded has struck a chord.

Cash and Carry

If you at all follow the start-up industry, you have heard the taxing news.  Congress wants to raise taxes on VCs and private equity executives.  Blackstone's IPO and the perceived excessive economics reaped by the firm's principals appears to have been the impetus for the new legislation proposed by representatives Charles Rangel (D-NY) and Barney Frank (D-MA).  As a side note, it is ironic that the sponsoring representatives are from two of the three states (California being the obvious third) whose local economies benefit the most from the private equity industry.  Talk about putting national (albeit populist) politics ahead of local interests!

At any rate, the economic impact involved is quite considerable.  Currently, we VCs get taxed at the long-term capital gains rate - that is, 15% - for our carried interest of 20-30% in a fund.  The new legislation would result in taxing the carry as ordinary income, typically 35%.

Just a reminder, the "carry" in a fund is the portion of the gain that the VC reaps as part of their compensation.  That is, if a $200 million fund returns 2x, or $400 million, a "20% carry" on the $200m gain is $40 million, which goes to the VC managers of the fund.  A 10x performance on a $200 million fund would yield $360 million in carry ($2 billion in returns, $1.8 billion in gains x 20% carry).  The tax difference for these two funds would be 20% points in incremental taxes paid by the principals, or $8 million and $72 million, respectively.

Some entrepreneurs have asked me to justify why VCs should get the capital gains treatment in the first place and I confess to being hard-pressed.  On the one hand, we do put capital to work and it is truly risk capital.  On the other hand, the capital we put to work is either other people’s money (our LPs) or our own money (our “co-invest”), which under any circumstances would be treated as capital gains – that’s not a part of the debate.  The carried interest is a more complicated portion to analyze because the carry isn’t really capital at risk – it’s a share of profits, not unlike what a sales VP or a stock broker might get in commissions, which are taxed at ordinary income rates. 

The industry is obviously aghast at the proposition of paying more in taxes.  The complaints are at both the micro (“you’re going to double my taxes!”) and macro level (“private equity and VC are fundamentally making American business more competitive and critical elements to the economy; increasing their collective tax payments will be deleterious to US growth and global competitive position.”).  Many VCs rightfully argue that the carry can’t be looked at in isolation – it is a single component of a range of components of private equity compensation that the general partners choose to allocate more of their dollars towards as compared to management fees exactly because of the favorable tax treatment.  If that were to change, they would simply raise management fees or increase the carry rate.  Increasing the taxes on VCs and private equity and having these costs passed through to the limited partners in the form of higher fees or carried interest payments will, in turn, lower the asset class returns for American private equity funds and result in capital shifting away from this asset class into other vehicles, likely private equity funds outside the US.

How will all this impact entrepreneurs?  Probably very little in practice.  On the margin, if it pushes a few private equity executives out of the business, the impact will be negligible given the current situation of "too much money chasing too few quality deals".  My observation is that entrepreneurs roll their eyes when they hear their VC friends whining about the topic, and probably rightfully so.

I guess in the end, I personally find myself in the unusual position of being a bit wishy-washy on the topic.  On the one hand, it is galling that Steve Schwarzman’s butler pays a higher tax rate than he does.  On the other hand, raising taxes on such a critical part of corporate America that is so intricately linked to our capital markets, industrial competitiveness and technology innovation clearly isn’t going to help our global competitive advantage.  In practice, my VC friends cynically tell me the whole debate is moot.  If Congress passes the contemplated law, an army of lawyers and accountants will begin advising us on intricate loopholes to structurally avoid the whole thing!

Building The Next Billion Dollar Company in Massachusetts

I'm participating in a panel this weekend at the TiE conference on the challenge in Massachusetts of building the next "billion dollar company". It's an interesting and timely topic, to say the least.

We seem to have an inferiority complex in Massachusetts on many dimensions beyond the historical trials and tribulations of our beloved Red Sox.  We stand in the shadow of New York City as a financial center, despite having a few strong private equity firms and hedge funds located in the Bay State, such as Bain Capital, Highfields and The Baupost Group. And we are a distance second to California in attracting job-creating venture capital, with $13 billion invested into 1,495 start-ups based in "The Golden State" as compared to $3 billion in 380 Massachusetts start-ups in 2006.  It’s not too shabby to be in second place to New York and California, considering we are only America’s 13th largest state as measured by population, but who wants to settle for second place?  With our mix of world-class academic institutions, hospitals, venture capital and technical talent, one would think we would have the potential to generate even more industrial horsepower. Our performance in creating industrial leaders is particularly discouraging, as we have produced a mere 10 of the country’s Fortune 500 companies that call Massachusetts their home state. Why haven’t we been able to create more billion dollar companies as opposed to numerous minnows that get gobbled up by the bigger fish out of state?

To analyze the situation, it is helpful to look at a few historical case studies of successful companies that have indeed broken out.  Two oft-cited role models who have "made it" are EMC and Boston Scientific. 

EMC is arguably the kingpin of the Massachusetts information technology scene.  Founded in 1979, the company has achieved enormous success in the information storage market, with a market capitalization of $33 billion, 2006 revenue of over $11 billion and 26,500 employees.  Boston Scientific holds a similarly exalted position in the medical technology market.  Also founded in 1979, the company’s success in medical devices has led to its growth to a market capitalization of $24 billion, 2006 revenue of $8 billion and 28,600 employees.

What do these two homegrown industrial titans have in common?  One interesting observation:  EMC and Boston Scientific were not classically venture-backed companies.  In both cases, the founders controlled the company through the IPO and had the fortitude to persevere throughout the early lean, start-up years without succumbing to the temptation to sell too early.  Patience in both companies on the part of investors and the entrepreneurs was a virtue.  EMC had its IPO in 1986 and hit $1 billion in sales in 1994, 7 and 15 years after its founding, respectively.  Boston Scientific had its IPO in 1992 and hit $1 billion in sales in 1995, 13 and 16 years after its founding, respectively.  In a nod to Jim Collins’ book "Good to Great", where he cites the importance of steady, consistent leadership, it is worth noting that the two founding leaders, Richard Egan and John Abele, were in their positions for 13 and 17 years, respectively. Another common attribute is that once they had achieved a strong position in their initial core market, both companies made bold acquisitions to maintain leadership and market supremacy:  EMC in the case of Data General and then numerous software companies, such as VMWare; Boston Scientific in the case of Guidant and numerous smaller device companies. In other words, the two companies did not rest on their laurels but instead took risks and aggressively sought to broaden their reach.

What are some of the inhibitors to replicating these two local success stories?  Beyond the lessons cited above, we would also observe that there are subtle differences in the way Massachusetts entrepreneurs and investors approach company-building as compared to our peer elsewhere.  Massachusetts entrepreneurs and investors prefer to push for early exits, exhibiting a predilection for taking their chips off the table early.  To be clear, none of us are beyond reproach here.  Beyond cultural conservatism, another driver of this behavior is the shallow pool of local senior management talent.  When Massachusetts boards consider selling or holding on, one of the key questions they ask themselves is, "Does my current management team have the horsepower to take the company to $1 billion in sales?".  In the absence of having numerous strong training grounds for executives to learn how to run operating units greater than $100 million, the answer is too often no.  You can’t swing a dead cat in Silicon Valley without hitting a high-tech executive with experience at an operating scale of greater than $100 million, but in Massachusetts there is a depressing dearth of such talent.

With the quality of our talent pool and the caliber of our business and political leadership, it’s not all doom and gloom. With home-grown powerhouses like Genzyme and Biogen leading the way, our position as a biotechnology cluster appears to have strengthened recently and we are increasingly attracting out-of-state employers who want to tap into the world-class scientific talent residing here. There are early signs of hope that we are well-positioned to lead in the nascent but potentially robust Green industry, with companies like Evergreen Solar and EnerNOC leading the way. And one of our most promising information technology "up-and-comers", Akamai, appears poised to achieve the magic $1 billion in sales in the next two to three years, dominating the Web content distribution market.

I am thus hopeful that we are on a stronger path in Massachusetts than ever before, so long as we have the continued leadership of the business, financial and political community to show the way.

The Wisdom of Crowds

I just finished reading The Wisdom of Crowds by James Surowiecki, an excellent book that provides insights into consumer behavior as well as the venture capital investment process.

The book's thesis is a simple one:  a crowd of well-informed, independently minded individuals will make better decisions than any one individual, no matter how smart or experienced.  The book support this thesis (not in a rigorous academic fashion, but in the breezy, conversational manner that you would expect from a New Yorker columnist) by examining a range of case studies that range from the frivolous (predicting the weight of a pig at a county fair) to the profound (the tragic explosion of the Challenger space shuttle).  In example after example, the book nicely weaves a compelling argument that "mob rule" may not be such a bad thing.  The author attempts to make connection from this observable human behavior to derive thoughtful insights into decision-making and capital markets.

In my own observations of consumer-based start-ups and their surge in the last few years, it strikes me that "the wisdom of crowds" is one of the more important factors in driving the success of Web 1.0 and Web 2.0 start-ups.  The Internet has enabled the efficient congregation of crowds of individuals from around the world and the rapid, low-cost aggregation of their input, allowing this "crowd power" to select the most interesting products to buy (eBay), videos to watch (YouTube), search results to view (Google) and knowledge to absorb (Wikipedia).  Arguably, the Web 1.0 and 2.0 phenomenon has largely been built on the theory behind the wisdom of crowds.

And, as usual, the book caused me to reflect on the venture capital process as well.  If you believe in the book's thesis - that no one person can be as smart as a group of informed, indepedent-minded people - then the way to make the best investment decisions is to construct a democratic investment process rather than a hierarchical one.  That is, collect aroud the table a group of experienced investment professionals with diverse backgrounds and perspectives and don't allow any one individual's power status to sway the discussion.  Instead, allow robust group group discussions and debates to ultimately yield better investment decisions; better even than any one smart individual might achieve operating alone.

Interestingly, in my experience, this is the construct of most good venture capital firms.  It would be an interesting study of VC firms' performance over time to determine whether firms that have democratic, open decision-making processes perform better on average than those that have more hierarchical, autocratic decision-making.  Understanding this dynamic within a VC firm is critical for entrepreneurs pitching to and working with VCs - an area in which I find surprisingly few entrepreneurs really probe deeply.  They should.

Soap Operas and Start-Ups

When we were growing up, my two older sisters would come home after school and immediately turn on the television and watch soap operas all afternoon.  I would sit on the floor playing with marbles, blocks and baseball cards for hours while General Hospital, All in the Family and As The World Turns droned on.  In retrospect, I wish I had paid better attention to these old-fashioned dramas.  It would have prepared me much better for being a VC.

Why would soaps and VCs be a good mix?  Because, at least in my experience, every start-up company is like a soap opera – full of intense drama and intrigue, conflicts and clashes, heroes, villains and beautiful (well, more often brilliant than beautiful) but flawed characters.

Why is there so much drama in start-ups?  If you look at the ingredients in a start-up, it shouldn’t be too much of a surprise.  Start-ups involve hard-charging, ambitious entrepreneurs and VCs who are aggressively trying to create value from nothing.  Strong (often eccentric) personalities and high stakes prevail, with literally millions of dollars at stake and the opportunity to meaningfully change the lives of the principals, for better or worse.  The participants in the drama ride the ups and downs together – sometimes working as a team, sometimes working against each other – under intense time conditions with competitors (and other villains) nipping at their heels.

Thus, with all the money, pride and ego involved, it’s no wonder there is so much drama in start-ups.  I’m always amused when an entrepreneur tells me they want to write a book about all the trials and travails they experienced in their recent start-up; amusing because what to them feels like such a unique, surreal life experience (one might event say, made for TV), is actually such a common one.

Over my 10 years as an entrepreneur and 4 as a VC, I’ve seen the following (I now realize not uncommon) scenes:

• Trust erodes so deeply between a CEO and some of the board members that they each believe everything the other says is an outright lie with a hidden agenda, resulting in completely dysfunctional relationships and requiring a premature sale of the company.
• The board of directors calls in three members of the senior management team and interview them individually to determine whether to fire the founder or the CEO, because both cannot operate in the same company any more.
• Some of the VCs in an under-performing company decide they don’t want to continue investing in the company and state their intention to walk away, causing the remaining VCs and management to scramble. That is, until business begins to show signs of picking up, and then these same VCs defend their position vigorously, resulting in management whiplash and dysfunctional relationships at the board.

Acquisitions.  Follow-on financings.  IPOs.  Missed expectations and quarters.  Hiring and firing.  Ego, pride and lots of money.  All mix together to create a tremendous amount of drama and tension.  Seasoned board members and entrepreneurs know to expect this and stay cool no matter what scene they find themselves acting in.  If only I had paid more attention to the beautiful people blathering on the tube rather than my baseball cards…

Green blog: better late than never

I’m probably one of the last people on the planet to watch Al Gore’s “An Inconvenient Truth”, particularly after its performance at the Oscars.  But my wife and I finally did sit down and watch this thought-provoking documentary cum college lecture from our former vice president and Green Cheerleader-in-Chief.

I have to say it was far more impactful than I had thought it would be.  The data presented was overwhelming and impressive.  Recent cover story articles in The Economist and Business Week underscore the importance and responsibility we all have to address this issue.  My wife and I are beginning to adjust how we operate as a family in order to attempt to reduce our carbon emissions.  And it changed my thinking on all the hoopla over venture investments in the alternative energy market.

Like many others, I had dismissed the alternative energy investment efforts as pie-in-the-sky and inconsistent with the fundamental early-stage venture capital equation:  invest small dollars in early-stage technologies that are 1-2 years away from commercialization and 4-6 years from creating enough value to sell to the public or, more likely, another company at a healthy multiple.  At least that’s the equation when practiced successfully!

But most of the alternative energy projects we have reviewed appear to be more “science projects”, 4-6 years away from commercialization, very capital intensive and with uncertain exit potential and candidates.  Further, this category seemed to me to be falling into the trap you see in numerous “hot” sectors – too much capital chasing too few ideas, thereby increasing price competition for the best deals as well as an oversupply of exit candidates for a small number of exit targets, all resulting in depressed return potential.  The numbers bear out these warnings.  Dow Jones VentureOne and E&Y reported last week that VCs invested $1.28 billion into 140 “clean tech” deals in 2006, up from $664 million and 103 companies in 2005.

But having seen Al Gore’s movie (and sitting with a few knowledgeable entrepreneurs in the space), I have changed my view on the sector.  At least in America, it appears that the consumer mood has shifted such that “being green” is now being seen as a positive brand attribute, akin to “organic” or “all natural”.  Thus, it is likely that large industrial companies will begin to make aggressive acquisitions of technology, once they are proven out by aspiring entrepreneurs.  Perhaps the time horizon will still be elongated, but state and national subsidies are becoming more available to supplement equity capital.  When an investor gets in early enough, you never know what might happen when big dollars from multiple sources get thrown at arguably the biggest problem on the planet.

And if there does end up being an overall over-investment in alternative energy industries?  Good for the planet.  But bad for our returns.

Barbell Strategy

Within the Boston VC community, there's a new hot phrase running around when it comes to deal selection strategy.  Four or five firms have recently informed me that they have concluded that a "barbell strategy" is the best approach for them and that they are uniquely positioned to execute it.  No, that's not a reference to some testosterone-induced competition amongst VCs over who can lift the most weight (answer to that trivia question below).  It refers to the strategy funds take who want to keep a toe in the early-stage waters, while still trying to justify more assets under management through large deals.

The math for this multi-stage strategy is simple and compelling.  The more assets under management, the more fee income the VC earns.  If the goal is to build a large VC fund with, say, over $1 billion under management, it's hard to write checks smaller than $10-20 million at a time per deal.  The deals that have enough mass to absorb that much capital at a time tend to be later-stage opportunities.

Yet, the historical data shows that the >10x return opportunities lie in the early-stage, Series A deals, where less money is invested at a lower price.  These companies commonly are looking to raise only $4-6 million at a time, often split between two firms.  Thus, VCs have a conundrum - whether to stay focused on early stage, where it's harder to put big money to work (and therefore earn big fees), or focus on later stage deals, where it's harder to generate 10x returns.

When faced with a hard decision such as this, some firms look in the mirror and make the tough decision...to do both.  They invest dollars at the early stage in small chunks hoping to get a >10x return, and then at the later stage in large chunks, hoping to get 3-5x.  Partners within these firms may either specialize in one stage or the other, as the skills can be quite different, or play on both sides of the barbell.

Either way, it's a risky strategy that many Limited Partners are complaining about.  Their beef?  Generally speaking, they prefer to have funds be focused on one stage or another, one market sector or another, even one geography or another.  They prefer to make the allocation decisions across funds representing different focus areas as opposed to allowing the VCs roam across boundaries, often resulting in mediocrity across the board.

The frustration that VC managers have is palatable when they learn that their business simply doesn't scale the way hedge funds do (