Silicon Beat

Thanks to Matt over at Silicon Beat for recently profiling my blog. Silicon Beat is part of my daily routine and the site and reporting are consistenly good sources for the latest in the technology and start-up world.

Matt's reference to Hummer Winblad suggests that the firm has been quiet of late. It is worth noting that Hummer Winblad has been an active and successful software investor through three major technology cycles: PC, client/server, and the Internet era. The firm's track record of successful investments includes Arbor Software, Net Dynamics (sold to Sun), Adforce (sold to CMGI), Powersoft (merged with Sybase), Scopus (sold to SEBL), and Wind River.

In the past 18 months, the firm led investments in 14 companies including Akimbi, Palamida, Scalent Systems, Cittio, and ActiveGrid. Active portfolio companies include Omniture, Voltage Security, and Employease.

Thanks again to Matt for the post and to the entrepreneurs who read Silicon Beat, please be in touch:)

2005 Redux

According to Feedburner's Item Stats, the following posts topped this blog's most read list. Happy New Year and here's to a wonderful 2006.

Running on Empty
Search: The Rise of Specialization
The Golden Age of IT Buying and What Does it Mean for Investors
H1-B Aliens and the Myth of Free Labor Markets
Sales Forecasting
Sales Management
IBM: Standards, Customer Alignment, and Ecosystem-based Competition
The Cost of Optimism
Pat Your Head and Rub Your Tummy

Absurd Athleticism

Watch this Russian video for some incredible footage. It is sad to see such talent amidst such poverty. Hopefully, the market is efficient and Hollywood talent scouts are on their way.

Cap Table Hygiene

Venture capitalists are very much tabla rasa investors. One frequently hears about deals with "no hair," "plain vanilla terms," and good hygiene. Conversely, deals that come with cap table challenges (too many investors, too much prior preference, or onerous terms granted to a prior round) are often dead on arrival.

Why? My view is that company formation and growth is hard enough - one has to deal with market risk, technology risk, team risk, downstream financing risk, etc; therefore deals that layer "bad organizational/legal hygiene" as an additional risk factor into the investment evaluation tend to fail to secure investment.

In thinking of starting a company, it is worth understanding the VC industry's attraction to greenfield situations and is well worth thinking through two specific capitalization challenges that often create downstream pitfalls.

1. Too Many Founders

A typical Series A sees the following equity ownership distribution: VC syndicate 50%, option pool 20%, founders 30%. Each subsequent financing will see founders diluted by roughly 20% per financing, such that after three rounds the founder shares represent 30%*.8^2, or 19.2% of the company. The per founder math is very simple - founder shares/# of founders. It almost seems redundant to state that too many founders can greatly impact the downstream economics of the founders, however, I have seen very smart, experienced founding teams launch with 5-6 founders and come to realize later that the per founder ownership in the entity creates real incentive problems. The VCs will rarely take less than 40-50% of a Series A and the pool is almost always 20%. Therefore it is important to think through the distribution of the remaining shares to ensure that each member of the team is truly required to get the company off the ground. Teams of 2-3 founders seem to be the norm and cap table issues, questions about equity (wrt fairness), often arise if the team gets much bigger.

2. Too Many Common Holders

All things being equal, the number of common shareholders is inversely proportional to a VC firm's interest in funding a company. The brutal reality of company formation is that often one must take capital from as many angels as necessary. While a small number of qualified angels can add needed runway and perspective, too many angels creates shareholder issues that may impact downstream financings, acquisitions, and legal liability. In raising angel money, try to limit the number of investors required to hit the financing target. When shareholder consents are required - financings, acquisitions, etc - the logistics of rapidly getting approvals can be problematic. I have seen some buyers require full shareholder consents, even if not legally necessary, in order to limit downstream problems relating to minority shareholder lawsuits.

Reality often dictates the necessity of sub-optimal strategies, however, if you can think through how many founders and how many angels to have in your next company you can limit the negative impact of "bad hygiene" on a venture financing.

Hip Hop Web

While listening to Tupac in the car today, it struck me that web 2.0 and rap music have a great deal in common.

The democratizing effect of "two tables and a microphone" allowed people without instrumental training to create wonderful music. Similarly, today's web tools are enabling thousands of web users to create content and applications without deep knowledge of programming languages and technology. Mashups are the web equivalent to rap's sampling, code jams the analog to rap's freestyle battles, beta launches the equivalent to demo tapes, shout-outs the analog to track-backs, Apple's Garageband software similar to Typepad or Jotspot. Moreover, the blogosphere and rap are perhaps the most self-referential creative mediums known to man, whereby songs and posts build off one another in a call and response manner. Mashup's are experiments that create rich blends of underlying applications, as rap tunes are created via the synthesis of jazz, funk, and soul classics. Creativity and innovation is redefined from ground-up development (100% original material) to innovations on the margin. Finally, web 2.0 and rap are both driven by young innovators, often around project-based interaction rather than long-term relationships.

The steady advance in web tools is introducing on-line creativity, rather than simply on-line consumption, to millions of people. As with rap, I think the world is richer for it.

How to respond to Nigerian Spam Mail

The ingenuity and implicit humor found in Nigerian spam mail inspired a close friend of mine, Mike Flynn, to send this incredicle response.

This could be the funniest thing I have read in a long time . Well done Mike.


Re: Next of Kin

Dear Paul,

By a most uncanny coincidence, I am also soliciting a barrister, preferably a national of your country, who worked with Shell development. By a most unfortunate series of events, I was being held hostage in the trunk of the car that claimed the lives of your client. Fortunately I was blown clear of the wreckage and was able to make my way through the jungles of Nigeria to the Plains of Arjuna dragging a dozen large boxes that I was informed by the sister of the mailman who claimed to be the ilegitimate heir to the throne of Uganda, Mr. Yanindada N'Golo Botticelli Vespa, manservant to your client, contained bars of gold bullion!

When I made it to the Baltic sea I was able to obtain safe passage (after many months of hardship as a fish monger's wife) in a freighter to northern Llapland where I met a Nordic Shaman named Odin who told me you would be contacting me after 23 full moons to fulfill my economic desires.

Paul, I feel I can trust and confide in you and feel from your words that you are a man of God and the people who will help me in my time of need. If you can help me with my immediate need of exporting 300,000,000 pink plastic monkeys to Jakarta I will then be in a better position to provide assistance in routing US$106M to my accounts in Lichtenstein.

be the ball Danny,
truly,
M

Dear Sir/madam

I am Barrister paul debayo Solicitor. I am the Personal Attorney to Mr
Thomas Anindya, a national of your country, who used to work with
shell development company in Nigeria.On the 2nd of may 1999, my
client, his wife And their three children were involved in a car
accident along Sagbama Express Road. All occupants of the vehicle
unfortunately lost there lives. Since then I have made several
enquiries to your embassy to locate any of my clients extended
relatives, this has also proved unsuccessful.

After these several unsuccessful attempts, I decided to trace his
relatives over the Internet, to locate any member of his family but of
no avail, hence I contacted you. I have contacted you to assist in
repartrating the money that belong to my client before they get
confisicated or declared unserviceable by the bank where this huge
deposits were lodged.

Particularly, the Bank where the deceased had an account valued at
about $30million dollars has issued me a notice to provide the next of
kin or have the account confisicated within the next ten official
working days. since i have been unsuccesfull in locating the the
relatives for over 3 years now I seek your consent to present you as
the next of kin of the deceased since you are from the same country
and bear the same last name ,so that the proceeds of this account
valued at $30 million dollars can be paid to you and then you and me
can share the money. 55% to me and 40% to you,while 5% should be for
expenses or tax as your government may require, I have the certificate
of deposit that can be used to back up any claim we may make. All I
require is your honest cooperation to enable us see this dealt
through.

I guarantee that this will be executed under a legitimate arrangement
that will protect you from any breach of the law.Please get in touch
with me by my email to enable us discuss further.

I WILL OBTAIN AFFIDAVIT FROM COURT WHEN YOU RESPONS TO ME.

Best regards,

Esq:paul debayo

New Web Site

Hummer Winblad launched our new web site yesterday.

The site provides a great overview of the firm, timeline of investments since founding in 1989, and our process.

For those of you who know the firm well know that John's dog is a key member of the team.

See if you can find an overview on our honorary senior canine leader.

H1-B Aliens and the Myth of Free Labor Markets

A wonderful constant in this valley of innovation, is the amazing contribution of immigrants to our economy.

In my daily meetings with founding teams and start-ups, there is not a single company that does not have an emigre as a key member. The contribution of Indian, Chinese, Russian, and other nationals to our economy is beyond question and a vital source of our success. From professors, to engineers, senior managers, company founders, and venture capitalists, our current success and prosperity is very positively influenced by our ability to attract the best and brightest to work and study in our country.

Unfortunately, America, while often a champion of free trade, is not a practioner of free labor markets. While technology talent is perhaps the most important input in Silicon Valley's decades of innovation, the US government artificially caps and limits the number of ambitious immigrants to our economy. This year, the H1-B Alien visa program is limited to 65,000. Moreover, since 9/11 the US government has clamped down on graduate student visas; current visa application security checks take 67 days and the total process takes over 3 months . The pernicious effect red-tape is that gifted students are less likely to bother applying, thereby greatly weakening our future prosperity and welfare.

A recent GOA study found that:

• "Lengthy waits to obtain a visa might lead Chinese students and scholars to pursue studies or research in countries where it is easier to obtain a visa. A consular chief in Chennai, India, agreed, saying that lengthy waits are also causing Indian students to decide to study in countries where it is easier to get a visa and, therefore, the United States could lose out on intellectual knowledge these visa applicants bring to our country"
• "Many officials with whom we spoke cited specific examples where scientific research and collaboration was delayed or prevented due to delays in obtaining a visa. NASA officials at post also noted that up to 20% of their time is spent dealing with visa issues when they should be focusing on program issues."
• "According to several surveys, scientific research was postponed, jobs were left unstaffed, and conferences and meetings were missed as a result of the delays."

True globalization requires the seamless flow of ideas, products, and talent. While the world is moving in the right direction, the future of the Valley requires that we make it easy for the world's best to study, work, and contribute to our economy.

Running on Empty

Several years ago, Pete Peterson, the founder of Blackstone and an ex-cabinet secretary, wrote an important and sobering book titled Running on Empty.

The book indicts both Republicans and Democrats for ignoring two troubling twin deficits - the the trade deficit and the budget deficit - which, he believes, may ultimately bankrupt the country. The hard-hitting book highlights the off-balance sheet, unfunded entitlement program liabilities that will fall due in the coming decades. With trillions of dollars in Medicaid, social security, and drug benefits promised to current and future retirees, he warns of some very hard choices that face the nation. For example, he estimates if Congress was forced to fund promised entitlement programs, we would face, "an immediate and permanent 60 percent hike in the federal income tax, or a 50 percent cut in Social Security and Medicare benefits."

Recently, news of corporate pension plans failing reminded me of Peterson's important book. For example, Delphi's unfunded pension liabilities present a scary harbinger of what is to come in corporate and government pensions. Delphi, the world's largest auto parts maker, faces an $11bn shortfall in its obligation to retirees. Delphi management, unable to negotiate with the unions, may file for bankruptcy, which would transfer the pension liability to the Pension Benefit Guaranty Corp, a government agency that insures pension plans. Unfortunately, the PBGC is itself underfunded, with assets of $56bn and liabilities of $79.2bn. Total corporate pension plan unfunded liabilities are estimated to be $450bn, well beyond the financial resources of the PBGC. Ultimately, tax payers will be liable for the failings of management to properly fund future obligations.

Roger Lowenstein wrote a wonderful NY Times Magazine article, The End of Pensions, which provides scary and powerful insight into the failing of the defined benefit program and the massive state and local pension obligations that dwarf the corporate dilemma.

Why am I writing about this?

Economic growth is a function of investment. As entitlement spending drives deficits, we will need to finance them with either massive tax increases or massive borrowing to cover our shortfalls. As we borrow more, we will see a higher percentage of our tax base go to interest payments and the lions share of our local, state, and federal budgets go to entitlement spending that reward historical work rather than into investment programs that drive future growth. Both parties appear incapable of addressing this fundamental problem, and I hope that the writings of Peterson, Lowenstein, and others wake the electorate up to the scary prospects of a failing corporate and government pensions and the mortgaging of our future to fund entitlement programs.

WSJ Article: How to Ship Better Software

Robert Guth of the WSJ recently wrote a fascinating article with respect to Microsoft's legendary challenges shipping Longhorn, WinFS, and quality software products. The article, titled Code Red, Battling Google, Microsoft Changes How it Builds Software, is an insider's review of Windows problems and the team assigned to make the product more modular, extendable, and easier to test. If you can, read it.

Not long ago, Detroit took 5-7 years to take a car from blueprint to the dealer's lot. Innovation fell prey to the inefficiencies of the Big 3's product development processes and customers abandoned US cars in favor of Asian manufacturers who responded more quickly to consumer tastes and sold higher quality products. Guth's article positions MSFT as the GM to GOOG's Toyota and underscores MSFT's inability to be first to market with innovative (desk top search, ad words, tabbed browsing, maps, etc), (endless patches and security warnings) quality products. Windows proved to be too large a boat anchor to allow MSFT to predictably ship products ahead of competitors.

The article gives credit to Jim Allchin, Window's top executive, for an effort to refactor Windows and, more importantly, the tools, culture, and processes of the Windows development organization. Allchin and Amitabh Srivastava set out to improve quality via new tools that automated unit testing, rejected checked-in code that failed quality checks, improved build processes, system tests and coverage, and a culture traditionally more focused on feature additions than architecturally integrity and quality software.

As a former BOD member of Klocwork, I know first hand that the enterprise and ISV market suffer from poor development processes, a lack of automated source code analysis tools, and a culture of missed ship dates and brute-force solutions. The market is waking up to the need to fix problems at "day zero" and to maintain architectural integrity as products mature. Failure to do so results in products that make innovation very challenging and impossible to maintain.

While MSFT is a poster-child for buggy products, the industry as a whole can benefit with a new generation of tools that improve software quality and reduce the cycle time for new releases that meet customer needs.

Hummer Winblad is an active investor in development tools solutions, with investments in companies such as Akimbi, Palamida, and others still in stealth.

If you know of other companies of note and interest attacking this problem, please send them my/our way.

Hummer Winblad Venture Partners

Per my prior post on early-stage havens, I am pleased to write that I am putting my hypothesis to work and joining Hummer Winblad Venture Partners.

Starting October 3rd, 2005, I will be part of HWVP and looking for exciting, early-stage software deals.

My contact info will be:

Hummer Winblad Venture Partners
One Lombard Street, Suite 300
San Francisco, CA 94111
w) 415 979 9600
e) wprice@humwin.com

I look forward to working with great entrepreneurs and the experienced HWVP team. Please feel free to send early-stage software deals my way!

Early Stage Haven?

Recent numbers suggest that early stage investing may yet prove to be a bastion of IRR and extraordinary returns. Why? Recent data provides interesting insights into industry dynamics.

In 1H05, VC firms raised roughly $11bn in IT Venture Capital. Over the same period, IT VCs invested roughly $5.5bn, for a ratio of IT$ invested YTD/IT$ raised YTD of .5. Not a sustainable number.

If IT VCs stopped raising money today (which will never happen), it would take ~12 quarters to invest the $32bn of IT VC$ available for new investment at the Q2 run rate of $2.747bn.

As we all know, the surplus capital appears to be a secular rather than a cyclical shift in the fundamentals of the venture industry.

A key question is, where is the capital going? Apparently, not in the early stage. According to VentureOne, the percentage of VC IT $ going into early stage is falling precipitously:

• 2000 Early Stage $/Total $ = 34%
• 2003 Early Stage $/Total $ = 20%
• 2004 Early Stage $/Total $ = 20%
• 1H2005 Early Stage $/Total $ =16%

With a -53% change in the amount of money flowing into early stage investments btwn 2000 and 1H05, it appears that the surplus will continue to flow into later stage deals. In later stage investing, winning is almost always a function of share price. Price discipline is eroded as firms bid deals up to deploy capital and "win."

With fewer dollars chasing early stage deals and meaningful non-share price based differentiators - deal flow, company evaluation in absence of customers/revenue, syndication, post-deal value add, etc - it may be that while extraordinary returns for the industry as a whole look challenging, early stage investing may prove to be a bastion of IRR and extraordinary returns.

I believe that smaller funds, specialized focus areas, and early stage investing are the way to go.

Thoughts?

Scale Free Profitability

Morgan Stanley's high-tech investment banking team present a wonderful chart that examines the effect of scale on software profitability. The chart powerfully illustrates that scale is increasingly necessary to achieve competitive operating leverage in the software industry.

For example, the distribution of LTM operating margin by revenue size is as follows:

• $75-300m in revenue = 7% operating margins
• $300-500m in revenue = 11% operating margins
• $500m-$1bn = 12% operating margins
• $1bn-$5bn = 18% operating margins
• >$5bn = 33% operating margins

The scale effect, as noted by Larry Ellison and Barron's, is driving rapid consolidation of the industry as vendors seeks to consolidate capacity, drive volumes, and get to minimum efficient scale. Consolidation, while good for exits in the near term, has troubling long-term implications wrt the market's expectations for future small cap software company growth, profitability, and viability.

Start-up companies and VCs, by definition, cannot rely on scale to help us achieve profitability. Rather, start-up companies must innovate their business models and strategies in order to reach attractive profitability metrics independent of scale.

As important as technical innovation, successful start-ups must innovate how we do business and prosecute R&D, marketing, sales, and operations.

If we simply innovate technically and rely on traditional business practices, we will suffer from the fate illustrated in the table above.

How we rip costs out of the software model while delivering value will be critical.

I would enjoy hearing from start-ups and investors on novel, optimized business practices that are helping to realize scale-free profitability. While open source software, offshore development, and channel based selling are well-known strategies, any fundamentally novel approaches would be great to share.

Pat your head and rub your tummy

Young start-ups need two things to survive: customer orders and funding.

The challenge, however, is that customers and venture investors often decide to "buy" based on very different messages.

To succeed with customers, start-ups need to articulate clear, focused value propositions. Often the nature of early stage product development is such that the product is of limited functionality and can best be sold by "narrowing the focus to broaden the appeal;" clear use cases, incremental value wrt products already in production, easy to install, and quick to show value.

Focus is often the key to early sales traction.

Investors on the other hand can often have a pejorative view of focus - VCs question nichey looking business plans ("is this a feature or a company?") and the proverbial "what is the TAM" and "can this thing scale" are often orthogonal to the product marketing challenges of selling version 1.0 products to skeptical customers.

In my experience as a VC and ex-startup CEO, young companies need to remember to develop and tell two stories. The first targets customers and explains specific, tangible, and focused value made possible via the currently available product. The second story targets the VCs and addresses the real concern with respect to scale, TAM, and a road map that supports the emergence of the company from a niche-product to a real company.

This challenge of orthogonal messages and the need to develop them simultaneously is similar to the age-old, "pat your head and rub your tummy" trick.

Some companies tell great customer stories and never get funding. Others are great at raising money, yet never seem to be able to sell the customer. It is the rare, and significant, early-stage company that can tell a story of relevancy that resonates with the buyer, while also painting a longer-term vision to VCs wrt how to build a large company that will make VCs a healthy return.

Any comments or experiences here would be great to share!

Fraternal Props

My brother, Rich, played a KFOG concert tonight in SF. The band sounded great and thanks to KFOG we enjoyed a wonderful evening of live music in front of the ferry building in downtown SF.

Rich is featured (track #2) with other emerging Bay Area artists on a really great CD, KFOG Local Scene 2. Check it out.

This new CD from KFOG features a variety of artists and bands from Northern California who deserve to be heard. Proceeds from "KFOG's Local Scene 2" will go to Music In Schools Today, a local charity that helps fund music education in Bay Area public schools. The CD is only $6 and supports a great cause, while introducing the listener to some great new music.

Rich Price headlining a KFOG local artists show in San Francisco. KFOG's new Local Scene CD is definitely worth getting, featuring Rich, Jack Johnson with Animal Liberation Orchestra, Hyim, among others 

NSCP - 10 years later

Today is the 10th anniversary of the Netscape Communications IPO. (see link for great set of Fortune articles).

16 month-old Netscape Communications went public on August 9th, 1995. The stock priced at $28, peaked at $75, and closed that day at $58 valuing the young company at a cool $3.3bn.

1995 also brought us Verisign, Yahoo, and Amazon, among others.

1995 represents a seminal year in technology innovation. In many ways it parallels 1959, the year Jack Kilby and Robert Noyce independently invented the integrated circuit and gave birth to the digital age.

Reflecting on the staggering impact NSCP, VRSN, YHOO, and AMZN have had on our lives, economies, and careers reinforces the promise and excitement of innovation, while reminding us how hard it is to appreciate non-linear developments, and harder still to foresee their ultimate impact.

As investors and technologists, let's all hope that 1995 is a spring board for changes still to come, and let's us also hope that we have the foresight to recognize "it" when/if we see it.

State of the blogosphere

David Sifry, Technorati's CEO and founder, just published a series of State of the Blogoshpere posts.

Summary Stats:
Technorati was tracking over 14.2 Million weblogs, and over 1.3 billion links in July 2005
The blogosphere continues to double about every 5.5 months
A new blog is created about every second, there are over 80,000 created daily
About 55% of all blogs are active, and that has remained a consistent statistic for at least a year
About 13% of all blogs are updated at least weekly

Wow. Simply amazing growth and well worth watching as investors and business people.

Strategic Planning

As a BOD member, non-profit volunteer, and employee here at Pequot, I am often asked to attend strategic planning sessions. This post shares my observations on common pitfalls and methods for using time as a group to add value and solve real issues.

Strategic planning sessions often fail to be either strategic or helpful in planning for the future. The expense in time, energy, and dollars can be significant. And yet, often the process leaves people frustrated and unfulfilled.

Why? What to do?

In my experience, the most effective offsites benefit from utilizing a mental model or framework that bounds the discussion, defines the assumptions, and helps people with a common lexicon and method for discussing issues and deriving answers. The absence of a framework or model for decision making and discussion and the lack of a common lexicon to discuss issues results in people talking past one another and endless loops that lead nowhere.

I am always amazed how varied peoples perceptions are to issues and the degree to variance can only be overcome if a common vocabulary and framework is agreed upon. This is especially true when you bring people together from completely different functional backgrounds.

For example, I recently served on the strategic planning committee of my church. Ten very smart people, well maybe nine, were asked to come together and define a three year plan for the church and its ministries. The first few meetings were pure hell. We talked endlessly about how to organize the committee, what the deliverable would be, and others simply jumped in and attempted to solve "key" issues. We got nowhere and lost energy.

We finally saw real traction when we all read a book that provided a framework for the process - with templates, a timeline, a sample deliverable, and a model for discussing the issues at hand. As soon as we adopted the model and the associated language, context, and logic, we made amazing progress and finished in no time at all. A shared approach that defined the problem and provided a path to deriving a solution allowed the group to think as one and it provided a baseline that made each individuals contribution additive.

In business setttings, the same lessons apply. Unless people buy into a mental model or construct of how to define, discuss, and solve the problem(s), conversations are endless streams of non-sequitors and serve only to frustrate the people involved.

Accordingly, I am a firm believer in

• defining the problem to solve
• agreeing on a model or framework for discussing the problem and deriving a solution
• ie defining the logic path and process that result in an answer
  
• defining a timeline
• getting team member buy-in wrt the above
  

Anyone else have experiences or processes wrt strategic planning worth sharing?

Rich Price - music you need to hear

My brother, Rich Price, is an amazing musician and a wonderful talent. Richard is a singer-song writer who is growing a great fan base, radio play, on movie soundtracks, and has released two wonderful albums (Miles from Anywhere, and Night Opens). Both albums are available on iTunes.

He recently launched a podcast and joined the blogosphere. Check out his music and his podcast, which is a great mix of original music and his favorite artists.

Finally, if you know of artists who are setting the standard wrt leveraging web 2.0 tools to share their music, please let him know. Email him at rich@richpricemusic.com.

I know you will love Rich - please check him out.

Will