In Reel Time

2010.41 My last week: ITExpo; Digital Music Forum West: Caltech/MIT Enterprise Forum

Last week I dabbled in a few conferences and then committed to a panel. What did I learn?

At ITExpo in downtown my big takeaway was speed. Evolution. Regulation. The cloud. Opportunities continue to develop at an increasing pace. And the battle of net neutrality continues. Indeed, Hank Hultquist gave a riveting speech on the major issues and regulation that comprise net neutrality issues…from AT&T’s viewpoint.

Panels at the Digital Music Forum West (Roosevelt Hotel) sometimes got confrontational, with the forces for change arguing against those with a vested interest in staying the same. A few later panels were too politically correct and mutually supportive (for my taste). But Rick Alden, SkullCandy’s CEO provided insight and emphasis on branding, which distinguishes how his company operates. Visionary and charismatic (with freebees to hand out) he garnered a lot of questions and a crowd outside the main hall. Best quote? “The best ideas won’t come from sitting behind a desk”.

Later panels on Brands & Music and Touring explored further specific instances of how acts and brands can customize and define themselves. The real message? Define clearly who you are and your audience. Then set yourself apart creatively in that context. And don’t tie your brand to an artist; develop your own broader, richer personality.

The conference highlighted innovation (and spots that lack innovation) within the music industry. As we all know, the music industry was ahead in getting hit with digital change, making mistakes in their response and now in coming up with new ideas to survive and prosper.

The Caltech/MIT Enterprise Forum – From Past Time to Prime Time (on Social Networking) – was where I committed. Kevin DeBre of Stubbs Alderton & Markiles introduced. Mark Suster of GRP and Jay Samit of SVnetwork spoke. You want to hear the message straight? They both deliver that. Mark told us to look outside of walled gardens (if you rely only on Facebook they own your audience – keep your website) as both closed and open systems work. Jay advised entrepreneurs to get between big trends and pick up the crumbs (great imagery).

The panel: Jay, Sean Moriarty (Mayfield Fund currently), Jonathan Strauss (awe.sm) and Andy Wilson (Momentum Ventures), with Mark Suster moderating. The panel offered so many insights; I only have room to list a few. The social capital that you bring to business is critical today. Traditional analytics don’t work in social media…the space is so fragmented; do you want pages views or transactions? Brands need to get where the customers are and realize that their “important” doesn’t matter as much as does their customers’. Individuals now communicate across channels. Local is (still) the great unsolved problem. Women are over-served in the major success stories of the past few years: daily deals, flash sites and social games (take the women away and…). Tigertext effectively erases the record of your digital communications.

My conclusion on the week? I’d prefer not to go to conferences/panels everyday (fun though they can be).

Next up, Digital Hollywood starting October 18. I myself am on a panel on Wednesday, October 20.

2010.45 Consolidation: or one industry evolution which often repeats

All the lessons of history in four sentences: Whom the gods would destroy, they first make mad with power. The mills of God grind slowly, but they grind exceedingly small. The bee fertilizes the flower it robs. When it is dark enough, you can see the stars.
Charles A. Beard

This morning I was speaking with David Cremin of DFJ Frontier (VC) and drinking some excellent coffee. The topic turned at one point to industry consolidation.

My initial point had been that select media related spaces will likely consolidate at some point (and indeed are starting to do so). This theme has been a big one for me lately and its roots arise from the industry consolidations I saw early in my career as a tech banker in Menlo Park. A number of companies that I’ve spoken to recently have had a potential acquirer lurking nearby – whether or not they are interested in selling.

Why do emerging industries sometimes evolve quickly into consolidating ones?

1. Emerging industries that get press and attention tend to grow quickly, have large markets, attract talented people, have multiple and iterative stages of evolution and scale. All of those factors also enable easier funding – either from business partners or venture capitalists.

2. Sometimes, as a result, they get over funded with multiple VC firms each owning a like company (and all of these heavily funded companies must slug it out in a fast moving, ever changing business sector to win market share).

3. New industries or business segments are hard to build. Business models are often based on precedent: like industries that targeted similar customers and monetized in related ways. In other words, you guess a lot, hopefully making reasoned guesses. A lot of mistakes are made (and some companies blow up) as a workable business model develops through trial and error. Google wasn’t the first search engine.

4. To build market share faster some companies wisely merge. This action can enable economies of scale, a better customer experience (more offerings; better geographical reach; better or deeper management team) and add audience/customers. Should the public markets be open the merger could create an entity large enough to go public; thereby becoming better funded than competitors.

5. The market can only support so many like companies (and it’s better to sell what’s left of a beaten company and realize some value from what you’ve built than none).

6. Buying something (capacity; products; customers; geographies) takes less time and money than developing it does. This factor can also lead to larger public companies buying into a new and emerging sector.

7. Selling later in the consolidation stage is often not as lucrative as selling earlier. The first companies snapped up typically get more resources to build their presence in the industry, giving them an advantage (and harming those that remain independent). The holdouts need to execute very well to maintain an early leadership position.

8. VCs may push for a sale to ensure that their portfolio company partners with other stronger sector players and they get a good return.

Other reasons do exist, including factors unique to different industries and companies.

For any industry in which scale, often ideally built quickly, is important (most) – such as media or (often) consumer technology – consolidation concerns are very relevant. What would you do if your biggest competitor was bought by a Fortune 100 company? Winning over a customer already dominated by a better funded and more established company can be a losing proposition. Best to seize your advantage early on once the consolidation winds start blowing.

2010.41 LAVA Los Angeles Venture Capitalist Breakfast

Earlier today I was at the Skirball Center listening to a panel of (thankfully) outspoken and even blunt venture capitalists: Jim Andelman of Rincon Venture Partners; Kevin Jacques of Palomar Ventures; Klaus Koch of Vicente Capital Partners; Sumant Mandal of Clearstone Venture Partners; and Mark Suster of GRP Partners. Stephen Hughes of Silicon Valley Bank and Scott Alderton of Stubbs Alderton & Markiles moderated. I won’t attribute remarks to an individual unless it pertains to a difference in their fund or distinctive (and perhaps not universal) viewpoint.

Among the opening questions was one that got to the heart of the matter: are venture capitalists going away? No, but the industry has changed with many funds (and the industry overall) posting negative returns for the past ten years. There is less money going into venture capital, thus smaller funds and fewer VCs. The funds in northern California are often larger than those here in Los Angeles. Practically, this means that local VCs invest smaller totals into their portfolio companies. And, while venture investing amounts in Los Angeles are up over the past six months – especially relative to other parts of the country – deal numbers are up less dramatically. Additionally, many of the larger investments in southern California have not been made by local VCs (Demand Media and Gravity are two examples). The costs required to start an Internet based business have declined so much that some businesses in this sector are profitable after spending less than $100,000. Since one local pool of talent comes from the media world and often starts such Internet businesses, VCs can often see a working business – with a proven concept – before they need to invest.

Returns are an expected topic and really what enables VCs to raise subsequent funds. Typically, for an early stage investment the VCs agreed that they want a ten times return; which would make up for the inevitable lesser performers. A lower risk, lower return wasn’t of interest as it damped overall returns and the money couldn’t be deployed into potential home runs. For a late stage business (clear monetization and diverse customer base) a three times return was the minimum required and they expected most of these companies would continue their high growth (75 plus % surviving). Total invested over the life of the company ranged between $6 and $25 million.

The IPO market remains somewhat weak so most exits are currently company sales and the lower returns they entail. Hence, when characterizing who should take venture money one criteria stated is that your company should be the type that other companies are interested in buying. Lots of larger companies are looking to acquire (innovation). The company should also be quickly scalable and have a good use for the added resources.

One much discussed topic was how to approach VCs. Mark Suster made a strong point that in this day and age of social networking there is no excuse for any entrepreneur not to manage to find someone who could make an appropriate introduction: ideal is from an executive at a VC portfolio company, next another entrepreneur who knows the VC and third is from advisors who know the VC. Kevin Jacques clarified that an introduction was not the forwarding of a business plan from a random connection on LinkedIn but rather someone who knows the industry and had done work with your company to help guide or mentor you.

And, research (Crunchbase; SoCalTech; Internet) which VCs invest in your type of company, are actively still investing and are the right size/stage. Not doing the requisite work is proof that you aren’t a real entrepreneur.

Power point slides are easier to read than Word documents for someone buried in hundreds of business plans.

The B round was referred to as a “sucker’s round” with fewer VCs willing to do a B round, especially if A round investors weren’t continuing to fund the company. During the 2008 crash VCs were too busy with existing portfolio companies (figuring out who to continue funding and who to let die) to take on anyone else’s mess – the B round. Angels likewise pulled back in 2008 as they worried about their own cross-platform investments. Slowly the angels are coming back but the B round investors aren’t.

So think clearly about which VC money you take (they should be the type who sticks by their portfolio companies for that B round; for the C round your concept is either working or not and funding will depend on that factor). It’s easier to get a divorce than exit this type of partnership, said Jim Andelman. Look at the investment as the beginning of a partnership and not just funding.

Eventual percentage ownership they’d like at a liquidity event ranged from about 25% to 50%; but really varied based on the stage they had invested and whether other investors were involved.

Overall, they were very upbeat about innovation in Los Angeles today. While the talent pool may not equal Silicon Valley’s in some ways other attribute of our local community and talent pool make up much of the difference.

For details on their varying investment types, the industries they favor, fund size and background please do the research. That is what a real entrepreneur would do.

And email me for more details on the panelist’s comment; I took many notes but aim to keep these postings short.

2010.21 Venture capital 2010 – Digital Hollywood update

The days of high valuations and large capital expenditures are over….

I listened to a few panels on (or related to) venture capital during my days at Digital Hollywood May 2010.  Below is a state of the industry 2010 based on those panels and some common sense “interpretation” on my part.  Rarely will I identify the speaker because doing so will clutter up the commentary.  I’ll list the names of the venture capitalists (and in one case a lawyer) who were on the panels.  Anyone wanting credit for points below feel free to comment or email me and I’ll post credit.

The past ten years have flipped venture returns into negative territory and their own investors are being much slower to fund new venture investments.   Some newer funds are likely to disappear and it’s only the large granddaddies (the Sequoias, NEAs… with their $500 to $700 million funds) that can chase large valuation companies.  

Over the past few years there have been few venture exits – almost no IPOs and M&A activity is down dramatically (with valuations also having dropped).  The exits have predominantly been in the $30 to $70 million range.  While venture targets a ten times return (almost impossible to get in today’s environment) they need a four to five times (investment) return.

Out of ten investments, a VC hopes for one to two that do very, very well; three to four will at least double their money; with the rest likely being written off or sold for scrap. 

In today’s environment, a “capital efficient” company can still generate a venture return.  That term essentially means that hiring can be reasonably priced, not a lot of equipment is required and minimal investment is needed.  Those parameters may sound constraining but more and more can now be outsourced or is cheaper (Google AdSense, Amazon hosting, cheaper bandwidth and equipment).  Capital intensive businesses – such as chip or hardware companies – are finding financing a tough go.

Since some of the basic start up costs have plummeted VCs are more focused on other factors including defensible IP, quality of the team, evidence of traction and a network effect.  Indeed, over the past year the VCs have been able to invest in what would have been, in the past, a B Round at what used to be an A Round valuation – while getting the benefit of seeing the company at that later and more developed stage.

In 2009 almost all companies did down rounds – if they could do a financing.  All panelists agreed that today it’s wise to keep valuations reasonable in round A because a down round on B or C or not having existing investors participate in the next round is the kiss of death – you’ll look distressed and get a distressed valuation if you can get money at all (hotly contested by many audience members).  Surprising on the upside is better in the long run for the company than getting a high initial valuation (10% of a $300 million company is the same as 50% of a $60 million company).

Areas of opportunity:

For larger companies in tech and media – practically – development no longer exists and they need to buy growth.  Therefore, in designing a business plan just don’t just target an amorphous exit – think about which large companies could buy you and start working with them on business partnerships/development opportunities (think Ankeena and Juniper).  True growth comes from small companies since they don’t have a legacy overhang and the large companies won’t eat their babies (existing cash cow businesses) no matter how dire their industry changes are.

Find an “unfair sustainable competitive advantage”.  Build multiple revenue streams.  Closed versus open is debatable (Twitter was so open they may have killed their true opportunity and aren’t monetizing their business; Facebook was so closed they’re now opening up).  An app alone is not a company.  Customize.

The value of the studios will keep going down over time.  Quality content is where value rests; the supply of distribution channels will continue to grow.

Sports, games (especially social network related games), companies that can shift ad dollars their way, creative ecommerce with proven monetization models, core data center components, location based.

Mobile is in its very nascent stages of development being where the internet was in the late 1990’s

In closing, the overall message was that now is a great time to start a company!  Lots of disruption is swirling through numerous markets, it’s cheaper to ramp up and capital exists for the right idea.

List of VCs who’s comments helped shape the above:  Jon Chait – Dace Ventures;  Tim Chang – Norwest Venture Partners; Neal Hansch – Rustic Canyon Partners; Alex Hart – Revolution Partners; Paul Lee – Peacock Equity Fund; Ross  Levinsohn – Fuse Capital; Erez Levy – TriplePoint Capital; Schuyler Moore – Strook & Strook & Lavan LLP; Robert Raciti – Raciti Capital Advisors; Len Rand – Granite Ventures; Kevin Spain – Emergence Capital; and Richard Yen – Saban Ventures.

2010.13 Outside investors: reasons to take a minority investment or re-capitalize (second in a three part series)

1. To raise funds
2. Add a strategic or financial relationship
3. Replace a minority investor that isn’t an ideal fit or needs liquidity
4. Retain control of the company going forward
5. Achieve some degree of liquidity for the founders (albeit not on the scale of a sale)
Writing this piece I pondered over numerous other reasons; then decided on simply these five so as not to overthink the obvious. The reasons to sell a company, go public, take an investment or re-capitalize overlap but aren’t full duplicates. Yet, essentially, the end goals are basic: get cash personally, for owners or to grow the business, or add capabilities or relationships.
Let’s cut to the chase: all money isn’t the same. Taking money from someone entails commitment especially if the funds are equity (or warrants, which can turn into equity). And I’m betting that you generally get to know someone before you commit (if not I know many lawyers across a wide range of disciplines…).
What do you want your partner to provide? Simply money, or is it more? Guidance? Relationships? Industry knowledge? Financial sophistication? Do they see the business growing similar to your own vision? Any liquidity goals for the future that will add unreasonable pressure? Do you want someone who leaves running the business to you or who will provide guidance or even more influence?
When potential clients call us about capital raise assignments, their first “ask” is usually our firm’s reach and range of investor relationships. But the additional reason many smart entrepreneurs work with an investment banker is to date with a matchmaker and chaperone in the room. While I wouldn’t refer you to Fiddler on the Roof as an educational text on meeting investors I would recommend getting introduced to many (don’t just fall for the first siren song). The auction concept exists for a reason (called the worst thing for bidders ever in the book The Last Tycoons: check out the book to find the catch in my reference). First, it gets the competitive juices going and presents you in your best light (have you ever watched The Bachelor?) Next, someone else can ask the tough questions to discern someone’s true intentions and whether you’re long term compatible.
Ultimately, the business owners and/or the board make the final decision on whether to accept an investor’s deal terms.

2010.11 Interview with an Angel

Today I spoke with a prominent angel investor, Frank Peters.  After starting and selling a software business, Frank began investing as an angel in 1999, joined Tech Coast Angels in 2003 and has since held several TCA leadership positions.  Frank estimates that he has made approximately 30 angel investments, mostly but not entirely through TCA.  Frank also blogs at The Frank Peters Show.

We all know that 10-year returns to venture capital funds are negative, so VC funding will likely continue to get harder to find.  On the other hand, the volume of angel investing is a function of the net worths, liquidity, investing track records and confidence of angels, none of which have fared well in the last two years.  So how does it net out?  Is angel investing becoming more important, or less so, to entrepreneurs and the growth economy?  And what are angels focused on now?

Too big a topic to nail in one post, but a few highlights:

• Frank agrees with the conventional wisdom (and me) that the general venture investing model is challenged if not broken.  An average fund size of $300 million means VC’s have to make big bets.  Quick profitable M&A exits don’t make their funds, they need big scores (generally coming from rare IPO’s) to overcome the inevitable failures in their portfolios.
• Frank estimates that in 2009, TCA members invested approximately half the dollars of previous years.  Further, perhaps 60% of those dollars invested went to existing portfolio companies, so only 40% of the lower total was for new deals.  Frank does not expect 2010 to be dramatically more active in terms of dollars invested.
• Whereas TCA used to be excited when a name VC looked to invest in a company that TCA angels had previously funded, that is now viewed as a mixed blessing because the holding period is likely to be so very long.
• TCA in general, and Frank in particular, are increasingly focused on the opportunity for early exits – invest, make progress with the business, reach a milestone or two, sell at a profit.  Ten years to an IPO is much less alluring than it used to be, especially given how rare that event turns out to be.
• In general, TCA expects to see companies that have accomplished a great deal more than new investments might have achieved a few years ago.  The dream company has bootstrapped it, generated some revenue and has customers that TCA angels can talk to.  That TCA can often hold out for this is a function of the less competitive investing climate that now prevails out there.

Bottom line, Frank is confident that there will always be angel investing (although he is concerned about draft language in Sen. Dodd’s financial legislation that could raise the bar for accredited investors and shrink the universe of angels).  Clean/greentech is a tough arena for angels, because they are generally so capital-intensive that the risk of future dilution is so acute.  Capital-efficient IT opportunities will likely continue to represent the bulk of angel investing.

But we may have lost a whole decade of angels, the crowd that made their money and exited their companies in the dot.com era.  Realizations have been so poor for angels generally in the past 10 years that younger angels with more recent entrepreneurial experience will be an important part of the angel landscape going forward.

Frank, thanks for the time!

For more information about Hadley Partners Incorporated please visit our website.