EntrepreneurshipVenture Capital

Raising capital and meeting expectations

Posted on by Ed Sim

What I like to tell portfolio companies is that on average it will take 6 months to raise capital with some cycles being shorter and some being longer. Given that, it is imperative for a company to start thinking about its next round well ahead of time and the milestones it needs to hit to have the right momentum to get potential investors excited. One area that I would like to caution entrepreneurs is being too aggressive on the milestones and revenue forecast, particularly in the near term.

Let me explain. Like any other VC, I love to invest in companies going after big markets with huge revenue potential. That being said, I also like to see plans grounded in reality as well. Rather than get me excited, showing a revenue ramp from $1mm to $17mm to $65mm will actually do the opposite for me, raising more questions and concerns than general excitement. Along those lines, it is also imperative that when you share your plans with investors that you are pretty confident that you will realize your milestones or hit your numbers in the next 6 months as investors like to see if you can deliver on your promises. One cardinal sin is being overly optimistic in the near term and falling flat on your face in the due diligence process. It is much better to position yourself in a way that you can meet and exceed expectations during the due diligence process than the other way around. When this happens the rest of your forecasts become more believable.

Web/Tech

The next generation web – scaling and data mining matters (continued)

Posted on by Ed Sim

I had some interesting meetings yesterday and as I reflected on them this morning, one common theme emerged which is that the next generation of the web will be built on data mining and extracting intelligence from the reams of data web services collect on a daily basis.  This reminds me of a post I made in March of 2006 titled "The Next Generation Web – scaling and data mining will matter" where I mention:

I truly believe the next battleground will be based on scaling the back end and more importantly mining all of that clickstream data to offer a better service to users.  Those that can do it cheaply and effectively will win.  The tools are getting more sophisticated, the data sizes are growing exponentially, and companies don’t want to break the bank nor wait for Godot to deliver results.

My first meeting was with a well known research analyst covering Internet stocks.  While we discussed the usual topics such as how the Internet was taking share from traditional advertising budgets and how the top brand advertisers have not really embraced the web yet, our most lively discussion centered around next generation advertising technology which all centered around increasingly complex forms of data analysis.  To that end, I mentioned one of the fund’s portfolio companies, Peer39, which is using natural language processing and machine learning to create highly precise matching of commercial offers and user generated content.  As you might guess, the secret sauce is the algorithms that the company has created.

Later in the day I had lunch with a friend who we had funded years ago.  What was interesting to hear was how many of the future product lines that we discussed a few years ago were finally starting to emerge as real revenue drivers for the business today.  Years ago the company’s first data center cost around $20mm and the latest one which has orders of magniture more customers cost only $3mm.  Clearly, any data-driven opportunities a few years ago were cost prohibitive in the first place and too early for the customer to understand in the second place.  That was the case because many businesses were just worried about not getting Amazoned and today they are all on the web thinking about how to drive better results.  That is why our discussion led to a massive data warehousing project his company was working on to take all of that data across his huge customer base and to help them better monetize their sites.

What I love about these kinds of opportunities is that algorithms scale, have high gross margins, and are proprietary and defensible.  The next generation web is not about what you click and see but what is happening behind the scenes every time you click on a page and move from site to site.

Digital Media

Old school content has value…again

Posted on by Ed Sim

Every day it seems we are reading about the power of social networking to transform the Internet and how we communicate online and also consume and discover new content.  While that is true and clearly changing the consumption habits of online users, today seems like a flashback to the old school Internet days where traditional content was king.  First IAC announced the acquisition of Lexico Corp which owns dictionary.com, thesaurus.com, and reference.com and then CBS announced the acquisition of CNET.  With $400+ million of revenue in 2007, it seems like a good buy for CBS at a little over 4x trailing revenue.  So looking at the fact that people are recognizing that social networks are not as easy to monetize as previously thought and the understanding that old school content can still be monetized, I wonder what other old school content companies may be in play in the future (can anyone say the Knot.com or the thestreet.com – full disclosure, i bought shares of these companies for my own account during the last couple of months).  Given the weakening ad spending environment and the fact that many of these small public Internet companies reported lower guidance for the rest of 2008, it is clear that now is a good time for strategics to buy and expand their uniques and ad inventory.  As I have always said, when it comes to the web, scale matters!  Also see Silicon Alley Insider for some comments from the CBS conference call regarding scale and the value of premium content:

CNET’s been very disappointing for past few years. What are your strategy for improving CNET revenue growth, margins?

CFO: We think that they have the asssets to do that, they’ve revamped a number of the sites. Combining with us is good because there’s very little overlap with our advertisers (auto, pharma, etc), but CNET audience demo very attractive to our advertisers. And then they reach advertisers (electronics, etc) that we don’t. Other efficiencies: One public co instead of two. Combining some ad platforms, etc.

Given MSFT/YHOO, other consolidation, does this make you big enough on the Web?

Les: We just tripled our digital platform. Are there possibilities to do tuck-ins? But right now, we have taken a major leap forward. We are very happy with the cards we’re holding now.

CFO: We’re now a top 10 Internet company. Could we be a top 5 over time? Sure. But would be through growth, not acquisition.

Les: Remember! Premium content!

VOIP

Open vs. closed networks and Facebook chat

Posted on by Ed Sim

As you know, I have always been a believer in open standards (see my post from January 2006).  Being a market leader, it is quite easy for Facebook to create their own standard similar to how every other instant messaging network was started.  And to that end, Facebook started down that path.  But just today, it announced that it was extending its chat and opening up its service by offering XMPP/Jabber support.  Assuming there are no restrictions, this is a huge win for openness.  Maybe one day Skype and MySpace and others will adopt the same strategy and move us to a world where we can IM anyone from any network and have one IM identity rather be forced to live in a world that was similar to the dark ages of email where Prodigy, Compuserve, and AOL users could only communicate with users on the same network.  Once Facebook starts with chat, maybe when and if it ever offers VOIP, it would leverage the open SIP standard as well. Rest assured that the development team at portfolio company Gizmo5 is digging into the details of the Facebook annoucement and in short order can offer seamless connectivity to Facebook chat from your mobile phone.  From the day Gizmo5 was started, it was built to live in a world of open standards leveraging the SIP protocol for VOIP and Jabber/XMPP for IM and Presence.  As you might imagine, the smaller networks who needed users were the ones to adopt open standards first.  Slowly but surely, larger and larger networks have adopted these standard starting with Google Chat in 2006 and now Facebook with its dominant market share in social networking.  It seems as if the floodgates are opening and this is quite exciting.  As I mentioned in my post from 2006:

Whatever happens it will be interesting to see if true open standards will triumph over closed and proprietary and how long that will take. At the end of the day consumers don’t care about protocols, they just want it all to work seamlessly and easily, and they do not want to be on their own island for communications.  What I want is one identity or phone number that works on any IM network, VOIP network, or even integrates with my PSTN and cell phone identity?

Wireless

Nokia-an Internet company???

Posted on by Ed Sim

As I have mentioned before, Nokia is one of the few handset manufacturers to get it (See my post from 2/07 on this).  Nokia understands that hardware margins are eroding and like in many technology businesses the value is in the software and monthly service revenue.  In addition, as time goes by, more and more people will be using their phones and data services to get information and communicate with friends.  Therefore it is no surprise that Nokia announced yesterday that it wants to be more like an Internet company and less like a manufacturing company. 

Our new structure is helping  Nokia to be more integrated as we focus more attention on developing new businesses around Internet services. Over time, it will allow us to be faster and more agile in bringing out new products and services, in serving our operator customers better, and in meeting our customers’ needs in different parts of the world.

Our goal is to act less like a traditional manufacturer, and more like an Internet company.

The other piece that Nokia gets is that if they don’t start offering services on their devices, Google, Microsoft, and Yahoo will.  The delicate dance that Nokia is playing is how to fend off the traditional Internet guys while also adding value to its carrier partners.  Despite the fact that Nokia is one of the few companies that sells a significant number of phones direct to the consumer, carriers still matter.  To that end, it will be interesting to see how VOIP plays into this delicate balance.  For more on this, take a look at Michael Robertson’s latest blog post (full disclosure-Dawntreader is an investor in GIzmo5 and I am on the board) on the world’s smallest dual mode wifi phone.  6300iwithball_2 Yes, dual mode wifi means the phone can make VOIP calls over wifi networks.  As MIchael says:

"This is not Nokia’s first wifi phone, but it is significant for several reasons:         

It has a street price of $200-300 (vs $400-900 for previous phones)

    Power utilization has improved so it can do ~3 hrs VoIP calls and ~4 days WLAN standby (historically wifi phones have had awful battery life) It’s Nokia’s first s40 wifi phone (the majority of Nokia’s phones are built with s40 parts so it will be very easy to create many more wifi models)

From my perspective, what is great is that the price point is falling quickly for dual-mode handsets, the battery usage/life is getting better, and manufacturers like Nokia are willing to offer innovative services on them through partners like Gizmo5.  2008 will surely shape up to be an interesting year in the wireless industry.

Entrepreneurship

Developing your way to success or failure…

Posted on by Ed Sim

During the last month, I have been in board meetings and thinking to myself about what was going well and what wasn’t.  And when the discussion came to revenue, one common theme that always seemed to surface was a focus on the next product.  What I mean is that when discussing why our current product wasn’t selling as well as it should have or getting as many users as projected, the answer was always focused on the next product or feature.  Granted, I have always believed that one needs an insanely great product or service to generate sustainable revenue and that constant iteration is key to success.  However, it is also important to understand why a current product or service is or isn’t doing as well as you thought.  In addition, entrepreneurs must also think about how they are going to get the product to the market and come up with the right messaging.  I have seen a number of situations where entrepreneurs can get too focused about developing and releasing the next product or feature without spending as much or even more time and resources in getting it out to the market.  Then when management and the board sit down to evaluate what went wrong, the answer seems to be that people clearly didn’t care.  That can be a huge failing because the product or service may actually be phenomenal but just may have had no marketing or support in reaching potential customers.

So my advice is that before you place all of your bets on the next product or feature, make sure you put enough effort into crafting the right message and value proposition and that you put just as many resources into getting it out to the market.  In other words, give your product a chance to succeed and don’t starve it to death.  Constantly developing new technology without having a well-thought out plan to get it to market can spell doom!  Developing your way to success can work only if you realize that it is only part of the battle.   

Digital MediaEntrepreneurship

Direct ad sales and startups

Posted on by Ed Sim

I have recently met a number of startups with interesting consumer applications or services.  As expected, many of these startups have a vision to rely on advertising to pay the bills.  And like many startups, a number of these companies have plans to add a direct ad sales staff over time.  That makes a ton of sense, but what I believe is that many entrepreneurs underestimate the direct capital and management costs necessary to build such a team.  In many ways, building a direct ad sales team is similar to building an enterprise sales team.  These thoughts may seem quite basic to you but here they are nevertheless.  First, don’t ramp up your sales team too quickly until you have a product to sell.  That means if you don’t have scale or enough eyeballs you are better off using Google Adsense.  If you don’t heed this advice you may quickly burn yourself out of business.  Secondly, I know that many startups may not know what kind of ad units to sell but be careful of not having a standard product list or rate sheet when you go out to the market.  Yes, I know you have to be creative if you have a new service and listen to your customers, but at the same time don’t base your business on selling one-off ad units for each advertiser because this can be a huge drain on your technical resources over time.  Next, make sure you never forget that what is right for your users is right for your business.  Many times I have seen companies that are trying to meet the advertiser’s inventory requirement make the ads much too prominent and sacrifice usability in the long run.  While this may drive some initial short-term results, it may come to bite you in the ass in the future. 

The bottom line is that Google Adsense works well for a reason-it has scale-it has tons of eyeballs, it has a huge customer list of advertisers, and is therefore more likely to get you great pricing and ad targeting.  Yes, I don’t disagree that over time you want your own sales team and don’t want to solely rely on one partner for your revenue, but just go into this with your eyes wide open and don’t ramp up before its time.  The direct costs, management costs, and hidden strains on your infrastructure may be more than you can handle if you ramp up too quickly.  Start slowly, figure out what it is that advertisers love about your service or product, figure out what kind of units deliver the best results, and then ramp.  Here is an earlier post on ramping up an enterprise sales team as there are many similarities to direct ad sales and direct enterprise sales.

Entrepreneurship

The economic headwinds are getting stonger

Posted on by Ed Sim

I was waiting for this day to happen.  Each day I go online and also glance at the newspaper, and there is nothing but bad news.  And yes, it is true that some of the best technology companies were built when the economy was at its worst.  And I always like to think that it takes a little longer for some of these negative effects to trickle down to smaller companies and startups.  Just the other day, I got the call from one of my portfolio companies which had won a huge deal last month.  We were waiting for the purchase order and the dreaded call came: "You still have the deal but our CFO needs us to cost justify every dollar we spend on IT – the deal will have to wait until next quarter."  That definitely put a kink in our plans and also caused us to adjust our Q1 forecast.  Fortunately, many of us had been through this before and management had prepared alternative plans based on various growth rates at our last board meeting.  We had a base case model which we were running our expenses on, an upside model which we had hoped we would achieve, and a lower growth scenario which we would have to implement if bookings did not materialize.  I know that this is one data point but all I can say is that if you have not done so already, prepare a few different models to make sure you can make appropriate changes to your business to conserve cash.  I won’t say that we are in a recession but if we get more data points on spending freezes, layoffs, and the like, it is only prudent to be prepared.  And yes, as I stated above, while some of the best technology companies were built when the economy was at its worst, they would not be here today if they weren’t standing when the markets rebounded.  That means that you have to rationalize your business and put more resources behind what is working and not spread yourself too thin.  That means if you are raising another round of funding try to raise more capital rather than less – focus on having about 18 months of fresh dollars to see through the other side.  Finally, stay strong and keep your head up because if you follow the above advice you will have a much stronger business when the markets rebound.

EntrepreneurshipWeb/Tech

The "free" business model

Posted on by Ed Sim

Chris Anderson does a nice job of summarizing the rise of the "free" business model starting with the Razor/razor blade to the world of the web where he argues that all services eventually get priced at their marginal cost. And as Chris rightly describes, that price is quickly going to zero in a world of technology where Moore’s Law continues to hold and where storage costs are declining rapidly. 

Among the many great examples in Chris’ article, the one paragraph that stood out most for me follows:

There is, presumably, a limited supply of reputation and attention in the world at any point in time. These are the new scarcities — and the world of free exists mostly to acquire these valuable assets for the sake of a business model to be identified later. Free shifts the economy from a focus on only that which can be quantified in dollars and cents to a more realistic accounting of all the things we truly value today.

In a world where everything is free, what is the most valuable asset?  I couldn’t agree more that "attention" and "time" are two scarcities that every company offering "free" services has to overcome.  There is only so much time in the day for all of us to join another social network, add a new widget, and try out a new web service. And this fight is not only for a consumer’s web time but for their overall leisure time – time to spend with their family, time for sports, and time for entertainment.  Given this competition for such a finite resource, you better have something incredible for me to try which will either provide awesome entertainment or provide an awesome utility that gives me a 10x improvement over existing ways of doing things.  Without that, I am sure you will get people to sign up and try your service, but I doubt you will have many active users 6-12 months down the line.

And my final point is that "free" is great and what consumers expect many times, but at some point in time dollars do have to come from somewhere whether it be venture capitalists (who will surely expect a big return on their investment), advertisers who will expect the same, or some other source of capital to sustain the business.  So in concept I agree with the notion that the world is getting cheaper by the second, but on the other hand don’t forget Chris’ points that free only means that dollars do eventually have to come from somewhere to pay the bills.  Oh yeah, one other point-as we move to this world of free, there will be lots of carnage and the road will be littered with many dead companies, as only a small percentage in a growing pie will be able to make this model work and viably consume your time and attention to deliver the money.

EntrepreneurshipInvesting/MarketsVenture Capital

Top tech M&A advisors for 2007

Posted on by Ed Sim

I just got the 451 Group’s summary on the top M&A bankers for 2007.  As with 2006, Goldman Sachs was #1 on the list.  Take a look:

Top five overall advisers, 2007

                        

Adviser Deal value Deal volume 2006 ranking
Goldman Sachs $79bn 43 1
Credit Suisse $75bn 29 3
Morgan Stanley $74bn 29 6
Citigroup $61bn 23 5
Lehman Brothers $56bn 21 4

Of course if you break down the numbers, you can see that the average deal size for all of these banks range from $1.75 to 2.75 billion.  Let me translate back for the startup community.  As I have written before, I am a firm believer that companies are bought, and not sold (see an earlier post).  In other words, I am not a fan of hiring a banker to shop a company around but rather find it better when a portfolio company receives an unsolicited offer and you then bring a banker in to leverage that bid to create a more competitive situation.  Assuming you are in this position, every startup I know says, "Let’s go get Goldman or Morgan Stanley."  While in theory we would all love to have these guys as advisors, the chances are that you are not going to get them on board.  First, they typically have high minimum thresholds of exit value typically in the $300mm plus range and secondly even if you fit that criteria you may not get all of the attention you need since a $5 or $10 billion dollar will clearly trump yours.  What I would advise is that you find a banker that has the recent experience selling companies in a price range that you are seeking, will give you the PERSONAL attention that you need to make the transaction successful, and has the network to reach out to the right people on a timely basis.  Based on my experience, I have found that some of the firms like Thomas Weisel Partners and Jefferies Broadview who are not bulge bracket but with strong reputations in the technology markets can be a good fit.  I am sure there are many other great firms that I am missing but you get the idea.