New York VC

Practice What You Preach

New Yorkers were rightly outraged by yesterday's Air Force One photo shoot over Manhattan.  What I haven't seen discussed, however, is the timing of what was likely a very expensive "classified mission" to update the photo of Air Force One on the White House website.

Back in November every politicianwas outraged when the Big Three auto industry CEOs flew private planes to DC to ask for taxpayer money.  This was a stupid move by the automakers and was a clear symbol of waste in an industry that has been operated poorly for decades. 

So why aren't politicians just as outraged over the taxpayer money wasted on yesterday's photo shoot.  I don't know the exact cost of an Air Force escorted photo shoot in downtown Manhattan, but I'm willing to bet it cost taxpayers a whole lot more than the auto industry CEO private flights back in November. 

To me yesterday's photo shoot flight (and lack of political outrage over the cost) is just as significant of a symbol as the private flights in November.  Our government finds more ways to waste taxpayer money on a daily basis than any corporation in this country - including the auto companies. 

Our government leaders need to start practicing what they preach. 

Pontiflex

Pontiflex, our Brooklyn-based portfolio company, announced a Series B financing round with new investor RRE Ventures.  The team at Pontiflex has achieved extraordinary growth since our initial investment a year ago.    

We're thrilled to welcome RRE as a co-investor and in particular Eric Wiesen to the company's board.  Not much more to say since earlier today Eric eloquently outlined on his blog where Pontiflex is positioned in the online advertising universe and why they're sitting on a golden opportunity. 

       

Fittest tech firms will survive in the future - Redux

I wrote an article for the Baltimore Business Journal 7 years ago during the last tech downturn while I was at Sterling Partners.  A lot has changed over the last 7 years but after coming across this article recently I realized many of the messages apply just as well today as they did back then.  I've pasted the article below as well:

-----------------------------------------------------------------------------------------------------------------------

Charles Darwin would have made one hell of a venture capitalist. Darwin's theory of the survival of the fittest was played out each and every day in the halls and conference rooms of venture capital firms and early-stage technology companies during 2001. More often than not, these young companies succumbed to the forces of natural selection.

So as 2002 begins to unfold, how can we expect Darwin's theory to affect the current crop of young technology companies? And just what characteristics are Darwin's agents, the venture capitalists, looking for in companies this year?

Entrepreneurs and investors should expect more of the same for the rest of 2002. While many weak tech companies have folded, many still remain. Our offices still receive business plans daily from existing technology companies still struggling to survive.

I predict by the end of 2002 all but a few of the "walking dead" technology companies will disappear and we'll be left with two types of young companies: survivors and upstarts. "Survivors" will emerge leaner and stronger after having survived the Darwinian market of the last two to three years. Upstarts will learn from the failed businesses of the last few years and bring new, improved and innovative ideas to the market.

And if history repeats itself, both types of companies will produce this country's next generation of technology leaders. One only needs to look back at the 1984-1985 recession to find a couple of good examples. In Silicon Valley, Intel became a survivor by shifting its business from producing memory chips to microprocessors, which led to its explosive growth during the 1990s. Meanwhile, in Texas that same year, a young college kid founded an upstart company called Dell Computer just as the PC market was in the midst of a complete meltdown.

I expect my colleagues and I in the venture capital industry will be on the lookout for both survivors and upstarts in 2002.

We're looking for technology companies that can deliver value to their customers, value to their partners and value to their shareholders.

We're looking for technology companies that offer a defensible and differentiated product or service. The successful companies will understand that they may forgo profits to achieve rapid growth.

And finally, we're looking for experienced entrepreneurs with domain expertise who are capable of managing their company through the ups and downs of the business cycle.

------------------------------------------------------------------------------------------------------------------------

One mistake I made in the article was stating that the walking dead companies would disappear by the end of 2002.  Many companies (and VC funds) proved to be more resilient than I expected.  They didn't thrive but did manage to keep the lights on.  I expect the same thing to happen again.       

The venture industry has always been a cyclical business and I don't expect that to ever change.  I do wonder whether or not the boom/bust cycles are getting shorter and shorter in our business.  Tech innovation cycles are shorter which may be tightly correlated to the venture cycle as well. 

Food for thought.    

Can you spare $1 a month for Facebook?

There seems to be an obsession over monetization of online properties through advertising.  The preferred formula is build a large audience, sell targeted advertising, get rich.  Google perfected the model better than anyone but it's not easy to achieve and is often the wrong choice.

We come across many bright entrepreneurs that are easily seduced by ad supported business models when sometimes alternative types of monetization can be more effective.  

Case in point - Facebook.   

At its core Facebook is a utility used by members for communication, community, collaboration and expression.  Facebook is providing a valuable service to consumers and deservedly should be compensated for its efforts.  

If i was an investor in Facebook I would be strongly pushing a subscription model.  Facebook has 175 million users worldwide and at $1 per user per month they could generate $2.1 billion in annual revenues.  Even if half of the members paid FB would generate over $1 billion sales on a recurring basis.  Of course not every user is active and a percentage will refuse to pay but I would argue that any user not willing to pay $1 per month isn't likely a great target for advertisers anyway.  The average Facebook user is now ovr 25 years old and $1 would mean buying one less cup of coffee or can of Coke each month to cover the cost.

The beauty of adopting a low-cost subscription model is that it wouldn't rule out FB's advertising opportunities at all.  Cable tv has figured out how to make both models co-exist successfully.  

Facebook management just needs to have more confidence in the power of their platform and the value they provide to members.  

Just one man's point of view but I would be interested in other views on this topic.             

Flat World Knowledge

I've been lucky to have a ringside seat over the last 8 years to watch as the education industry evolves right in front of my eyes.  First at my old firm Sterling Partners which sprouted blockbuster companies like Sylvan and Laureate Education and where I was exposed to a consistent dose of young, innovative education companies over several years.  In recent years I've been fortunate to spend a fair amount of time both formally and informally interacting with some of the largest education publishers in the world right here in NY.  One of them is in fact an investor in our fund.  What I've learned over the years as a VC is that finding a compelling early stage company to back in the education industry is challeging.  The venture industry's collective investment track record across the sector over the last 20-30 years confirms this to be true.  To be a successful investor in the education sector it's necessary to attack a large, preferably unregulated segment of the market with a highly disruptive solution and with an A team of domain experts that understands the education industry inside and out (rookies need not apply).  

Which brings me to the $8 billion college textbook market.  

Much has been written over the last year about the imminent demise of the $40 billion print newspaper industry at the hands of digital media.  At Greenhill SAVP we believe the newspaper industry is just the tip of the iceberg and that conditions are in place right now for disruptive and rapid acceleration of other print content to all web-based or web/print hybrid content solutions.  College textbooks are near the top of the list.  Let me explain why. 

Unlike the newspaper industry which is highly fragmented, the college textbook industry is an oligopoly where the major publishers utilize their size and pricing power to effectively control the market.  The average new business & economics college textbook today costs $150 and many have surpassed $200 during the past year.  In an age of seemingly readily available and cheap digital content, textbooks prices are actually rising.  For a 4 year public college student, the estimated average cost of textbooks and related materials as a percentage of tuition and fees is 26% and for a 2 year community college student, the percentage is about 76% (U.S. Department of Education).  As the recession has deepened, enrollments in colleges rise, university budgets are being cut, and everyone is being asked to do more with less.  In response many institutions of higher learning have been forced to raise tuition and fees to keep the lights on while students who are already struggling financially are asked to shoulder an even higher financial burden.

The current situation is not sustainable, particulary in today's economic and political climate.  A perfect storm is brewing that's created the ideal conditions to disrupt the college textbook market and rewrite all the rules.  That's why we're thrilled to announce the latest addition to the Greenhill SAVP portfolio - Nyack, NY based Flat World Knowledge.

Flat World Knowledge is the world's first publisher of open source textbooks.  Their highly disruptive business model and technology platform is breaking all the rules and doing nothing less than reinventing the textbook publishing industry.  Flat World publishes premier textbooks written by leading experts that are as good or better than those offered by major publishers.  All students can access their online texts for free or purchase affordable alternatives from paperback editions, audio chapters, Kindle versions, .mp3 study guides, mobile flashcards and web quizzes.  In other words, students can consume educational content anywhere, anytime, anyhow and in anyway.  

Additionally, Flat World openly licenses their books and provide an easy-to-use platform so faculty can modify the book and deliver a customized version to their students.  The platform also provides a rich learning environment for students through the ability to collaborate around the textbooks where students can actually create, share and sell study resources to one another.

We're excited to be an investor in Flat World Knowledge along with our good friends and colleagues over at Valhalla Partners and High Peaks Venture Partners.  In particular, I'd like to thank Hooks Johnston from Valhalla for first introducing me to Flat World Knowledge.  We look forward to working with Jeff Shelstad, Eric Frank, Brad Felix and the rest of the the Flat World team (our A team of domain experts) over the coming years to help revolutionize an industry in desperate need of change.

 

 

 

 

Tim Armstrong named Chairman & CEO of AOL

I was very happy to see the news today that Tim was named the new Chairman & CEO of AOL.  Tim's a friend and I've been fortunate to work with him first as a fellow board member at KnowledgeStorm and over the last 4+ years as an investor and Advisor to our fund, Greenhill SAVP. 

Personally seeing Tim in action and having had the opportunity to pick his brain and exchange ideas on a number of initiatives over the years, I can state that his appointment as Chairman & CEO of AOL is one of the more important announcements in the digital media/advertising market in a long time.  People that are in the know are aware of how significant of a role Tim played in the success of Google.  Tim was long overdue to take the helm as CEO of a major media company.   

I have no inside knowledge but I expect AOL will get the following from Tim:

• Strong leadership - Tim is a natural born leader and excels at rallying the troops towards a common goal
• Focus - Tim will bring real focus to AOL and will build on AOL's core strengths while jettisoning side projects that don't provide sustainable value to the franchise
• Re-Invigorated Sales Culture - Tim plays to win and as a former athlete is very competitive.  Expect him to revamp and revitalize the ad sales team
• Deeper Technology Moat - Tim is generally thought of as a sales leader but he very much understands the importance of utilizing technology to create an edge over the competition.  I expect Tim to emphasize technology through focused investment in R&D 

Fixing AOL isn't an easy task but Time Warner couldn't have chosen a better individual both personally and professionally to make it happen.  I wish Tim the best of luck and look forward to watching him lead AOL to a better future. 

Is the venture capital model dead?

There's been an increasing belief over the last few years about the impending death of the venture capital business.  I'm not going to elaborate on the various theories floating around out there.  If you want to learn more then a simple google search with the keywords "venture capital dead" will provide you with plenty of reading material.

The bottom line is the venture business is alive and well but is in the midst of a long period of transition.  Alan Patricof, one of the deans of the venture industry, did a fantastic job in a NY times article a couple of days ago of explaining how the business has shifted over the last 40 years.  His view is very consistent with ours at Greenhill SAVP and exactly the view we shared with our LPs back in 2005 while raising our current fund.

Prior to fundraising back then we did a lot of research and crunched a lot of data about the venture industry and came to several conclusions:

• historically the most successful VC-backed companies are consistently the most capital efficient
• the most successful early stage venture funds were smaller in size with virtually no evidence in our industry (outside of late 90's bubble funds) of early stage funds generating strong returns above $300 million
• valuations matter - A LOT.  Fair and reasonable valuations work better for venture funds AND entrepreneurs.  Inflated valuations combined with too much capital consistently lead to exit value expectations which statistically have not been reached with enough frequency.  Most exits are less than $100 million in value with bigger exits serving as the exception, not the rule.  Too many venture funds are currently structured so they can only succeed by producing several "exceptions" in each fund.  
• the venture industry will need to contract signifcantly over the next decade.  Between 1997 (the year I entered the venture business) and 2007 the number of venture funds and number of investment professionals increased about 60% and average fund size increased 120%.  We think we'll revert back to 1997 levels over the next 3-4 years. 
• venture capital and entrepreneurship is democratizing and becoming increasingly global as core technology becomes widespread and cheap.  Silicon Valley will continue to be important but less so than the previous 30 years.  Innovation will become more distributed and certain geographies with particular depth of domain expertise (e.g., financial services in NYC) would stand out as future centers of innovation. 

Four years later our view is unchanged and in fact we expect to see these changes to accelerate.  We constructed our venture fund and investment approach based on the above-mentioned assumptions because we felt it was the best formula to serve both entrepreneurs and our investors.

We feel now is a terrific time to invest in innovative, capital efficient start-ups and we plan to be active investors in 2009.   We're fortunate to be well-positioned today with plenty of capital to invest and believe that we'll look back on the companies we fund in today's environment as some of our best performing investments.  On a macro level, we're long-term bulls on the venture industry, long-term bulls on a continued strong rate of innovation and long-term bulls on the entrepreneurial spirit that has always been the foundation of America. 

Pontiflex

Despite the fact that lead generation has been the fastest online ad category, the market is riddled with inefficiencies and problems which have led to a high degree of friction and fragmentation.   Lead generation deals take longer and significantly more effort to set up than search campaigns or banner buys. Today, to run a lead generation campaign, several different departments must get involved: media buyers / sellers, creative groups, and technology teams.                                          

                                                                                                                            

More importantly, today there is currently no efficient way for advertisers and publishers to access the entire lead generation market. Advertisers lack a way to access the universe of potential publishers to run their offers. Similarly, publishers do not have a streamlined way to present their networks and sites to advertisers.

                                                                                                      

This fragmentation leaves most companies reliant on a few large lead gen ad networks and brokers. The ad networks and brokers for the most part keep their partner lists secret, forcing the advertisers to run their lead campaigns “blind.”  Advertisers typically do not know where their offers are running, what the true markup is, and how much of a return they are yielding on their advertising investment. This lack of transparency, in turn, has led to a host of issues, including problems with lead quality, improper use of promotional incentives, and resale of leads without advertiser authorization.  As a result, the lead generation market has attracted a number of disreputable parties which has damaged the sector’s reputation and held back the overall market.

                                                                                                   

When an advertiser and publisher do strike a deal, they often have difficulty transferring lead data or advertising creative due to a variety of standards that currently exist.  For instance, some advertisers want their lead data sent by email, while others prefer HTTP or FTP format.  As a result, publishers have to set up each lead generation campaign from scratch – a process that can take several days worth of work.

                                                                                                                                       

The opaque nature of the market and the complications associated with data transfer has made it difficult for advertisers to optimize and accurately calculate the ROI of their campaigns.  Many large brand advertisers have avoided the use of lead gen for some or all of these reasons.

   

It's against this backdrop that we first became interested in Pontiflex.  Pontiflex is looking to solve all of these issues with the recent soft launch of the industry's first and only open and transparent lead generation marketplace.  Pontiflex enables advertisers to:

• find lead gen publishers
• set up and run campaigns
• optimize, report and validate leads, 
• and transmit leads in real-time

Advertisers can achieve all this with the same ease as running a search campaign with Google with the benefit of full transparency.  We believe by addressing a number of the key problems in the lead gen market, Pontiflex can grow the overall market by attracting more mainstream advertisers into the fold.  The same advertisers that adopted banner ads and search ads over the last 5-10 years can now add lead gen to the mix just as easily.  Despite being in open beta launch mode, Pontiflex has already attracted a large number of advertisers and publishers to their platform and can already deliver access to 17 million leads monthly for advertisers. 

                                                                                                                                             

We're thrilled to have invested in Pontiflex with New Atlantic Ventures and look forward to building a great company with them and Pontiflex's team - Zephrin Lasker, Roshan Bangara, Jon Beardsley, Geoff Grauer, Arun Krishnan, Chris Halvorsen and Nick Herman.      

    

Bear Stearns Fire Sale

JP Morgan is acquiring Bear Stearns for $2 per share ($235 million) in what will go down as one of the most spectacular flame-outs in investment banking history.  Consider these three points:

- Bear Stearns was trading at $150 per share just 9 months ago representing a market cap over $17 billion. 

- AOL last week announced the acquisition of Bebo for $850 million or almost 4x the acquisition price of Bear Stearns.  Bebo's reported 2007 revenue - $20 million.  Bear Stearns 2007 revenue - $6 billion.

- Widget maker Slide recently raised $50 million at a valuation of $550 million.  Revenue - little to none.

Despite Bear's troubles this will one day be known as one of the best acquisitions of an investment bank or any business ever and will become a landmark deal in the career of Jamie Dimon. 

If you were to look out 2-3 years from now and had to predict which one of these three deals will be the most lucrative for the acquirer/investor which deal would you choose? 

We sure are living in interesting times!

It's the People, Stupid!

There have been a number of posts from Fred Wilson, Michael Arrington, Jason Calcanis and others over the weekend about the need for startups to save money by watching their pennies.  I agree with some, but not all of the ideas on saving money but I think Michael Arrington got it right - hiring the right people is what matters most.  You can save a few dollars here and there but there's no substitute for great talent.  Besides, the "right" people will look for ways to pinch pennies and turn $1 into $10. 

The classic argument within the VC community is what matters most - people, market or product?  I'm not going to rehash that argument here but through my experience 90% of success in venture is due to the people.  If you'd like empirical evidence take a look at the scientific study conducted by ghSmart.

There are three primary challenges in filling your organization with "A" players.  First, you have to find and source talent from the right candidate pool.  Second, you need the skill to identify an "A" player when they're in front of you.  Finally, you need to convince the "A" player to join your company.  All 3 of these tasks are not easy but let's deal with them one at a time.

- There are many methods to identify and source candidates including executive recruiters, email blasts, LinkedIn, job boards, etc.  I've found that using a combination of sources usually leads to the best results.  All of them can be effective depending on your time frame and the role you're seeking to fill.  Fred Wilson wrote here not to waste money on recruiters but I'd disagree.  You'll waste a lot more money by making the wrong hire, losing 6-12 months and having to start all over again.  Recruiters can be more effective than other sources (particularly for senior level jobs) and having a firm that spends each and every day wading in the talent pool can often give you a broader view of the high quality talent market than LinkedIn.  Most startups dip in and out of the talent market and as a result only get a snapshot of the available talent, not the full movie.  One of my portfolio companies used an executive recruiter last year to attract one of the top online marketers in the country to become their new CMO.  Her last two gigs she was a key factor in taking the companies from startup to $75m+ in sales in 4 years or less.  When we did our references (provided and back-channel) every person told us she was one of the top 10 online marketers in the country.  You may be able to find and recruit this kind of talent on LinkedIn but it's unlikely.

- Knowing you've got an "A" player when they're in front of you can be tough.  The biggest mistake startups make is hiring the wrong people.  The reason is simple.  The ability to interview is one of the most ignored skill sets in almost every company but especially within startups.  Startups are usually strained for resources as it is and often don't make time to train their team to interview effectively.  I find it amazing that in a world where talent defines success that very few people have gone through formal interview training to properly assess a candidate.  ghSmart talks about four types of approaches to evaluating talent by VCs but I think they apply to anyone that's interviewing a prospective employee.  They are the:

Airline Captain - assessment is a formal, structured process (like a pre-flight checklist)

Art Critic - not sure how to describe a good candidate, but I know one when I see one (like a painting)

Prosecutor - assesses candidate like a prosecuting attorney (sharp, challenging questions)

Sponge - assess candidate by soaking up information (spending a lot of time with them)

The best method to insure success is the Airline Captain.  Statistically, most VCs are Art Critics or Prosecutors.  Airline Captains post investment results that are 4x the next best method (art critic).  My belief is that most startups use the Art Critic or Prosecutor methods as well.  If you want to hire right then try to become an Airline Captain.  Learn how to conduct structured, behavioral based interviews and have a defined process with a clear understanding of the needs of the position.  Create a scorecard with the most important attributes and have all the interviewers rank candidates accordingly.  Don't wing it or suffer the consequences.  It's not a coincidence that the 2 companies that have dominated the tech landscape over the last 20 years (Microsoft and Google) are also known for their rigorous and structured interviewing process.  I've found that "A" players are attracted to companies that have rigorous, process oriented hiring practices.  They want to be with other talented people and "A" players that see a rigorous hiring process will expect the company to be talent rich. 

- So now you have found the "A" candidate and you've put them through the ringer and it's time to close them.  I find the best approach is the full court press.  Come up with a fair offer and add 5% to show them you love them.  In other words, give the candidate the love hug.  Use a team effort to get them on board.  Involve anyone from your team that can help seal the deal - managers, board members, investors or your mom.  Yes, I once backed a startup were the founder's mom came in every day with fresh, home baked cookies for the entire company.  The mom helped close an executive by telling him he was joining a family and handing him a warm chocolate chip cookie. 

Over time if you have markedly better talent than your competitors you're likely to win.  Pinching pennies is great and can help you tread water a while longer but consistently screw up on your hiring and you'll be dead in the water.