New York VC

Be Careful of Painting with the Same Brush

Last week there was an article in the Wall Street Journal titled "In Silicon Valley, Start-ups Begin Hitting the Brakes".  The article struck a very negative tone that as the economy slips into a recession that VC-backed start-ups are very worried about slowing sales and hence are rushing out to raise wads of cash in case of a downturn.  The article's tone made it seem like a new bloodbath is on the way for VC-backed companies.  As usual, the press looks to paint the entire picture with the same brush.  I can hear the editor at the WSJ saying - hey, let's go talk to some start-ups and VCs to get feedback on why the recession will hurt them and what they're doing to make sure they survive a downturn in the economy. 

In any recession a number of industry sectors suffer from a poor economic environment and start-ups are no different.  I'm sure we'll see our share of failures if the economy continues to falter.  However, I expect we'll also see quite a number of companies thrive in a bad economic environment and I've always felt that the greatest tech-related companies are usually born during the worst economic times.  In a bad economy a young company becomes battle tested, has more time to get their business model right with less competition nipping at their heels, are forced to focus on only what matters to be successful and are able to recruit higher quality talent more easily. 

This brings me to the story of KnowledgeStorm, an online lead generation company I invested in back in 2001 only a few weeks after September 11th.  If you recall that period, the tech industry was being written off, online marketing was being written off and the internet was considered dead.  Very few venture deals were getting done at all.  The entire KnowledgeStorm management team had to rent a van and drive almost 20 hours to our offices for a final presentation to our entire partnership for investment approval.  There were no planes flying yet at the time and the country was still in fear.  The truth is I knew I would fund the company before they even walked into our conference room.  Having the whole team leave their families during that time to travel and drive 20 hours in a cramped, rented van showed me they would have the guts to persevere during the toughest times.  They could have rescheduled for a later date but the team wanted the financing now and they couldn't know for sure when the airlines would be flying again.  For me the investment was a no-brainer and Kelly Gay and her entire team proved my instincts to be right.  KnowledgeStorm built a good business which was sold successfully last year earning us a solid return on our investment.   

At the time we invested, KnowledgeStorm only had $300k-$500k of revenues.  Despite the economic environment and the fact that I couldn't find another venture firm to co-lead the deal with me I was convinced it was the ideal time to make the investment.  KnowledgeStorm essentially offered technology marketers the highest quality leads and a compelling ROI during a time that tech marketing budgets were being cut dramatically.  A registered user would search tech solutions and opt-in to have the vendor contact them to provide more information.  They were offering hot, buyer initiated leads during a time when tech companies felt like they were wandering the desert for months in search of water.  Essentially, KnowledgeStorm had a countercyclical product and was able to provide the perfect offering at the perfect time.  Tech companies pulled back on B2B magazine ads and trade shows and subscribed to the KnowledgeStorm directory to acquire leads. 

KnowledgeStorm experienced tremendous growth from 2001-2004 and continued to scale once the economy turned positive again.  This brings me back to today.  In 2007 we invested in 3 new lead generation companies: BDMetrics, BestContractors and ReachForce.  All three companies are focused on a different area of lead gen but have one common thread - they provide a compelling, measurable ROI to the marketer that can't be easily achieved through alternative marketing channels.  We didn't make these investments knowing that the economy might move into a recession during 2008, however, if that happens I expect all 3 companies to see even stronger top line growth.  We'll be more likely to step on the gas, not hit the brakes. 

Lead gen isn't the only sector that does well during an economic downturn.  I'm not going to name them all here but there are a number of sectors that are either countercyclical or have absolutely no correlation to the economic environment (health care). 

And for those companies that are operating in more vulnerable sectors.  My advice is to use poor economic times to focus on what's most important so that you'll come out the other side even stronger.  Remember the old saying - what doesn't kill you makes you stronger.  For evidence see Google, Microsoft and countless other tech companies that built their commanding market share and tremendous value during a weak economy.   

   

I love the Acela

I'm typing this post from the Acela Express train from NY to Baltimore.  I'm headed down there this morning for a board meeting.  High speed train travel sure beats the hassle of flying commercial.  No long security lines and I get to keep my shoes on before boarding.  Most importantly, with my Verizon broadband card I have high speed internet access and can log into my network to work as efficiently as I do in my office. 

I wonder if the cost of building high speed train service across the U.S. would be worth the productivity gains we'd see nationwide as a result.  Food for thought.

Build a Company, Not a Product or Cool Feature

Over the last 18 months at Greenhill SAVP we've seen an alarming increase in the number of business plans claiming to be the next big thing in web 2.0, social media, mobile (fill in your own "hot" space here).  It's really beginning to remind me of the last time this happened in our industry - 1999. 

It's always a bad sign in our business when entrepreneurs are:

1.  pitching unproven products or platforms they're planning to build in order to leverage other unproven products or platforms. 

2.  pitching businesses that really only offer a product feature that should be part of an existing product at an existing company. 

To cite a general example without calling out any specific companies - online video has seen tremendous growth with YouTube as the clear market leader so far in terms of usage.  Despite YouTube's impressive usage Google is still trying to figure out how to monetize the platform and hasn't gotten very far to date.  Many other video sites have seen good usage rates but have little revenue to show for it so far.  Users (eyeballs in 1999 vernacular) are not enough to make a real business.  Having a better video player, a different method to package ads or a viewing feature that's new doesn't make a great company or investment opportunity.  Sure 2-3 of these companies may see successful exits to larger companies in a frothy, bull market but that's not a formula for success. 

We like to call these momentum plays in our shop.  Google, Yahoo and others have made a number of small acquisitions of companies that I would call momentum plays.  When the market is hot and stock prices are rising that's what happens.  Luck and timing become the most important factor for success during these periods.  Some VC funds are masters at taking advantage of momentum and buzz to create value but this isn't a sustainable model for our industry and will end up hurting entrepreneurs and the VC industry in the long run (I'll save the reasons why for another post).  In normal markets (70-80% of the time) companies create value by growing revenues rapidly and producing significant cash flow or having a clear path to producing significant cash flow (see Microsoft, Google, eBay, Amazon, Cisco, etc.).  This applies to every industry - not just technology.  At the end of the day, a business is a business and it must produce sales growth and real cash flow to have lasting value.  Companies that can't do both over time are non-profits or hobbies. 

I know this post will likely upset a few people because it's more fun to write and talk about how every new company is going to revolutionize their market.  The media enjoys writing about new company buzz because its more sexy and they make more money reporting about it.  Some VCs and some entrepreneurs use this buzz to create quick "hype value" for their companies in order to sustain funding, perceived momentum or to create exits for otherwise unsustainable businesses.  Congrats to those who get lucky and hit the lottery or time the market right, but the odds are against you if this is your planned path to success.  Instead I would offer the following advice....   

Before you start a company really ask yourself a few important questions:

1.  Does what I'm creating really matter and why?

2.  Can what I'm creating be a REAL business or should it just be a feature in someone else's product? 

3.  Can I really monetize what I'm creating by producing sustainable and increasing revenue and cash flow over time?

4.  Am I offering a unique solution that solves a problem or fills a true need, want or gap in the marketplace?

If you're building a great company and need a true financial and strategic partner that can help you achieve your vision our door is open and we're ready to help.  Shoot me an email or give me a call.   

If you're looking to make a quick buck off of market buzz and momentum then I wish you the best of luck - you'll need it.   

Intercontinental Exchange acquires YellowJacket

On Thursday Intercontinental Exchange (NYSE: ICE) announced they agreed to buy our portfolio company YellowJacket.  We made an initial small investment in YellowJacket in November 2006 and made a larger follow-on investment into the company in May 2007.

Greenhill SAVP is only 16 months removed from our first investment in our new fund and only 14 months removed from our initial investment in YellowJacket.  While I'm very pleased to be able to provide an excellent early return for our investors, this acquisition is bittersweet for me as I've really enjoyed working with two talented founders in Jacob Pechenik and Greg Campbell as well as the rest of the management team.

The team's strategic vision, foresight and technical competence to create innovative technology to power a peer-to-peer, bi-lateral communications and trading network for the highly complex OTC energy derivatives market has been a key to the company's early success and has led to the creation of so much value in such a short period of time. 

While we're confident YellowJacket could have continued to created a large, successful company on its own we feel YellowJacket's strong management team, powerful technical platform and loyal customer base combined with ICE's vast distribution, asset class diversity and broad customer set will lead to very rapid growth for the foreseeable future.

I'd like to congratulate Jacob, Greg, Michelle, Andy and the rest of the team at YellowJacket on a great result so far and expect the team will continue to fulfill its vision and exceed its goals as a member of the ICE family.  I'd also like to thank Matt Gorin from Contour Venture Partners for being a terrific co-investor, fellow board member and partner on this investment.   

   

      

Google Execs Should be Dancing on the Ceiling...

If I worked for Google and had to hatch a great plan to create a setback for my biggest competitors I would do whatever I could to get Microsoft to acquire Yahoo.  Here's why:

1. Microsoft and Yahoo both operate struggling online advertising operations that have stumbled time and time again over the last few years.  In any type of business combining two struggling operations is usually a recipe for disaster.  This time will be no different.

2. By the time the deal receives regulatory approval, a coherent strategy is formed, executives jostle for power and position in the combined operation, technology is integrated (search, portals, ad platforms, etc) and operations are combined the market will have moved quickly and MSFT/YHOO will need a new plan.  The internet business in general, and the online ad world specifically is innovating at a rapid pace.  Keeping up with the market changes requires focus and determination.  When employees are forced to focus internally and employees are more concerned with where they stand in the new organization than how to progress the business and gain more market share, bad things usually happen. 

3. Google only needs to aim one large gun in only one direction making it easier now to further leverage their market position and increase their reach and power.  I expect almost immediately for Google's share of search to increase and for MSFT to continue to lose share and for YHOO to start losing share.  While MSFT and YHOO will lose focus, Google's will increase.

4. Microsoft is a seasoned company that is unseasoned at making and integrating large, transformative acquisitions.  To date, Microsoft has prided itself on building a large company while making only relatively small acquisitions.  As a result, the company's DNA isn't conducive to this sort of deal further increasing execution risk.  Add the smaller acquisitions MSFT and YHOO are still in the process of integrating (Blue Lithium, RightMedia, FAST, etc.) and the risk inherent in a MSFT/YHOO combination skyrockets.

5. Brain drain - our fund has seen a steady flow of YHOO resumes over the last year.  Many of the best brains have already left YHOO for greener pastures (Google), new ventures or retirement.  Will the remaining stars at YHOO want to stay to see this deal through or will they be picked off?  If they do stay, how much money will MSFT need to hand out to retain them?

So turn up the music..............................

While Google execs should singing Lionel Ritchie's Dancing on the Ceiling:

Man what in the world is happening down
At the end of the hall'
I don't have a clue'
Let's check this thing out!

What is happening here
Something's going on that's not quite clear
Somebody turn on the lights
We're gonna have a party
It's starting tonight
Oh, what a feeling
When we're dancing on the ceiling
Oh, what a feeling
When we're dancing on the ceiling

Microsoft and Yahoo execs should be singing Simon and Garfunkel's Slip Slidin Away:

Slip slidin away
Slip slidin away
You know the nearer your destination
The more youre slip slidin away

Are you sure you want or qualify for venture capital?

I sat on a panel last week for a Young Venture Capital Society event.  While the event was tailored to young VCs there were quite a number of entrepreneurs in the room.  I'm always impressed with the resourcefulness of entrepreneurs to get in front of VCs even if it's not their venue.  After the panel I was approached by 15-20 entrepreneurs all looking to pitch me their business and is typical at events like this only a small percentage are a fit for venture capital at all.  I find this happens more here in NY than in larger venture markets like Silicon Valley or Boston that have a more mature, venture ecosystem. 

One of the biggest misconceptions is that venture capital is at the center of the startup/early stage funding world.  The reality is venture capital is the cream - not the coffee.  Just take a look at the numbers to prove this out.  In 2006, angel investment in the U.S. totaled over $26 billion compared to $5.6 billion of seed and early stage venture capital.  That's less than 18% from VCs and more than 82% from angels.  (see these files for more info: Download 2006angelmarketanalysis.pdf Download 06q4mtprnewsfinal1.pdf).  Also, since venture deals tend to be larger than angel deals my guess is VCs represent less than 10% of overall companies funded at the seed or early stage.  Add all of the self-funded companies (cash, credit card, mortgage, etc) and that 10% number likely drops much further to perhaps 5% of all new company financing. 

There are a number of reasons why this is the case but I'll mention the four reasons I feel are the most significant:

1. Most companies don't fall within the industry focus of VC firms. 

Many early stage VC firms talk about how their investment strategies are unique or different than their peers.  The truth is the differences between funds are within a relatively narrow niche of the new business creation market.  Most VC funds invest in companies that are tech or science centric.  There are exceptions but 90% plus of the available early stage dollars are focused to tech or science related companies (web, software, hardware, life sciences/biotech, cleantech, etc.).  If your company doesn't fall within this narrow band you're likely not a candidate for venture capital at the early stage.  Areas where few VCs invest in seed/early stage include retail, consumer products, non-tech services based businesses (law, accounting, consulting, financial services, etc), health care services, restaurants, non-tech entertainment, government regulated industries, companies that sell primarily to governments and restaurants/bars/nightclubs and on and on.  I think I'm making my point.  Some of these industries represent a substantial part of the U.S. economy but just aren't candidates for VC investment because of point #2 below. 

2. Most small, new companies don't have the potential to grow up and become big successful companies - and that's ok.

VCs invest millions of dollars into companies at the early stage with the expectation/potential to return 5x-10x on their capital and preferably over a 4-8 year time-frame.  To use a simplistic example, if a VC fund invests $2 million for a 20% stake in a business the company is worth $10 million post-investment on paper.  For the VC to realize a 10X the company needs to sell for $100 million.  Very few types of businesses have the potential to reach a value of $100 million.  VCs often talk about only backing companies that can create billion dollar markets.  The reality is there are only so many billion dollar markets.  The average entrepreneur can make a really nice living being successful in a $50 million market or in a $5 billion fragmented market with 100 companies. 

I have a number of friends that run and own successful businesses that generate significant cash flow but can't grow revenues at the rate necessary to create a $100 million enterprise value in a relatively short period of time.  Many VCs use the term "lifestyle business" to describe this sort of company.  Some of these lifestyles are really nice.  My friends that run businesses like these are very happy, make a lot of money and in some cases have homes that would qualify for MTV Cribs. The one common denominator of all successful VC investments is a business model that can scale revenues rapidly and in a nonlinear fashion.  So if you're in a business that isn't capable of achieving that kind of growth pursue other sources of financing.  How do you know if your business isn't VC backable?  Research other companies in your space and if none of them received venture capital it's likely there's a reason.

3. You have no desire to sell your business or pursue an IPO in the next 10,20,30 years.

The best VCs are patient investors and are willing to work with an entrepreneur over a number of years to create significant value.  Despite this fact VCs need to return capital to their investors to stay in business and raise new funds.  LPs in venture funds look for returns over a 4-8 year period and VCs work hard to make sure this happens.  If you want to own/run your business for your entire career or hand off your business to your son/daughter (and an IPO isn't a possibility) then venture capital is not for you.

4. Your company is geographically undesirable. 

This has become less true over the years but the reality is most early stage VCs are based in only a few areas: Silicon Valley, metro Boston, metro NY, Seattle and N. Virginia/DC.  Other areas of the country have some venture presence but rarely more than 3-5 VC funds.  That's a small pool of VCs if you're not in a major market.  There are newer groups like Village Ventures that are doing a great job trying to change this fact but we're still a long way from the VC industry being highly distributed throughout the U.S. 

This is important since most VC funds insist on investing in seed/early stage deals that are local.  VCs like to be close to their companies to provide the most value to the entrepreneur.  It's also much easier to monitor an investment if it's local.  Many Silicon Valley VCs have strict rules about investing only in companies that are a car ride away.

So before you decide to pursue venture capital think hard about these points.  If you feel any hesitation it's likely you should pursue other methods of financing. 

 

 

Fashionably Late

I've been asked by numerous people over the last few years why I don't blog.  I've usually given the following reasons:

1. I don't have the time.

Each day I wake up thinking about what I need to do to help my portfolio companies come closer to reaching their ambitious goals.  When I'm not focused on the portfolio I'm meeting with scores of entrepreneurs looking for my next potential investment.  When I'm spending time with entrepreneurs I'm doing primary research on sectors that could produce significant returns over the next 5-10 years.  When I'm not conducting research I'm spending time with new contacts (other VCs, corporate execs, service providers, thought leaders, etc).  When I'm not meeting new people I'm updating my LPs on the progress of our fund.  When I'm not updating my LPs I'm thinking or working on building out our firm and plotting out the firm's future direction.  And when I'm not doing any of those things I try to find some time to spend with my wife, friends, family and dog.  Oh yeah - sometimes I do sleep although if you asked any of the CEOs of my portfolio companies they don't believe I actually ever sleep!

2. Why would I want to be tempted to reveal secret details about our strategy or my portfolio companies strategies?

Most of the greatest investors in the world don't blog, they don't share their deep thoughts or let others into their psyches for fear of losing their edge.  Warren Buffett doesn't blog and either do the most legendary VCs.

3. VCs should be LESS visible in general.

Entrepreneurs are the rock stars and should be the face of innovation.  Everyone knows Brad Pitt but can you tell me who has produced his biggest movies?  Everyone knows The Rolling Stones but can you tell me who has produced most of their albums?  Ideally the entrepreneur and her company should be more famous than the VC backing them.  Our industry worked that way for a long time and I often wish we could go back to that time.  I'm not saying VCs shouldn't work their asses off trying to promote their companies publicly but the focus should be on the company and entrepreneur.  VCs shouldn't be trying to prove how smart they are to the public or shouting from the mountain tops about their fabulous returns.  Arthur Rock never needed to feed his ego this way.  Ed Glassmeyer at Oak (a role model for me and one of the best VCs on the planet) keeps his head down and makes good investment after good investment.

So why start now when there's already 8 trillion VC bloggers?  Simple - it's the only way I can think of to most efficiently raise entrepreneur awareness of our firm here in the NY venture market as well as nationally.  My hope is through this blog I will attract the following:

- great entrepreneurs that are looking for a venture firm that will never rest in its effort to create value while putting the success of the entrepreneur's company first, second and third. 

- great entrepreneurs that value substance over flash, hard work over superficial value-add and intellectual honesty over sound bites and false support