Musings of a VC in NYC

Doubling Down On The Overpay

One thing I've seen many VCs do wiith their initial investment in a company is invest more when the valuation gets expensive. They are ownership driven, not valuation driven. So if they originally wanted to invest $4mm at a $20mm post money valuation and buy 20% of the company, they talk themselves into investing $8mm at a $40mm post money valuation so they can still buy 20% of the company.

I have never liked this approach. When the price of an initial investment goes up, I prefer to invest less, or nothing at all. Investing nothing at all is a fairly obvious approach when the price gets beyond your comfort zone. Investing less is not as obvious.

My rationale for investing less has to do with the fact that most venture investments involve multiple rounds. If you believe there will be additional opportunities to invest in the company and you really want to be involved, then you can invest less and reserve more funds to invest later in hopes that the risk reward of the investment improves. Since you will be an investor in the company, you will be shown those opportunities before or at least alongside new investors in future rounds.

Investing more when the price is too high makes no sense to me. If you are overpaying by 2x, doubling down feels like overpaying by 4x.

I think the root of this "doubling down on the overpay" issue is that many VCs manage large funds of other people's money and they really don't care so much about how much they invest in each deal. They are looking to buy large stakes in companies and hope that one or more turns into a big winner.

I try to invest as if I have a fixed amount of capital and it is my own capital (some of it is). I like to think that every investment we make takes funds away from other investments we can make, even though this is not actually true. Our firm could raise more money if we wanted it and needed it. But I think raising larger funds will ultimately lower the returns we can deliver to our investors and we have resisted doing that.

So instead of being ownership focused, I prefer to be valuation focused. And the key figure I look at is average valuation of our entire investment. We take the total amount of capital we have invested in a company and divide it by our total ownership. We like that number to be as low as possible relative to the current value of the business. I believe that is the recipe for the best returns and that is what we seek to deliver to our investors.

A Fun Talk This Morning

I met Scott Kurnit in the mid 90s when I had just started Flatiron Partners with Jerry. He pitched me on the Mining Company. I passed on it. We stayed friends and have both regretted that decision for the past fifteen years. Mining Company went on to become About.com which went public, was sold not once but twice, and has produced many amazing entrepreneurs and manager alums in the NYC tech scene.

It's fun to think back to those days in 1995 and 1996 when there were so few people working in NYC tech and we had an inkling of what was going to happen. It did happen and NYC is a different place as a result.

This morning at 8:20am eastern I am going to talk to Scott for about 40 minutes at the Paley Center and it will be broadcast live on this URL.

Just think about that last bit "broadcasting live from the Paley Center on this URL." That says it all. I hope you can log on and join us. It should be fun.

UPDATE:

It was fun. Here's the video. Also, William provided some cliff notes in the comments.

paleycenter on livestream.com. Broadcast Live Free

In Search Of Open Internet Access

Our regular programming, MBA Mondays, is being interrupted this week for a public service announcement.

The net neutrality debate is front and center again. FCC Chairman Julius Genachowski has announced that he will ask the FCC to adopt rules to protect the open Internet at its open meeting on December 21st. We have not seen these rules. Apparently nobody has outside the FCC. But we have been briefed on them. And we think that with one small tweak they will work well. But without that small tweak, they are problematic. My partner Brad has posted our firm's thoughts on the USV blog.

Back in the 80s and 90s, you could start, build, and invest in cable based services. But in order to get your new company distribution on the cable system, you'd have to go to the cable MSOs and give them free equity in your company for distribution. This mafia style shakedown has not existed on the Internet thank god. And the result is literally millions of web services and trillions of dollars of shareholder value.

That's what this debate is all about. The advent of broadband internet access has resulted in a duopoly in most markets. And the companies that provide you broadband internet access want the ability to "manage their networks." We think it is critically important to set some rules on how they can manage their networks to make sure we don't recreate the cable monopoly on the Internet.

We'd love to have an open and unregulated Internet access market. That will take a lot more competition in the last mile than we have now. We need policies that allow the spectrum and fiber to the home to become available and the capital to get invested in making that happen. Until that happens, we need some rules to keep everyone honest in the Internet acccess market.

The FCC's proposed rules prohibit unreasonable discrimination but don't define what that is. We think they need to go that extra mile so that startups don't end up in expensive lawsuits with monoplies with huge bank accounts.

And we are proposing that the FCC adopts the following language:

A non-discrimination rule that bans all application-specific discrimination (i.e. discrimination based on applications or classes of applications), but allows application-agnostic discrimination.

The logic and reasons behind this approach are laid out in our blog post on the USV blog. If you are interested in this debate, and we think you should be, please go read it.

Related articles

• Internet Access Should Be Application-Agnostic (unionsquareventures.com)
• Gigi Sohn: The Fight for Net Neutrality Begins (huffingtonpost.com)
• FCC Prepares to Vote on Net Neutrality (readwriteweb.com)
• Julius Genachowski: Preserving a Free and Open Internet (huffingtonpost.com)

The Present and The Future (continued)

It's the theme of the weekend. What looks great today may suck tomorrow.

Case in point, Blackberry and their parent company RIM. I was at dinner a few weeks ago with old friends. Both of them carry Blackberrys and they love them. I predicted that they would be using a new device shortly and that RIM would be in deep financial trouble within a few years. They were surpriseed to hear such a negative point of view.

But as this excellent analysis of RIM's business suggests, the present and the future look very different for RIM. The charts in this post come from the post I just linked to. You should read it.

If you look at RIM's financials, everything looks rosy:

Not only are revenues and profits at an all time high, but so are subscribers:

But subscriber growth has peaked:

And may be headed into decline:

It is often the case that on the surface companies can appear to be in great shape. If you just focus on the financial results, you can miss the underlying symptoms of future problems. I've made that mistake many times, hopefully enough times that I will make it less in the future.

What you need to do is peer into the future and try to figure out what is going to happen next. In RIM's case, I sense that a "platform collapse", as the author of the blog post calls it, is a real possibility in the next year or two.

RIM's stock is trading at a PE of just under 12, almost identical to Microsoft's. It seems like the market is well aware that the growth era is over and is counting on a long period of flat growth but strong profits for years to come. A platform collapse is not baked into the market's multiple.

The big platforms out there, Apple, Android, RIM, Facebook, Twitter, etc are powerful but fragile. They need to keep innovating and providing users AND developers real value. As myspace has shown, when platforms stagnate they can easily fall apart and the decline can be fast and devastating.

I think the assumption that tech platforms can stop growing but remain great businesses is flawed in most cases. Maybe RIM can pull it off. Their strong enterprise franchise may make it possible to execute the long fade, but it is also possible that it won't. If you are an investor or manager in a large tech platform, dont' get caught up in the present. Think hard about the future and where the platform is going. That's where the value is.

The Present and The Future

Howard Lindzon has been asking people to think about The Next Ten Years. He says:

Few of us are thinking of the next TEN years. It’s hard not to get excited and short term distracted with Twitter, Groupon and Facebook adding billions in value as private companies in just a few years.

Thinking about the future is what VCs and entrepreneurs must be doing. Focusing on what is working now is not the way to join that billion dollar club in the future.

Last week I wrote a post about mobile OS market share and where developers should be focusing. It generated a great discussion in the comments and led to a number of posts in the blogs and traditional media. Many of those who disagreed with my conclusions focused on what is working in iOS today. And my counter to them is what is going on today will not be going on a year from now and certainly not five years from now.

If there is any certainty in the tech business, it is things are going to change. What we should all be doing is thinking about how those changes will develop, what forces are at work, and what new directions things will head in.

This blog is a big part of how I do that kind of thinking. And I am not the only VC who is thinking out loud. Mark Suster wrote a great post this past week where he lays out his vision of how the cloud stack is getting built out. Maybe Mark is right and maybe he is wrong. Maybe I am right about Android and iOS and maybe I am wrong.

The most important thing is that we are all thinking about where things are going and making bets about the future. Because betting that things will stay the same is a bad bet. I am sure of that.

Email Pain

My partner Albert wrote a post about email today. In it he says:

I just don’t see a way anymore of answering everything that hits my inbox and theoretically should get an answer.

It's a familiar tale and I sympathize with Albert. I have been struggling with this issue for years. I've blogged endlessly about it and you all have been very helpful with suggestions. I moved to gmail which has helped. I use labels and shortcuts which help. I use priority inbox which helps. But everytime I make a productivity gain, the volume eventually overwhelms me.

One of our portfolio CEOs told me an entrepreneur complained to him that "fred wilson never returns my emails." That hurts to hear but I suspect it is more true that I want to admit.

Like Albert, I am sorry. I wish I could return every email I get. But I can't and I don't. In the past I've suggested everyone out there just keep trying. I'm beginning to wonder if that is good advice.

I've thought about getting an email assistant. But I am worried that putting more capacity into the system will simply create more volume that will eventually overwhelm the increased capacity.

So I've decided to adopt other approaches to be more available to entrepreneurs, like office hours, meetups, more skype chats, more blogging, more events. I'm not sure if that is better either, but it's where I'm headed at the moment in my never ending effort to solve this problem.

We Are NY Tech

Imagine if there was a blog that wrote about one person who works in NY Tech every day and over time built the seminal database (like Crunchbase) of everyone working in NY tech. How cool would that be?

Don't imagine it. Just head on over to We Are NY Tech and witness it in action. You can also follow We Are NY Tech on Twitter.

Unlike silly lists like the Business Insider "Coolest 100 People" which is bullshit and I hate it and wish they would stop putting out nonsense like that, We Are NY Tech is democratic, wonderful to look at and read, and is exactly the kind of service we need in NYC to identify who is who and who is doing what and why.

We Are NY Tech was build by the team at Simande, a creative shop that builds great websites. If We Are NY Tech is a anything, its a great example of their work. I suspect this is a labor of love by the Simande team, but if I were Silicon Valley Bank, Gunderson, Cooley, Ambrose, and a host of other service providers to NYC's startup community, I'd be trying to buy sponsorships of We Are NY Tech. No better way to show the support of the community than to support a living breathing database of the community.

Well done We Are NY Tech. I'm following you and I hope the rest of the NY Tech Community is too.

The Follow On Round Birthday Party

Rachel Sklar is one of the women leading the charge on #changetheratio, a cause I am totally and completely behind. She's also the editor at large at Mediaite and the founder of Charitini.

When Rachel saw that we are doing the AVC Donors Choose Meetup tomorrow (wednesday) night, she figured she'd tie that into her own Donors Choose Birthday Campaign and do an after party she calls the "Follow On Round". I like that name and the idea.

Here's how it works. If you want to come to the after party (whether or not you come to the AVC meetup), you need to donate a minimum of $20 to one of the classrooms on Rachel's Donors Choose Giving Page. That's it. Then you are then on the list.

The "follow on round party" will be from 9-12 tomorrow (wednesday) night at The Red Room at the Merc Bar in Soho. The bar is open from 9-11 thanks to sponsor Jess3 (a data viz agency). The event is also being supported by BirchBox, Rent The Runway and Fashism (all women-run startups) and they will be taking donations at the door via Square.

Here are the details:

DATE: December 8, 2010

PLACE: The Red Room at Merc Bar

TIME: 9 - 12, or karaoke

OPEN BAR: Yes, from 9 - 11 (Thanks to sponsor Jess3)

SPECIAL GUESTS: iPad DJ Rana Sobhany (hott) + someone who is 99% confirmed (TBA hott)

CUPCAKES: Obviously 

REQUIRED MIN DONATION: $20 

Here's where you donate: http://bit.ly/RSbday

The Gotham Gal and I will be there after we meetup with the AVC crew at Washington Irving High School. Should be a fun night in honor of a great cause.

Invest In The Mess

There's a front page story in the NY Times today about the hyperactivity in web startupland. They quote from a few posts I've made on this blog and I think Jenna and Evelyn did a nice job with the story.

The thing that's clear from reading the story is the hyperactivity is in the early/seed stage market and the late stage market. Investors are throwing money at energetic entrpreneurs with plans, hopes, and dreams and at emerging winners like Groupon, Gilt, Twitter, Facebook, etc.

But from where I sit, there is none of that hyperactivity in the middle stage, which I like to call the ugly adolescent stage. The ugly adolescent stage is when you've built the product and are now building the business. It is when the team grows beyond the intial founding group and not everyone is getting along so well. It is when you are no longer that "bright shiny thing" that everyone wants to talk about. It is when your users are complaining that the service is not reliable or they hate that new feature or interface. It is when you have to figure out how to make money and get profitable. It is when the founder starts to wonder whether this CEO thing is for him or her. It is when you need that next round of financing and it isn't so easy to raise this time.

This is the messy stage of startup life. I have watched hundreds of startups go through this phase. Some don't get through it at all. Some throw in the towel and find a home for the company and the team. Many make it through and into adulthood.

Right now, this is where venture capital investing remains attractive. Like all forms of investing, the hard investments to make are the ones that are the most rewarding. Everyone knows that Facebook is a winner. Investing in Facebook is not hard and it is expensive, although it may well be rewarding.

Not everyone knows how to invest in the mess. But experienced VCs should know how to invest in the mess because they have all had to help their companies get through this stage. They understand the issues, they understand what it takes to cure them, and they should have the courage to know that investments made at this stage will be handsomely rewarded when the companies emerge into a successful adulthood.

We have plenty of portfolio companies in the ugly adolescent stage. And most of them are not finding it easy to raise money. We are doing many of these rounds as inside rounds, meaning the existing investors are funding the company without a new lead investor. I see this as a big opportunity for our firm and I am excited about it and entusiastic about making these investments. I know that not all of them will be great investments. But I know that many of them will be. And we are getting to make these investments at attractive valuations that don't have the least bit of irrational exuberance written on them.

I know that many of my friends in the VC business are doing these inside rounds in their portfolio companies as well. And I think they will be similarly rewarded. What I don't see is a lot of firms interested in leading these messy middle stage rounds as a new lead investor. I'd like to see more deal flow from other VCs at this stage because I think this is where you want to be in the VC business right now. I think you want to invest in the mess.

Donors Choose Wrap Up

It's December 1st. November sure went by fast. And so the annual AVC Donors Choose campaign is over. And the results are in:

We raised $22,400 for classrooms where young women learn science and technology. But because of the HP Match, that will actually be $45k.

More importantly we will impact the lives of 8,543 young women (actually way more because of HP). That's a lot of young women. Maybe one of them will go on to start an important tech company. Maybe one of them will go on to teach other young women. Maybe one of them will go on to get a nobel prize. Whatever happens to these young women, I am incredibly proud of this community's generosity. Thank you.