Wednesday, March 28, 2007

Mulecon 2007

Today, Mulesource, the leading open source integration software provider, held its inaugural Mule developer conference. The event proved to be a smashing success.

See my prior post on Mule here.

Over 100 developers flew in from around the world to share their expereinces, use cases and passion for the Mule project. For a company less than a year old, the size, diversity, and evangelical nature of the audience was simply remarkable to observe.

The best companies create ecosystems of customers, partners, and developers who realize their own economic interests and dreams via the given company's platform and technology. For example, both eBay and Microsoft benefited from the energy, investment, and activity of the thousands of companies in their ecosystems. The leverage possible when you are the fulcrum by which third parties leverage their businesses is powerful indeed.

Typically, creating vibrant ecosystems takes years to accomplish and material investments in developer, partner, and customer acquisition and development programs. Mulesource, riding the momentum of an authentically grassroots open source project, hit the ecosystem milestone within 9 months of incorporation.

Today,, H&R Block, Fimat,, etc...presented use cases, reference architectures, lessons learned, competitors considered, and endorsements of Mule. For those interested in Mule, Eugene Ciurana's very detailed Mulesource case study from The Serverside is definitely worth reading.

For the prospects in the audience, hearing first hand why the largest mission critical applications in e-commerce, trade processing, tax form processing, etc chose Mule over competitive open and closed source vendors, many of which already had enterprise license agreements with competitors in place, proved invaluable.

Watching the developers share best practices and their genuine appreciation for Mule's flexibility, ease of use, and value helped me realize that the company is in the enviable position of having a fully functioning ecosystem where the interests of the ecosystem and the company are becoming fundamentally intertwined. Historically, that proved to be a very good thing!

Congratulations to the Mulesource team and to the many third party customers and developers who are driving the project and company forward.

Thursday, March 22, 2007

Shift in the on-line video landscape

While the world focuses on Youtube's battles with mainline media, Move Networks is quietly altering the underlying infrastructure landscape powering on-line video.

The investment community and media are largely focused on the battle between copyright holders and Google, however, an equally important shift in on-line video transport is underway. While the battle for copyright, traffic, and the on-line ad dollar is raging, another battle is underway; that is, how best to stream live and archived television to web audiences.

Today, Youtube, NBC, CBS, etc use Flash Video and Flash Media Servers to deliver their content. Many pundits are also pushing the merits of P2P....

As of yesterday, however, moved away from Flash and is now streaming full episode content via the Move Networks player. Full episodes of Lost, Desperate Housewives, etc are available via Move.

ABC joins Fox, Televisa, the CW, and other major content ownders who see five core reasons to move away from Flash:
  1. quality
    1. Move provides continuous play video with no buffering or jitter
    2. Improved quality ensures 8-10x longer viewing times
  2. increased revenue
    1. longer viewing times naturally create more ad avails and higher revenue
  3. reduced cost
    1. Move rides on HTTP and leverages the economics of commodity HTTP transport rather than proprietary RTP transport
    2. Flash Media Servers are materially more expensive than commodity web servers and web caches
  4. DRM
    1. Flash does not support DRM
  5. scale
    1. Move scales to an order of magnitude larger number of simultaneous streams
    2. Why? Move scales with the web not via deployments of proprietary media servers in CDN fabrics
Move is the only video delivery system that allows customers to deliver both live and on-demand content, supports continuous play, utilizes least-cost CDN pricing and routing, leverages commodity web infrastructure, provides full support for PVR features, and provides per stream, per user reporting and tracking.

The net results of Move’s solution is a 10x increase in average view times versus alternative technologies, a 10x reduction in delivery costs, and a 10x increase in the possible audience size. At $25 CPM rates, content owners enjoy 95% gross margins, or 1.5x more than broadcast economics, and the Web moves from a marketing vehicle for broadcast programming to a profit center in its own right.

With $55bn of TV ad spend at risk, the stakes have never been higher and the race is on to monetize video content on the web.

Disney's move (pun intended) to Move represents a remarkable shift in the on-line video infrastructure landscape. Two of the big four networks are now streaming via Move's protocol, and the era of jerky, unwatchable on-line video is coming to a close.

Check out the site and watch full-screen video - who knew web video could look so good?

See prior posts here
Move Networks
24 is on the Web!

Friday, March 16, 2007

How do you plan for M&A?

Happy St. Patrick's Day. Please find below my guest post on start-up company M&A from Ask the VC.

Question: How do you plan for M&A? Trying to build our company, thus far we went the regular path – market research, sales projection models, expenditure / P&L models, potential products/product lines and the like (text book?), but many people we met told us ("shouted") that we should plan for a strategic partnership/ M&A, how do you do that? Should there be a special business plan?How does a P&L look in that case? How do you plan the selling of your IP to a large company? Selling after you have a finished product? Selling the company after initial sales? Letting the company grow a bit more? Is it good practice / healthy to plan your business on somebody buying you? Will it be acceptable to prospective investors/ VCs?

Plan for Independence. There is a famous VC saying, "companies are bought and not sold." Accordingly, the best "plan" is to plan for success as an independent company.

The company’s operating plan, technology road map, and executive team should not focus on unnatural acts, in the hopes of attracting a buyer, but rather on building a company with the potential for independence. Companies built to "flip" often flop. They often flop due to the fact the team is not truly committed but, instead, looking for a quick buck. Bad motives drive bad behavior.

A fundamental concept that helps focus management on building to independence is optionality, or BATNA – which is MBA-speak for "best alternative to a negotiated agreement." BATNA is a fundamental tool for understanding negotiating leverage and strategy. If you work to ensure you have a BATNA – for example continued independence or a higher offer – the company is able to negotiate from a position of strength. If no BATNA exists (i.e. the choice is between a fire sale or running out of cash), the company is at the mercy of the buyer and the negotiation becomes an exercise in Russian roulette. Always have a BATNA.

Be Prepared for Acquisition: Sourcefire ("FIRE") went public this week. Since the last security company went public – NetScreen – there have been over 250 security M&A transactions.

So what?

While the security software market is an extreme example, it is far more probable that a successful tech company will be bought rather than go public. Accordingly, while no special plan for sale should be developed, it is highly logical to expect M&A to emerge as the path to liquidity.

While VCs believe "companies are bought and not sold," acquirers tend to believe that "successful partners make the best acquisition targets." Successful partnerships are characterized by

  • a history of successful joint customer engagements,
  • successful technical integrations and co-deployments,
  • a joint roadmap,
  • co-marketing and sales traction, and
  • management teams and team members with a track record of collaborating to reach shared objectives.

A great example of the partner-to-buy model is SAP and Virsa, although there are many such examples.

Keep Good Records: Finally, M&A is a diligence driven exercise. The final cliché is that "good record keeping makes for good diligence and good diligence makes for expedited outcomes." Good records include:

  • Articles of Incorporation/company charter
  • all Board minutes, contracts, signed employee assignment of IP forms
  • capitalization table
  • option plan records
  • prior financing documents
  • audited financials
  • patent filings
  • documentation relating to litigation, assessments, or claims

Any material gap in records will either 1) delay the sale process and/or 2) will lead to a higher escrow to offset potential liabilities that may "appear" post-close.

In summary, all clichés are common sense and the M&A related clichés noted in this post are no different:

  • build companies for independence (always have multiple BATNAs),
  • partner well,
  • keep good records

Thursday, March 15, 2007

Hedge Funds and Venture Capital

Brad Feld and Jason Mendelson kindly asked me to serve as a guest blogger on Ask the VC.

Today's question and my response follow. The original post can be found here.

Question: As the alternative asset classes continue to converge, there has been growing evidence of hedge funds looking to be more involved in venture (both passively and actively). As an early stage venture capitalist, what are your thoughts on this? Are you seeing the trend? Have you considered partnering with any hedge funds, and if so do you view hedgies as primarily a source of passive capital or are they demanding/receiving strategic places at the table?

Economic theory can be used to explain the phenomena described above. The theory in question, "economies of scope," states that a reduction in per-unit costs is possible via the production of a wider variety of goods or services. For platform funds, the incremental cost of the nth fund is significantly less than the cost of establishing and managing the first.

Accordingly, alternative asset platform funds – Carlyle, Bain Capital, Pequot Capital, Blackstone - are aggressively pursuing economies of scope in raising funds that leverage their LP relationships, back office systems, strategic relationships, etc Platform funds are aggregating assets in ways that maximize their resource base and economic interests. Whether the interests of LPs and the platform fund’s principals are aligned remains a more complicated question.

See my earlier post on alternative asset platform companies here. In short, I am not a big fan.

The center of gravity for platform players largely falls into two camps- private equity firms and hedge funds. The question above accurately reflects the fact that hedge funds are increasingly showing up in later stage deals. As an example, see $60m Brightcove financing led by Maverick Capital.

First, this is reminiscent of the late 1990s when the mezzanine market proved to very lucrative. Hedge funds piled into pre-IPO rounds in hopes of buying six to twelve months ahead of the IPO.

Second, one needs to separate the strategic vs. opportunistic players. Carlyle and Pequot, for example, have made long-term commitments to the venture category. The two firms built dedicated venture teams investing dedicated venture funds; not hedge fund managers investing "cross over" funds in one-off private deals. The opportunistic players’ presence in the market is tied to the economic cycle rather than to a secular commitment to the asset class – ie. fast money in, fast money out.

Finally, the decision to consider an investment from a hedge fund needs to be context sensitive. If the company is looking for mezzanine financing, a passive hedge fund investment makes perfect sense. The goal of the round is to raise expansion capital at the highest valuation and most company-favorable terms possible.

If the company is several years away from a liquidity event the decision is more complicated – I would suggest weighing the following variables in evaluating a hedge fun investor– will the investment be made from a dedicated venture fund, is there a dedicated venture team, does the fund keep adequate reserves for follow on rounds, does the company need an active net new board member, if so, could the partner in question add value, do they have referenceable portfolio companies and CEOs that can speak to their strengths…? The investor must be judged on their merits as value-added private company investors, not as easy sources of capital.

We would absolutely consider working with a hedge fund in a later stage round, however, we prefer to syndicate A round deals with likeminded investors with a successful history of A round investing and a long term commitment to the early stage venture asset class.

Friday, March 09, 2007

You Can Multi-task But Your Company Cannot

Yesterday, Verne Harnish, a start-up growth guru, visited Hummer Winblad.

Verne, founder of Gazelles Inc, is a thought-leader in start-up growth management and the author of a must-read book, Mastering the Rockefeller Habits. Please see my detailed post on the book here.

Verne's book is based on the management style of John D Rockefeller, whose management style centered on three key areas:
  • priorities
    • define the 1-5 most important organizational objectives
  • data
    • identify and manage to the key metrics and leading indicators, and
  • rhythm
    • run a well-organized set of daily, weekly, monthly, and quarterly meetings that keep everyone aligned and accountable
The core premise is that success is the sum total of all decisions being made in an organization. Leaders/managers influence decisions, and hence success, and need a framework regarding how best to do so.

Verne led eight Humwin CEOs through a presentation on how best to master, manage, and benefit from growth.

While the session proved rich in content, one lesson struck me as particularly profound.

"You Can Multi-task, but remember that your company cannot."

Entrepreneurs are by definition multi-taskers - they can juggle five to six balls at once and switch gears with no loss of momentum . Too often entrepreneurs ascribe to their companies those same capabilities and are amazed when people and organizations complain about being whipsawed and of being uncertain as to priorities and direction.

How best can a leader ensure a company moves quickly and as one? A leader must strive to harness the collective energy of an organization by defining common objectives and a common cadence.

Changing focus leads to energy diffusion, loss of momentum, plunging moral, and organizational confusion.

Think about crew...a boat with eight oars pulling to the same rhythm almost leaps out of the water...if the cadence is out of synch the boat wallows...

Organizations that shine channel energy towards common goals and benefit from the cumulative leverage of many brains and hearts focusing on the same objectives. An entrepreneur simply cannot run a company the way he runs his day.

The challenge for start-ups often lies in how quickly the market, product, and opportunity changes.

The great leaders, however, insulate their companies from the pernicious effects of course correction and shifting objectives and see the benefits of harnessing energy rather than unintentionally diffussing it.

Wednesday, March 07, 2007

Ernest Gallo: Passing of a Giant

Ernest Gallo, a true giant in Californian business and entrepreneurship, passed away yesterday.

Mr Gallo, who co-founded E&J Gallo Winery with his brother Julio 70 years ago, passed away at age 97.

Starting with $6,000 dollars and book on wine making from the local library he built the world's largest winery, which today produces over 62 million cases of wine each year.

Along the way, he pioneered many of today's standard business practices:

  • vendor managed inventory,
  • end cap product placement,
  • national sales forces;
  • brand advertising,
  • brand extensions;
  • modern distribution systems,
  • and, perhaps, most significantly, introduced wine to a country that only drank beer and hard liquor.
I once asked his son, the current CEO, why they use the Gallo name in their premium wines. He asked me, "how long do you think it will take consumers to see us a premium wine brand name?" I told him, "ten to twenty years." His response was telling - he said, "fine, we are not going anywhere."

In a valley that thinks in terms of months not decades and works to minimize time to exit, the Gallos are an amazing example of resiliency, vision, and multi-generational commitment to the business.

Mr Gallo was a great entrepreneur, pioneer, and Californian who will be sorely missed.

Updated Link for Introduction to Presentation Venture Capital Pitch

Apologies for the incorrect link to the presentation.

Please click here for the slides.

Tuesday, March 06, 2007

Introduction to Venture Capital

Today, I guest lectured at Stanford University.

The class, the Entrepreneurial Engineer, is a graduate course for engineers interested in starting their own companies.

The professor, Roger Melen, asked that I provide an overview of the venture capital industry, insights into the venture process, and a suggested play book for entrepreneurs looking to raise venture capital.

While a well-covered subject, I attach my slides for review and discussion. Also, if widget fails to load visit:

HWVP in the FT

The FT recently profiled John Hummer and Hummer Winblad.

The article, titled "Think boring is the tip from Silicon Valley," highlights conclusions from a review of Hummer Winblad's 18 year investment history.

In the spirit of George Santayana's quote, "those who cannot learn from history are doomed to repeat it...."the article reviews some of John's conclusions on the "model" that works best for HWVP and, equally as important, the model that doesn't work.

Chief among the conclusions are 1) a focus on capital efficiency with small A rounds, 2) a bias towards infrastructure companies, and 3) the importance of investing in disruptive platform shifts/waves.

While the above is not a universal recipe for success, I believe that introspection is fundamental to defining strategy and securing consensus and focus.

One thing I can vouch for is the leverage and productivity possible when the full team subscribes to a common model and measures investment opportunities along a common curve.

Friday, March 02, 2007

The Mathematics of Energy: Have We Reached a Tipping Point?

The VC industry profits from secular disruptions. In IT, platform transitions – mainframe to client/server to web, etc – create massive disruptions, new companies, and fantastic returns to investors.

In a absolute sense, disruptive companies initially operate on the margin of major industries. GOOG, for example, is the leader in the online ad market, a market which represents less than 6% of the total advertising market.

It is often not the absolute levels of market share that drive market capitalization but rather the rate of relative change in new technology platform adoption. The rate of change is a function of the economics and value of the emerging technology platform.

GOOG’s market cap reflects the market consensus that the online market’s share of total advertising will grow from 6% to 10% to 20% and that GOOG will disproportionately benefit from the reallocation of spend.

Okay, online advertising is 6% of the total.

Anyone care to hazard a guess as to clean energy’s share of the US energy market?

Clean energy, a new vc darling, is 2.3% of the US electricity market.

The 2.3% breaks down the following way:
1.5% from bio-mass
0.44% from wind
0.36% for geothermal
0.01% for solar power.

The other 97.7%?
49.7% coal-fired
19.3% nuclear
19.1% natural gas
6.5% hydro
3% oil-fired

Wow. 97.7% is non-renewable, with 50% carbon spewing coal.

Now, the environmental benefits of clean energy aside, is clean energy economically competitive?

Caveat….the environmental impact/cost of traditional energy is not captured by market prices. Non-price costs are referred to as externalities and, ultimately, serve to understate the costs of traditional energy. Pricing externalities remains beyond the scope of the market – ie. What is the cost of Greenland’s melting ice sheets, who should pay for it, how should it be imputed into the market price for energy?

The DOE provides interesting answers as to price competitiveness. For a plant coming on-line in 2015, the per kilowatt hour prices, by energy source, are forecast to be:

Coal $0.0531 per kwh
Wind $0.0558 per kwh, or 1.051x coal
Natural Gas $0.0525 per kwh, or .98x coal
Nuclear $0.0593 per kwh, or 1.12x coal
Solar $0.30 per kwh, or 5.65x coal
Biomass $0.075 per kwh, or 1.41x coal
Geothermal $0.075 per kwh, or 1.41x coal

In essence, the DOE believes that, independent of subsidies, that only natural gas will be cheaper than coal. Importantly, wind, nuclear, biomass, and geo-thermal are approaching the cost of coal.

The sad fact is that in the absence of either 1) subsidies, 2) innovations in pricing models that can capture the costs of externalities, or 3) a material breakthrough in technology, that the importance of coal will be undiminished. This is reflected in TXU’s plan to build monster coal fired plants in TX – they are economic actors.

For the clean energy sector, the math does not yet work. In order for the 2.3% to become 5% then 10% then 20%, we appear to need two things

1) the analog of Black-Scholes pricing models to emerge. We need to develop a pricing model, that the market will accept, that can capture the externalities and hidden costs of non-renewable energy production.
2) A breakthrough not only in the cost of alternative energy production, but also an ability to scale. Wind today can serve 20m homes – we need massive increases in scale.

Monster companies emerge not when they own 20% of a market but when the market realizes that the economic advantages of the new platform will create massive dislocations in the market. When we see clean energy reach 5%, it will be interesting to see if a GOOG type company is leading the reallocation of capital with an economic value proposition that leaves coal, thankfully, in the dust…

See for an excellent analysis of the topic above