What kind of company is YOUR company?

With all the frenzy around angel and venture investing, sometimes rationality and reason get tossed out the window. I mean, if you CAN raise angel or venture capital why wouldn’t you take it, right? It’s flattering. It can help take the pressure off my immediate cash needs. And hey now, YOU’VE BEEN BACKED. Yes, but to what end? Backed against the wall? Backed into a corner? Or perhaps backed in a promising large-scale venture? Before ever taking someone else’s money, the first question an entrepreneur should ask themselves is: DO I REALLY NEED THE MONEY GIVEN THE SCOPE OF MY MISSION, BUSINESS OBJECTIVES AND PERSONAL GOALS? Because many a business has been backed that didn’t warrant getting backed, not because the business wasn’t sound but because the motives of the entrepreneur and the investors weren’t properly aligned. Please don’t let this happen to you.

Lifestyle businesses

These are businesses that don’t warrant taking external funds from anyone. You aren’t going into it looking for a liquidity event (which is what most angel and venture investors seek), but for regular cash flow that enables you to work less and do more other stuff. These are often characterized by web businesses that largely run on their own and monetize via ads, lead generation or e-commerce. Lifestyle businesses are awesome and can often help their owners achieve freedom one thought unimaginable. However, these are most assuredly NOT businesses for which external financing should be sought, because of the fundamental misalignment of motives between the business owner and investors. 

Angel-backed businesses

An angel-backed business comes in two flavors, one which leads to future venture financing and one which does not. The former case will be dealt with below. The latter case is one where the business opportunity is attractive from a financial standpoint for external investors, and where the founder has the goal of selling the business in the future. However, the size of market opportunity might not raise to the level necessary to attract (or warrant) venture financing, but with the right amount of angel capital and support the business can yield an attractive outcome for all constituencies. Exits in this realm are frequently in the $20-$30 million range, but can sometimes top the $50 million mark. These businesses tend to be very capital efficient and leverage the networks and expertise of the angels involved, offering a great opportunity for a smaller idea to get funded while avoiding the brain damage and time suck of a VC roadshow that is bound to yield poor results. 

Venture-backed businesses

These opportunities often have an angel round as a precursor, with a small group of individuals providing seed capital as runway to hit the proof points sufficient to raise a venture round. For a business to be venture-backable, it generally needs to be targeting billion-dollar+ markets with exit opportunities measured in the hundreds of millions of dollars - or more. Almost all businesses that execute successfully against opportunities of this scale require lots of capital, which makes them perfect for venture financing. This approach also requires founders who want to “go for it” to build the massive company, and won’t be satisfied with an exit in the tens of millions that might yield an attractive result for the founders but a pretty uninteresting outcome for the venture investors. In today’s market, venture investors can keep founders in their seats by providing partial liquidity in conjunction with a growth capital round, but the point remains: the DNA of the founders needs to be LETS BUILD A GIANT COMPANY, DISRUPT MARKETS AND NAVIGATE A HUGE EXIT. Yes, money is a big motivator, but being in it to win it goes far beyond the coin. It is an obsession.

Being honest with yourself at the inception of your business is absolutely critical for achieving the desired outcome. Don’t be seduced by people throwing money at you if you know what you really want is a lifestyle business, or if you really believe taking too much capital too early creates risks to disciplined decision-making or sets the exit bar too high. You are in control of your own destiny: don’t let others take it away from you. Making the right decision upfront has life-impacting implications. Be deliberate, thoughtful and smart about it.

Tweet

How to get a VC internship out of B-school? GO WORK AT A START-UP

What is the best way to get a VC internship out of graduate school? 

• Leverage your networks to get introduced to as many VCs as you can
• Research VC portfolios, really understanding how firms are differentiated and coming up with ideas around their investment theses to augment “market mapping” exercises
• Dig into a handful of portfolio companies whose products and services you’re passionate about, and come up with some specific ideas and ways of generating value
• Be willing to do anything just to get to hang around the firm or their portfolio companies. From their end it should be as frictionless as possible: you come in, you generate value
• Be an original thinker and be able to articulate your innovative, orthogonal ideas in clear and persuasive ways
• Know what’s going on across the tech community. Read tech blogs, VC blogs and domain-specific blogs in your areas of interest. Nothing is more of a turn-off than a candidate who isn’t tuned into what’s going on
• Be an active user of the latest applications and devices and have a view about them. How do they rock, how do they suck, how would you do it better?
• Don’t regurgitate textbook crap you learn at school about valuation, etc. They are worthless in the early-stage venture realm. Look to real sources of information - practitioners, expert bloggers, etc. - for how things really work
• Be original and don’t be afraid to take chances when putting yourself out there. It doesn’t mean be a doofus who shoots from the hip, but don’t be afraid to share unconventional perspectives on new ventures, product features or industry trends if your position is well-argued and clearly stated

Formal programs are great and should be pursued, but using guerilla tactics will likely yield better results. The point is, you have to stand out in terms of your passion, thought process, amount of homework you’ve done and ability to help. Challenge yourself as to why you should get a spot - and be honest. What makes you better than the next person with a platinum resume and a passel of Hs in your classes? You’ve got to outwork and outthink the rest of the class if you want to bust into the industry from school; it’s a different story if you’re a 2-time successful entrepreneur and ready to shift into the VC game. But if you think of the process as work and not as a passion, forget it. The business is just too hard and all-consuming for it to be looked upon as a job. 

My friend Jon Steinberg and I were on a panel at Columbia Business School last week discussing entrepreneurship, start-ups and venture investing. Jon made an offer to every person in that room (which also applies to anyone reading this as well) - study the advertising technology market, really understand how insertion orders work, analyze Buzzfeed’s business and potential client base and approach him with a concrete plan for closing some business for the company. If you know what you’re talking about, have a clear plan and a hunger to help out, he’ll likely give you a shot. He said he has never been approached by anyone in this way, and was befuddled staring out at 100+ CBS MBA students as to why this was the case. I have to say I agree. One of the best ways to learn about venture investing is to start at a start-up, and there are far more start-ups than venture firms. Why so many want to go right to investing without gaining experience as an operator is misguided. 

So the real answer as to how to land a VC internship coming out of CBS is to intern at a great start-up, prove yourself for free, get hired, gain invaluable experience and then if you still really want to be an investor to network into the venture industry from a position of strength. I’m not saying getting into venture straight out of B-school is impossible; clearly it’s not. But you need to ask yourself if this is truly the best route to take. I’d argue that working at 2-3 start-ups is invaluable training for being a successful investor. And having been on both sides over the past seven years as well as being a B-school grad myself, I think I’ve got a pretty good sense of the landscape…

Tweet

Froth or famine?

Let’s be serious - EVERYBODY is wondering if there is another shoe to drop in the Great Internet Gold Rush of 2011. $6 billion for Groupon? Nah, too low. Something between $8-$10 billion for Twitter? Sure, why not? Eight-figure pre-money valuations for numerous West Coast consumer web start-ups? Hey, it’s just supply and demand, and besides which, they DID go through YCombinator. $50 billion+ for Facebook? How about $70 billion in a handful of trades on SecondMarket. Even $315 million for HuffPo. Is AOL nuts? What’s up?

There is a strong desire to characterize the market in a homogenous way, e.g., “We’re in a bubble” (Fred Wilson) or “Valuations are reasonable” (Chris Dixon). Bottom line, this doesn’t begin to explain the variations observed in nature. There is a world of difference between Quora and Facebook, YCombinator start-ups and Groupon, every “social shopping” start-up and Twitter. One needs to look beyond the headlines and ask “What is REALLY going on here?”

Great franchises cannot always be valued purely on the basis of revenue or current cash flow. This isn’t sophistry, it’s simply reality. When Google paid $1.65 billion for YouTube, many thought this was merely a symbol of having way too much cash to spend on something irrational which it coveted. Fast forward, Google has had to pump hundreds of millions into integrating and scaling the YouTube platform, but will this acquisition pay off on an ROI basis? Google has created a unique property in one of the fastest growing segments of the online market, and they have the resources to take the long view. I bet it will turn out to have been a prescient deal for the company.

Facebook has effectively created a parallel Internet, fostering a level of engagement and stickiness Google would drool to have. Social, messaging, location, recommendations, commerce and more. Facebook also hosts the websites of millions of businesses globally. Are the levels at which Facebook is trading irrational? I have no idea what its fundamental value is, only what others are willing to pay. But there is no question that it represents a massive and rapidly growing franchise, a business that has immense competitive barriers and powerful network effects. It may well be worth what people are paying for it - and more. Its mid-11 digit valuation is certainly not indicative of a bubble.

Groupon? Please. The company is generating cash like a casino, except in a much more predictable manner. Was turning down $6 billion crazy? Not if you consider the valuation that it may well be able to claim via IPO. Given that its principals were able to take hundreds of millions off the table in the most recent financing, there is no reason for them to sell the company. They are in it to win it, and have the momentum to support its growth through an IPO and beyond.

Twitter is an enigma. A household name with an large and engaged user base. A powerful platform that has supported the growth of countless businesses on top of its pipes. A force for freedom, commerce and distribution. The revenue story is only just beginning at Twitter while rumors swirl about its eventual acquisition by either Facebook or Google for a reported $8-$10 billion. It has also had some legendary outages, and continues to crash on a fairly regular basis. Few revenues, iffy infrastructure, $10 billion. Really? Crazy? Well… Twitter, like Facebook is a unique property. It is the global connective tissue linking together millions of people across the globe, enabling the sharing of news, ideas, hopes, dreams, product reviews and offers. For some it has replaced newspapers, magazines and RSS as a vehicle for aggregating relevant information from trusted sources. For others it serves as a platform for sending messages to a targeted audience. Widespread adoption and brand are its competitive barriers, much as Bloomberg chat locked in hundreds of thousands of terminal subscribers for decades. In the hands of Facebook or Google, might a $10 billion price tag be rational from both economic and strategic perspectives? It may, indeed.

I can’t pretend to understand the valuations of many West Coast consumer web start-ups, and I won’t attempt to rationalize them here. There has been an explosion in the availability of seed stage capital in and around Silicon Valley, and I believe it has had a marked effect upon valuations of consumer-driven businesses in the region. As I’ve discussed previously, I do not believe there has been a parallel phenomenon in New York or Boston, and I don’t find the froth around Foursquare to be indicative of bubble-like behavior on the East Coast. Supply and demand appear to be out of whack among a segment of the West Coast seed stage universe, driving up valuations to what seem to be unsound levels, but the jury’s out.

All in all, I do not see pervasive bubble behavior among US-based technology companies. In fact, in several segments of the market and across myriad geographies, there appears to be a dearth of Series A capital available for investment. So depending upon where you’re standing, the tone of the market looks very different. Froth or famine? Both can be observed in nature. But deal discipline coupled with common sense can yield attractive values across much of today’s venture investing landscape.

Tweet

Will there ever be a shake-out in the Venture Capital industry?

Whether or not there will be a “shake out” in the venture industry depends on how you define it. If it means that certain formerly prestigious VC firms will close up shop and wind down, then yes. If it means a sharp decline in the number of venture firms, then no. 

I look to the hedge fund industry for an analogy of how an alternative asset class has dealt with turmoil. Back in 2006, my original thesis was that the hedge fund industry would begin to resemble a barbell (as measured by assets under management), with a bubbling cauldron of smaller start-up funds focused on alpha at small scale, while a group of large asset management titans with best-in-class compliance, control and reporting environments would reinforce their already strong positions. Firms in the middle would have a hard time, as they lack the resources to compete with the largest firms while having “alpha at scale” problems not felt by the smaller firms. While small firms have jumped to the mega-class and some larger firms have imploded, I believe my thesis has largely been borne out.

Venture, unlike hedge funds, doesn’t scale as well due to the illiquid nature of the asset class (and therefore being difficult to risk-manage using quantitative analysis) and the time required to manage a single investment. Also, the costs of compliance, reporting and control are much more easily attained by smaller firms through outsourced service providers, and once a firm achieves a certain scale (somewhere between $50-$100 million in committed capital), I’d argue that the competitive advantages of scale as it relates to running the operation has largely been neutralized. The real issue is what types of firms are best suited to the investment opportunities, and how this might impact the structure of the industry. 

Unlike the barbell shape of the hedge fund industry, I’d posit that the venture industry, at scale, looks more like a normal probability distribution. If there is little operational leverage in scale, then it is the nature of the firms, their capabilities and their risk-taking that governs the shape of the industry:

• Micro VC: As with hedge funds, I expect there to be a bubbling cauldron of seed stage firms, small and nimble that are able to efficiently write smaller first money-in checks and which bring professionalism to the seed stage landscape. These firms, as they do today, will partner with angels to drive “Friends and Family” rounds of financing though may follow on as investments mature. Some Micro VCs will make the jump and morph into the next stage (Life-cycle VC), but others will keep fund size small and focus largely on seed stage investing that stops at the Series A. Most Micro VCs have funds between $10-$75 million. Examples of current Micro VCs include Founder Collective, Metamorphic, Freestyle, SoftTech VC, Floodgate and my firm, IA Ventures.

• Life-cycle VC: These are firms that will often establish an ownership position at the seed stage, but which have the capital to continue financing a start-up into the Series B and C rounds. Sometimes they will first invest in a company at the Series A, but only if is reasonably priced and where they can establish a threshold ownership position. These firms generally have funds between $150-$250 million, and will (and can) increase exposure to a winning investment as they require additional capital for growth. These firms in many way sit in the “sweet spot” of venture investing, small enough to dip down into the seed stage while having the dry powder to reserve heavily and to plow $15-$20 million into a single company if it makes sense. Examples of Life-cycle VCs include True Ventures, Flybridge, Foundry and Union Square Ventures.

• Growth VC: It strains the term to call this stage of financing “venture” investing, as much of the execution risk has been stripped out of the business and all that remains is rapid scaling. These firms are a hybrid of venture and private equity, in that the analysis of what constitutes a winning investment is markedly different than what Micro VCs and most Life-cycle VCs perform. The dollars deployed are much larger and the exit multiples much lower, but the risk profiles are sharply muted relative to the Micro and Life-cycle VC models. Investments at Series C and D stages and beyond can be upwards of $100 million per company, and require fund sizes of $750 million or more. Examples of these firms include IVP, Insight Ventures and Tiger Global.

I expect to see the greatest AUM in Life-cycle VC, with Micro VC and Growth VC being smaller but critical elements of the venture marketplace. Regardless of the poor 10-year returns, the venture capital industry is alive and well, and an essential catalyst of innovation in our country and across the world. Poor performing “zombie” firms will eventually be swept away, but it in no way casts a pall upon the industry. The quest for management fees and venture capital are anathema: those firms which became intoxicated by large AUM got burned and will die a slow death. A healthy and growing body of new, carry-focused funds will rule the day, which is why the Micro VC and Life-cycle segments of the venture landscape are so exciting and hold such promise.

Tweet

The Role of UI/UX in the Big Data Revolution

This week’s Strata Conference was a truly magical event for those immersed in the world of Big Data. Congratulations to Tim O’Reilly, Gina Blaber and the rest of the O’Reilly team for throwing a fantastic event. It was great to be a part of it and I’m looking forward to being deeply involved in the next edition, New York style. It also afforded myself and the IA Ventures team the opportunity of spending quality time with our fellow data geek-masters (and mistresses) such as Hilary Mason, Mike Driscoll, Drew Conway, Bradford Stephens, Flip Kromer and others with whom we consumed many fine (and not so fine) beverages and eats. Such an assemblage of brain power and personality is seldom observed in nature, but Strata had it in spades.

When reflecting back on the conference, the hallway meetings and late-night conversations, one feature of my myriad mind-bending explorations emerged: the importance of interface design and user experience in helping display the power and value of sophisticated Big Data technologies and analytics. This theme also emerged in a discussion I had with Mac Slocum of O’Reilly. I find that I never learn so much about what is going on inside my head as when I write or am interviewed, as being forced to let stream-of-consciousness flow minimizes the effect of preconceived notions and biases.

So much of Strata and, in fact, the dialogue around Big Data in general is focused on hard-core technologies, bleeding-edge analytics, data manipulation and consumption via APIs. The truth is, however, that much of the complexity and depth of Big Data analysis only comes to life and becomes actionable when presented in a clear and intuitive manner. This places a huge premium on start-ups with awesome UI/UX skills. And when I started to reflect on the IA Ventures portfolio - BankSimple, BillGuard, Kinetic Global, Metamarkets, PlaceIQ, Recorded Future, Sulia and TraceVector - almost all of our investments have an essential focus on interface design and user experience to extract value from extremely complex data-driven architectures. In my talk with Mac I used the example of BankSimple as a firm with a core focus on UI/UX - so much so, in fact, that the company really grew out of the question “What do consumers really want and how can we optimize their retail banking experience on mobile devices?” and developed an architecture and set of business processes to deliver on this value proposition. But such thinking isn’t merely the province of B2C; it also applies to those selling to the enterprise. Metamarkets ingests terabytes of publisher data in real-time and performs sophisticated analysis to provide them with powerful, actionable information that impacts inventory pricing decisions. The importance of the design and usefulness of the Metamarkets dashboard can’t be overstated; several large, global publishers are dependent upon this information, and it is Metamarkets job to make it readily consumable, easy to understand and immediately actionable. Without a great interface, the power of massive data and valuable analytics wouldn’t be nearly as profound.

Another interesting feature of these Big Data companies is their mixed DNA: world-class hackers and data scientists together with data visualization and user experience experts. Clearly these worlds overlap; many a great visualization guru is a top-flight data scientist. It’s just that getting these multiple personalities and skill sets to work together in a seamless manner to drive value to the client, whether they be consumer or business, is no mean feat. But these companies have been able to instill the importance of “customer first” within their organizations, forcing the intersection of real-time actionable information with a great user experience in perfect harmony. Now THIS is a Big Data revolution: giving the props not only to the data engineers but to the data depicters. Algos are great, but a picture is worth a thousand words.

This line of thinking has been reinforced in a book I read recently, A Whole New Mind by Daniel Pink. The essence of his thesis: right-brain (conceptual) thinking will become increasingly important to the West where much of the left-brain (analytical) tasks are being commoditized and outsourced to Asia. Most great data scientists I know are a synthesis of right and left-brain attributes: super powerful analytical minds but with a rich creative streak that extends into elegant code, unusual and insightful analytics and highly effective visualizations of complex data sets. And I believe the market has spoken. Great UI/UX people are in high demand, as are the most creative and efficient coders and data hackers. And these people aren’t 2x or 3x better than the merely good: they are 50x or 100x more valuable. Supply and demand are massively out of whack, and I fully expect this to continue unless our educational system moves away from rote memorization into critical thinking and celebration of orthogonal ways of looking at problems. Time will tell, but the role of the US in the Big Data revolution may well depend on it.

Tweet