After 17 years in M&A, Derivatives and Trading, I'm spending my time with young entrepreneurs in and around financial technology and digital media.... Read more »

June 28, 2010

From Angel Investor to Venture Investor: A Process

For several years I invested exclusively for my own account. Now I manage a fund. This has given rise to a necessary change in strategy and approach to investing. I didn't really appreciate the magnitude of the differences until I was in the middle of the transition. The net result is an investment approach and money management strategy of seed stage investing that I like a lot. Is it "right?" I don't think there is a right answer, but it feels right to me and my partners. Will it evolve? Certainly yes, and it will change based upon dollars under management. Another important cultural and operational issue is moving into a position of fiduciary responsibility. Now I've run fiduciary investment vehicles before, most notably as CEO of the Registered Investment Adviser DB Advisors, so I am familiar with the nature and magnitude of the responsibility. But it is a change of which newbie fund managers should take note. While every angel starting a fund has to wrestle with these transitional issues themselves, hopefully by sharing a bit of my story it will both create a dialogue around optimal investment approach and be useful for those starting their own funds.

My life as an angel - smooth sailing

Prior to starting a fund, I had been an active angel investor and entrepreneur for over five years. I had seeded or incubated 40 businesses, established my presence as an active blogger, Tweeter and online denizen, and deployed a significant amount of personal capital in building a new career and life. I focused my investing in verticals I understood, where I perceived there to be plentiful and attractive investment opportunities, and where I felt my domain knowledge and suite of relationships would be most helpful in building businesses: digital media, advertising technology and financial technology. Notwithstanding my angel status, I felt as if I invested and was perceived as a sort of "mini-institution," bringing capital, energy, engagement, relationships and know-how more akin to what I perceived a real venture capitalist to be. I prosecuted my strategy with initial check sizes ranged from $25k to $100k, with a median of $100k. I would generally take advantage of my pro rata rights where possible, and had cumulative investments of up to $250k in the companies with which I was most actively involved.

From angel to institution - doh!

However, it wasn't until I raised a venture fund that I realized I was woefully inexperienced in areas with which I was intimately familiar during my years as a derivatives and trading professional - asset allocation, optimal bet size and bet types. As an individual I was focused principally on one thing - doing great deals in my areas of focus whenever they presented themselves - and it worked pretty well. Sure, I was conscious of investing in verticals I understood well and in which I perceived I had a competitive advantage. And I always invested with an eye towards creating ecosystems around my investment themes, enabling my companies to work together and to extract the network benefits inherent in such an approach. However, I never really thought about how many big vs. medium vs. small initial investments I should be making. I didn't actively consider that if I was going to follow on, how much should I invest and how should I think about my long-term percentage ownership objectives. I also didn't apply strict discipline in how I allocated my time across my investments. These shortcomings became apparent very rapidly after becoming an institution as my team was deluged with incredibly attractive investment opportunities, yet constrained by fund size and our lack of a detailed approach to capital and resource allocation. We intuitively knew the issues we needed to address, but at the beginning lacked the experience and data to develop a granular philosophy and approach to money management. Thankfully, this has changed.

The IA Ventures Approach to Investing

The first order of business was to take our core "Big Data" mission and to convert this into investment criteria. We spent a lot of time articulating the Big Data value stack as we see it on our website, and this was a healthy process for codifying our investment approach. At the end of the day we decided on three basic investment criteria:

Investment Criteria

  1. Mission: We will invest in and incubate early-stage companies building tools and technologies to manage or extract value from Big Data. Companies focused on "extraction" are generally shorter-term plays. Firms focused on "management" tend to be longer-term plays. We will not stray from our mission.
  2. People: We have to love the entrepreneur(s) to do the deal. Period.
  3. Space: One of the IA Ventures' partners has to be deeply passionate and excited about the space to do the deal.

Given these criteria, the question then becomes which kinds of bets to make and how many of them can be made given the firm's capital base and the ability and desire to follow on. After considering our investment philosophy (heavy alpha generation leveraging our specialized skill sets, experiences and industry contacts across a more concentrated portfolio), we bucketed our bet types and are constructing our portfolio in the following manner:

Portfolio Construction

Concentrated bets: (~75% of capital; initial check up to $1mm; 2x reserve; 8-10 companies). This is the core of our portfolio. We will lead or co-lead the round, take a board seat and invest a significant amount of time per month helping with business development, recruiting, etc. These are investments where we believe our domain expertise, technology know-how and business development relationships make our money better than other investors' money. Even so, we always take a syndicate-based approach to investing, working with top firms and individuals to create the strongest and most strategic investment group possible. We expect a single concentrated bet to return a significant share of the fund's committed capital. Examples of concentrated bets in the current IA Ventures portfolio are MetaMarkets and The Trade Desk.

Opportunistic bets: (~20% of capital; initial check between $100-$250k; 1x reserve; 10-15 companies). These are companies that fit with the mission of the fund and where we love the entrepreneurs, but where we either don't have sufficient investment capacity or don't want the depth of involvement required by a concentrated bet. We don't take board seats and take a "lightweight" approach to helping out, e.g., leveraging our networks for business development opportunities, recruiting, etc., but not on the heavy lifting required of board-level engagement. We might want to get close to the entrepreneur because this will be the first of many companies they found. We could be particularly interested in the company's technology or area of focus, and view investment as strategic to the fund. And we always look for a bet to generate an attractive ROI and diversify our overall risk. Regardless, we see so many attractive deals that fit within the fund's mission that we want the flexibility to do a larger number of smaller investments when particularly attractive opportunities present themselves. Examples of opportunistic bets include CrowdSpot and FluidInfo.

Incubation bets: (~5% of capital; milestone-based financing of up to $500k; 3 companies). Occasionally we run into outstanding talent with ideas that need nurturing, but also need help with building out the operational infrastructure associated with the idea, helping to identify key early employees and require only a modest amount of capital to achieve critical technical and product milestones. These are companies where IA Ventures is able to own a significant share of the company in exchange for a ton of work and some capital. It is expected that a single successful incubation bet could return a multiple of the firm's total committed capital. An example of an incubation bet is TraceVector. From an investment perspective, the hope is that these ventures migrate from incubations to concentrated bets over time.

Larger incubation bets require the companies to be domiciled in New York City; the high-touch nature of these relationships cannot be supported remotely. If I run a larger fund after this one, I could see having some in-house incubation space in order to both support our companies and to extract the network effects of being around other smart, early-stage business builders. We are also exploring doing smaller project-oriented "explorations," where a super smart entrepreneur working at a company has a relevant Big Data idea and wants to leave to pursue it single-mindedly. These deals would be in the $50-$75k range for a small piece of the company, enough for the entrepreneur to quit and to work full-time on their idea for 6-9 months. These are opportunities driven largely by personal relationship, where someone within our network is ready to make the move and we are "jonny-on-the-spot" to provide the early risk capital and support to the venture. Kind of like a seminar-of-one version of YCombinator/TechStars/SeedStart. Call it the IA Ventures Way.

In short, IA Ventures is seeking to most efficiently deploy its capital for the benefit of its LPs. This means not only investing in deals but building a real business, one which is well-known and respected for the value it drives to entrepreneurs and their businesses. It is this awareness and respect which creates the virtuous cycle of seeing great deals, having the opportunity to work with great business builders, helping them exit profitably and further reinforcing the reputation of being smart, supportive investors and partners. It also means playing an important role in the seed stage venture ecosystem, bringing together thought leaders and practitioners to help solve big, important problems of today. While IA Ventures is a small firm we take our roles and responsibilities very seriously, and strive to have an impact on business development, job creation and wealth building that far outstrips our modest capital base. This is how we roll.

Addendum 6/29/2010 - What I gave up by becoming a fund manager

During a breakfast meeting with my friend and High Peaks Capital VC Brad Svrluga it became clear that I had neglected to discuss a key aspect of my transition: what I've lost by becoming a very focused, thematic venture investor. Prior to the fund, I could invest in any deal that made sense to me. While I imposed a measure of vertical discipline on my angel investing activities, I had a far broader mandate than I do now as a fund manager focused on Big Data tools and technologies. I have extensive personal investments in social media, many of which would have been a "no go" for my fund but which fit my angel investment approach. Have I seen many of these deals go by that are getting done by friends and colleagues with broader investment mandates? Absolutely. And it is a bummer not being able to do them. However, I have unwavering passion and conviction for my fund's area of focus, and feel that notwithstanding the give-up of flexibility it was a trade well worth making. But it is a trade that needs to be entered into eyes wide open. Being an angel and being a venture investor are not the same thing, with the only difference being a leveraged position in deals you would have done anyway. There must necessarily be a higher bar, both in terms of deal-specific thought process and due diligence and overall portfolio construction. Managing other people's money is a big responsibility. It's not just all about fees and carry.

June 07, 2010

Constructive Dialogue: Just Business, Not Personal

I have been an online denizen for some time, and have engaged in countless online debates both on this blog and elsewhere. At time those debates get pretty heated, as reasonable but opinionated people can disagree but do so with passion and intensity. Sometimes language can become snarky and sarcastic, as emotion and reason mix in an interesting and often entertaining brew. But when these dialogues devolve into personal attacks, where assumptions are made about people's motives and character, the value of the entire discussion thread drops precipitously. And this is a shame, because often a lot of excellent thought is missed in the wake of judgment and hostility. And the online age has sharply increased the incidence of this kind of messaging, as the depersonalized nature of sending a comment into the ether has made it perilously easy to communicate things you'd never bring yourself to say to someone's face. Yet this should be the check for whether something should be written as well.

While the catalyst for my message are the blog entries and tweets of Chris Dixon and Jim Robinson, this is an issue I've been thinking about for a long time. It's just that Chris and Jim's interaction, given the fact that I know them both and many of the others who have taken a stance in the carried interest taxation debate (e.g., @fredwilson, @bussgang, @pkedrosky), has made it much more real and personal. Chris and Jim are two exceptionally smart guys with strongly-held views. As it relates to the carried interest debate, they happen to be on opposite sides of the issue. Big deal; the often-snarky Mr. Kedrosky has more than a few times roasted me on issues where he and I disagree. And I have tossed it right back at him. But those exchanges are focused on the issues, not on either of our characters, motivations or integrity. Based upon Chris's tweets in response to Jim's strong but reasoned blog post, it is clear that he doesn't know the Jim Robinson I know. No matter, the criterion for engaging in spirited but respectful debate should not be whether or not someone knows the commenter.

It should be that basic respect is afforded anyone who enters the debate in a respectful manner. Jim's language is strong but not personal. It addresses Chris's views and others who have staked out a similar position. But Chris's response to Jim's post was highly personal, not to mention uninformed. In my opinion it crossed the line and, in fact, much of the thread of "good versus evil" that has been taken up in this debate is neither intelligent nor helpful towards getting to a better perspective on the issues. Believe me, I understand the technique of "shock value" and taking a bold, hard-line stance. But to paint everyone who happens not to specifically agree with you as somehow morally bankrupt is absurd.

In other words, I am not arguing for a world where debates become some form of sanitized drivel. I am arguing for an approach where people can use colorful language to express their views with passion and intensity but with respect and in a de-personalized manner. I think people entering the fray need to take a deep breath, pause and consider their words before launching them onto Twitter, blogs or other forms of social media. Would you say these words to the person's face? Would you want to be dealt with in this manner? If the answer is yes, then let it rip. If not, then resist the urge and re-cast the message. There are so many smart people with so much good stuff to say. It is shameful when so much good content is lost to poor form.

May 10, 2010

Seeding a Start-up Culture

About a week ago, James Kwak penned a very thoughtful post titled Why Do Harvard Kids Head to Wall Street? He provided a series of perfectly rational reasons as to why this happens, e.g., the job is billed as a good launch-pad for the future, recruiters make it easy, the money, etc. Whether he has all the right reasons is neither here nor there: he is asking the wrong question. The right question is: how do you lure the best and brightest into game-changing areas such as start-ups and social enterprises that can effect hundreds of millions of people or more?

One of the issues with making it easy to get into start-ups and similar enterprises is that persistence, focus and energy are often good screens for success in these fields. If you make things too easy it can lead to adverse selection. However, there are many things that can be done to change the calculus, some of which are already being done in Silicon Valley and Boston but less so in New York City. I know several venture capitalists in the Bay area who teach at Stanford and Berkeley, in the Business school as well as the Computer Science (CS) and Electrical Engineering (EE) departments. They use their positions as vehicles for identifying top students, building relationships that ultimately result in ideas getting funded or students placed in promising start-ups. The students are steeped in not only start-up lore, but myriad perspectives on the challenges and opportunities of start-ups as told by experienced Founder/CEOs. I can assure you that these discussions are a lot more interesting, colorful and compelling than presentations on the worlds of Wall Street or consultancy. My friends Larry Lenihan at FirstMark and Ed Zimmerman of Lowenstein Sandler both do this. They are not enough. And we need more technical lecturers as well.

The venture capital and start-up industries need to do a much better job selling, serving to funnel desirable candidates on the basis of excitement, impact and long-term rewards as opposed to (perceived) stability, basic training and short-term cash. Yes, it would be great if NYC's great universities did a better job of this at an institutional level, but I'm not suggesting we wait around for sclerotic bureaucracies to change. I'm talking about a grass-roots effort on the part of local venture investors and successful start-up executives to get into the classrooms and onto campus to re-orient talented students away from the money culture and towards the building culture. Alter their utility functions through education and exposure and get them early.

I think many equate start-up enterprises with uncertainty and fear, and only appropriate for those with massive risk tolerances. This is bad marketing, plain and simple. Yes, doing a pre-revenue start-up is gut-wrenching, all encompassing and horrifying at times, but it is also mind-bogglingly stimulating, exciting and requiring all of a young person's skills and abilities. There is not a job on Wall Street or at a top consulting firm that gives a young technologist or business person the exposure and responsibility of a start-up, even one that has received venture investment. There are early-stage companies all along the risk continuum, any of which can offer up great experiences for the right people. And every student that goes into these companies or or starts their own is part of creating something, and contributing to the engine of growth that can help the US and other Western nations fight against the weight of their aging populations and economic malaise. And the skills obtained while working at a start-up are applicable to a wide range of future opportunities, whether at another start-up, one's own start-up or more established enterprises.

And once the ball gets rolling it becomes a virtuous cycle, with this enlarged crop of entrepreneurs and start-up athletes having an increasing number of successes, and subsequently investing in others start-ups and their own new businesses. This is part of what has made the SF/Silicon Valley community so vibrant, the recycling of capital from successful entrepreneurs into the businesses of others as well as their own. And so it goes...

But it is hard to escape the fact that education and re-orientation has to start in the universities. Because by the time these talented students get seduced by the fancy conference rooms and the cash, it is difficult to bring them back. And each year a talented student gives to old-line money businesses is a year taken away from building something truly great and seeding the start-up culture. Is changing culture easy? No. Can it be done with the work of all interested constituencies - universities, Governments, venture firms and start-up businesses? Absolutely. Let's get to it.

May 04, 2010

Bond Analytics: Taking an Open Souce Approach

Much has been written about what's wrong with the rating agencies: structural conflicts-of-interest; intellectually over-matched; lacking in creativity and orthogonal thinking. Some believe the rating agency industry as we know it is on death row. To be honest, I tend to agree. Attempts at resuscitation are unlikely to yield the material changes required. The biggest problem: lack of transparency and insight into the multi-trillion dollar debt market. Much as the OTC derivatives market needs an overhaul, the opaque corners of the debt market need to move out of the shadows as well.

One of the unique aspects of the debt market is its mind-numbing diversity and dimensionality: maturity, amortization, optionality, collateral, seniority, etc. A "one size fits all" approach simply does not work for the bond market, and it is questionable as to whether a single entity has the intellectual horsepower and access to the resources necessary to effectively and efficiently analyze its range of securities. Large, seemingly intractable software problems have benefited from the massive collaboration available through the open source movement. This has been an effective method for not only addressing a core problem, but for keeping up-to-date and relevant as technology evolves. It has also been a vehicle for value-added service providers to build on top of these solutions (e.g. Red Hat/Linux, Lucid Imagination/Lucene, etc.) for specific use cases, providing needed service levels and documentation, etc. While not a panacea, the open source movement has effectively harnessed the world's intellectual capital and applied it to big problems relevant to a broad array of constituencies.

If an open source approach has worked so well in software, why not apply it to the ratings problem? Whether or not ratings should be required for institutional investors to buy certain securities is not the issue; the essential point is getting better transparency into and analysis of instruments constituting the investable universe. Imagine a university or a large institutional investor seeding the open source initiative by putting their own debt ratings models into the public domain and allowing others to contribute to its development. I can see a suite of open source libraries by type of instrument, with a new industry emerging to deliver additional analytics, data and recommendations on top of these libraries. There would need to be a Wikipedia-type board of curators, ensuring that additions to the libraries are sensible and increase the stock of intellectual capital. But I can't see why such an approach wouldn't address the biggest problems facing the ratings industry today.

Combining bond analysis and the open source movement could deliver:

  • Transparency;
  • Unbiased input;
  • Access to a global talent pool;
  • Opportunities for specialized applications to be delivered in tandem; and
  • Institutional-grade analytics and research available to all.
I haven't seen or heard of a better solution to the problem, and the problem certainly isn't going away. If we as a financial community are committed to such an approach, it is bound to be successful. Let's give it a shot.

April 28, 2010

Regulation vs. Retribution

The United States Congress, at the urging of our President, is in the midst of passing a "comprehensive" package of financial reforms in response to the recent financial crisis. Both the Executive Branch and Congressional Majority leaders have specifically stated that these tough regulations should be enacted, bipartisanship be damned. Democratic leaders sense a window of opportunity to play upon public anger and fear in order to roll back the clock on Wall Street and the financial innovations of the past 30 years. The problem is, however, that lost in the discussion is an honest accounting of who and what precipitated the financial crisis, the underlying motivations for the proposed regulations and a reasoned analysis of the structure of Wall Street by people who actually know what they are talking about. And because of this opacity and dishonesty, the desire to leverage populist rhetoric into votes and a fundamental lack of understanding of how Wall Street and capital formation works, we will likely get a package of regulations that will hurt the US and the global economy fall more than they will help. And this would be a shame, because it will reflect the loss of a golden opportunity to do something truly positive.

The financial crisis was merely the tail-end of a daisy-chain of events seeded by two policy disasters: (1) the Greenspan-led credit bubble; and (2) Congressional approval of a multi-trillion dollar expansion of Fannie Mae and Freddie Mac's balance sheets (GSEs) and the resulting diminution of underwriting standards. This was neither caused by CDOs and other derivative securities nor the existence of Wall Street proprietary trading desks. As all manner of entities lined up to take advantage of the Federal Reserve's and Congress's largess - mortgage brokers, borrowers, banks, structured finance operations, derivatives desks and rating agencies - fraud, deceit and poor risk management emerged in its wake. A breakdown of conduct on this scale and associated conflicts-of-interest were enabled by poor rules and regulations as promulgated by the Financial Accounting Standard Board (FASB), the SEC and Congress. I would posit that this was due to a lack of understanding of the forces at work coupled with the influence of lobbyists, greed and self-interest. Nobody looks good coming out of the crisis and hundreds of billions of dollars were lost, so in our media and PR-driven society somebody has to pay - now. But the last thing Congress and the President should be doing is agitating for change without truly understanding its impacts, and focusing on payback instead of fundamentally reforming elements of the system that are truly broken. I am deeply concerned that this is exactly what they are doing.

Given the severe flaws in macroeconomic policy underpinning the crisis, the outcome was not surprising. But as we look at th subsequent chain of events what might have dampened the magnitude of the crisis? I see four core principles that, if they had been in place prior to the crisis, could have materially altered the outcome: (1) financial markets transparency; (2) enhanced accounting disclosures; (3) clear and punitive rules against conflicts-of-interest and (4) elimination of the US Government as a perceived back-stop for creditors.

Transparency should be the cornerstone of any discussion around legislation. Proposals agitating for banks to shut down or spin-off their swap operations are nonsensical and destructive. When used properly and with adequate collateral to handle changes in mark-to-market value, they are powerful tools for risk management and speculation to support efficient, two-sided markets. Moving the lion's share of over-the-counter derivatives volume to exchanges will substantially enhance the transparency around market pricing, how derivatives desks make money and reduce risk of inadequate capital provision. Accounting disclosures have recently been tightened to better address off-balance sheet exposures, but still fall woefully short in areas such as fair value accounting. Conflicts-of-interest are still embedded in many aspects of our system; it is incomprehensible that rating agencies still retain their position considering their pivotal role in the credit markets crisis. Not smart enough to understand the possible impacts of highly structured instruments? Then they shouldn't slap on a rating. The excuses provided for their miserable performance are divorced from reality: they were greedy, and they did what they had to in order to maximize short-term profits. Case closed. Open-sourcing credit ratings is likely the right avenue for dealing with this particular conflict, but many other conflicts remain. And until the US Government is no longer perceived as 100% certain to bail out the creditors of complex financial institutions, we will see a repeat of 2008 again and again. Could the answer be a tax based upon the complexity, scale and risk of a bank's operations, rather than an open checkbook provided by the US taxpayer? Perhaps, provided that such rules were applied globally and in conjunction with regulators of the other major financial centers. This would also help address the "Too Big To Fail" issue, as super-sized institutions would pay out-sized taxes because of the risk they pose to the global financial system.  But one thing is certain: without elimination of the implicit US Government guarantee, private and public/private (GSEs) institutions will revisit the sins of the past decade without adopting fundamental change.

I penned a little-read post back in November 2007 where I touched on certain of these issues; my fundamental views have not changed much over the past two and a half years. It is almost as if the aftermath of the crisis has turned into a soap opera; painfully slow-moving and not particularly entertaining. And the way things are looking, the outcome might be of similar quality to what is being served on daytime TV.

April 20, 2010

For the Good of the NYC Venture Scene I'd like to see...

...some chunky IPOs of NYC born-and-bred companies - Everyday Health, Gilt Group, TheLadders and others in or approaching the $100 million revenue club. NYC has spawned some great companies; it is time for the world to see them on stage and get to participate in their future growth.

...Foursquare to sell out (to Yahoo, Google, I don't care) for $100 million-plus. What a huge success story to put in the bank for the NYC venture ecosystem when exits of this magnitude are few and far between.

...some successful NYC-based serial entrepreneurs with $5 million of spare change to get super active in the angel investor ecosystem. Smart angels finance smart ideas, create jobs and lay the foundation for subsequent funding rounds. Silicon Valley/SF has probably 20x the number of "scale" super-angels as NYC. More of these people will help turbocharge the creation of a vibrant, self-sustaining NYC venture community.

...the NYC area schools to get serious about entrepreneurship. Foster a culture of entrepreneurship within the Engineering and Computer Science programs. Get professors out into the real world, not of research but of commerce and creativity. Turn professors into feeders of great talent into NYC-based start-ups. Look at Stanford. They do it right. A little benchmarking and emulation wouldn't hurt.

...more early-stage funds started in NYC. You can count the number of early-stage firms in this town practically on two hands. Not enough capital, not enough mentoring, not enough cross-fertilization. The early-stage ecosystem is developing with firms working together more and more, but we are in the first inning of a nine inning game. Greater collaboration. Greater communication. More capital required. policy support, not restrict, investment in early-stage businesses. Also, policies and programs need to be better communicated in order that start-ups can avail themselves of the benefits. Navigating NYC is neither easy nor cheap, and it is an impediment to starting a company here. Given its natural resources, e.g., home to seven of the largest industries on the planet, NYC should be a magnet for start-ups. Smart policy changes can help.

...a more vibrant hacker culture, where a few people, an Amazon account and some pizza and beer money can get a prototype built in a matter of weeks. It still feels like this town has a fear of failure. We need to embrace failing the right way as a badge of honor and praise pivoting into something more relevant and powerful as a natural part of the entrepreneur's evolution.

...general adoption of clean, non-participating preferred term sheets with commercially reasonable protective provisions. The West Coast has had this right for quite some time, and NYC is getting there. But we need to fully get there in order to attract the smartest entrepreneurs and the best deals.

...less chest bumping and rhetoric and more results. There is a lot to be proud of, but until we see a spate of successful scale exits lingering doubts will remain. Put up or shut up. NYC will indeed put up; of that I am highly confident. But in the meantime, let's just do good work, stay humble and kick ass.

April 16, 2010

U.S. Congress: Mandatory Training Required

This has been a week full of cloudy events: Icelandic ash, the Greek bail-out and the Goldman CDO lawsuit, to name a few. Notwithstanding the "transparency imperative" in the wake of the financial markets meltdown, we are still mired in opacity. Gillian Tett of the FT shared similar sentiments in today's column. Readers of this blog are well aware of my views on transparency in every aspect of the financial markets: financial reporting, risk management and trading. Yet transparency remains a stubborn and seemingly unattainable goal, even with the knowledge that the social and financial costs of opacity are stunningly high.

Why the trouble? Easy - lobbying, money and ignorance. While transparency is couched as super-sophisticated Wall Street issue, it is fundamentally a Main Street issue. Opacity is what leads to "unexpected" crisis, the price tag of which is invariably picked up by Main Street. Fundamental reform stuck in Congress? Tell your Congresspeople to get on the stick and to represent their constituencies - not their lobbyists. Moving the lion's share of OTC derivatives to exchanges is both an academic and pragmatic no-brainer, yet this shift is consistently stonewalled by those with huge checkbooks and contacts in Congress. I have written about fair-value accounting and how it should be used in all situations where there is neither the intent nor the ability to hold an asset to term. Not surprisingly, there has been huge push-back on this issue from the same people who want continued opacity in the OTC derivatives markets. And more complete accounting disclosures with "plain english" footnotes would also be a thrilling development, yet many corporations are none too keen to have to display all their laundry, dirty and otherwise. Common sense has not prevailed, largely because of our system of lobbying, privilege and fear of reduced campaign contributions if a powerful business interest is angered.

The costs of friction in everything from complying with our arcane tax code to complex documentation for non-standard financial transactions to extra time spent analyzing byzantine financial statements has to exceed $100 billion - per year. And this says nothing about the reduced investment due to fears over the high costs of growing businesses. Consider the recent proposal to cause venture funds with over $30 million in AUM to have to register with the SEC because of fears over systemic risk. This is nothing more than a publicity stunt by an ill-informed Congressman, but it is simply a microcosm of the bias towards posturing and grandstanding instead of substantive, common sense reform. We are in the midst of a jobless recovery, yet a Congressman is wasting time and money talking about idiotic regulation of the venture capital industry whose very lifeblood is creating the high-value jobs we need to resume a healthy growth trajectory. Why isn't he talking about tax reform, financial transparency, or something else that really matters? Because those issues don't make for good headlines and he probably lacks the knowledge to propose something intelligent.

Perhaps the issue is that our Congresspeople are simply ill-equipped for the job. Based upon their decision-making, it is fairly clear to me that many lack even basic knowledge of economics and finance, yet have a hand in making legislation that requires real understanding of the issues. My guess is that the lobbyists and special interests, who have a very keen understanding of the issues and what's at stake, have a large hand in how legislation is worded. This does those of us who pay our Congresspeople and put them in office a great disservice, and it is hard to see how this will change unless people get really angry. At a minimum, incoming Congresspeople need to go to school, a finance and economics "boot camp" for starters. Classes on micro and macroeconomics. International trade. Financial markets. Corporate finance. Basic yet important stuff. Should a Congressperson really be able to cede their vote to someone more knowledgeable (e.g., that lobbyist or special interest making a campaign contribution) than they are? Clearly not.

So much of what needs to be done is just so simple. None of this is rocket science, but it does require a basic level of understanding (and a good heart, common sense and a conscience). Naysayers will mutter "What you are saying is stupid - your suggestions are unrealistic." My response: Why?

April 13, 2010

Twitter: Optimizing Long-term Value

After Fred Wilson's Twitter "inflection point" post and the subsequent freak-out by much of the Twitter app community, I started to think about fundamental long-term strategy and whether or not Twitter's approach was rational. Then I remembered that in October 2008 I penned a post titled "Twitter: Monetize the Apps, not the Platform," and had provided some early thoughts on this very point. Here is an extract from the post:

I love Twitter because of its immediacy, the "one to many" concept and the fact that culturally, so many of those on Twitter monitor and manage their messages with a vigilance far exceeding that of email. This is its power at the most basic level. But when you think of creating communities around Twitter, be they related to companies, brands, entertainers, common interests, politics, etc., it is easy to see the massive power that can be harnessed pretty quickly.

So what do you need? Groups. Perhaps human-curated groups. With hierarchies and sub-hierarchies to help people best search and discover pockets of people they want to follow. Much as AOL, iVillage and the other major portals did to help organize and target their massive horizontal audiences. This easily helps new users get engaged and get busy, as they can simply wade in and find relevant groups with a few clicks. Further, groups are great targets for future advertising and lead generation, as they've self-selected into particular areas of interest.

You also need vertical applications. Investing. Shopping - cars, music, etc. Travel. And on and on. With a sufficiently robust API, the developer community can innovate in much the same way as they have for the iPhone. Create a Twitter App Store? Maybe. But the main goal should be providing the environment for developers to come up with great stuff that will be used, that ultimately people will be willing to pay for.

So Twitter itself didn't create an app store; another company has done so (oneforty, one of my portfolio companies). I also backed the "group" thesis as evidenced by my investments in Stocktwits and TLists. Tweetdeck has evolved into a social dashboard that allows streams to be separated by both origin and in customized groups. Twitter has worked hard over the past few years to enhance the stability of its infrastructure and to provide increasingly open access to its data. But Twitter's recent acquisition of Tweetie and the launch of its ad platform puts it squarely in the middle: it is neither pure utility nor suite of applications. It's not Linux and it's not Red Hat; it's kinda both. It is this straddling of two worlds that is causing the tension and confusion among the developer community. They want Twitter as utility. Twitter Management has finally taken a stand and said "Being a utility isn't enough. We are laser focused on the user experience, and therefore will control key elements of the value stack that we perceive most impact that experience." Clumsy insertion of ads in the tweet stream? No way. Ceding of the mobile user experience to others? Nope. All of a sudden it is as if Twitter has finally come around to a strategy for controlling and extracting value from its vast assets - its users and those who wish to reach them.

If Twitter were to have continued its role as utility, it is hard to see how it could have generated an acceptable return for its investors (and sustained itself over the long run). If, conversely, it decided to go head-to-head with the developer community on all fronts, it would have made a lot of money in the short run but stifled innovation that would have damaged its long-run prospects for value maximization. However, it has chosen likely the most difficult but most rewarding path, that of providing the functionality of a utility while also owning pieces of the application value stack. This has created a delicate balancing act with the developer community that will take time to play out, and will require far better communication with the community than it has had to date. But when the dust settles Twitter will control the most valuable engine of monetization - mobile advertising - while enabling others to earn significant profits from their own applications. This potential for profits will continue to draw in elements of the developer community most consistent with the white space Twitter has left open, driving innovation that will further attract new users and potential ad dollars for the mother ship. Near term pain and discomfort for long-term gain.

The key is understanding Twitter's strategy and intentions, and it is incumbent upon them to be clear - and fast - to help better shape third-party initiatives. This will result in a win-win for users and developers alike. Will some current apps be left out in the cold? Of course. But there will be plenty of residual opportunity to design new and useful stuff - just probably not another Twitter interface. And Twitter shareholders may well find themselves near the optimal point on the NPV curve.

Brands: Authenticity and Pattern Recognition

There are two catalysts for this post: Chris Dixon's recent tweet that said

"Does anyone really want to have a "conversation with brands"? I I want my relationship to Starbucks limited to buying coffee."

And Doc Searls post which proclaimed that

"Brands are Bull."

Two bright guys whose views I respect, but I must heartily disagree with both of them.

When it comes to conversations, and specifically those conversations that are deemed valuable, I believe the overriding issue is authenticity. People tend to be pretty good at discerning who is real and who is merely a self-promoter, and power and influence tends to flow to those who are authentic. Do people want to converse with brands? I think that is the wrong question. The right question is "Do people want to converse with people who are authentic in their support of brands?" Starbucks the brand can't talk to you, but a passionate Starbucks employee can. These individuals could be employees of the brand, external representatives of the brand, or merely fans. But if the people having these conversations are authentic, my sense is that yes, people want (and do in large numbers) have these kinds of conversations every day. Twitter, Facebook and other forms of social media are very personal, and when they are de-personalized (by brands acting big, stupid and impersonal) interactions are bound to be unsuccessful. I am an investor and Board member of a company called Buddy Media, that has developed and manages a powerful Facebook Pages platform (like the Bud Light fan page) that is used by major brands to connect with their fans and potential customers. People flock to these pages to chat with and learn from engaged communities organized around brands, take advantage of special offers on these pages and enter contests to win products being promoted by the brand. This could only be successful if people found value in the brand as an organizing principle, with Facebook and Buddy Media as facilitators of this interaction. And let me assure you, it is successful.

Doc Searls, in his post about the uselessness of brands today, discusses how the mere presence of Tiger Woods in an ad means nothing relative to what a company does.

Nike, the brand, famously supports its sponsored athletes because the company is about athletes and athletics. Which is all fine. What matters is what the athletes do on the field, on the court, on the golf course. Sure. But what matters more is what these companies actually do.

Here in Reality, companies buy Accenture’s services. Individuals buy Nike’s shoes. None of what customers buy from either company gets an ounce of substantive worth from Tiger Woods, or from anything those companies do with their “branding” strategies, no matter how much those strategies serve to help sales and stock prices.

We live in an age when we can kick tires hard. Accenture’s and Nike’s tires are not Tiger Woods. And Tiger Woods, even if he’s long been a lying sack of shit, isn’t a tire either. He’s a human being, and that’s what makes him interesting. Not what his golf game says about companies that pay him.

What Doc Searls is saying reflects the view of an empiricist: tell me the features, give me the stats, and let me make a decision. This is not how many - if not most - items are purchased. Consumers, be they retail or business, are impacted by the perception of a brand. What people say about it and what they've heard about it are both relevant to the purchase decision. Do I perceive it to be high quality (separate from the cold, impersonal product specs)? Will it make me successful?  How do I project my experience as a result of purchasing the product/service? Issues of authenticity, trust and recognition all play a part in how successful a brand may be. Objective product features and quality clearly play a role, but if I equate Tiger (with whom I have a positive association) and his success with the outcome of using a particular product, then I'm likely more apt to buy the product. It's just common sense and represents the underpinning of the entire advertising industry.

The issue isn't whether brands are bull - they're not. Creation of a successful brand results in pattern recognition that can help consumers more efficiently locate what they want and builds substantial value for the brand owner. The issue is whether it is bull (or just plain stupid) to choose an athlete or, for that matter, any single human being as the basis for selling a multi-billion dollar product line. As Doc correctly points out, humans are interesting - and volatile. Charles Barkley said it best: "I am not a role model." Well, neither is Tiger or most people walking the earth. Building a brand around a successful individual is akin to leveraging up a corporate bond position and continuing to take on more leverage when things are good. However, when things go bad they go very, very bad very, very fast. Brands flee the fallen idol and the consumers (or the public stockholders of brand owners) flee the brands. We've seen this movie before in every market; why should brand management be any different?

Even in a long-tail world with increasingly available information, brands, like relationships, will continue to matter. In fact, they might even become more important as the flood choices becomes overwhelming, brands and offline relationships will become increasingly powerful tools in the product discovery process.

April 06, 2010

The Best Kind of Venture Deal

I have had the good fortune of backing many great entrepreneurs. I have been introduced to these companies in a variety of ways: through venture capitalists, angel investors, and other entrepreneurs. Some of these companies were investable from the time I met them. Others, less so. They were more ideas than companies, but with very talented founders who needed some input, mentoring and time to figure out the plan. While requiring the most time, energy and patience, I learn far more from the projects than the more fully-baked start-ups. And they also happen to be much more fun.

I just happen to be working on one of these deals as we speak. I am working with an entrepreneur with a big brain, lots of domain experience, endless enthusiasm and a persistence that borders on maniacal. In short, I liked him immediately. I met him probably eight months ago. He had lots of really great ideas, was focusing on a space I like a lot and understand pretty well, but was, shall we say, scattered in his approach. Focused on a Big Idea requiring big-time infrastructure and necessitating a first-round raise of $4 million or so. In my typically blunt way, I called bullshit.

I counseled that he was focusing on too many things that were initially on too large a scale. I recommended setting up a series of discrete, achievable milestones that would culminate with sufficient demonstrable traction to warrant a true Series A round. I wasn't raining on his desire to execute the Big Idea, only the manner in which he was proposing to go about it. I connected him with a group of domain experts and professional investors he could pitch in order to continue getting feedback on and refining his idea. My associate Ben worked with him on his financial model, helping him define the milestones to be achieved and sizing a more sensible first-round raise of $2 million. This all happened over the period of a few months in the Fall. It was starting to come together. But it wasn't ready - yet.

Armed with more realistic business and financial models, a bunch of people to talk to and a clearer sense of what constitutes an investable business (at least from my perspective), I said "Go bootstrap for a while, refine your plan, build an early product and get some early users. Then let's talk again."

At this point many things could have happened. He could have ignored my advice and gone on his way and succeeded or failed. He could have taken my advice and flopped. Or could have taken my advice and succeeded, and either come back to me as an investor or sought financing elsewhere. Well, over the ensuing months he stayed in touch, kept me apprised of his progress (e.g., finding a technical co-founder, securing three alpha clients, continuing to learn from discussions with both potential customers and investors), and basically did all the things he and I had talked about. And after five months he came back. And now I am leading his deal and building what will be a truly powerful, value-added investor group which will help make his Big Idea become reality.

This is the greatest part of being a seed-stage investor: having a positive impact on the vision and execution strategy of the entrepreneur. While it is terrific stumbling into those full-formed entrepreneurs with a substantially-baked plan that is fundable from the get-go, finding a truly great person who grows into the role and helping them get there is far more satisfying. It makes it fun getting up and going to work each and every morning.

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