Wireless

The wireless Internet is heating up

Posted on by Ed Sim

The Wall Street Journal announced another Nokia mobile internet purchase today of a company called Twango which allows users to share photos, video, and media.  According to the WSJ, the Twango service will be integrated into Nokia phones and will start with a free and premium based subscription model.  While this acquisition in and of itself is not mind blowing, the fact that Nokia has made a number of acquisitions over the last 18 months encroaching on possible carrier revenue does make the story more compelling (see an earlier post-Nokia’s Coopetition with Carriers).

Taking a step back and looking at the wireless industry overall, one can continue to hear the buzz about Apple’s entry into the wireless handset market with the iPhone.  And as much as analyts and the like want to pit Apple vs. Nokia and others, I see lots of similarities between both companies.  In fact, the more I look at the world, the more I see Nokia taking a page out of the Apple playbook and vice versa.  Apple, as we all know, has done a tremendous job with its vertical integration strategy – developing new products from start to finish, controlling the design, hardware, and software to create insanely great products which are incredibly powerful yet elegant and simple to use.  That is why the Mac gets the margins it does and why the iPod has been doing so well versus the competitors who have solely focused on one piece of the device ecosystem, software, hardware, etc.  Looking at Nokia, it seems to me that the company could clearly go into a couple of different directions – go the Dell route by providing awesome hardware or going the Apple route and providing a full end-to-end elegant experience for the consumer.  What I mean by that is that Nokia can either just be a dumb handset manufacturer with decreasing margins like Motorola or it can try to figure out how to control and provide a seamless and great user experience from handset to desktop for its customers.  What is at stake are significant margins and dollars. 

Given that Nokia has always had expertise in the hardware side of the world, the fact that the company is increasingly buying software companies for its devices (loudeye, gate5, intellisync, and now twango) and integrating it into the handsets shows that it is bulking up and getting ready for the next battleground, the phone as minicomputer and gateway to the Internet. As you know more people around the world access the web from a mobile device versus a PC or laptop.  The blurring of cell phone and mini computer is only increasing as Apple, RIM, Nokia, and others come out with devices that can do more and more-take/share/view pictures/video, listen to music, surf the interent, make VOIP calls, and watch television.  What is at stake is a bigger opportunity that will bring Apple, Nokia, RIM and others head-to-head with the large Internet players like Google, Yahoo, and Microsoft.  At the end of the day, Nokia is more like Apple than you can imagine as it is starting to take control of its destiny and beginning to offer its own web-based and wireless services directly to the consumer. Like Apple, it is increasingly clear that Nokia wants to provide its consumers with a holistic end-to-end experience delivering everything from the hardware to the operating system to the applications that reside on the phone and desktop.  This is an important shift and one that Motorola does not seem to be getting and consequently one of the many reasons its stock has been floundering.  As mentioned in an earlier post, Nokia has acquired Loudeye for a future music offering, gate5 for turn by turn navigation, intellisync for syncing software and email, and now twango for music, photo, and video sharing. Nokia ships around 350mm handsets every year and it can either let the Internet players GYM seize the opportunity or go after itself.  This is an interesting transformation that will take years but think about how much money Nokia could make if it could extract an extra $0.50 or $1 per month from a customer.  Of course the carriers won’t like that but this is why watching the wireless Internet market is so fun.

Web/Tech

Answers.com to acquire Dictionary.com for $100 million

Posted on by Ed Sim

Congratulations to the Answers.com team on the announcement of this deal!  Since I am a board member and it is a public company (NASDAQ: ANSW), there is not much commentary I can add except that I wholeheartedly agree with Bob Rosenschein’s assessment of the transaction (see press release):

"The acquisition of Lexico is a transformative event for us," explained Robert S. Rosenschein, Chairman and CEO of Answers Corporation. "We are excited about applying our experience in monetization to significantly increase Lexico’s 2008 revenues and EBITDA. Lexico’s suite of popular brands, steady direct traffic and loyal users are valuable assets that we believe will reduce our products’ reliance on search engine-driven traffic. Post-transaction, we estimate that over 70% of our total traffic will now be direct from end users or people searching specifically for the term ‘dictionary’ in search engines. Our combined size and available ad inventory should provide greater exposure among online media buyers, which we expect will lead to increased advertising sales."

As I have mentioned in earlier posts, scale matters in the Internet space and becoming a Top 28 web property in the US (according to our combined 22.5m monthly unique visitors in June based on Comscore) will provide the company with an even better opportunity to monetize our reach.

If you are interested in learning more, here are a couple of other highlights from the press release:

Lexico is a leading online provider of reference products and services, which attracted approximately 11.5 million unique monthly users in the U.S. during the month of June 2007, according to comScore Media Metrix.

Lexico is a highly profitable company that strongly complements Answers’ user base. In 2006, it generated revenues of $7 million, EBITDA of $2.9 million and net income of $2.8 million. This strategic acquisition drives Answers to a leadership position in online information publishing.

    Key benefits of the acquisition include:

    – Page Views: Lexico’s Web properties currently generate approximately three times the total page views of Answers.com.

– Monetization: Lexico’s Web properties currently monetize at approximately one-third the rate of Answers.com, presenting material revenue upside.

– Direct Traffic: Over 85% of Lexico’s traffic is direct from end users or people searching specifically for the term "dictionary" in search engines. The resulting shift in traffic mix should significantly reduce Answers.com’s current reliance on search engine algorithms.

– Market Leadership: Based on the June 2007 comScore data, the addition of Lexico’s Web properties will increase Answers reach to over 22.5 million monthly unique users, which would rank #28 in the top U.S. properties.

Venture Capital

Are all of the venture returns in B2B?

Posted on by Ed Sim

The Wall Street Journal has an interesting article today about how the resurgence of tech IPOs have really come from "less glamorous, business-focused companies selling such products as telecommunications equipment and computer storage."  In fact many of these companies have market caps > than $1b each.  The article is right in that alot of buzz gets centered on consumer Internet companies like Google or YouTube and that on absolute market capitalization many of the big returns are found in the B2B type deals.  However, I do disagree with the notion that because some of these "consumer web firms are selling themselves to larger Internet companies such as Google or Microsoft Corp. for a few hundred million dollars or less" means that returns for investors can be mediocre. In fact, what the article fails to look at is how much money some of these infrastructure companies have raised in order to get public.  Obviously if a VC is looking for 10x type multiples on their invested capital, the more money raised means the higher ultimate market cap a company needs to achieve.  Taking this a step further, let’s look at the amount of capital raised by some of the more recent IPOs:

Starent Networks: $100mm pre-IPO with first VC round in August 2000, $986mm market cap

Limelight Networks: $100mm pre-IPO with the big round in summer 2006, $1.6b market cap

Infinera Corp: $345mm pre-IPO with first VC round in December 2000, $2b market cap

Shortel: $102mm pre-IPO with first round in 1997,

Based on this data, one can see how many of the existing investors generated some great returns on absolute and relative terms.  So while there have been very few Internet companies worth $1b or more on absolute terms, one must look at the capital efficiency of these businesses to understand why companies that raised $20mm or less can still sell in the $200-400mm range and still create tremendous returns for their investors.  At this level of funding the risk/reward balance is just much different than in a traditional infrastructure play.  Sure many of these Internet companies being financed may not be standalone IPO candidates but that doesn’t mean that companies that generate 10-20x for their investors are bad investments either.  However what is beginning to scare me is that valuations for these consumer internet plays are continuing to creep higher.  In addition, many of these "capital-efficient" companies are raising bigger rounds of capital meaning the bar for exiting is getting higher and higher.  If these two factors continue to increase over the next couple of years, this could lead to disappointment for many VCs in the long run.

Entrepreneurship

What kind of customer do you have?

Posted on by Ed Sim

I was in two board meetings recently, and I was shocked at myself when I seemingly gave contradictory advice to two companies.  On the one hand, I told the first company to do whatever it takes to land that big account for the quarter, and on the other hand, I told the second company to push harder for a higher price or to walk away.  Shouldn’t you always do whatever it takes to land a customer and continue building the pipeline?  Yes, in theory, but at the same time you have to understand what kind of customer you have: is it a good customer or a bad customer.  While there is no perfect definition for these two types of customers, let me give it a try.  In the first portfolio company’s case, the good customer we were going after was going to be a marquee win and great reference for future prospects down the line, would help us validate our technology and team in a head-to-head competition vs. the big incumbent, and finally would be a repeatable sale where we could take and package our software to many other prospects.  In that case, we told the company to be aggressive in order to land that customer, including giving it away for free for a short period of time to get that first big win.  The great news is that we landed that marquee customer and did not have to go the free route.  Ideally a good customer is also one that is profitable.  In this case, even though the first marquee win may not have been profitable in year 1, we were able to see future profitability down the line from expansion opportunities in the existing account and from that customer serving as a great reference and industry leader in helping us close other deals.

A bad customer is clearly the complete opposite of a good customer – one that requires too much one-off customization, is not a marquee account or potentially a great reference for future sales prospects, and ultimately an account that does not lead to repeatable sales.  In addition, bad customers for the most part will be highly unprofitable as you will probably spend way too much time on the account trying to make it referenceable.  So in the second portfolio company’s case, given that we had a bad customer, I told them that we should go back to them to charge more to at least make some money from the current deal or walk away.  Ideally, if it is a bad customer, you may just want to walk away altogether to go find that good customer which will lead you to many more great opportunities.  Starting your company with a handful of bad customers can kill your business so be ruthless with your time and carefully assess what kind of customer you are about to close.

Web/Tech

LinkedIn and Facebook on collision course?

Posted on by Ed Sim

I signed up for LinkedIn in mid-2003, and since then I have not been very active on the service other than accepting invites as they came to my inbox.  Over the last couple of weeks, I have noticed a significant increase in the number of requests from friends and colleagues and interestingly most of them are not from the technology industry.  It is clear to me with over 10mm users worldwide that LinkedIn has crossed the proverbial chasm.  The company has clearly done a great job creating a strong revenue model around social networking and leveraging the technology industry to get started, but as I see more and more mainstream users join the service I wonder how big it can get and how it will play against the other players in the space.  LinkedIn has repeatedly stated that it believes people will have two profiles, one professional that is maintained on LinkedIn and one personal which is maintained on MySpace or Facebook.  I don’t doubt that at this time, but I must admit that while Facebook has mostly been about friends and personal relationships, I have been surprised at the number of professional and business contacts wanting to add me as a friend on Facebook ever since it opened up its platform.   It will be interesting to see how these two services grow, how the boundary between friend and professional contact continues to blur for the professional, and whether Facebook makes a concerted effort to enter into LinkedIn’s turf.  For example, why couldn’t I maintain one profile on Facebook and only share the professional information with those in that network and the personal with those in another?  Expanding that thought, wouldn’t it be great if there was a metaservice where you only maintained one user profile and you could check off which details were fed into which different social networks.  I would love to hear your thoughts on the subject.

EntrepreneurshipVenture Capital

Don't forget to look at venture debt when raising a new round

Posted on by Ed Sim

We all know the story – it is incredibly cheaper to start a web-based business versus 5 years ago with the rise of open source software and commodity servers.  However, while getting started with thousands of users is cheap, scaling to significant numbers will require some dollars.  The good news for you and for venture investors is that your buck can go alot further today versus yesterday not only because of the commoditization of infrastructure but also because the venture debt market is alive and kicking.  In the last six months, we have augmented some of our existing venture financing with venture debt as the market has become quite competitive which means pricing and terms are getting more attractive for  all of us.  In addition, while most associate venture debt with investments in companies with core technology, more and more venture debt firms  are back and willing to offer capital to earlier stage web-based companies with  no  financial covenants and MAC (material adverse change) clauses.   Of course the more flexibility you have with respect to uses of cash means that pricing will go up.  All I can say is when evaluating your company’s cash needs and potential runway, looking at the venture debt market is not a bad idea.

There is also another market metric that is driving a renewed interest in web-based companies for these lenders- they are getting funded by VCs (venture debt lenders mostly like to do deals with strong financial sponsors which increases their likelihood of getting paid back) and these startups are better able to manage their burn rates reducing risk and offering lots of upside.  Sure, while some of these venture debt firms recognize that web-based businesses may not have as much hard and true intellectual property, the fact that they are more capital efficient and can scale more rapidly means they can also generate pretty nice returns from the warrant portion of their deal.  Getting in earlier also allows these venture debt firms to buy more of the company from a warrant perspective than getting in on later rounds.  The trick for entrepreneurs is to look at bringing on debt concurrent or soon after your close of equity financing. 

Why can raising venture debt be great?  It is quite simple –  the dollars are relatively cheap compared to an equity financing  and extending your runway to hit more critical milestones means a potentially better valuation for your company down the road.  And of course if you exit before raising another round, there are more dollars available for the equity holders.  A typical structure for an early stage deal could be an equity raise of $3-5mm with another $1-2.5mm of debt.  From a pricing and terms perspective, you should look for capital which is flexible in terms of use for true  growth capital (growing your business) with no financial covenants or MAC (material adverse change clauses) which can put more risk into the debt equation.   Of course, the more flexibility you have, the higher the interest rate will be relative to other types of loans. Most venture debt deals will have an interest only portion for a short period of time before amortization (monthly payments of principal and interest kick in).  Typically you will see terms of 30-36 months where your lender will get paid his full portion of the loan and interest by that time frame.  In addition, lenders will ask for warrants equal to a percentage of the dollar amount raised (for example, depending on the deal, a 5% coverage for $1mm could be equal to $50k of equity to be purchased at the current share price).

All is not rosy as there are some potential and hazardous downsides to this model.  If you burn through your cash and can’t make the monthly principal and interest payments, your lender can take over your company as their debt is usually secured against your company and intellectual property.  Trust me, a number of companies got burned with this during the Internet boom when their businesses were based on wildly inflated revenue projections and unilimited capital resources.  Just when you needed another month or two to sign that strategic deal, the venture debt guys would come in and pull the rug from under you.  Granted it is not that bad as your lenders are your partners and will negotiate with you, but at the end of the day, if they see their ability to get paid in significant jeopardy, they will do what they have to do to recoup as much value as possible.  For some investors and entrepreneurs, this risk may not be worth the dollars.  For others who are confident in their execution and ability to raise another round, there is no better way to stretch your dollars in the company and create more value with minimal dilution.  So the next time you hear the word "debt," don’t be scared and keep an open mind as you may be able to stretch your resources further and achieve some additional critical milestones driving increased value in your business.  The interest in web-based businesses is there and the competitive market means that pricing and terms are pretty attractive now.

Entrepreneurship

Transitioning from startup to growth phase – don’t be afraid of process

Posted on by Ed Sim

As an early stage investor and board member of several companies, I am fortunate to get the opportunity to work with some great entrepreneurs and also pattern match and observe trends, both good and bad, in early stage companies.  I am not here to throw platitudes at you but simply to share an observation of the differences between some of the better run companies and the ones that have less than stellar execution.   In one portfolio company, we had some of the standard issues of coordinating product management with engineering and balancing sales requirements with engineering priorities.  Having a company operate solely in departmental silos is like having each body part with a different brain-sure it is your body but it is also hard to move fluidly if each body part is moving in a different direction.  As I spent time with management, I quickly recognized that there was no real communication of company goals and awareness of what each department’s priorities were.  This is a standard problem I have seen time and time again as companies transition from startup and initial product development to company growth and expansion.  There is no panacea for turning things around overnight, but I can assure you that layering the proper amount of structure and organization is an important element in improving cross-functional communication.

What makes a startup team great early on in terms of getting product out the door and rapidly refining and honing the product from live market feedback can also lead to issues down the road if companies and employees are managed on a similar basis.  What is easy to roll out in a 5 person company gets harder to manage in a 25 person and even harder in a 50 person company.  Take the test – ask your key executives what the 3 key company goals are for the month?  Are they the same or not?  How will they help contribute in each of their functions to delivering on the 3 key company goals?  If they are not on the same page and you have trouble getting them together, you may want to continue reading for some thoughts on how to improve communication and accountability.

Here are some simple steps you can take to create a more fluid organization.  First, institute a weekly management meeting.  Yes, like you, I have an allergic reaction to the word meeting, but believe it or not, simple processes can help tremendously.  It is a great way for the CEO to get input but also guide the team to focus on the same company goals for the month or quarter.  Secondly, have key team members provide a weekly dashboard report and list of key goals to accomplish for the following week.  At every weekly management meeting, have each team member discuss progress against his/her team’s goals and what they will be working on for the following week.  How does each of the departmental goals contribute to helping the company meet its goals?  Once again, this all may seem simplistic and a giant waste of time versus managing the next product release, but you will be amazed at the number of companies I meet that have not gotten to this point and consequently seem to have different ideas of what the business is and how to get there.  In addition, having weekly management meetings and clear weekly goals with simple yes/no criteria goes a long way towards creating an action-oriented culture of getting results.  If a VP doesn’t deliver consistently, all of the other executives know and they also know it is time to make a change.  No one wants to be the manager that is known to overpromise and not deliver.  There is also a real difference between a manager having weekly individual meetings with their CEO vs. openly discussing theirr priorities and completed tasks with their peers.  With respect to cross functional communication, rather than complaining about engineering, for example, sales and marketing can now understand engineering priorities and what it may take to adjust and rearrange some of them to meet the revenue targets for the quarter.  Trust me, there are many more factors to a company’s success and failure, but please don’t make an allergic reaction to scheduled meetings and a simple lack of organization your cause for execution problems.

Digital Media

Internet Ad Frenzy – what’s next?

Posted on by Ed Sim

Wow-what a past couple of days!  First I would like to say congratulations to David Moore, CEO of 24/7 RealMedia, on the company’s pending sale to WPP Group for $649mm.  I first met David in 1996 when he made his move from offline to online advertising as my prior fund invested in the initial round of 24/7.  We have stayed in touch throughout the years and what has impressed me most about David is his perseverance, sticking with the company through a few near-death experiences, struggling to find cash to make payroll, dealing with a penny stock, and ultimately fighting and building his way back to this exit.  What kept David plowing through was the belief that the crash was a temporary blip and that dollars would eventually move online in a big way.  Looking back, one could easily say that is a no brainer, but if you lived through the bubble you have to remember how the Internet was a dirty word.  Anyway, Aquantive is another company that survived the meltdown and is now about to sell itself to Microsoft for $6b.  I am not going to dive into the metrics here, but let me say that I still believe we are just in the second inning of this shift from offline to online advertising and that we should start looking for the next battleground.  What is interesting is that 24/7, AQuantive, and Doubleclick make most of their money from the boring stuff like SEM and display ads.  If you talk to most of these guys they will have a small bet on mobile and broadband video but will clearly admit that when it comes to managing a public company and having to hit quarterly revenue targets, you have to listen to your customer, the advertiser.  This means that the video and mobile stuff will be big but it is still way too early in those markets.

With AQuantive, Microsoft will get advertiser relationships and a platform from which to build a real online business.  I still think that Microsoft needs a Yahoo or even an AOL to compete with Google but despite that here are some things I would do.  I would go small and focus on building its publisher base where Google gets over 1/3 of its revenue.  I would buy small/medium sized companies that offer free and premium web analytics, feed management and RSS Ads, and potentially even a blogging platform from which to offer MSN AdCenter at the point of creation.  Getting publishers on board will help Microsoft get more data on clicks, increase its revenue base, and also allow the company to build relationships and good karma with the next generation of Internet entrepreneurs.  It already seems that Google is ahead of the curve as it is rumored that it is trying to buy Feedburner, a leading feed management and RSS ad platform (I currently use FeedBurner to manage my RSS feeds and deliver RSS Ads).  Besides the mobile and broadband space I mentioned above, one other opportunity that is huge and here for the taking today is the television and cable advertising market.  Companies like Spotrunner and VisibleWorld (a portfolio company) are approaching the market in different ways but clearly offer advertisers tremendous potential to bring Internet like tools and business models to an analog market.

Digital MediaWeb/Tech

Second Life for Kids (continued)

Posted on by Ed Sim

The kids space is hot.  Techcrunch just reported on rumors that Montgomery and Co or Monty was working with Club Penguin on a sale to Sony for $500 million.  Montgomery is the same investment bank responsible for selling Intermix (MySpace) to NewsCorp and Grouper to Sony so they have been building a nice practice in the Internet and digital media sectors.  As for the price tag, $500mm is pretty big money (I have heard ranges of $250-500) but according to Techcrunch the company projects around $65mm in revenue with $35mm in profit.  No wonder why the company didn’t need my angel or VC money :-).  If most of this revenue comes from subscriptions at $6 per month or $60 per year for upfront commitments, using a blended rate of $65 annually, you get around 1mm paying subscribers (this is simple math and does not take into account growth and ramp).  Not bad for a company that was started by 3 dads.  As I mention in an earlier post, virtual worlds are hear to stay and there will be a number of acquisitions in the space over the next couple of years.  In my household, Webkinz has taken the top spot.  It will be interesting to see what Ganz, a privately held company in Toronto, does with this fast growing property.  I can think of lots of ways it can further build out Webkinz and also monetize the community without losing its appeal and innocence.

Web/Tech

Social Shopping (continued)

Posted on by Ed Sim

Congratulations to my friend Gary Vaynerchuk of the Wine Library for his acquisition of Cork’d (see Mashable and the Alarm Clock for coverage).  When I had dinner with Gary a few months ago we talked about how the next big opportunity for e-commerce was to weave social networking and blogging tools into the existing infrastructure to directly drive transactions (see excerpt below from an earlier post on social shopping).

The next step in this evolution of commerce will be social shopping or companies leveraging Citizen’s Media (blogs, podcasts, videocasts, tagging) to drive commerce.  According to Answers.com, "Social Shopping is based on the principles outlined in the wisdom of crowds where a large group of users can recommend products to each other and between them work out what to buy and which ones have the most buzz." I believe this is an interesting area that has not been fully tapped yet.  At the root of it, people want to connect.  Most people I know tend to check the Internet first to research a purchase and also ask friends for recommendations or reviews about products.  The more inefficient a market is, the more opportunity there is to educate consumers and peers leveraging the web.

While the Alarm Clock calls this a roll up in the wine space, I view this as the beginnings of the return of the 3 Cs (content, community, and commerce) with a year 2007 flair.  Speaking of the 3 Cs, I also noticed that Amazon bought dpreview yesterday, a leading provider of digital camera reviews and information.  Amazon acquiring a content site may sound odd but we must remember that one of Amazon’s competitive advantages is its huge database of consumer reviews. As commerce sites begin to recognize the value of content and community again, I wonder who is next on the hit list?