blogger badge - get one today

Widgetbox is home to 43k+ widgets and counting. For all the bloggers out there we just released a blogger badge which I think many of you will find useful.

The blogger badge allows you to provide one click access from a widget to your profiles on:

• facebook
  
• linkedin
  
• twitter
• myspace
• digg
• stumbleupon
• flickr
• your blog
  
• etc
  

My version of the badge is below and is also now a default widget on the upper right of my blog.

Moving from Humwin to Widgetbox

I am pleased to report that, as of today, I have joined Widgetbox as CEO.

HWVP seeded Widgetbox in April of 2006, and I have steadily grown in confidence in the market, team, and opportunity. The company is an anchor tenant in the web widget marketplace and it will be fun to stay in touch with you all as I move onto a new and exciting chapter in life.

While my six years in venture provided amazing exposure to great teams, companies, and learning, I felt compelled to try my hand, once again, on the operating side. The confluence of my personal aspirations and the quality of the Widgetbox board, investors, team, and market made this an opportunity I could not afford to pass up.

If you have the interest and time, I covered my reasons for the move via a guest post on Techcrunch today.

For those of you who read my blog for insights into the venture business, thank you for reading and commenting on my thoughts to date. From today, the blog will focus on my transition to an operating role, the consumer Internet space, the world of web widgets, and my mistakes and learnings as I look to work with my colleagues at Widgetbox in building a great company.

It should be fun!

Why Blog....and Widgets

Entrepreneur Magazine has a fun article on blogging and how it helps VCs find deals.

Brad and I are interviewed - he found Feedburner through his blog and I am very pleased to have found YieldBuild. If you are wondering why we blog, not only is it fun, an incredible forum for learning, but it is also a wonderful vehicle for meeting new people.

Also, I did a podcast (my first one ever) on widgets for Businessweek.com. They recently ran a series of articles on widgets and my talk is part of their CEO Guide to Technology.

Magic Number for SaaS Companies

Guest post by Lars Leckie. Another great one and real food for thought.


Josh James, CEO of Omniture (a Hummer Winblad portfolio company), gave an inspiring talk on building a SaaS company last week at the Opsource summit. Josh walked through the history of Omniture as a case study for building a SaaS company. He talked about the need to invest in the company with a firm hand on the wheel as the recurring revenue slowly built up over time. He outlined the different stages of evolution of the company:

1) Product: build a rock solid product. Prove you can sell it as founders before moving past this step.

2) Sell: Sell like crazy, build out a team, hire some QBSRs (Quota Bearing Sales Reps)

3) Retention: focus on churn and retention issues, hire more QBSRs

4) Marketing: spend on marketing, hire more QBSRs

The next phases, not surprisingly, also included hiring more QBSRs but interestingly it is not until later that investments in efficient infrastructure and operations hit their ToDo lists. This outline displays a strong focus on finding a product market fit and then adding gas to the fire as the market opened up. The key metric that Omniture used to decide how much gas to pour on the fire was the Magic Number.

The Magic Number

The magic number ("MN") is a metric that can be used to tell you the health of your company from the perspective of growing monthly recurring revenue ("MRR"). It is a common mode metric to compare companies MRR scaled by sales and marketing spend. The MN provides insight into the effectiveness of previous quarter Sales and Marketing spend on MRR growth. Your MN will be penalized if the spend is wasted (bad marketing, bad sales execution), if your churn is high or if the market has issues (saturation, competitive forces). It also has a very high correlation with Q/Q growth rates so in general, high Magic Numbers are good.

To calculate:

QRev[X] = Quarterly Recurring Revenue for period X
QRev[X-1] = Quarterly Recurring Revenue for the period preceding X
ExpSM[X-1] = Total Sales and Marketing Expense for the period preceding X

Magic Number = (QRev[X] – Qrev[X-1])*4/ExpSM[X-1]

For example, consider a hypothetical company with the following financials
Q1 Q2 Q3
Revenue (recurring total) 1M 1.2M 1.5M
S&M Expense 800K 900K

Then the magic number is 1.0 for the end of Q2 and 1.33 for Q3.

Fundamentally, the key insight is that if you are below 0.75 then step back and look at your business, if you are above 0.75 then start pouring on the gas for growth because your business is primed to leverage spend into growth. If you are anywhere above 1.5 call me immediately.

Josh provided the following gas-pouring throttle chart for SaaS companies to evaluate how much to invest in their go-to-market spend. The data on the charts if from Omniture and other public SaaS companies.

Calculate yours…and get back to me if it is interesting! For fun and extra credit take a look at difference in Magic Number for some of the public SaaS companies like Omniture and SuccessFactors. I can be reached at lars@humwin.com

Eat Your Own Dogfood

Guest post by Hummer Winblad's Lars Leckie.....Lars drove our firm's investment in Aria Systems and, most recently, vKernel.

Last week Phil Wainewright wrote a great post (as he always does) called SaaS vendors, eat your own dogfood, or die. In the post, he describes how SaaS companies need to embrace the SaaS services available in the ecosystem.

I support the viewpoint from the post that SaaS companies need to have religion and leverage SaaS in everyway they can – further, I believe if they don’t they leave themselves open for other SaaS companies to disrupt them. From discussions with the infrastructure management of many leading SaaS companies I often hear how they are forced to use some on-premise pieces on the back-end reluctantly. This has provided the motivation for a few of our SaaS infrastructure investments (eg. Aria – SaaS billing and customer management).

Phil’s title had me thinking along another important vein for SaaS companies…literally to eat THEIR own dogfood and use their own product. For example, Salesforce aggressively uses Salesforce to manage prospects, Omniture eats their own analytics for online marketing, Teleo uses their own product for recruiting and SuccessFactors brags about their own talent management. Luckily we don’t all work for tobacco companies…

My belief is that SaaS companies must use their product for a few reasons:

1) Point of View: it puts everyone in the company in the seat of the customer. This means that the internal teams will live the same pain, the same experience and the same leverage that you are espousing as a vendor. This POV extends the advantages SaaS has of bringing the vendor closer to the customer by putting the customer in the office next door.

2) Analytics: By using your own product you will think about the product extensions and depth of how to apply the benefits of analytics to build stronger products and best practices. SaaS companies have a huge edge with analytics so it makes sense to use them internally as well.

3) Sales Roadblock: a fair question for a prospect to ask would be, “if your solution is so great, why aren’t you using it?" SaaS vendors can do their sales team a great favor by getting ahead of this question.

Any interesting SaaS companies that are using their own product and want to reach out – I’d love to hear from you. Please email me at Lars@humwin.com.

Embracing Uncertainty

I spent this morning with George Kembel, Director of Stanford University's d. school, and a d. school Fellow, Kerry O'Connor.

The Stanford Institute of Design is an inter-disciplinary school that brings together business school students, engineers, and social scientists into an integrative, iterative, and immersive process of discovery.

The process is integrative in that multiple voices of feasibility (engineering), viability (business), and usability (social science) are baked into the process. The process is iterative in that the teams use rapid prototyping and user testing to discover product/need fit. The process is immersive in that the team is placed in the environment of the targeted user to observe and listen.

The core idea is that innovation must be cross-functional, A/B test driven, and that products are shaped gradually over time through a process of feedback rather than declaratively and upfront. The philosophy holds that rather than fight amongst the team about what to do, solve the argument via data-driven tests that are designed to answer key unknowns.

This implies that the only "right" part of a plan that it is "wrong." Moreover, rather than be paralyzed by that fact, the best teams harness the voices of all key departments in the company, let the user guide them, and invest themselves in a process of data-driven, prototype-driven discovery that slowly peels away the "right" answer.

The competitive position of the company is anchored more on whether it is a learning organization - flexible, nimble, user-driven - rather than whether its founders enjoyed a single epiphany of genius.

With respect to venture capital, the implications are interesting. Most teams pitch three-year plans and product roadmaps. Like the book the Black Swan holds, the odds of the forecasts being right are nil - fundamentally, given the forecast error inherent in any plan, the investment decision should not lean heavily on the proposed plan.

Rather, as George and his colleagues would argue, perhaps the investment should be predicated on a defined user/customer target, a process and fluency with A/B testing and prototyping, an integrated team, and an openness to discovery rather than a priori certainty.

VKernel and Hummer Winblad Join forces on Virtualization Infrastructure

Guest post by Lars Leckie.

Hummer Winblad is pleased to welcome Alex Bakman and his VKernel team to the Hummer Winblad family. We are very excited for the opportunities ahead and look forward to working together. The recent press release and further details can be found here.

Enterprise IT environments are undergoing one of the biggest shifts in 25 years – shifts that have not been seen since the move from mainframes to client-server. Big shifts in infrastructure open up large gaps in the current management solutions. Virtualized environments provide many benefits to the enterprise from flexibility to lower TCO but along with that have introduced a few headaches too…

- “vmotion” – servers growing legs and dynamically moving
- “vm sprawl” – servers multiplying at unmanageable rates
- Shared resources – performance, monitoring, resource accounting, etc
- Cost visibility – no longer tied to physical resources

vKernel is a new platform for system management in enterprises that are embracing virtual infrastructure to power their businesses. Enterprises IT managers face increasing challenges as virtualization spreads within the datacenter. vKernel provides an essential suite of virtual appliances tailored to meet the virtualized datacenter including chargeback and capacity planning management. These appliances require zero installation, are quick to deploy and provide insights within minutes.

More information can be found on vKernel’s website and webinars – or download the latest virtual appliance to try it out today.

Hummer Winblad’s enthusiasm in virtualization is captured by our investment in vKernel as well as several other companies including Scalent and Akimbi (acquired by VMWare).

OnMedia NYC

I will be in NYC this week for the OnMedia NYC conference.

The conference looks like an interesting intersection of technologists, advertisers, and media companies. I will be speaking Wednesday on the OnMedia Venture Capital and Seed Financing Workshop - 10 am at the Lotus Suite.

Venture Capital and Angel Financing Workshop
Moderator: Sam Angus, Partner, Fenwick & West
Will Price, Managing Director, Hummer Winblad Venture Partners
Dan Beldy, Managing Director, Steamboat Ventures
Jed Simmons , Chief Operating Officer, co-founder, Next New Networks
Mark Stevens, Partner, Fenwick & West


While in NYC and at the conference, I would love to meet with any founders looking for their A round. Please ping me at wprice at humwin.com to set up a time to meet.

HWVP Portfolio Job Site

Hummer Winblad just added a portfolio company jobs section to our web site.

The site currently lists 161 jobs. If you are looking to join a great start-up, please peruse at your leisure:)

Downturn - Now What?

My first year in venture was 2002. The great bull run of the 1990s was over, the dot com movement had come to a crashing halt, and Silicon Valley settled into a year of retrenchment and reckoning.

I remember long and painful board meetings where companies decided on reductions in force, recapitalizations and investor wash outs, and the slow, painful realization that the company's infrastructure, employee base, and positioning had gotten way too far in front of economic realities.

Friends who had accepted start-up offers thinking that they would go to HP or Oracle if things did not work out suddenly found their start-ups shutting down and HP and Oracle closed to new hires. Valuations seemed absurd in retrospect, companies with no sales were sitting on $50m-100m post-money valuations, $30m of paid-in-capital, and absolutely no chance of raising money; save a complete restart. A collective "what were we thinking" rolled through the valley.

The venture industry, like the tech industry at large, slowed down to not only digest "problem" portfolio companies, but also out of fear that large enterprises were no longer buying start-up products. The industry put $100bn to work in 2001 and only ~$20bn in 2002. It is fair to say that it was a bloodbath and billions of dollars were written-off and hundreds of companies quietly shut down. Venture investors largely sat on their hands and net new deals were very few and very far between.

As we all read the economic news this month, key questions are begged....how should an economic downturn impact venture investors behavior?, are there lessons one can learn from the dot com bust that can be applied in the current housing and credit bust?, will a recession hurt our companies, perhaps fatally?

If I take the last downturn as my guide, I can say with confidence that venture investors would be well suited to continue to invest right through the downturn - in 2002 and 2003 terrific companies were formed and funded at very reasonable valuations and with business models that reflected the demand for capital efficiency and economic viability.

Like Occam's Razor, recessions whittle away unnecessary and non-value-added businesses and the capital, purchase order, and resource scarcity inherent in downturns forges companies of real substance and durability.

I do believe, however, that certain classes of company will find fund raising very challenging in this environment. The last few years saw the rise and success of "field of dreams" web companies - ie companies where the business model and economics were secondary to utility, usage, and adoption. Perhaps most famously, Twitter is exploding with the principals publicly downplaying the need to define a business model. As consumers, the innovation possible via a "field of dreams" approach is wonderful, as investors, however, the market's patience to "uncover" the economic model over time and to, in the meantime, fund continued expansion and adoption is a major risk factor.

The last downturn saw the valley swing violently away from consumers to the enterprise - bastions of value, hard ROI, tangible value propositions, enterprise pain points and budgets, etc became the mainstay of investment decisions and the consumer, I kid you not, was literally a bad word.

Partner meetings where an investor said, "I have a great deal - it is a consumer play with great adoption metrics and a plan to work out the business model over the next 18 months," were a recipe for total and outright ridicule.

The valley became all enterprise, all the time.

Now, today's companies can leverage low-cost infrastructure and an ad-market in a way that their predecessors never could. However, I believe the following will occur: new deal investing will slow, perhaps radically, the enterprise segment will regain some of its former glory, consumer companies looking for capital in the absence of working business models will find raising money next to impossible, and employees will be much more scrutinizing of the companies they elect to join.

However, history suggests that capital efficient companies solving well-characterized pain points will continue to be great investments. Valuations, input costs (labor, rent, services) will fall, and future returns will show that 2008 and 2009 were great years to do start-ups. Similarly, in early 2009, as the consumer start-up market finds itself cut off from funding, it will be pay to make bold and brave investments in the consumer space.

None of us can predict the markets or future valuations, we all, however, can understand fundamentals. Businesses that solve real pain points with disruptive technology, a huge value/price advantage, and a scalable business model will work - the kiss of death, however, will be getting the capital structure ahead of those very same fundamentals. Failure is often a function of too much capital and too high prices suddenly running into economic expectations that are materially reduced with respect to market size, market growth, and trading multiples.

To survive, one may indeed need capital. The trick is to stay lean and not to overfund and overvalue companies where the investment only "works" if it eventually trades at 8x revenue and never needs another round of funding.

It way well be that Slide raising $55m from mutual fund companies at $500m+ pre-money will be the "what were we thinking" moment of the current cycle. I think, however, the investor who leads a $4 on $4m Series A in a company with a differentiated technology and a direct tie to hard ROI will feel calm in the storm.

The Wadget Revolution - How Brands Can Harness Widgets

Tomorrow night (1/24) I will be moderating a panel titled "The Wadget Revolution" sponsored by the Bay Area Interactive Group.

The title, a play on widget and gadget, will address the widget revolution and how marketers can best take advantage of this emerging channel.

I expect a lively discussion on how brands can use widgets to reach consumers and how publishers can use widgets to monetize their content.

Please find details on the panel below.

The Wadget Revolution:

The event is at the St. Francis Hotel on Powell Street just off Union Square in downtown San Francisco. The Stockton Sutter parking garage is close by.

Abstract:
The digital channels are engaging. It's that simple. Engagement remains elusive as a singular dynamic, but seems more a catch-all descriptor/metric for a variety of mechanisms that deliver utility, information and entertainment to audiences in new ways. One of the "channels" within the broader digital mix that saw tremendous growth in '07 and really begins its sophomore year in 2008 is the "Wadget" (ok, we couldn't decide between Widget and Gadget, so we compromised). They seemed to come out of nowhere, or to be coming suddenly from everywhere and we all nodded our heads in approval (though many of us grabbed a friend and remarked "what the heck are these things anyway?". It's time to shed some light on this.

What are Wadgets, what do they do, who makes them, who uses them and most importantly, how do marketers harness the power of them are the questions we're going after at our next event on Jan 24.

We'll have some masters of Wadgetry talking about the phenomenon from their perspective and showing all of us how they concept, build, deploy, engage and SELL their Wadget genius…and then they'll take your questions, so come prepared.

The panelists are:
· Will Price – Hummer Winblad

· Donna Stokes – HP

· Heidi Henson – Rock You

· Ken Barbieri – Washington Post Newseek Interactive

· Kevin Barenblatt – Context Optional

Martin Plaehn's Quick Hits: Do's and Don'ts of Entrepreneurship

I spent last Thursday and Friday in Utah attending the University Venture Fund's Annual Conference.

The conference brought undergraduate and graduate students from around the country interested in entrepreneurship and venture capital to SLC for a two-day event. The speakers included Bill Price (co-founder of TPG), Brad Feld, and other noted investors and entrepreneurs.

A side benefit - the Sundance Film Festival started the night we arrived and Brad and I got a chance to the see the world premier of In Bruges.

One of the panelists was Martin Plaehn, a former HWVP company CEO and current CEO of Utah-based Bungee Labs. Martin is a very sharp guy and he passed around his list of start-up do's and dont's. I thought they were terrific and include them below.

Martin Plaehn’s Quick Hits: Do’s and Don’ts of Entrepreneurship

Do’s

1. Do ensure for yourself (as founder or chief) that you are addressing a real market and a sustainable one; where the exchange of value is transacted and measured in US currency
2. Do only hire for pre-identified expertise, operating need, and the energy to accomplish excellence; if you get more, great; don’t hire otherwise
3. Do always know your cash level, weekly cash spend and receipt rates, cash-runs-out date, and close-up liabilities amounts; start finding funding choices when you hit t-minus 6 months till operating cash runs out
4. Do money deals with money people (e.g. Angels, VC’s, banks, and credit unions); do product deals with product people (eg. Commercial companies); and do risk deals with risk people (e.g. Insurance companies). Don’t get these confused. If a product company wants to invest in your company, can they afford to take the whole thing? If not, then not.
5. Do ensure that at least one of your early formal investors has the financial wherewithal to keep investing in subsequent increasing rounds many years down the road; do make sure your different investors are really compatible
6. Do always accumulate choice; two by definition, three of four is better; then make decisions and have a back-up
7. Do let the stress of overload and/or capacity strain the triggers for expansion; demand flexing the edges of the system is usually the truest sign of real growth
8. Do track revenue and cost per employee; have trigger thresholds for when to add staff or subtract. Human efficiency and innovation is what creates value

Don’ts

1. Don’t hire of goodness of heart or friendship
2. Don’t hire anyone who you and your team are not genuinely excited about
3. Don’t tolerated mediocre engineers; for that matter, mediocre anyone. An early sign of mediocrity is when you downgrade tasks and expectations to align with an employee
4. Don’t count on your investors to take care of you when things get rough and/or protracted
5. Don’t over interpret or count on the stated operating “value-add” from investors during their solicitations during fundraising
6. Don’t build out your staff or infrastructure in expectation of rapid growth; be strong enough and tolerant of market back-pressure or order/service backlog
7. Don’t keep the same sales and marketing execs if the business isn’t growing or changing for growth; no sales and marketing VP was ever fired prematurely
8. Don’t over delegate to consultants, accountants, or lawyers; even the great ones are only as good as you are as an engaged client; read and understand everything; if left alone, you must have a point of view, right or wrong


Thanks to the students at BYU, Univ of Utah, and from around the country who worked hard to make the event a real success.

Subprime failure and Prediction markets

What do the subprime meltdown and Iraq have in common?

Massive failure due to forecast errors.

I have written in prior posts about my respect for Nassim Taleb's book Black Swan, which speaks to the enduring inability of humans to recognize the fallibility of forecasts and linear thinking.

With respect to the subprime mess, Merrill Lynch, Morgan Stanley, and Citibank, alone, have announced $36+bn in write-downs to date. The most technically advanced companies in the country failed to live up to their raison d'etre: to price and manage risk.

Their failure is a powerful reminder that sophisticated business processes, risk management models, and management teams are no panacea if the assumptions that architect their systems are wrong.

For example, risk management is based on the premise that events in financial markets exhibit normal/Gaussian distributions. Value-at-risk models calculate the maximum loss not exceeded with a given probability/confidence interval over a given period of time. For example, the risk manager will report that with a 95% confidence the maximum capital at risk is $x. The losses in the financial sector are a powerful reminder of how rare events blow up the models and with them the business processes, risk controls, and balance sheets of their creators.

In supply chains, forecast errors compound across the supply chain in a phenomena known as the bullwhip effect resulting in excess inventory and a costly failure to match supply with demand.

Examples of forecast errors are legion - product ship dates, sales forecasts, demand forecasts, value-at-risk models, elections, stock price predictions, etc. A common remedy to forecast errors is to increase the liquidity of guesses - the greater the number of independent predictions the more accurate, in aggregate, the final prediction.

We can see this phenomena in today's social web - the web is rewriting the rule book on how we program content- rather than a top-down, command economy approach, where programmers decide what we should read, watch, and discuss - users are leverage social media sites to "reprogram" content. Communities, like liquid markets, vote with their time, comments, and clicks and the best of the web gets pushed to the top. Innovative companies are leveraging the wisdom of the community to ensure a better match between supply and demand.

So, where am I going with this post? Prediction markets are nascent business tools that allow employees to buy or sell certain business events - probability of product shipping on time, unit volumes to ship in the quarter, annual bookings, prioritizing new business ideas - and thereby allow their employers to improve the quality of information factored into predictions. The formal chain of command is infamous for distorting and hiding information - it is no wonder that CEOs are flying blind...their business systems are based on flawed models and their teams are incapable of accurately reporting the true state of affairs. Chinese whispers corrupts information moving up the chain and smart people are stuck making decisions with bad, misleading data.

We will never be able to predict the future, however, all of us should consider how we can open up our decision making processes to allow for non-biased, comprehensive input that allows the wisdom of our organizations to weigh in on key decisions - better inputs enable better capital and resource allocation decisions and can help avoid disaster.

While prediction markets are much less complex than advanced prediction algorithms, in the spirit of less is more, the front line sales people, developers, mortgage loan officers, etc will always have better information than the central corporate staff. What seems to be failing corporate America is an open framework for capturing that knowledge in a non-biased, confidential manner.

For centuries soldiers have complained that the central staff had no idea what was happening on the ground - the science, tools, and applications, however, exist today that allows for the harvesting of the collective wisdom of the group.

I predict, yes am I aware of the irony, that in 2008 corporate American will come to adopt one of the mainstays of web 2.0 - ie applications that leverage the tacit or explicit wisdom of a community. Prediction markets are needed to help unlock the tacit knowledge of organizations and to lessen the colossal forecast errors now reverberating through our economy.

Content Community on Innovation, Start-ups, and Venture Capital

I write to invite readers of this blog to join the Innovation, Startups, and Venture Capital content community powered by Corank.

The site is dedicated to sharing ideas, books, best practices, news, etc on entrepreneurship, venture capital, and new company formation.

To join Corank, click here. To add the RSS feed, click here. To add a Firefox bookmarklet to post articles to the community, click here.

I hope that this site fosters the sharing of ideas that will help all of us. Please do join and share content that matters to you.

A widget of the current top content stories follows:

New Deal Checklist

Pilots, no matter how many flying hours they have, never take off without checking their pre-flight checklist. The risks of oversight, missing a mechanical or procedural failure, etc are too severe not to ensure all systems are go.

I put together an analog to the pre-flight checklist - a new deal checklist - that I hope will similarly help avoid losses due to "pilot error."

In the spirit of transparency, please see my list below and let me know if you think I am missing any core issues.

1. Can I understand the business?
1. what is the product?
2. what is the value?
3. who is the buyer and why would they buy?
4. can the buyer quantify the value? If so, what unit?
2. Is the market attractive?
1. Growth rates?
2. Profitability?
3. Is there a fundamental disruption that is the basis for the opportunity and limits the incubments' competitive repsonse?
1. Market --> SaaS, Open Source
2. Product --> core innovation
4. Is the product delivered in a buyer appropriate way?
1. open source for infrastructure
2. SaaS for a business app buyer
3. REST/SOAP/JavaScript for a web service
5. Is the core value tied to a technical innovation?
1. ex. HWVP's portfolio company examples = Baynote's collective intelligence algorithms and Move Networks' streaming protocols
6. Are their frictions in....?
1. time and resources required to test the value proposition?
2. time and resources required to deploy?
3. time and risk to realize value?
7. Is there a good market comparable for both the business model and the exit multiple?
8. What unit scales the revenue model?
1. page views, sales heads, downloads, sessions?
9. Is the architecture scalable and does it leverage the best available infrastructure - EC2, S3, Rackspace, etc?
   
10. Are there exogenous dependencies?
1. carrier or MSO deals?
2. RFID deployments, etc?
11. Is there a market master?
1. WMT or MSFT or Dell....
2. Who is the incumbent? How will they react?
12. Who are the other new companies in the space?
13. Is the team able and honest?
1. Prior track record of working together?
14. Is the CEO special?
1. What is his/her motivation, passion, strength?
2. Where do they need help and complement?
15. Are the round size and pre-money reasonable?
16. Is the model reasonable (profit margins, growth, burn)?
17. Is the plan capital efficient?
1. how much money for 18 months?
2. margin of safety?
3. are their clear milestones in the plan that will allow for an objective assessment of value creation - ie a new investor
   
18. Can this be a homerun?
19. What are the core risks?
1. why will the company fail? is their a plan in place to mitigate such risks?
   
20. What are the KPIs - ie leading indicators to measure and track the company's progress?
    
21. Is the cap table clean and the paid-in capital reasonable?
1. Is the progress to date commensurate with the money in?
2. Has the money in to date been productive?
   

While I am sure there are risk and questions not raised above, the goal is to systematically measure a prospect against a consistent analytical framework that, hopefully, ensures smooth take-offs, flights, and landings.

How to Handle Tough Questions

I just finished a book that should be on the reading list of all entrepreneurs, In the Line of Fire, How to Answer Tough Questions When It Counts by Jerry Weissman.

Jerry is a well-known corporate presentations coach and is frequently brought in to help CEOs prepare for their IPO roadshow. The book builds on his first one, Presenting to Win, and is terrific.

Having given and sat through countless presentations, it is often not the subject matter of the presentation but the ability of the presenter to cogently respond to questions and concerns that wins the day. The book's aim is "not so much to show you how to respond with the right answers as it is to show you how to establish a positive perception with your audiences by giving them the confidence that you can manage adversity, stay the course, and stay in control."

There are three classic flawed responses to questions that will haunt the presenter: defensiveness, evasiveness, and contentiousness. The book provides examples of Trent Lott and Ross Perot that bring the damage of these reactions home. After team's present, it is often commented that the CEO seemed evasive, did not address the question, became combative, etc...all reactions that doom the pitch.

Here are some of his suggestions:

1. actively listen to your questioner - do not rush to answer the question, instead make sure your body and mind are concentrating and listening to the question
2. identify the key issue at the heart of the question - questions may drag on and ramble, it is your job to work out the key concept driving the questioner's concern - is it market size, competition, pricing model, technology, team dynamics, location....
3. paraphrase the question to confirm that you understand the key issue being raised
4. do not answer until you see visual affirmation that the key issue you paraphrased is in fact the questioner's issue
   
5. answer all questions with care and confidence - there are no irrelevant questions
6. anticipate and recognize the universal issues - management - do you have the right people? is your team complete, competition - how will you meet and beat the competition, market - how big is the market, business model - sales, delivery, and pricing model, contingencies, timing, problems, intellectual property....
7. know your Point B - the audience starts the meeting at Point A, Point B is where you want them to get to - what is your goal
8. speak to WIIFY - or what's in it for you - people need a reason to act and it must be their reason, not yours
9. prepare and practice
10. be agile and respond thoughtfully to questions
    
11. never lose control - be slow to answer and slower to anger

Weissman mentored CSCO, YHOO, INTU, MSFT, and many others through their presentations and q&a preparation. The book needs to be on your shelf and the models skills in your arsenal.

Panel: Will the VC Market Decline in 2008

I am on an Under the Radar Panel tonight titled: Will VC Market Decline in 08?

This is also the time of year for "what will be hot or not" forecasts. In preparing for the panel, the following jumped out at me.

VC Market
The VC market is already showing signs of decline. How so? In 2006, venture funds raised $24.7bn from limited partners. In the first half of 2007, the fund raising number is $6.4bn, or $12.8bn annualized. $12.8bn represents a -48% decrease in capital invested in the asset class. Moreover, q106 saw LPs invest $8.5bn, while in q107 the number was $3.1bn, or a -63% decline.

What is going on here? See my post on Venture Capital and Emerging Managers for a more detailed answer, however, I believe that LPs are now wise to the Pareto distribution in industry returns, ie less than 20% of the firms drive 80% of the returns. If you cannot get allocation to the top firms, then get out of the asset class.

A few other stats to share: California is consistently taking 40+% of total VC dollars in the US, with the Bay Area taking 30+%. New England, a story of faded glory, now represents only 11%. Other, ie non-TX, CA, New England, NY, is 27%.

To paraphrase, while the world may be flat, it seems that there are two network effects taking place in the industry - 1) the top firms are taking more and more of the returns and, in turn, LP dollars, and 2) the Bay Area is enjoying a virtuous circle of innovation, wealth creation, talent acquisition, large company exits, repeat cycle that is seeing the region take a disproportionate amount of venture and exit dollars. The Bay Area appears ascendant and there are real ecosystem and systematic variables that suggest it will continue to be so.

Moreover, while total dollars into the industry may be falling, as capital leaves the combination of less money chasing deals plus strong fundamentals will result in not a decline in average returns but a rise. Yes, LPs are cutting back allocation, ironically, the top firms in the industry may be on the cusp of great results.

Am I bullish for 2008?
Yes. Why?
1) utility computing is real - cost per computing cycle and cost per gigabyte are no longer stuff of IBM and Sun marketing bs. Start-ups can now leverage the infrastructure assets and operating scale of AMZN, CRM, MSFT, and Google to grow their businesses where costs are now variable and not fixed. The cost of innovation, in essence, is plummeting with respect to non-differentiated infrastructure and there is no longer a need for expensive, bespoke infra build outs that suck dollars without adding customer utility.
2) performance based marketing is real - an economic downturn will accelerate marketing spend on high ROI and performance based ad units. In a consumer spending slowdown, brand advertising, whose value if hard to quantify, will get hammered and the reallocation of dollars from off line to online will accelerate - ie I think CPX Internet advertising will prove counter-cyclical because it is measurable and the spend can be tied directly to leads, orders, and revenue.
3) personal link analysis is real - while google monetized page rank, new companies are emerging to monetize person rank. Social networking will drive derivative investments of value - social networking analysis will become a mainstream marketing practice - ie rather than look at consumers as independent members of a market segment, marketers will now be able to analyze who you know, who matters to you and if they influence you, how well you know them, what groups you belong to, and word of mouth marketing campaigns that target "influencers" in given communities will outperform traditional direct marketing. I just looked at a company with powerful tools in this area - they are able to deconstruct a 3m member community into 17m discrete connections between members and over 300,000 discrete groups - by identifying the key "influencers" and "connecters" in each group, marketers will be better able to launch new products, drive product diffusion, and capitalize on the myriad of connections that now exits between us all, of which we seem to add 5-10 per day.

The lower costs of funding innovation, the speed by which products are diffused in a connected world, the virality possible in mining social networking and exploiting them, and the continued allocation of marketing dollars to performance based ad units should make 2008 one to remember despite the message of the video below - however, amusing it might be.

Confirmation Bias

My first blog post on May 12, 2005 reviewed Nassim Nicholas Taleb's wonderful book, Fooled by Randomness.

I am currently reading his second, The Black Swan, the Impact of the Highly Improbable.

The first book centers on the "hidden role of chance in life and in the markets." As an investor, it is particularly apropos as one tries to identify systematic methods of creating value via investing. Investors and investees like to believe that the investment world is deterministic with clearly understood cause and effect. Understanding causal drivers of value helps to create repeatable models for investment that scale both across time and individuals in the firm. Nassim challenges us to be very careful in over ascribing reason and logic to an outcome. Too often, investment outcomes are the result of randomness rather than science, ie being lucky rather than good.

The second book posits that we expect the world to operate within very narrow bands of probability and tend to discount the possibility of extreme events, or black swans. For example, Wall St uses Value At Risk models that analyze capital at risk with a 95% confidence interval - the models, based on Monte Carlo simulations, create a range of statistically probable outcomes. The savings and loan debacle, the current subprime mortgage mess, Long Term Capital, etc illustrate the fallacy of discounting the highly unlikely.

The book also introduces a key concept that with real application for venture capital - confirmation bias. He writes, "cognitive scientists have studied our natural tendency to look only for corroboration; they call this vulnerability to the corroboration error the confirmation bias." Due diligence is the process by which investors analyze and evaluate investment opportunities. Too often, however, diligence is confirmatory in nature. As Taleb notes, "...subjects supplied mostly questions for which a "yes" answer would support the hypothesis. Disconfirming instances are far more powerful in establishing truth. Yet we tend to not be aware of this property. A series of corroborative facts is not necessarily evidence. We can get closer to the truth by negative instances, not by verification."

In my experience, investors often look for corroboration at the cost of negative empiricism - ie at the cost of looking for non-confirming evidence. Such evidence in itself may not argue against the deal, it will, however, help avoid Pollyannish projections based more on hope than on truth.

Panel on Investing in Innovation

Last night, I spoke on a SVOD panel discussing investing in innovation.

Invitations to speak always spark new ideas and new frameworks for trying to cogently boil down large and complex ideas into a few key ideas.

The topic of the panel and this post provided a framework for thinking about the issues.

For example, innovation is the science of new possibilities. Investing in innovation, however, centers on the science of consumption.

Innovation in a vacuum leads to failure and the commercialization of innovation is predicated on a ready ecosystem in place to enable the development, delivery, and sale of a product.

Consumption, in the broadest sense, demands the marriage of science with application.

A useful framework for tying technical innovation to consumption follows:

Commercial Success = Customer Need x Offering Innovation x Sales and Delivery Model x Ecosystem Development x Risk-adjusted Return

Customer Need = a clear view of the buyer's problem, identity, motivations, and resources

Offering Innovation = a material, rather than marginal improvement in the state of the art

Sales and Delivery Model = a distribution model that aligns product-market fit and, like Occam's razor, reduces any unnecessary frictions from the buying process

Ecosystem Development = no material exogenous market developments are required for the company to be successful. Rather, the ecosystem is ripe to support the innovation.

• For example, wimax deployments, RFID reader deployment, etc.
  
• Also, like Newton's "on the shoulder of giants," all start-ups require a foundation of enabling conditions to truly be successful. Understanding the cornerstones of the opportunity and how to leverage them is key to commercialization.
  
• Also, innovation is largely symbiotic. Bill Joy's quote, "innovation happens elsewhere" is important to keep in mind as product design should benefit from the innovation of others rather than solely on the company's employees.

Risk-Adjusted Return = ROI alone is not sufficient to motivate customer behavior.

• Like any investor, return must be analyzed with risk and customers, like investors, will seek to maximize their Sharpe Ratios, or return divided by standard deviation.
  
• Many start-ups fail to realize the vendor, operational, and product risks they are asking customers to take on. Selling absolute return independent of the risk ignores a major component of customers' product selection. Be conscious of inadvertently creating risk and manage risk out of the sales and deployment model.

The panel agreed that a holistic approach to investing in innovation is required. The maturity of a team's plan depends on moving from the art of what is possible to the science of what is most efficiently consumable.

Top Dealmaker List

AlwaysOn, in partnership with KPMG, just released their inaugural Top Dealmakers List.

The lists include the top LPs, early stage firms, late stage firms, corporate vcs, law firms, investment banks, etc...

As Letterman knows, everyone loves a list. Worth a quick read.