Fighting battles that leverage your assets and competitive position rather than your competitors is common sense.
Too often, however, underdogs choose to compete with the market leader on the leader's terms; ie mimicking their strategy and business practices. Rather than seeking to shift the terms of the battle, companies seek to match the products, pricing, and delivery best practices of the industry leader. Think MSFT's current strategy vs Google - ie let's out Google them by focusing on search and text advertising.
The WSJ recently ran a great article on HP's PC business and its battle with Dell.
The article focuses on HP's new PC chief, Todd Bradley, and his decision to change the battlefield and basis of competition.
Prior to Bradley's arrival, HP took on Dell at their own game; HP focused its efforts on battling Dell in direct sales over the Internet and phone.
Bradley's epiphany was to realize that fighting Dell on their terms put HP at a disadvantage and that the HP should instead focus on its core assets, namely the retail channel and retail stores.
A quick inventory found that HP's obsession with Dell's online advantage had left the core retail channel under served and under utilized. Bradley's audit of the channel found HP lacking in on-time shipments to retail, shoddy retail and wholesale account management, and poor supply chain controls.
He actively courted large retailers and committed HP to on-time channel shipments, improved account management, and marketing and product design campaigns to help retailers market the in-store buying experience and custom product offerings.
In one year, HP's market share grew from 14.9% to 17.6%, while Dell from 16.4% to 13.9%. In-store PC purchases went from 54% to 61% over two years.
I found the article compelling and an excellent reminder that head-on competition with market leaders will likely lead to large losses and that it pays to play to your strengths rather than theirs.
Wednesday, July 25, 2007
Friday, July 13, 2007
You Owe it to Yourself
This summer buy and read Woody Allen's The Insanity Defense: The Complete Prose.
You will laugh out loud at least once a page.
The Insanity Defense: The Complete Prose
Be careful reading it on a plane. The passengers may start to worry.
You will laugh out loud at least once a page.
The Insanity Defense: The Complete Prose
Be careful reading it on a plane. The passengers may start to worry.
Wednesday, July 11, 2007
Widgetbox and Forbes.com
Widgetbox, a Humwin portfolio company, announced today a partnership with Forbes.com
Widgetbox will distribute Forbes content and advertising via eight initial widgets all sponsored by Visa.
The atomization of the web is underway and media companies and advertisers are looking to distribute content, application functionality, and advertising to social media and web site end points. The Forbes widgets are a powerful example of a major advertiser, Visa, and content publisher, Forbes, recognizing the power of widgets to reach a distributed audience.
The widgets can be found here and I include an example below.
Congratulations to Widgetbox and Forbes.com on a great launch.
Widgetbox will distribute Forbes content and advertising via eight initial widgets all sponsored by Visa.
The atomization of the web is underway and media companies and advertisers are looking to distribute content, application functionality, and advertising to social media and web site end points. The Forbes widgets are a powerful example of a major advertiser, Visa, and content publisher, Forbes, recognizing the power of widgets to reach a distributed audience.
The widgets can be found here and I include an example below.
Congratulations to Widgetbox and Forbes.com on a great launch.
Tuesday, July 10, 2007
3M: Six Sigma vs Innovation
Innovation is the lifeblood of Silicon Valley. Technological and business model disruptions drive the cycle of category, company, and wealth creation.
Innovation often leads to high growth and growth often demands the introduction of processes to ensure quality and scale.
There is, however, an obvious tension between innovation and process, between standardization and disruption. How does a company best manage that tension and avoid the extremes of creative anarchy vs bureaucratic and rigid process?
Companies that optimize for scale often begin to look like eBay - a monolithic app that is always up but still looks the same five years later. While companies that optimize for creativity, like Handspring, stumble with quality and return issues.
BusinessWeek recently profiled the impact of process, via Six Sigma, on innovation in an article on 3M. In 2000, 3M hired Jim McNerney from GE and introduced a total quality management initiative designed to lower costs and drive efficiencies. The company cut 8,000 jobs, operating margins grew from 17 to 23%, and thousands of Six Sigma black belts were trained and turned loose on the company. The short term gains proved popular with Wall St, however, longer term cracks began to appear.
Historically, 3M prided itself of delivering 1/3 of its sales from products introduced over the last five years. Under the Six Sigma regime, however, the ratio of revenue from new products fell to 1/4 and the company lost its creative edge.
The article notes, "while process excellence demands precision, consistency, and repetition, innovation calls for variation, failure, and serendipity."
At Hummer Winblad, we believe that founders are the key creative sparks that drive innovation and vision.
A business school framework defines three classes of company: operational excellence, customer intimacy, and product leadership. VC-backed companies typically succeed via a focus on either customer intimacy or product leadership. Senior executive hires that seek to optimize operational excellence too early in the company's development tend to lead to frustrated engineers and a rigidity that eliminates the chance to innovate. The absence of innovation in a company with few customers or product offerings is an almost certain predictor of failure.
Ideally, our founder-CEOs add a wrapper of operational excellence to their core focus on product leadership and innovation. Rather than move founders to CTO roles and bring in "grey" hair CEOs to drive process-led execution, we would rather see the founder as CEO, infusing the culture and product with their passion and creativity while learning the "tools" of the management trade.
Process, moreover, can be brought in at the VP level to compliment innovation and to help institute best practices that help with visibility and predictability while working to avoid hindering creativity and a culture of trial and iteration.
In summary, it is hard to balance innovation and process, however, in early stage companies innovation is a prerequisite to success. Accordingly, it is often very dangerous to move company founders to staff roles and to hire senior executives with operational depth but little emotional or intrinsic connection to the product market and problem.
Just as it is hard to Six Sigma your way to innovation, it is hard to execute your way to disruption.
Innovation often leads to high growth and growth often demands the introduction of processes to ensure quality and scale.
There is, however, an obvious tension between innovation and process, between standardization and disruption. How does a company best manage that tension and avoid the extremes of creative anarchy vs bureaucratic and rigid process?
Companies that optimize for scale often begin to look like eBay - a monolithic app that is always up but still looks the same five years later. While companies that optimize for creativity, like Handspring, stumble with quality and return issues.
BusinessWeek recently profiled the impact of process, via Six Sigma, on innovation in an article on 3M. In 2000, 3M hired Jim McNerney from GE and introduced a total quality management initiative designed to lower costs and drive efficiencies. The company cut 8,000 jobs, operating margins grew from 17 to 23%, and thousands of Six Sigma black belts were trained and turned loose on the company. The short term gains proved popular with Wall St, however, longer term cracks began to appear.
Historically, 3M prided itself of delivering 1/3 of its sales from products introduced over the last five years. Under the Six Sigma regime, however, the ratio of revenue from new products fell to 1/4 and the company lost its creative edge.
The article notes, "while process excellence demands precision, consistency, and repetition, innovation calls for variation, failure, and serendipity."
At Hummer Winblad, we believe that founders are the key creative sparks that drive innovation and vision.
A business school framework defines three classes of company: operational excellence, customer intimacy, and product leadership. VC-backed companies typically succeed via a focus on either customer intimacy or product leadership. Senior executive hires that seek to optimize operational excellence too early in the company's development tend to lead to frustrated engineers and a rigidity that eliminates the chance to innovate. The absence of innovation in a company with few customers or product offerings is an almost certain predictor of failure.
Ideally, our founder-CEOs add a wrapper of operational excellence to their core focus on product leadership and innovation. Rather than move founders to CTO roles and bring in "grey" hair CEOs to drive process-led execution, we would rather see the founder as CEO, infusing the culture and product with their passion and creativity while learning the "tools" of the management trade.
Process, moreover, can be brought in at the VP level to compliment innovation and to help institute best practices that help with visibility and predictability while working to avoid hindering creativity and a culture of trial and iteration.
In summary, it is hard to balance innovation and process, however, in early stage companies innovation is a prerequisite to success. Accordingly, it is often very dangerous to move company founders to staff roles and to hire senior executives with operational depth but little emotional or intrinsic connection to the product market and problem.
Just as it is hard to Six Sigma your way to innovation, it is hard to execute your way to disruption.
Food for Thought: Target Post Money Valuations and Capital Structure
Jeremy and Josh's thoughts on valuation are well worth reading.
Not only should founders be mindful of valuation issues, but also need to be thoughtful about capital structure and shareholder mix.
Venture capital is often described as a business of pattern recognition - experienced investors pick up on market patterns, management team dynamics, and seemingly random data points to draw powerful insights. While I am still relatively new to the industry, I am struck by a few capital structure patterns that are generally bad omens.
The Too Large "A" Round
Ideal company formation reminds me of agile programming - small teams driving quick, iterative cycles that allow for the most insights, appropriate changes in strategy, and, ultimately, the highest quality "product."
I often say that genius is a function of context, and until a company is fully immersed in the context of the given problem set the best insights and strategies are often not apparent.
Too much money too early and too many people too early interferes with the productive process of iteration. Large teams with lots of resources and a very uncertain sense of direction or purpose are a bad combination.
Too High "A" Round Post-Money Valuations
While a self-serving argument, an equally challenging problem is a too high "A" round post-money. High "A" round valuations are often Pyrrhic victories.
High posts and middling execution often leaves a company in a grey zone whereby objective value creating milestones have not been clearly met, yet some qualitative progress has been made. A common result of such a financing is a bridge round that extends the runway and is designed to allow the company a quarter or two to "grow" into its post-money "A" round valuation. More often than not, the bridge becomes a pier and the company and founders suffer from a post-money that proved you can win the battle and lose the war because of it.
"A" round financing strategies should be tied to discrete logic tests and proofs and the goal should be to optimize the validation/dollars ratio. Can we validate the technology and business model on as little as capital as possible? The ratio forces founders to think through the material questions that need to be answered with the use of proceeds. Will the product work? Will customers buy it? Can we sell it? If so, how? How much do we need, with a slight cushion, to answer these questions? Given all the noise in a start-up, what are the real issues and risks we need to manage?
The validation/dollars ratio is a measure of efficiency and a quasi measure of return on equity. Start-ups that maximize the ratio are generally rewarded for it.
A reasonable Series "A" raise and post-money combined with realized value-creating milestones generally leaves a company in an enviable position when raising the Series " B". The key hypotheses have been validated and a reasonable mark-up is possible.
To that end, Fewnwick's recent report on trends in venture capital reported that the median valuations for A-D rounds were $5m, $12m, $23.5m, and $41.71m respectively.
Patterns and data suggest that for software companies an $8-10m "A" post appears to maximize the probability of a healthy B round and good optics and pattern recognition.
Not only should founders be mindful of valuation issues, but also need to be thoughtful about capital structure and shareholder mix.
Venture capital is often described as a business of pattern recognition - experienced investors pick up on market patterns, management team dynamics, and seemingly random data points to draw powerful insights. While I am still relatively new to the industry, I am struck by a few capital structure patterns that are generally bad omens.
The Too Large "A" Round
Ideal company formation reminds me of agile programming - small teams driving quick, iterative cycles that allow for the most insights, appropriate changes in strategy, and, ultimately, the highest quality "product."
I often say that genius is a function of context, and until a company is fully immersed in the context of the given problem set the best insights and strategies are often not apparent.
Too much money too early and too many people too early interferes with the productive process of iteration. Large teams with lots of resources and a very uncertain sense of direction or purpose are a bad combination.
Too High "A" Round Post-Money Valuations
While a self-serving argument, an equally challenging problem is a too high "A" round post-money. High "A" round valuations are often Pyrrhic victories.
High posts and middling execution often leaves a company in a grey zone whereby objective value creating milestones have not been clearly met, yet some qualitative progress has been made. A common result of such a financing is a bridge round that extends the runway and is designed to allow the company a quarter or two to "grow" into its post-money "A" round valuation. More often than not, the bridge becomes a pier and the company and founders suffer from a post-money that proved you can win the battle and lose the war because of it.
"A" round financing strategies should be tied to discrete logic tests and proofs and the goal should be to optimize the validation/dollars ratio. Can we validate the technology and business model on as little as capital as possible? The ratio forces founders to think through the material questions that need to be answered with the use of proceeds. Will the product work? Will customers buy it? Can we sell it? If so, how? How much do we need, with a slight cushion, to answer these questions? Given all the noise in a start-up, what are the real issues and risks we need to manage?
The validation/dollars ratio is a measure of efficiency and a quasi measure of return on equity. Start-ups that maximize the ratio are generally rewarded for it.
A reasonable Series "A" raise and post-money combined with realized value-creating milestones generally leaves a company in an enviable position when raising the Series " B". The key hypotheses have been validated and a reasonable mark-up is possible.
To that end, Fewnwick's recent report on trends in venture capital reported that the median valuations for A-D rounds were $5m, $12m, $23.5m, and $41.71m respectively.
Patterns and data suggest that for software companies an $8-10m "A" post appears to maximize the probability of a healthy B round and good optics and pattern recognition.
Monday, July 09, 2007
Debtor Nation
This month's Harvard Magazine includes a great article on the implications of America's current account deficit and negative savings rate.
The article addresses a key question - how much longer can the US continue to consume more than it earns? And equally importantly, how much longer will other nations continue to provide the US access to cheap capital by buying US Treasuries and holding US dollar reserves?
The long term fear is that a move away from US dollar reserves, ex. to Euros, will lead to a depreciated dollar, negative impact on US consumer purchasing power, and a rise in interest rates to attract capital back to the US.
The opening paragraph outlines the scope of the problem:
As investors, entrepreneurs, and technologists, we have a vital interest in positive net savings rates that allow for investment in the future rather than debt service payments to cover historical obligations and spending.
If Gross Domestic Investment = Private Saving + Government Saving + Foreign Saving, then the low rate of private and government savings demands that we import capital. Future growth is conditional on investment in infrastructure, education, and health care. However, we as a nation are no longer saving; thereby forcing us to borrow abroad to fund our consumption and investment.
The key concerns are
1) that the debt service associated with the current borrowings drowns out the ability for net new investment or
2) foreigners stop providing us cheap capital and dollars available for investment (and hence growth) are limited.
It will be interesting to see how quickly the current account deficit becomes part of the public policy discourse and how politicians will wrestle with the enormity of the problem and complexity of the issues involved.
The article addresses a key question - how much longer can the US continue to consume more than it earns? And equally importantly, how much longer will other nations continue to provide the US access to cheap capital by buying US Treasuries and holding US dollar reserves?
The long term fear is that a move away from US dollar reserves, ex. to Euros, will lead to a depreciated dollar, negative impact on US consumer purchasing power, and a rise in interest rates to attract capital back to the US.
The opening paragraph outlines the scope of the problem:
"In 2006, the infusion of foreign cash required to close the gap between American incomes and consumption reached nearly 7 percent of gross domestic product (GDP), leaving the United States with a deficit in its current account (an annual measure of capital flows to and from the rest of the world) of more than $850 billion. In other words, the quantity of goods and services that Americans consumed last year in excess of what we produced was close to the entire annual output of Brazil. “Brazil is the tenth largest economy on the planet,” points out Laura Alfaro, an associate professor of business administration who teaches a class on the current account deficit at Harvard Business School (HBS). “That is what the U.S. is eating up every year—a Brazil or a Mexico.”
As investors, entrepreneurs, and technologists, we have a vital interest in positive net savings rates that allow for investment in the future rather than debt service payments to cover historical obligations and spending.
If Gross Domestic Investment = Private Saving + Government Saving + Foreign Saving, then the low rate of private and government savings demands that we import capital. Future growth is conditional on investment in infrastructure, education, and health care. However, we as a nation are no longer saving; thereby forcing us to borrow abroad to fund our consumption and investment.
The key concerns are
1) that the debt service associated with the current borrowings drowns out the ability for net new investment or
2) foreigners stop providing us cheap capital and dollars available for investment (and hence growth) are limited.
It will be interesting to see how quickly the current account deficit becomes part of the public policy discourse and how politicians will wrestle with the enormity of the problem and complexity of the issues involved.
Tuesday, June 26, 2007
JavaScript-Enabled Services, SaaS, and Open Source: Friction Free Models that Drive the Reallocation of Capital
What do JavaScript-enabled services, SaaS, and Open Source all have in common?
They are product delivery models that dramatically reduce the cost, time, and resource requirements to test products and their purported value.
The risk to trial is mitigated and individual users can experiment and validate value in isolation of the broader enterprise.
More than ever, companies that focus on reducing the risk and resources required to trial their product or service are outperforming "heavy" footprint product companies.
The capital markets are highly efficient and dollars quickly flow to the highest yielding assets. IT markets, however, are characterized by high degrees of friction that artificially limit capital reallocation and flow.
Typical IT frictions include: required asset requisitions, proprietary interfaces, multi-department decision making, multi-level budget approvals, lack of connectivity, lack of resource and expertise, and behavioral inertia.
It truly pays to ask what are the exogenous barriers that artificially limit value testing and access.
Today's fastest growing companies seek to optimize two core things:
1) friction free adoption and
2) hard "value per unit" analysis; such as price per click, price per CPU, price per seat.
Capital flows to the highest yielding assets.
Once economic actors are able to validate the "value per unit," the dollars will flow:
They are product delivery models that dramatically reduce the cost, time, and resource requirements to test products and their purported value.
The risk to trial is mitigated and individual users can experiment and validate value in isolation of the broader enterprise.
More than ever, companies that focus on reducing the risk and resources required to trial their product or service are outperforming "heavy" footprint product companies.
The capital markets are highly efficient and dollars quickly flow to the highest yielding assets. IT markets, however, are characterized by high degrees of friction that artificially limit capital reallocation and flow.
Typical IT frictions include: required asset requisitions, proprietary interfaces, multi-department decision making, multi-level budget approvals, lack of connectivity, lack of resource and expertise, and behavioral inertia.
It truly pays to ask what are the exogenous barriers that artificially limit value testing and access.
Today's fastest growing companies seek to optimize two core things:
1) friction free adoption and
2) hard "value per unit" analysis; such as price per click, price per CPU, price per seat.
Capital flows to the highest yielding assets.
Once economic actors are able to validate the "value per unit," the dollars will flow:
- at a rate proportional to the relative increase in yield (value/cost) from product A to product B and
- at a rate inversely proportionate to the number of barriers that limit the free flow of capital to product B (the higher the # of frictions, the slower the reallocation to the economically advantaged unit of value).
- market are efficient and capital flows to the highest yield assets
- products that provide a higher yield (value/cost) will attract capital
- ex. cost per action, cost per seat, cost per CPU
- product delivery models that reduce frictions will see faster capital allocation
- efficient product test, validation, and delivery mechanisms stimulate capital flows
- equity value creation is a function of the amount of total capital at risk and the rate of reallocation from one class of assets to the next
- ex. total capital at risk = total ad spend market
- ex. "value unit" = cost per sale
- ex. "yield" comparison = $100 sale/$2 cost per click= 50x vs $100 sale/$15 per telesales call = 6.66x, or 7.5x differential in yield
- ex. "friction" = JavaScript implementation of AdSense vs setting up telesales trial
- the targeted pool of capital
- the economic unit of value in question
- the differential in yield from model A to model B per given unit of value
- barriers to capital reallocation from model A to model B
- barriers that protect model B from replication
Monday, June 18, 2007
IRR Multiplication Table
The attached IRR Multiplication Table is a very useful reference tool.
The data table calculates IRR by years (x-axis) and multiple (y-axis).
Dan O'Keefe, who I worked with at Pequot Ventures is the brains behind the spreadsheet. I suggest printing it out and keeping it by your desk.
When you are on the phone you can impress your friends/boss by quickly reeling off the IRR on a 5x over 5 years (38%), 10x over 6 years (46.8%), 3x over 3 years (44.2%) etc.
Start-up Sales Management
My prior post provides a model for how to forecast revenue over the life of an operating plan. Another classic start-up conundrum is how to forecast revenue for this quarter.
Sales forecasting is a notoriously difficult problem and start-ups generally learn the hard way that sales meetings, prospect interest, and apparent momentum do not translate into purchase orders in any where near the time and speed one would hope.
Professional sales management forecasting techniques can help eliminate emotion and excitement ("We had such a good meeting, I know they are going to buy!") out of the process.
Missing a sales forecast really hurts no matter what size company you are. However, given that most start-ups are not profitable, missing a top line revenue number can have disastrous impacts on cash burn, employee morale ("we are working so hard and getting nowhere"), and shareholder confidence.
While there are many different models out there, I will share one with you that works well for the companies that I work with in conjunction with an investment in a CRM system, like Salesforce.
As a first time CEO or manager, a managing a sales pipeline by sales stage can improve forecast accuracy.
A key, however, is that the whole sales team buy into the process and be religious wrt its application. Top leaders must constantly evaluate where an opportunity is relative to the key sales milestones and if sales reps are realistically categorizing various opportunities.
Sample Pipeline by Sales Stage
Sales forecasting is a notoriously difficult problem and start-ups generally learn the hard way that sales meetings, prospect interest, and apparent momentum do not translate into purchase orders in any where near the time and speed one would hope.
Professional sales management forecasting techniques can help eliminate emotion and excitement ("We had such a good meeting, I know they are going to buy!") out of the process.
Missing a sales forecast really hurts no matter what size company you are. However, given that most start-ups are not profitable, missing a top line revenue number can have disastrous impacts on cash burn, employee morale ("we are working so hard and getting nowhere"), and shareholder confidence.
While there are many different models out there, I will share one with you that works well for the companies that I work with in conjunction with an investment in a CRM system, like Salesforce.
As a first time CEO or manager, a managing a sales pipeline by sales stage can improve forecast accuracy.
A key, however, is that the whole sales team buy into the process and be religious wrt its application. Top leaders must constantly evaluate where an opportunity is relative to the key sales milestones and if sales reps are realistically categorizing various opportunities.
Sample Pipeline by Sales Stage
- Prospect New (10% probability - telemarketing lead or tradeshow follow-up)
- Prospect Engaged (20% probability - webex, phone contact, early requirements discovery)
- Technical Evaluation (30% probability - demo/presentation completed, NDA executed)
- Budget Qualification (40% probability - major discovery requirements phase)
- Proposal Submitted (50% probability - confirm budget, test commitment)
- Technically Selected (60% probability - building ROI analysis with customer)
- Contract Negotiations (70% probability - reviewing proposals, technically selected)
- Getting Final Signatures (80% probability - selected, budget confirmed)
- In Purchasing (90% probability - waiting for fax to ring!)
- Closed (100% - purchase order in house!)
When forecasting revenue, try to match each sales engagement against the milestones/stages listed above. The forecast is then equal to the sum of the dollar weighted opportunities by stage.
Another key question is what is the required sales pipeline coverage ratio - ie divide the pipeline by the target and you get the coverage ratio...a typical rule of thumb is that you want $3-4 of pipeline for every $1 of targeted revenue.
The coverage ratio, sales cycle, conversion ratio of prospect to closed...all will help identify the required investment in lead generation/marketing necessary to hit the number.
If the coverage ratio is ~1, one can be sure the target will not be hit. Missed targets kill cash as gross and net burn become one in the same. It truly pays to forecast revenue in a disciplined and realistic manner, especially given the high cost of start-up capital.
While a rigorous process is not sufficient to hit the number, I believe it is a necessary condition to doing so in a predictable and repeatable manner.
Sunday, June 17, 2007
Forecasting Revenue
This post addresses a key question for start-ups, how do you model and forecast sales?
Please note that the technique below is best for enterprise-oriented companies rather than consumer Internet companies.
Forecasting Revenue
A key mistake start-ups make in raising money relates to how they model future revenues. This post explains a bottoms-up approach to forecasting revenue. My favorite bottoms-up forecasting method is the productive sales rep model.
In this model, future bookings are NOT a function of market share, size, and penetration rates ($500m market x .005 penetration, or $2.5m) but rather of how many mature sales reps are in the company and the expected sales rep quota and productivity.
A top-down approach is simply too hard to handicap and fails to ensure that a company matches an investment in sales resources with projected bookings and revenue.
First Model Bookings
Bookings = mature reps x quota per rep x productivity
Bookings = purchase orders
Mature reps = the number of reps with sufficient market and product experience to be effective (typically six months with the company)
Quota = bookings quota per year (typically $1-2m per rep in a start-up, and $2+m per rep in a mature company)
Productivity = percent of total quota achieved, on average, by the sales force
Therefore, for a start-up, with two mature reps entering the year, one rep joining in January, a $1.5m quota, and an expectation of 75% productivity, bookings would equal:
2.5 (mature reps) x $1.5m (quota) x 75% (average productivity as % of quota), or $2.8125m.
Then Assume Bookings Mix and Revenue Recognition Policy
To get to revenue, we then need to assume 1) a revenue recognition policy and 2) a bookings mix across license, maintenance, and professional services. This mix is typically 70% license, 15% maintenance, and 15% professional services.
Wrt revenue recognition, license revenue is recognized either at the time of sale for perpetual model or ratably for SaaS vendor, while maintenance and professional services revenues are recognized pro-rata over the course of the year/project. For example, assuming the bookings mix above a $1m purchase order (booking) on April 1 would contribute the following revenue in the year:
License revenues: $1m x 70%, or $700k
Maintenance revenues: $1m x 15% x 9/12, or $112.5k
Services revenues: $1m x 15% x 9/12, or $112.5k.
While there were $1m in bookings, revenues would be $925k, with the $75k difference on the balance sheet at year-end as deferred revenue.
The key issue is make sure that sales projections are tied to tangible investments in sales resources and are based on reasonable assumptions of sales rep productivity, time to maturity, and quota. Finally, think through how bookings translate to revenue. A sophisticated approach to the problem will go along way in gaining credibility with a prospective investor.
Please note that the technique below is best for enterprise-oriented companies rather than consumer Internet companies.
Forecasting Revenue
A key mistake start-ups make in raising money relates to how they model future revenues. This post explains a bottoms-up approach to forecasting revenue. My favorite bottoms-up forecasting method is the productive sales rep model.
In this model, future bookings are NOT a function of market share, size, and penetration rates ($500m market x .005 penetration, or $2.5m) but rather of how many mature sales reps are in the company and the expected sales rep quota and productivity.
A top-down approach is simply too hard to handicap and fails to ensure that a company matches an investment in sales resources with projected bookings and revenue.
First Model Bookings
Bookings = mature reps x quota per rep x productivity
Bookings = purchase orders
Mature reps = the number of reps with sufficient market and product experience to be effective (typically six months with the company)
Quota = bookings quota per year (typically $1-2m per rep in a start-up, and $2+m per rep in a mature company)
Productivity = percent of total quota achieved, on average, by the sales force
Therefore, for a start-up, with two mature reps entering the year, one rep joining in January, a $1.5m quota, and an expectation of 75% productivity, bookings would equal:
2.5 (mature reps) x $1.5m (quota) x 75% (average productivity as % of quota), or $2.8125m.
Then Assume Bookings Mix and Revenue Recognition Policy
To get to revenue, we then need to assume 1) a revenue recognition policy and 2) a bookings mix across license, maintenance, and professional services. This mix is typically 70% license, 15% maintenance, and 15% professional services.
Wrt revenue recognition, license revenue is recognized either at the time of sale for perpetual model or ratably for SaaS vendor, while maintenance and professional services revenues are recognized pro-rata over the course of the year/project. For example, assuming the bookings mix above a $1m purchase order (booking) on April 1 would contribute the following revenue in the year:
License revenues: $1m x 70%, or $700k
Maintenance revenues: $1m x 15% x 9/12, or $112.5k
Services revenues: $1m x 15% x 9/12, or $112.5k.
While there were $1m in bookings, revenues would be $925k, with the $75k difference on the balance sheet at year-end as deferred revenue.
The key issue is make sure that sales projections are tied to tangible investments in sales resources and are based on reasonable assumptions of sales rep productivity, time to maturity, and quota. Finally, think through how bookings translate to revenue. A sophisticated approach to the problem will go along way in gaining credibility with a prospective investor.
Friday, June 08, 2007
Reid Dennis
This week IBF held the 18th Venture Capital Investing Conference.
Reid Dennis, the founder of IVP, received a lifetime achievement award. His acceptance speech proved both educational and inspirational.
A few highlights follow:
I would argue that the impact of cuts in capital gains taxes, ERISA safeguards, etc on the health and vitality of the economy are similarly complex. It is hard to appreciate the link between capital gains tax policy, innovation's access to capital, and regulation on an economy's vitality. Yesterday's speeches by our industry leaders, however, warned of the peril of missing the connections and causality between policy and innovation.
Other speakers included Ed Glassmeyer, the founder of Oak Investment Partners. While he spoke eloquently on the history of Oak and the state of the industry, one story really stood out for me. It took him 4.5 years to raise Oak I.
The chance to see Dick Kramlich, Ed Glassmeyer, Gary Morgenthaler, Lip Bu Tan, Dixon Doll, Reid Dennis, etc recount history, discuss the state of the industry, and prognosticate on the future proved really inspiring.
Reid Dennis, the founder of IVP, received a lifetime achievement award. His acceptance speech proved both educational and inspirational.
A few highlights follow:
- Reid began investing in Silicon Valley start-ups in 1952, 55 years ago!
- His first job out of the GSB paid $425 per month
- In 1952, there were NO public electronic companies in Silicon Valley
- HP went public in 1957 and sold 10% of the company at the IPO for $4.8m dollars
- The first 25 electronics companies required total capital of $300k each and private individuals formed the basis of the early syndicates
- Reid founded IVA in 1974 and IVP in 1980
- Reid's firms, IVA and IVP, spawned many of today's top firms
- Redpoint spun out of IVP
- TVI spun out of IVA
- August and Benchmark spun out of TVI
- Reid played a key role in two pivotal moments in private equity history
- the 1978 reduction in the capital gains tax from 49.5% to 28%
- the 1978 change in ERISA laws that allowed pension funds to invest retirement funds in alternative assets
- in 1975, prior to the relaxation of ERISA laws, the entire VC industry raised $10m
- He spoke of the need to work with Washington to eliminate tax and regulatory disincentives that limit the free flow of capital to innovation and entrepreneurs
- With the "carry tax" under discussion in Congress, he warned the audience that the golden goose is at risk if today's industry leaders do not forcefully fight to protect the industry
"I think one difficulty is that the problem is one of such enormous complexity that the very mass of facts presented to the public by press and radio make it exceedingly difficult for the man in the street to reach a clear appraisement of the situation. It is virtually impossible at this distance to grasp at all the real significance of the situation."
I would argue that the impact of cuts in capital gains taxes, ERISA safeguards, etc on the health and vitality of the economy are similarly complex. It is hard to appreciate the link between capital gains tax policy, innovation's access to capital, and regulation on an economy's vitality. Yesterday's speeches by our industry leaders, however, warned of the peril of missing the connections and causality between policy and innovation.
Other speakers included Ed Glassmeyer, the founder of Oak Investment Partners. While he spoke eloquently on the history of Oak and the state of the industry, one story really stood out for me. It took him 4.5 years to raise Oak I.
The chance to see Dick Kramlich, Ed Glassmeyer, Gary Morgenthaler, Lip Bu Tan, Dixon Doll, Reid Dennis, etc recount history, discuss the state of the industry, and prognosticate on the future proved really inspiring.
Tuesday, May 29, 2007
Decision Making and the Venture Capital Process
I recently read a fascinating scientific paper by Anthony Bastardi and Eldar Shafir titled On the Pursuit and Misuse of Useless Information.
The paper's thesis is that decision makers often delay decisions to pursue additional noninstrumental information - information that a priori will not affect the decision at hand - yet then proceed to make use of the information, thus making it instrumental, once it is obtained.
The key issue for executives and venture capitalists is the following: one needs to determine what information may prove critical to the decision at hand, and, therefore is worth waiting for, and what information is unlikely to affect (and thus need not delay) the decision at hand.
The authors note that "people often arrive at a decision problem not with well-established preferences and clearly ranked preferences, but rather with the need to determine their preference as a result of having to decide, and they often look for additional information in hopes that it may facilitate the choice."
The venture capital process is a class example of this phenomena.
Investors often do not have a priori preferences with respect to an investment decision and need to determine their preference to fund a company and do indeed, as all entrepreneurs know well, seek additional information with which to make their decision.
The central issue is clearly identify which information is instrumental, "information that can alter what decision is made," versus which information is noninstrumental, "information which will not impact the decision at hand if it were available."
Given people like to obtain information and base their decisions on compelling reasons for one option versus another, research finds that, given the option, people will wait for noninstrumental information.
Worse yet, once the noninstrumental information is gathered, people alter their choice based on this noninstrumental information. The cost is not only delayed decision making but also poor decision making as noninstrumental information impacts the final choice.
The key take-away is that all of us, when making a decision, need to carefully think through what we absolutely need to know in order to make a good decision, rather than delaying decision making and leaning on the crutch of more time to gather non-essiential data that may contribute to a poorer decision.
The paper's thesis is that decision makers often delay decisions to pursue additional noninstrumental information - information that a priori will not affect the decision at hand - yet then proceed to make use of the information, thus making it instrumental, once it is obtained.
The key issue for executives and venture capitalists is the following: one needs to determine what information may prove critical to the decision at hand, and, therefore is worth waiting for, and what information is unlikely to affect (and thus need not delay) the decision at hand.
The authors note that "people often arrive at a decision problem not with well-established preferences and clearly ranked preferences, but rather with the need to determine their preference as a result of having to decide, and they often look for additional information in hopes that it may facilitate the choice."
The venture capital process is a class example of this phenomena.
Investors often do not have a priori preferences with respect to an investment decision and need to determine their preference to fund a company and do indeed, as all entrepreneurs know well, seek additional information with which to make their decision.
The central issue is clearly identify which information is instrumental, "information that can alter what decision is made," versus which information is noninstrumental, "information which will not impact the decision at hand if it were available."
Given people like to obtain information and base their decisions on compelling reasons for one option versus another, research finds that, given the option, people will wait for noninstrumental information.
Worse yet, once the noninstrumental information is gathered, people alter their choice based on this noninstrumental information. The cost is not only delayed decision making but also poor decision making as noninstrumental information impacts the final choice.
The key take-away is that all of us, when making a decision, need to carefully think through what we absolutely need to know in order to make a good decision, rather than delaying decision making and leaning on the crutch of more time to gather non-essiential data that may contribute to a poorer decision.
Thursday, May 24, 2007
Does Geography Matter?
In a world of high-speed data and voice networks, web-enabled applications, and a global talent pool, does geography matter?
Will technology break down traditional industry clusters and distribute innovation, wealth, and opportunity across an increasingly flat world?
As an investor and resident in the Valley, it is an important question.
Should company founders leverage the benefits of operating in a high-tech cluster and pay the cost premium of doing business here, or should they leverage the benefits of enabling technologies and remain in lower cost geographies?
The work of Michael Porter helps think through the issues. In his HBR article, "Clusters and the New Economics of Competition," he lays out a convincing argument for the long-term viability of clusters.
He defines clusters as,
His core thesis is that advantage in the global economy lies increasingly in local things - knowledge, relationships, and motivation.
Traditionally, competition centered on input-cost advantages - natural and human resources. Today, however, competition rests more on the productive use of inputs, which requires continual innovation. He writes, "modern competition depends on productivity, not on access to inputs or the scale of individual enterprises."
He defines the following characteristics of a cluster that accelerate productivity:
The most important insight for me is that the modern economy competes on innovation and that operating within a cluster shortens the cycle time to identifying, resourcing, and realizing areas of need and opportunity.
The genesis for this post was a conversation I had with two founders, currently based in Atlanta, about the merits of moving to the Bay Area to start their company. Michael Porter's thoughtful analysis helps me better understand why the Bay Area "cost premium" is well worth it. Market cap is a function of innovation and growth, and innovation is a function of access to ideas, talent, and supporting resources that eliminate frictions and catalyze connections and progress.
Ironically, in an increasingly globalized economy the Valley is gaining not waning in prominence. Boston is now the home to one large public tech company, EMC, and the valley takes close to 40% of total US VC, with CA taking well over 50%.
The key to our magic innovation machine is not to let government policy limit the free flow of talent, energy, and ideas into the cluster. It is incumbent on all beneficiaries of the Bay Area cluster to promote truly free labor markets that serve to fuel our unique productivity and innovation.
Will technology break down traditional industry clusters and distribute innovation, wealth, and opportunity across an increasingly flat world?
As an investor and resident in the Valley, it is an important question.
Should company founders leverage the benefits of operating in a high-tech cluster and pay the cost premium of doing business here, or should they leverage the benefits of enabling technologies and remain in lower cost geographies?
The work of Michael Porter helps think through the issues. In his HBR article, "Clusters and the New Economics of Competition," he lays out a convincing argument for the long-term viability of clusters.
He defines clusters as,
"geographic concentrations of interconnected companies and institutions in a particular field. Clusters encompass an array of linked industries and other entities important to competition. They include, for example, suppliers of specialized inputs such as components, machinery, and services, and providers of specialized infrastructure."
His core thesis is that advantage in the global economy lies increasingly in local things - knowledge, relationships, and motivation.
Traditionally, competition centered on input-cost advantages - natural and human resources. Today, however, competition rests more on the productive use of inputs, which requires continual innovation. He writes, "modern competition depends on productivity, not on access to inputs or the scale of individual enterprises."
He defines the following characteristics of a cluster that accelerate productivity:
- sourcing of information, technology, talent
- coordinating with related companies
- measuring and motivating improvement
- better access to employees and suppliers
- access to institutions and public goods (venture firms, lawyers, universities)
- complimentarities
- co-optition, cluster promote both competition and cooperation
The most important insight for me is that the modern economy competes on innovation and that operating within a cluster shortens the cycle time to identifying, resourcing, and realizing areas of need and opportunity.
The genesis for this post was a conversation I had with two founders, currently based in Atlanta, about the merits of moving to the Bay Area to start their company. Michael Porter's thoughtful analysis helps me better understand why the Bay Area "cost premium" is well worth it. Market cap is a function of innovation and growth, and innovation is a function of access to ideas, talent, and supporting resources that eliminate frictions and catalyze connections and progress.
Ironically, in an increasingly globalized economy the Valley is gaining not waning in prominence. Boston is now the home to one large public tech company, EMC, and the valley takes close to 40% of total US VC, with CA taking well over 50%.
The key to our magic innovation machine is not to let government policy limit the free flow of talent, energy, and ideas into the cluster. It is incumbent on all beneficiaries of the Bay Area cluster to promote truly free labor markets that serve to fuel our unique productivity and innovation.
Tuesday, May 22, 2007
Mulesource Raises Series B
Mulesource, the leading open source integration framework, announced today the successful close of a $12.5m Series B. Lightspeed led the deal, with return participation from the Series A leads, Hummer Winblad and Morgenthaler.
The raise reflects five important characteristics of the company:
- large target market - the integration market is roughly $8bn
- large pricing umbrella - incumbents' products sell for ~$90k/cpu
- very active developer community - hundreds of contributors
- mission critical use cases - high conversion rates from free to paid
- ramping customer acquisition and bookings
As I wrote in a prior post, the closer to a transaction the higher the open source conversion rates. Enterprise risk controls demand that software that touches critical to revenue/transaction systems be supported.
The attached graphic, forgive my graphics design skills, helps me think through the opportunity
- how large is area A, ie the degree of overlap between a project with an active developer community and a enterprise use case that is mission critical?
- how much headroom is there in area B, ie the pricing umbrella created by the incumbents' price points, TCO, and cost of sale and implementation
I would argue that Mulesource offers a very large overlap, represented by area A, with 10x price umbrella support, represented by area B in the above graphic. The financing, but more importantly the amazing developer, customer, and employee acquisition traction validates the premise.
Congratulations to the team.
Saturday, May 12, 2007
Concept to Company Event: Widgets to Riches -- Monetization Strategies for Emerging Web Services Platforms
On Tuesday, May 15th, VLAB and Hummer Winblad are co-hosting the following event:
Concept to Company Event: Widgets to Riches -- Monetization Strategies for Emerging Web Services Platforms
The event is scheduled for 6-8:30 pm at Stanford Business School.
This year's Concept-to-Company will focus on Widgetbox, the leading web widget marketplace and syndication platform. Widgetbox's CEO, Ed Anuff, will present an overview of the market and company.
Other speakers include:
Max Mancini, Senior Director of Platform and Innovation, eBay
Adam Sah, Architect, Google Gadgets, Google
Lance Tokuda, CEO and Founder, RockYou!
The above industry leading experts plan to explore how the widgetization of the web will impact the way we maximize the potential of online communication, efficiency, and revenue generation.
Text from the event host follows:
With the recent proliferation of widgets, widget companies entering the marketplace, and the atomization of content and services, what opportunities do entrepreneurs and VCs see as ways to capitalize on this current trend? Is there a profitable business model for the current trend of decoupling content and services from their source?
Concept to Company Event: Widgets to Riches -- Monetization Strategies for Emerging Web Services Platforms
The event is scheduled for 6-8:30 pm at Stanford Business School.
This year's Concept-to-Company will focus on Widgetbox, the leading web widget marketplace and syndication platform. Widgetbox's CEO, Ed Anuff, will present an overview of the market and company.
Other speakers include:
Max Mancini, Senior Director of Platform and Innovation, eBay
Adam Sah, Architect, Google Gadgets, Google
Lance Tokuda, CEO and Founder, RockYou!
The above industry leading experts plan to explore how the widgetization of the web will impact the way we maximize the potential of online communication, efficiency, and revenue generation.
Text from the event host follows:
With the recent proliferation of widgets, widget companies entering the marketplace, and the atomization of content and services, what opportunities do entrepreneurs and VCs see as ways to capitalize on this current trend? Is there a profitable business model for the current trend of decoupling content and services from their source?
Bauer's Second Law
In reading From Airline Reservations to Sonic the Hedgehog, A History Of the Software Industry, I came across a wonderful axiom.
Bauer's Second Law states that:
Bauer's Second Law states that:
Talent migrates from areas of well defined and stratified responsibility to areas of expanding activity at a rate proporational to the rate of expansion. Or, stated more simply, talent goes where the action is.
Today, the valley is witnessing an amazing migration of talent from Yahoo!, eBay, AOL, MSN, and other leading web properties to start-ups. The start-up economy is benefiting from Bauer's Second Law in action. The best and brightest Directors and VPs are leaving large cap web companies at a rate proportional to the resurgence of the start-up landscape.
A few years ago, with low rates of start-up expansion, start-ups struggled to attract large company talent. Today, those days are a memory and incredible teams are coming together very early in a company's life cycle. Bauer's axiom helps make sense of the trend and the key driver for the migration of talent towards high-growth vehicles.
Wednesday, May 09, 2007
Leaders as Weather Vanes
In the 70th anniversary edition of Forbes, I found a wonderful 1915 quote from Charles Mitchell, the President of National City Bank of NY (today's Citibank).
Mitchell said,
"The principal duty of the head of an organization in the formative, developing stage is to pump, pump, pump energy into every fiber of it, to train thoroughly every member of it, and to infuse into every employee white-heat enthusiasm."
Wise words.
A vital lesson for developing leaders is that leadership is a public act. The gestures, facial expressions, and postures of leaders project across the whole organization. Like a weather vane, the comportment of the leader is a viewed as a predictor of the future climate. Leaders must be sensitive that employees will seek answers to the state of the company, health of its prospects, etc in the physical countenance and tone of the leader.
As President Mitchell's quote implies, leaders are also conductors of energy and must be careful to inject vitality, passion, and drive into the culture and not apathy, malaise, and surrender.
90 years later, Mitchell's words of leaders "pump, pump, pumping energy into every fiber" of a business ring as true as ever.
Mitchell said,
"The principal duty of the head of an organization in the formative, developing stage is to pump, pump, pump energy into every fiber of it, to train thoroughly every member of it, and to infuse into every employee white-heat enthusiasm."
Wise words.
A vital lesson for developing leaders is that leadership is a public act. The gestures, facial expressions, and postures of leaders project across the whole organization. Like a weather vane, the comportment of the leader is a viewed as a predictor of the future climate. Leaders must be sensitive that employees will seek answers to the state of the company, health of its prospects, etc in the physical countenance and tone of the leader.
As President Mitchell's quote implies, leaders are also conductors of energy and must be careful to inject vitality, passion, and drive into the culture and not apathy, malaise, and surrender.
90 years later, Mitchell's words of leaders "pump, pump, pumping energy into every fiber" of a business ring as true as ever.
Monday, May 07, 2007
Hubpages: SEO and Dynamic Monetization Innovations
User-generated content is a key secular trend driving consumer behavior, Internet usage, and technology. The legs of the content stool are content creation, search engine optimization, monetization, syndication, and tracking/analytics.
For most small publishers, the process today involves bespoke integration of point solutions to allow for content to be easily created, served, monetized, and tracked. A typical blogger may use Typepad, Ad Sense, Feedburner, and Google Analytics. Not only are solutions stitched together via JavaScript, but also today's solutions fail to provide search engine optimization and dynamic monetization.
Given the Google is a vital source of traffic, it is very important that content appear in natural search results. Given domain aging, link analysis, etc., new sites suffer from very poor natural search placement and limited organic traffic.
Today, content creators need to pick an ad network and STATICALLY bind their content to a single monetization source and format. There is no way to ensure that the most effective ad unit, placement, color, ad network provider, etc. is used for any given piece of content.
Monetization, therefore, is clearly sub-optimized, while natural search results are hard to come by. The net result - very limited traffic and ineffective monetization.
Today, Hubpages, a Humwin company, announced a major upgrade to its self-publishing service. Hubpages provides an integrated content creation, SEO, ad yield optimization, and tracking solution that automatically ensures the best possible natural search results and the most optimal monetization programs.
Since launch in August 2006, Hubpages has enjoyed spectacular growth:
Abstracting SEO and ad optimization represents a vital breakthrough in freeing authors to focus on content creation and not on bespoke integration of a set of tools with a static tie to a single source of revenue.
For most small publishers, the process today involves bespoke integration of point solutions to allow for content to be easily created, served, monetized, and tracked. A typical blogger may use Typepad, Ad Sense, Feedburner, and Google Analytics. Not only are solutions stitched together via JavaScript, but also today's solutions fail to provide search engine optimization and dynamic monetization.
Given the Google is a vital source of traffic, it is very important that content appear in natural search results. Given domain aging, link analysis, etc., new sites suffer from very poor natural search placement and limited organic traffic.
Today, content creators need to pick an ad network and STATICALLY bind their content to a single monetization source and format. There is no way to ensure that the most effective ad unit, placement, color, ad network provider, etc. is used for any given piece of content.
Monetization, therefore, is clearly sub-optimized, while natural search results are hard to come by. The net result - very limited traffic and ineffective monetization.
Today, Hubpages, a Humwin company, announced a major upgrade to its self-publishing service. Hubpages provides an integrated content creation, SEO, ad yield optimization, and tracking solution that automatically ensures the best possible natural search results and the most optimal monetization programs.
Since launch in August 2006, Hubpages has enjoyed spectacular growth:
- traffic is growing 150%+ month over month, to 2.4m uniques and 6.2m page views
- 90% of the traffic is from organic search - ie SEO in action
- 43% increase in ad yields per page due to Hubpage's Behavioral Formatting Yield Optimization technology
- 20,000 hubs created and 14,000 authors on the system
- $1,800/month/top authors in income
Abstracting SEO and ad optimization represents a vital breakthrough in freeing authors to focus on content creation and not on bespoke integration of a set of tools with a static tie to a single source of revenue.
Monday, April 30, 2007
VC Returns through 12/31/06
Today, the NVCA released venture capital returns performance data through year-end 2006.The data suggest an early, if not yet sustained, recovery in venture performance.
While Keynes famously said, "In the long run, we are all dead;" retrospectively the long-term investment returns are excellent.
The key question is whether the current structural reality - i.e. # of funds, amount of committed capital - of the venture industry will support like returns over the next 10-20 years.
Returns are driven by two key components, systematic returns and idiosyncratic returns (see CAPM model). Systematic returns are market returns. Idiosyncratic returns, however, are where professional investors earn their stripes - they are returns in excess of the market.
To be a decent investor, one must at least deliver systematic returns. To be a great investor, one must deliver idiosyncratic returns. In the bubble, random investments looked genius. The systematic returns (returns for the asset category at large) were simply amazing, thereby creating great wealth and perhaps reputations for genius that were more due to circumstance and timing than investing prowess.
The questions for us to ponder is what will be the future systemic returns to the venture capital asset class, and has the inflow of money and people into the venture capital industry made it impossible to generate idiosyncratic returns. Are funds' returns systematic (an index of the market) or extraordinary? Will there be a Vanguard-like vc fund that is a low-fee provider of index funds for the private markets!? What is the basis for extraordinary performance over the market index? Is the success of vc investors and funds due to serendipity or to process?
These are key questions for investors (both general and limited partners). Can one deliver quality returns in an industry full of capital and people chasing "good" ideas?
One key difference between the public equity markets and the venture capital markets is the degree to which information is transparent. The public markets are by regulation open and transparent with data available to all.
The private markets are marked by imperfect information, proprietary insights, and information asymmetries. Certain private investors simply enjoy access to information, ideas, and talent that are not generally available to others. For example, certain leading firms leverage the footprint of their portfolio (talent, ideas, reach) to drive insights that lead to investments that others are not in a position to make. An obvious example, is Sequoia Capital's investment in Yahoo! and Google. With a BOD seat at YHOO, Mike Moritz enjoyed access to information relative to GOOG's search technology simply not available to others weighing the decision to invest in GOOG, presuming they even had the chance.
The question for venture capitalists may be as simple as, "what do I know that others don't?" With the corollary, yet vital question begging, "will I be smart enough and sufficiently certain of myself to act on such information?" For as Keynes famously once said, "Worldly wisdom teaches that it is better for reputation to fail conventionally than to succeed unconventionally."
If one knows nothing proprietary, has no unique relationships, access to ideas, and information, then life may be very challenging.
Saturday, April 28, 2007
Limiting H-1Bs: Economic Suicide
In a prior post, H1-B Aliens and the Myth of Free Labor Markets, I wrote,:
"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, Bulgarian 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 week's Economist includes an article titled Deportation Order.
Since 2003, the US government has reduced the number of H1-B visas by 66%; from 195,000 in 2003 to a measley 65,000 this year. Within hours of the application deadline, 150,000 applicants submitted visa requests; a frightening 85,000 on-time applicants lost out to a random number generator that selected the lucky winners.
The article quotes the Harvard Crimson commenting that "many of the foreigners in its class of 2007 have received their deportation orders."
The valley's position as the leading cluster for technology innonvation is contingent on the seamless flow of ideas, capital, and talent. Artifical limits on the ability to source talent will have profound downstream consequences, reducing the quality of innovation, wealth creation, and utility.
Friday, April 27, 2007
Large Companies - New Equation of Big Company Behavior
Start-up time is to dog years as enterprise time is to human years. Start-ups move 7x faster as the urgency of the next fund raising, competitive threat, cash position, etc... drive Herculean efforts.
A familiar start-up complaint is that the contrast in cadence (btwn small and nimble and big and slow) is incredibly frustrating. The time it takes to negotiate on OEM deal, partner with, sell to...large companies is often maddening.
Yesterday, over coffee with a great entrepreneur I heard the frustration summed up in a moment of brilliant wit.
The entrepreneur argued that:
an individual's competency x company size = a constant
In essence, the bigger the company, the less competent the people.
Now, we all know that there are many smart and hard-working people at large companies. There is, however, also a common malaise that somehow limits the ability of large companies to make decisions, to move quickly, and to be productive.
Many of my friends work at large tech companies and frequently complain of the siloed thinking, the blackbox decision making, the inability to make decisions, and the frustrating inability of the company to harness the collective energy and initiative of the group.
Why?
What is it about size that limits effectiveness? Why do people feel so powerless in large company settings and so frustrated?
While there many reasons, I see three core drivers
A familiar start-up complaint is that the contrast in cadence (btwn small and nimble and big and slow) is incredibly frustrating. The time it takes to negotiate on OEM deal, partner with, sell to...large companies is often maddening.
Yesterday, over coffee with a great entrepreneur I heard the frustration summed up in a moment of brilliant wit.
The entrepreneur argued that:
an individual's competency x company size = a constant
In essence, the bigger the company, the less competent the people.
Now, we all know that there are many smart and hard-working people at large companies. There is, however, also a common malaise that somehow limits the ability of large companies to make decisions, to move quickly, and to be productive.
Many of my friends work at large tech companies and frequently complain of the siloed thinking, the blackbox decision making, the inability to make decisions, and the frustrating inability of the company to harness the collective energy and initiative of the group.
Why?
What is it about size that limits effectiveness? Why do people feel so powerless in large company settings and so frustrated?
While there many reasons, I see three core drivers
- incentives
- the incremental compensation that accrues from initiative is not worth the risks and costs of fighting the corporate inertia
- politics
- a preponderance of energy is invested in internal battles
- companies and individuals have finite stocks of energy
- employees of large companies spend more energy on internal issues than on external customer facing and value-creating issues
- dead wood
- large companies become safe harbors for mediocrity
- middle management gluts the system and limits the ability of the young and the restless to advance
- the Wall St "up or out" culture ensures the young hard chargers always have room to advance and that seniority and tenure are no guarantee of protection
VC Interviewing Best Practices
VC firms hire infrequently. Given the slow cadence of new hires, it is critically important to hire well.
Two years ago, when I interviewed at Hummer Winblad, I went through the traditional in-person interviews where partners probed my educational, operating, technology, and investing background.
The last step in the hiring process, however, proved to be the most challenging and most rewarding. After having met all the partners, I received a call saying that things were looking good. There was one more step, however, that they wanted to me to pass. I remember thinking, okay...what now?
The request...come in two days from now and present your thoughts on the future of the software industry to the full partnership. The guidance...don't mess it up as things were looking good.
I presented the embedded deck to the HWVP team. Since then, I have been asked many times about the process of interviewing at venture firms and what to expect. I believe that a "best practice" is to give the candidate a platform to share their thoughts and analytical skills. One should be prepared to white board or present a deck that lays out an investment thesis, sample company of interest, etc; thereby providing a window into how you think.
The key point is not the deck itself, but rather a "candidate pitch" moves the process from conversation pleasantries to structured information exchange.
The file can be downloaded from here.
Two years ago, when I interviewed at Hummer Winblad, I went through the traditional in-person interviews where partners probed my educational, operating, technology, and investing background.
The last step in the hiring process, however, proved to be the most challenging and most rewarding. After having met all the partners, I received a call saying that things were looking good. There was one more step, however, that they wanted to me to pass. I remember thinking, okay...what now?
The request...come in two days from now and present your thoughts on the future of the software industry to the full partnership. The guidance...don't mess it up as things were looking good.
I presented the embedded deck to the HWVP team. Since then, I have been asked many times about the process of interviewing at venture firms and what to expect. I believe that a "best practice" is to give the candidate a platform to share their thoughts and analytical skills. One should be prepared to white board or present a deck that lays out an investment thesis, sample company of interest, etc; thereby providing a window into how you think.
The key point is not the deck itself, but rather a "candidate pitch" moves the process from conversation pleasantries to structured information exchange.
The file can be downloaded from here.
Monday, April 23, 2007
The Value of Scenario Planning
A standard part of the investment process is to identify a business model's key variables and to generate scenarios that test their impact on revenue and cash.
Sure signs of a thoughtful management team are:
- the ability of the management team to articulate the material business drivers in the model
- to test the impact of the variables on material financial metrics
- to sanity check the assumptions with market comps - i.e. not to base the business on a black swan outcome
- to focus the management team and company KPIs on the identified variables.
- the inclusion of scenario analyses in investor presentations
The attached example illustrates the value of data tables in analyzing
- the impact of CPM rates and
- revenue share on an ad network.
For example, the analysis illustrates that for the company to hit 2008 revenue
- at a $5 cpm, 20% revenue share
- the company needs to grow monthly impressions to
- 333.33m PVS/month
- 6.67x current traffic
- 56% of MSNBC's current monthly traffic
- However, at a $2 CPM and 10% revenue share
- the company needs to grow monthly impressions to
- 1.666bn PVS/month
- 33.33x current traffic
- 282% of MSNBC's tarffic
- Ie, the model begins to look precarious and "black swan-like, ie possible but highly improbable"
Monday, April 09, 2007
Board of Directors
Corporate America is intensely focused on corporate governance and on the duties of Directors. Whether CEO compensation, corporate performance, ethics, financial statement integrity... boards are increasingly subject to exacting standards and accountability.
Students of finance are familiar with the principal-agent dilemma; management, agents of the principals, often fail to act in the best interests of the principals, shareholders. The degree to which directors are truly independent speaks to their ability to ensure agents maximize shareholder and not agent wealth.
Warren Buffet believes there are four key requirements for board members:
How? Ownership is concentrated into the hands of a few firms who have direct board level representation. By definition, VC board members are owner-oriented and interested. Whether they are business savvy is subject to a case by case analysis, while independence is not possible.
The question for venture capital boards, therefore, centers not on how best to represent owners, but rather on how best to create a productive board that maximizes the probability for company success.
On Wednesday, I am speaking at the LA VC 2007 Investor Conference. My panel is focused on "Building Boards." Since, my specialty is early stage venture, my thoughts on an ideal board follow (modeled on Buffet's four criteria.)
For aspiring entrepreneurs, I would seek a board with the following characteristics
Students of finance are familiar with the principal-agent dilemma; management, agents of the principals, often fail to act in the best interests of the principals, shareholders. The degree to which directors are truly independent speaks to their ability to ensure agents maximize shareholder and not agent wealth.
Warren Buffet believes there are four key requirements for board members:
- owner-orientation
- business-savvy
- interest
- true independence
How? Ownership is concentrated into the hands of a few firms who have direct board level representation. By definition, VC board members are owner-oriented and interested. Whether they are business savvy is subject to a case by case analysis, while independence is not possible.
The question for venture capital boards, therefore, centers not on how best to represent owners, but rather on how best to create a productive board that maximizes the probability for company success.
On Wednesday, I am speaking at the LA VC 2007 Investor Conference. My panel is focused on "Building Boards." Since, my specialty is early stage venture, my thoughts on an ideal board follow (modeled on Buffet's four criteria.)
For aspiring entrepreneurs, I would seek a board with the following characteristics
- small and nimble
- 3-5 total directors (CEO, 1-2 VCs, 0-1 independent)
- start-ups are fast paced and iterative; often board issues are event driven and pre-scheduled meetings often fail to coincide with the natural cycle of progress
- being held hostage to scheduling logistics drives CEOs nuts and delays the time to decision and action
- economically aligned
- if the economic incentives of the board are different, consensus regarding financings, M&A events will become more complicated
- if people make money at very different exit outcomes...
- empowered
- ensure the VC board member is well established at their firm and has "juice."
- the start-up road is long and bumpy, VCs with limited internal power are often more proxies than decision makers and their limited internal power may unfairly taint the credibility of the company
- their political weakness will limit their ability to support the company in times of peril
- value-added
- VCs must be able to accelerate the cycle time to success and understand the business
- The best VCs truly understand the human, financial, and market dynamics of their companies
- effective CEO-board and director-director communication
- CEOs must share information - both good and bad
- Directors need to work well together in executive session issues: compensation, audit, financing and other core issues
- Failure to act quickly on compensation/bonus programs and other executive session issues impacts morale and limits the effectiveness of company management
- informed directors
- Early stage companies need to begin to track, measure and report on relevant and timely data. Good board packages make for good board meetings.
- This is normally an iterative process but data and KPIs enable informed decision making and analysis
- productive processes and meetings
- Develop well structured meetings with adequate frequency and cadence
- Focus the meetings on critical path issues
As companies grow, the size, make-up, and roles of the Board change with it. This post reflects my observations of the critical success factors for healthy, functionining Series A boards.
For a more in depth analysis, please read "The Basic Responsibilities of VC-Backed Company Directors."
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, Walmart.com, H&R Block, Fimat, MLB.com, 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.
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, Walmart.com, H&R Block, Fimat, MLB.com, 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, ABC.com 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:
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 abc.com site and watch full-screen video - who knew web video could look so good?
See prior posts here
24 is on the Web!
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, ABC.com 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:
- quality
- Move provides continuous play video with no buffering or jitter
- Improved quality ensures 8-10x longer viewing times
- increased revenue
- longer viewing times naturally create more ad avails and higher revenue
- reduced cost
- Move rides on HTTP and leverages the economics of commodity HTTP transport rather than proprietary RTP transport
- Flash Media Servers are materially more expensive than commodity web servers and web caches
- DRM
- Flash does not support DRM
- scale
- Move scales to an order of magnitude larger number of simultaneous streams
- Why? Move scales with the web not via deployments of proprietary media servers in CDN fabrics
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 abc.com site and watch full-screen video - who knew web video could look so good?
See prior posts here
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.
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:
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.
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
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:
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.
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.
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.
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:
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.
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 WSJ.com/reports for an excellent analysis of the topic above
Tuesday, February 27, 2007
Framing: Creating the Right Mental Impression
George Lakoff, a professor at Berkeley, is a renowned expert in cognitive linguistics. His particular expertise lies in applying linguistics to the study of public political debate.
His core thesis is that metaphors and concepts are the building blocks of thought and the mechanism by which we process reality. He says, "Our ordinary conceptual system, in terms of which we both think and act, is fundamentally metaphorical in nature."
In Lakoff's vernacular, we think in "frames." He writes," Every word, like elephant, evokes a frame, which can be an image or other kinds of knowledge. Elephants are large, have floppy ears and a trunk, and are associated with circuses, and so on. The word is defined relative to that frame." When I say "elephant," you cannot help but think of the characteristics noted above.
This is very important as it argues that every word we choose to use carries with it related associations, emotions, imagery, correlated ideas, values, etc. He argues that we can control the way people think and relate to our positions by the words we use and the frames (ie. related meta-associations) that we choose to employ.
In politics, he credits the Republicans with a mastery of framing - for example, the concept of "tax relief" implicitly suggests that taxes are a burden and any opposing position would be pro-tax and pro-burden.
Why is this important? How is it relevant to start-ups and the venture process?
VC is fundamentally a patter recognition and classification exercise. Every time you pitch a VC, they are, in real-time, classifying the company and opportunity into a master taxonomy. VC is an exercise in decision making by metaphor - this company is Salesforce.com for X, Youtube for Y. The evaluation process involves first classifying the opportunity into a conceptual bucket and then quickly associating the company with the attributes of the given bucket.
If you can indeed control the associations, both positive and negative, that are an inherently part of any frame, then it is vital that we choose our words very carefully. Entrepreneurs must carefully consider the frames and buckets they choose to use to describe their businesses recognizing that each chosen word carries with it either "positive" or "negative" connotations and baggage. It should be the goal of every CEO to ensure "positive" categorization.
In the VC lexicon, there are certain buckets that are minefields or "third rails." It is important to control the categorization exercise and preemptively "frame" the discussion in your favor.
Example "third rails" or "negative frames" can be either failed markets (ASP, P2P file sharing, egovernment), business models ($50m to break even), or team dynamics (husband and wife team, 15 founders, etc). These frames all evoke negative emotions, memories of capital loss, and a desire to quickly end the meeting.
When you describe your business, unconsciously the words you employ are raising a set of memories, emotions, inclinations...in the mind of your listener. Be mindful how best to control the reaction of your audience by anchoring off positive tailwinds, successful companies, and other anchors that ensure your name evokes a smile not a smirk.
His core thesis is that metaphors and concepts are the building blocks of thought and the mechanism by which we process reality. He says, "Our ordinary conceptual system, in terms of which we both think and act, is fundamentally metaphorical in nature."
In Lakoff's vernacular, we think in "frames." He writes," Every word, like elephant, evokes a frame, which can be an image or other kinds of knowledge. Elephants are large, have floppy ears and a trunk, and are associated with circuses, and so on. The word is defined relative to that frame." When I say "elephant," you cannot help but think of the characteristics noted above.
This is very important as it argues that every word we choose to use carries with it related associations, emotions, imagery, correlated ideas, values, etc. He argues that we can control the way people think and relate to our positions by the words we use and the frames (ie. related meta-associations) that we choose to employ.
In politics, he credits the Republicans with a mastery of framing - for example, the concept of "tax relief" implicitly suggests that taxes are a burden and any opposing position would be pro-tax and pro-burden.
Why is this important? How is it relevant to start-ups and the venture process?
VC is fundamentally a patter recognition and classification exercise. Every time you pitch a VC, they are, in real-time, classifying the company and opportunity into a master taxonomy. VC is an exercise in decision making by metaphor - this company is Salesforce.com for X, Youtube for Y. The evaluation process involves first classifying the opportunity into a conceptual bucket and then quickly associating the company with the attributes of the given bucket.
If you can indeed control the associations, both positive and negative, that are an inherently part of any frame, then it is vital that we choose our words very carefully. Entrepreneurs must carefully consider the frames and buckets they choose to use to describe their businesses recognizing that each chosen word carries with it either "positive" or "negative" connotations and baggage. It should be the goal of every CEO to ensure "positive" categorization.
In the VC lexicon, there are certain buckets that are minefields or "third rails." It is important to control the categorization exercise and preemptively "frame" the discussion in your favor.
Example "third rails" or "negative frames" can be either failed markets (ASP, P2P file sharing, egovernment), business models ($50m to break even), or team dynamics (husband and wife team, 15 founders, etc). These frames all evoke negative emotions, memories of capital loss, and a desire to quickly end the meeting.
When you describe your business, unconsciously the words you employ are raising a set of memories, emotions, inclinations...in the mind of your listener. Be mindful how best to control the reaction of your audience by anchoring off positive tailwinds, successful companies, and other anchors that ensure your name evokes a smile not a smirk.
Thursday, February 15, 2007
Isolating Causality: Bad Market or Bad Company
Cervantes famously once said that, "proverbs are short sentences drawn from long experience." In venture capital, one often hears industry veterans say something like, "bad markets make for bad investments."
The importance of the growth, health, and timing of a market to a start-up's postive outcome is both vital and well-known. Cliched and yet, as with many proverbs, true.
When a company is behind plan, an investor must ask is it the market or is it the company? A frequent challenge for an investor is to isolate causality in a given investment. Isolating market (exogenous) or company (endogenous) causality is vital with respect to the appropriate remedial action. If it is the market, there is little chance that more money or new management will change the outcome. If it is the company, additional resources (both capital and human) may indeed impact the outcome and be reasonable.
I have seen some of the smartest people work the longest hours, code round the clock, make the most sales calls, and reap no reward. When the market does not care about your solution, or, worse yet, does not exist, no amount of management talent, hard work, or capital can remedy the situation.
If the market is the challenge, additional investment is a dangerous example of escalation of commitment that will result in capital loss. Often the signals as to the health of the market are ambiguous - are the data points in question indicative of the market's development and health or more random and indeterminant?
I have observed several key indicators that help identify market failure and that suggest further investment is a challenge:
If the market is healthy, then there may in deed be logic in additional funding and new management. Understanding which of the two situations exists can help avoid unnecessary pain and capital loss.
All start-ups iterate their product and value proposition as they hone in on the eventual mission...the challenge is when to know if the challenges are part of the natural evolution or a symptom of operating in a market vacuum.
The importance of the growth, health, and timing of a market to a start-up's postive outcome is both vital and well-known. Cliched and yet, as with many proverbs, true.
When a company is behind plan, an investor must ask is it the market or is it the company? A frequent challenge for an investor is to isolate causality in a given investment. Isolating market (exogenous) or company (endogenous) causality is vital with respect to the appropriate remedial action. If it is the market, there is little chance that more money or new management will change the outcome. If it is the company, additional resources (both capital and human) may indeed impact the outcome and be reasonable.
I have seen some of the smartest people work the longest hours, code round the clock, make the most sales calls, and reap no reward. When the market does not care about your solution, or, worse yet, does not exist, no amount of management talent, hard work, or capital can remedy the situation.
If the market is the challenge, additional investment is a dangerous example of escalation of commitment that will result in capital loss. Often the signals as to the health of the market are ambiguous - are the data points in question indicative of the market's development and health or more random and indeterminant?
I have observed several key indicators that help identify market failure and that suggest further investment is a challenge:
- 3 VP sales...
- when the plan is missed, the favorite scape goat is the VP Sales.
- A single misfire may be legitimate, but every time that I have seen multiple VP Sales fired in a short amount of time the core problem is not sales management but the fact the market does not care nor exist.
- VP Sales turnover is a classic red herring.
- no competitors
- company's operating in non-existent markets are often unable to point to direct competitiors.
- While competitors may exist on the margin, the names vary from account to account and no clear enemy, or set of enemies, emerges. Lack of competition is a sure sign the market does not care.
- no RFPs
- no customers are soliciting the company and there is a dearth of inbound requests for proposals.
- no repeatability in customer deployments
- while good teams can generally get 2-3 customers, an early warning sign of a bad market is that there is no consistency in customer need, no common abstraction of use case, and no way to build a repeatable marketing, sales, and product positioning against a common set of needs.
- no partners
- companies in dead markets cannot explain where they sit in the market ecosystem and are characterized by no legitimate partner activity
- no energy
- the company culture begins to calcify and visitors can feel the lack of energy and nothing appears to change month to month - ie it's like groundhog day...
- no one knows what the company does
- companies that suffer from the above challenges are often the ones that cannot simply and clearly explain what they do. after 45-60 seconds of buzzwords, the listener is left bereft of any sense of clarity and their eyes begin to glaze over.
- when i first started in vc, i remember thinking..."wow, these guys are so smart, i have no idea what they just said." after a few years, i began to realize that if i have had no idea, then i could be damn sure the customers wouldn't either.
- thrashing
- the company begins to thrash, with constant changes to the positioning, core problem being solved, and the productand there is no longer a core mission or center of gravity
- tempers fray as the lack of common mission leads to each executive articulating their own and failing to agree on a direction
- companies that are in healthy markets close enough business to:
- develop a clear value proposition
- build repeatable marketing, sales, and delivery models around common uses cases
- know their top 2-3 competitors cold and see them in every account
- are solicited for business
- have real, active partners engaged in common customer accounts
- have highly energetic cultures where the changes month to month are signficant
- can explain what they do so that almost anyone can understand
- share a common mission that everyone in the company can articulate
If the market is healthy, then there may in deed be logic in additional funding and new management. Understanding which of the two situations exists can help avoid unnecessary pain and capital loss.
All start-ups iterate their product and value proposition as they hone in on the eventual mission...the challenge is when to know if the challenges are part of the natural evolution or a symptom of operating in a market vacuum.
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