GlobalizationVenture Capital

Venture capital in China

Posted on by Ed Sim

I recently caught up with my friend Derek Sulger, founder of Linktone (Nasdaq: LTON) and current founder and CFO of Smartpay, a Paypal-like play in China (I really like what Derek is doing with this one-no credit in China, use the mobile phones for debiting from bank accounts).  Derek and I are college friends and we certainly have come a long way from college when he finds my email on Google under a heading "Geeking out with Ed Sim" (thanks to Jeff Clavier for this one!) because his mobile device with all of his data on it is cracked on his flight from China.  That being said, we had a great chat on VC in China and opportunities he sees there.

First, from his perspective, he would rather pick one or two ventures at a time then spread out investments VC style.  If you think about it, there have only been around 7 or 8 internet-type companies that have gone public in China since the last bubble in the US (Linktone is one of those) when the Sina.coms were out in the market.  Given that, he would rather pick a couple sure bets and really work with them cradle to grave.  It is also tough to have any real governance and control of an investment by just sitting on a board in China, especially if you are monitoring a deal from thousands of miles away.  Secondly, he said it is tough to find good, experienced talent.  That is one of his gaiting factors in ramping up his ventures.  Finally, from an investment perspective, he would rather go consumer than enterprise.  His first business was a systems integration play which spawned Linktone and Smartpay.  He said it was difficult because the private companies you are selling to are really quasi-government agencies.  It is tough to get paid and very tough to protect your intellectual property.  At least on the consumer side, if you price your product or service appropriately, you can build a real PAYING user base and protect yourself from competitive threats with your base of subscribers.  Look at the history of China going from Boeing to the automakers like GM which did joint ventures with companies in China only to have their IP recreated and used against them.  I am sure GM could have protected themselves by charging less for their Buicks!

So there you have it from an experienced entrepreneur in China.  His thoughts make a ton of sense.

Open Source

Welcome GreenPlum and Bizgres

Posted on by Ed Sim

I have looked at a number of open source projects over the last year and mostly agree with Bill Burnham’s comments that many of these open source plays are "marketing gimmics for startup companies."  Many of these companies are trying to start a new project from scratch, hoping to build a community brick by brick.  In addition, without the ability to create a community, it is hard to build a real sustainable revenue model.  Finally, open source does not matter if there is no customer need for the solution.  That being said, I am quite excited about the relaunch of one of my portfolio companies, GreenPlum, which is bringing the power of open source to enterprise business intelligence.  (Stop reading if you are not interested in a pitch for a portfolio company)

Quite simply, Greenplum is using an open source database optimized with supercomputing architecture to bring terabyte scale datawarehousing to enterprises.  Leveraging this architecture, Greenplum will be able to offer significant price performance benefits over existing BIG IRON solutions.  In addition, Greenplum is working with Josh Berkus and the PostgreSQL community to launch a new project, Bizgres, whose goal is to build a complete database system for BI exclusively from free software.  From a business perspective, what I like about our strategy is that we are building off an already existing and strong community of PostgreSQL developers.  Secondly, rather than pursue a broad platform play for all databases, we are focusing on a large but focused market in BI.  We believe this is a great way for open source to enter the enterprise as the market is riddled with expensive solutions, BI is a top 3 initiative in most enterprises, data is growing like a weed in most places, and because we are not asking CIOs to bet their transaction systems on open source.  Finally, our revenue model is not based fully on a support/service play.  The open source DeepGreen product will target small-medium sized businesses or anyone with data marts and reporting apps in the 10-300 gigabyte range.  GreenPlum will sell licenses for any company that wants to to deploy the DeepGreen MPP product to scale to multi-terabyte environments.  While it is yet another spin on open source, I am quite excited about what GreenPlum is doing and truly hope that by leveraging the success of PostgreSQL, staying focused on a targeted market, and employing a dual license model that the company will be able to rise above the noise.  As I have mentioned in a previous post, one of the clear benefits of open source, especially if you leverage an existing community, is to reduce the friction in the sales and marketing process.

Entrepreneurship

Working with partners

Posted on by Ed Sim

I can’t tell you how many early stage companies I talk to tout their great list of partners.  I always step back in amazement at how a small company can support more than one, really large partner in the beginning.  In fact, I remember being in a meeting with a strategic partner once and having them tell me that we would break if they put their resources behind our product.  You have to realize there are 2 kinds of partners – technology partners and real partners.  In my mind, if you and your partner are not generating revenue for each other than it isn’t a real partnership but rather just a Barney press release.  Yeah, you know the "I love you, you love me" kind of partnership that sucks precious resources from a startup and yields no value and no customers.

So how do you make a real partnership work?  In theory, it is very simple but requires a ton of hard work.  Here are a few rules I like to use when working with partners. 

Rule #1 – Don’t rely on corporate; engage at the field level. 
Many early stage companies try to create partnerships from the top down without recognizing that the real action is in the field.  If you can bring your potential partner customers and lots of customers, you will get attention and be in a much better position to negotiate a real partnership.

Rule #2 – Focus, narrowly focus your opportunities.
Many of your potential partners are huge enterprises, and it is easy for a small company to get lost in the shuffle.  Try choosing a group in the large organization (it depends on how the company is organized) where you can effect a real P&L and create a strong value proposition.  In some companies that might mean focusing on a vertical like energy or financial services while in other companies it may mean picking a specific function like business intelligence or compliance.  Either way focus on groups where you can make a real impact. 

Rule #3 – Your partner’s sales force needs to get comped
Once you are able to demonstrate a handful of customer wins, it is time to get a deal done.  No matter what kind of deal it is, make sure that your partner’s sales force is comped for selling your product.  If there is no comp for the sales force, your product will not move in a highly leveraged way.

Rule #4 – Dedicate the proper amount of resources to make the partnership successful.
Once again, lots of companies think that once you sign a deal the hard work is done.  On the contrary, this is just the beginning.  You need to treat your partner like your largest customer and provide the same amount of focus on your partner as you do your customers.  You will have to develop a joint business plan together, figure out the proper sales strategy, put together compelling joint collateral and presentations, offer sales and SE training to your partners and their resellers, and finally get your customer support ready.  In addition, make one person responsible for making the partnership work.

Rule #5 – Don’t get sucked into your partner’s black hole.
Be careful of developing custom software for your partner or making too many proprietary tweaks beyond the necessary integration.  I have seen early stage companies too often bend over backwards without thinking about the real benefits of all of your partner’s requests.  As an early stage company you have to walk a fine line between leveraging partners for sales but also not becoming so glued to the partner that you alienate other potential channels.  As I have said in previous posts, it is ok to say no to some requests especially if you can demonstrate why it will not help generate more sales for both comapnies.  Either way, your partner will respect you and know that you are not a pushover.

As you can see, it is quite hard to support more than one partner for an early stage company. 

Venture Capital

Go early, go late, or go home

Posted on by Ed Sim

After having returned from vacation last week, I had the chance to reflect on the current venture and investing market.  Yes, one of the big challenges is that there is still way too much money sloshing around in alternative assets.  As I think about how to make money in this competitive environment and where to make new investments, I keep coming back to the thought that there is still opportunity very early or very late in a company’s life cycle.  On the late side, the tech sector is clearly maturing, growth is slowing, and forward P/E ratios relative to the S&P are pretty equal or even less indicating strong value.  Combine this relative value with the fact that many tech companies, particularly large software companies, derive 50-70% of their revenue from annual recurring maintenance and you have an opportunity to buy out many of these businesses due to their predictable cash flow.  I see this as a trend that will only accelerate in the next few years as you have venture funds, LBO shops, and even hedge funds get into the tech buyout action.  Witness the recent Sungard deal and others.  If the private investors are willing and able to pay $11.3b for a company then no public software company is sacred.  This includes companies like Siebel and BMC who both recently missed their earnings targets.  There is plenty of value left in these software companies that the public does not see, and therefore plenty of money to be made by smart investors.

On the early side, I continue to believe there is much innovation to be done.  As the VC funds get larger and larger, they are under increasing pressure to put more dollars to work in every deal.  Therefore, it remains quite difficult for the larger funds to dole out money in $2-4 million chunks, and the valuations are quite attractive at this stage.  As a fund, we typically like to lead or co-lead the first institutional round (post-angel) where the company has a strong entrepreneur, innovative technology, and a handful of customers to prove the market need.  Where I do not want to be is in a Series B or Series C round in a "hot, momentum" company.  I have had a number of these companies come through my door, and I keep asking myself how a company which is only a feature of a much larger offering will create a significant return for the fund after having raised too much cash at too high a price.  When I see "hot" companies with revenue less than $5mm raise capital at $50mm pre-money valuations, I start getting worried, and it further reinforces my thinking on where to make good investments.

In the end, making good investments is predicated on taking advantage of inefficiencies in the market.  As we look at every new deal, we always revert back to the lesson that Warren Buffet’s mom gave him, "Buy low and sell high."  This includes investing on both sides of the barbell, very early with innovative technology in new markets and very late with established, out-of-favor software companies throwing off good cash flow.  Considering that I am an early stage VC, I will have to play the later part of the barbell with personal investments in the public markets.

Entrepreneurship

Competing with the big boys

Posted on by Ed Sim

I was talking to a portfolio company CEO today about his sales pipeline and one of the key items of interest for me was understanding competitive dynamics.  Besides looking at the raw numbers, I like to understand whether or not we are seeing more or less competition, why we are winning, and why we are losing.  As I started to dig into this area over the last two quarters I have noticed that the big boys or incumbents have started to show up in more deals.  In my mind that is a good sign because incumbents don’t enter a market unless they believe it is worth pursuing.  I also typically do not mind competing with the larger players as they are generally less agile and less innovative than startups. 

That being said, incumbents tend to add confusion in the marketplace and lengthen any startup’s sales cycle.  Their typical tactics including saying they have the product when they don’t, promising they will have the product in one to two quarters (maybe three or four or never is the real answer), or giving it away for free in a bundle of other things that the customer buys.  The last one is a tough one to counteract – I mean if the customer gets it for free, then it doesn’t have to be as good as an innovative startup’s product, does it?  So how do you compete against these tactics? 

First, as a startup you have to get away from a feature/function battle because you will always lose against a big boy.  If a customer has already bought a product from an incumbent, they are more often than not willing to stay with that incumbent if they can deliver the extra feature/function soon enough in a good enough way. What I like startups to do is win with the product roadmap and vision.  Show the prospect how you solve their needs today better than the incumbent but more importantly why you are different and how your approach will solve their future needs.  If you can differentiate on this level, it gives you a much better chance to win. 

One other piece of advice is that you must qualify the opportunity early in the sales process.  If the incumbent is esconced in the account, you may be better off walking away quickly in pursuit of greener pastures.  As I got off the phone with the portfolio company CEO today, what made me happiest was not hearing about all of the wins against the incumbents, but how we walked away quickly from those types of deals. Just today the CEO had a conversation with a particular prospect who said that our software was the best but the incumbent was willing to offer it for $30k instead of $150k.  We ended up walking away from this deal and told the prospect to return to us when the product didn’t work.  Having been through this before, I can tell you that many of these prospects will come back to you.  Over the long run, if the market is big enough and you build enough market share and critical mass early it will always be easier for an incumbent to buy you rather than start from the scratch.  If not, you may want to figure out how you can partner with the incumbent or their competitors.  Either way, remember one of your key advantages is to keep innovating and staying a product generation ahead of your competition.

EntrepreneurshipVenture Capital

When competitors are acquired…

Posted on by Ed Sim

It is clear that we are moving towards a consolidation phase in the technology sector.  M&A activity has been heating up over the last 18 months as strategic acquirers are looking to bulk up and broaden their product offerings.  During the last few months, we have had a few board discussions on this very topic.  The conversations were not about us trying to shop any of our companies as I firmly believe that companies are bought and not sold (see an earlier post).  Rather, our discussions focused on what happens when one of our competitors are acquired.  Usually when a competitor is bought at a huge price the first reaction is why it wasn’t me.  The second reaction usually becomes fear as you begin to worry about what your competitor’s product will do in terms of market share with a huge sales force and partner channel, strong brand name, and global infrastructure to support the customer growth. 

Having been through this a number of times, this is the point at which you need to take a deep breath, stay the course, and look at the situation in a positive light.  First of all, the majority of acquisitions fail.  Secondly, your competitor will be inwardly focused and quite distracted for the first 6 months trying to integrate with the parent company.  Finally, depending on how the acquisition was completed, employees will begin to leave as soon as they get the bulk of their money off of the table.  When a competitor is acquired, rather than sulk and worry about why it wasn’t you, try to aggressively exploit the situation and use it as an opportunity to grab market share and poach some experienced and talented personnel from your nemesis.  Last year, for example, one of my companies was able to build an incredible sales team overnight, saving us six months of hiring and giving us an opportunity to hit the market harder and faster.  So the next time this happens remember that you will more likely than not be in a better situation after your competitor is taken out of the market leaving you with plenty of opportunity to grow.

Investing/Markets

Cisco, a value play?

Posted on by Ed Sim

I was reading Barron’s this morning and came across an article (sorry-need subscription for this) claiming Cisco’s potential appeal as a value stock.  It is hard to believe that this high flying company which once was the largest market cap company at $600b is now potentially a great value play.  The hot growth sector these days is energy and now Exxon Mobil is the largest market cap company at $400b.  Anyway, this table from the article says it all.  The P/E ratios (range from 18.7 to 19.6)of the tech giants like Cisco, Microsoft, Intel and Oracle are equal to or less than non-tech large caps like J&J, Wal Mart, and Coca Cola (range from 19.4 to 21).  In fact, Cisco’s 2005 P/E at 17 is less than that of the S&P 500’s at 17.4.  When most people think tech, they think high growth but this chart and these P/E ratios should really bring us back to earth.  I don’t disagree with Larry Ellison’s assertion a couple of years ago that the technology markets are maturing.  That is one of the reasons we see all of these huge mergers happening as companies seek to expand their markets, their product lines, and revenue.  That being said, there are still large pockets of growth which will provide startups with plenty of opportunity to succeed.  Cisco, for example, is spending heavily in new markets like security, VOIP, storage, and wireless.  The great news is that in pursuit of growth many of these big players are not afraid to pay up for the right products (think of the $450mm Airespace acquisition in the wireless area as an example).

Entrepreneurship

Know when to say “No”

Posted on by Ed Sim

I have said many times before that with respect to doing deals that saying No is as important as saying Yes.  Let me elaborate.  A portfolio company has recently been in trials with a potential strategic partner about a reseller relationship.  We got in first, set the criteria for success to leverage our technical and business advantages, and were selected as the winner.  We had the most customers, the best product, and best customer support.  There was one huge caveat-one of our competitors who came in second place was willing to do the deal at a 50% discount.  The strategic partner asked us to do the deal at that price if we wanted the win. 

Of course, there was much deliberation on our side and as we ran the numbers over and over again there was no way we could understand how this competitor could ever make money on the strategic partnership.  From our calculations, it would take a couple of years to breakeven off the deal under the very best circumstances.  Trying to make the deal work for both sides, we went back to the potential partner and asked them to give us an NRE (non-recoverable engineering expense) and to handle level I customer support.  At the very least, if the partner handled the first tier of customer support, we could be marginally profitable.  The potential partner said no, and we walked away from the deal.  Trust me, it was a tough decision, and we tried to rationalize why it made sense.  However, when the deal is not a win-win situation it is very hard to make it work successfully. 

From my perspective, one of the huge problems is that there is tons of VC money out there and lots of me-too deals as Brad Feld elaborated in a post recently.  A space gets hot, lots of venture money pours in, and only a few companies survive while the rest vaporize.  We do live in a competitive world and taking market share and killing your competition is part and parcel with being in a startup in a large market.  That being said, what killed many companies during the bubble was pursuing market share at all costs.  I feel like that mentality is coming back in the market.  In my mind, losing money on every new customer signed up is not a long-term winning strategy unless you think you can get financed to infinity (yes, many did during the bubble).  At some point in time, to be a real business you have to generate cash flow from internal operations.  Having done enough deals, I am of the opinion that if it is extremely one-sided and never makes economic sense, it is a recipe for disaster.  To that end, I wish my competitor the best of luck because I can see the train wreck around the corner.  We will stay close to the strategic partner and when the time comes reopen the dialogue.

Web/Tech

RSS Ads

Posted on by Ed Sim

From day one, I got into blogging not knowing what to expect and figuring out the best way to learn about a market is to dive into it and become a user.  So I did that 18 months ago assuming that the time I spent as a blogger would either help me find compelling investment opportunities or provide me with in depth knowledge to help existing portfolio companies leverage this new opportunity.  Since becoming an avid blogger and reader, it is clear to me that embedded ads in RSS feeds will be a key way for content owners to monetize their assets.  First, the fact of consuming RSS feeds will typically reduce traffic at many publishers’ websites giving them less opportunity to monetize their assets.  Ads in RSS will help publishers overcome the lower traffic to their sites while still providing their users with up to date content.  Secondly, ads embedded in RSS feed gives great targeting opportunities for advertisers and publishers.  Hopefully this will allow for greater clickthrough rates.  Given these factors and the fact that users want free content, I believe ads embedded in RSS will become a defacto way for publishers to monetize their assets and for users to continue to consume content for free.  I also believe that as we morph into podcating and vlogs that publishers will find ways to monetize their content through automated embedded audio and video ads. Give this some time as there is not enough content out there, but I see a world where a new service is created which will allow rich media publishers to automatically embed audio and video ads as simply as contextual based text ads. 

Given this backdrop, I am excited that Morever Technologies (a portfolio company) and Kanoodle recently launched a partnership called FeedDirect RSS Ads.  Quite simply, FeedDirect will allow content owners to not only monetize their assets with content-targeted sponsored links via Kanoodle but also get maximum distribution through the Moreover network.  All it takes is a few clicks to sign up and begin generating revenue.  As a VC, one of the cliches we often talk about is eating your own dog food.  In other words, entrepreneurs and VCs, where applicable, should be users of products or services they create or in which they invest.  To that end, I am changing my RSS feed to incorporate the FeedDirect service.  From a transparency perspective, I plan on sharing some of my data with you as my RSS feeds get converted.  To subscribe and test out the FeedDirect service, please change my feed to this link.  If these ads annoy you or if you have thoughts on improving this, please let me know.

Web/Tech

Speed versus flexibility

Posted on by Ed Sim

A number of companies are developing software and sytems which rely on packet processing at high speeds to deliver their respective functionality.  This includes companies in the networking and security space.  The debate over custom ASICs versus off-the-shelf components has raged on over the years.  Over the last five years a new class of chip has arrived on the scene called the network processor.  It is supposed to give the engineer the speed of ASICs with the flexibility of software.  If you are interested in learning more about NPUs and the debate over the merits of NPUs versus ASICs, I suggest reading this article by Douglas Comer in the Internet Protocol Journal (link via Martin Tobias).  Douglas sums up the debate as follows:

Although the demand for speed pushed engineers to use ASIC hardware in third-generation designs, the results were disappointing. First, building an ASIC costs approximately US$1 million. Second, it takes 18 to 22 months to generate a working ASIC chip. Third, although engineers can use software simulators to test ASIC designs before chips are manufactured, networking tasks are so complex that simulators cannot handle the thousands of packet sequences needed to verify the functionality. Fourth, and most important, ASICs are inflexible.

The inflexibility of ASICs impacts network systems design in two ways. First, changes during construction can cause substantial delay because a small change in requirements can require massive changes in the chip layout. Second, adapting an ASIC for use in another product or the next version of the current project can introduce high cost and long delays. Typically, a silicon respin takes an additional 18 to 20 months.

Given the need for flexibility and speed to market (particularly in the security space), a number of companies I have seen over the last few years have taken advantage of NPUs to deliver product with good enough performance with more up-to-date functionality than their ASIC brethren.  As we move on, I expect to see further improvements in NPUs in terms of speed and programmability as we all continue to recognize that the value is in the software.