Posts from March 2009

Most venture deals involve more than one VC firm. In our industry vernacular, we call them "co-investors".  The group of venture firms is called the syndicate. How the syndicate comes together is an art and not a science.

Sometimes, one firm will do the first round by themselves, a second firm will join in the second round, a third firm will join in the third round, and the syndicate will get built round by round. That's how Twitter's syndicate got built. Our firm, Union Square Ventures, led the first round and some well known angels joined us in that round. Spark Capital led the second round and joined the syndicate. In the third round, which recently closed, Benchmark and IVP joined the syndicate.

Sometimes, two firms will do the first round together, a third firm will join the second round, and so on. That's how Zynga's syndicate was built. Brad Feld from Foundry Group and I co-led the first round, Rich Levandov from Avalon led the second round, and Bing Gordon from Kleiner Perkins led the third round and was joined by Sandy Miller from IVP.

Note that I started to use partner's names in the paragraph about Zynga. The individual partners involved are really important. While VCs work in firms, and firms do have reputations, it is the individual VC that you end up working with so it is the person first and foremost that you are working with and the firm second. Don't forget that when you put together a syndicate. I've seen many an entrepreneur make a mistake by picking a great firm as the lead investor and getting stuck with a crappy partner on the board. It happens all the time.

But back to the topic of putting VCs together. It's a very tricky process and frought with risk. The best way to solve the problem is to work with VCs who have shown that they can work together successfully.

There are probably five or ten VCs who I have worked with frequently in my career and I know very well and love to work with. It's not hard to figure out who they are and I've been paired with them on many occasions. And that lists grows and changes over time. Bijan Sabet of Spark Capital only got into the venture capital business a few years ago and he and I have worked together successfully on a couple deals now and he would most certainly be on that short list.

In fact, Bijan was interviewed the other day on this very topic by Mark Kathleen Flynn of The Deal. Here's what he had to say about this topic.

There are two great lines in this interview:

"We generally like each other"

and

"You can't fire your VCs"

So in closing, when picking your syndicate, choose carefully, make sure the VCs will "like each other", and focus on the person more than the firm. And most importantly, check out your VCs like they check out you. It's an important choice that you most likely will not be able to change once you've made it.

This has been rumored for quite a while now. I don't think corporations should be doing venture capital and I don't think Google should be doing it. Here's what I said last July on the subject. Nothing has changed in the past nine months to make me think differently.

That said, I welcome Google to the business, wish them luck, and hope we find something to do with them.

I've gotten used to the snarky and cynical comments that people make on techcrunch and other tech blogs when there's a post about a startup that get's funded.

It's a good thing that people debate and discuss these investments. Clearly not every venture investment that is made is a good one. In fact I've written many times that if we had a rear view mirror, we would not make 2/3 of the investments we make. Only 1/3 of the investments we make generally turn out as well or better than we thought they would.

And so I appreciate the debate that these posts often generate and I almost always read the comments as far down as I can to get a sense of what the blog readers think of the investment. That goes for our investments and every other investment I read about. I find it informative, interesting, and useful data in my daily effort to get smarter and become a better investor.

But every now and then, I find the totally dismissive comments annoying. And so it was today on Alley Insider's post about the bit.ly funding. I know the bit.ly team and investors and have been using bit.ly almost exclusively for URL shortening for as long as it's been out. I think it's a very useful service and a material improvement over the other URL shorteners I have used.

I realize that there are many who think that URL shortening is a bad thing for the Internet and I share some of those concerns. But I also find what bit.ly is doing around analytics and click tracking to be differentiated, valuable, and potentially quite lucrative.

We did not invest in bit.ly, but as I said, I try to read the comments on every web investment I see blogged about and so I waded into the comments on the Alley Insider post. This was the second comment I came across on that post:

I've heard the same comment elsewhere. My partner Albert told me he coded up a URL shortener for Daily Lit (a web service he built back in 2007) in one day.

But just because something is simple to build doesn't mean it won't be a good venture capital investment. I've heard many people say they could build twitter in a weekend. I don't doubt it. But twitter is more than code, it's a popular communications service and an API that thousands of developers have built upon. We've seen many people knock off twitter and the knockoffs haven't gone anywhere. Back in 2004 and 2005, we saw a lot of people knock off delicious with similar results.

What is critically important is an active user base that is engaged and getting a lot of value out of the service. And on that count, bit.ly is doing very well. That same Alley Insider post said that 20 million bit.ly links were clicked on last week and that number is growing at 10% per week. That doesn't speak to engagement, but I can tell you that I use bit.ly several times per day and I suspect many of its users do as well.

So I find the "only 10 lines of code" comment annoying. Let's discuss something that's material to the probability of this being an important web service that people should use and/or whether it will be a good investment. And there were certainly a number of good comments on those lines in the Alley Insider post. But let's not be snarky and dismissive and petty. That doesn't do anyone any good.

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I wrote a post a week or so ago thinking outloud about what a good "venture return' is.

Yesterday, one of our investors, Lindel Eakman of UTIMCO, stopped by this blog and left a very interesting comment on that post.

Lindel pointed out that UTIMCO's portfolio return on all VC funds over the past 10 years was in the range of 9pcnt and that he thought that wasn't very good.

He did point out that VC is well ahead of the public equity markets in their portfolio and so to the extent they have their equity dollars in VC (or other private equity), that is better than public equity right now.

The punch line to Lindel's comment is important. He wonders if VC can't do better than 9pcnt across a diversified portfolio, would UTIMCO simply be better in bonds given the illiquidity and greater risk of the VC asset class?

And sadly, it may well come to that. VC has not proven that it can scale as an asset class since the mid 90s. The vast amount of money that has come into the sector from public pension funds in the past fifteen to twenty years has not been put to work very well and returns for the asset class as a whole have come down.

It may well be the case that the public pension money (and other money) may leave the asset class as CIOs and the investment committees ask the hard questions that Lindel is asking.

Peter Parker, a long time VC and entrepreneur, replied to Lindel with the observation that a downsizing of the VC business would be a good thing for the LPs that remain because the best firms in the business are doing very well and are generating returns well above the 9pcnt which may well be the average performance for most investors in the VC asset class over the past 10 years.

I note that the industry returns I posted on this blog a month or two ago show a 10 year average return of 17.3pcnt so UTIMCO's portfolio is in theory below the average, but those 10 year returns are heavily influenced by the late 90s internet bubble and also the phenomenal returns delivered by KP and Sequoia on their Google investment. I would not be surprised to see that 9-10pcnt returns are the average for funds that did not take advantage of either of those big return generators.

Many will argue that this is not good news for entrepreneurs. And that may well be true. But I think entrepreneurs in the web sector have done a great job of figuring out how to build companies on much lower capital needs and we also have a vibrant angel and early stage (pre-VC) market developing.

So it may be that the real problem is that there is simply too much money looking to get put to work in the VC asset class (certainly that is true in information technology) and that as money starts to leave the sector, we'll have a smaller and healthier VC business to operate in.

I don't know what this means for biotech and cleantech and it may well be that those sectors can handle larger sums of venture capital and still generate acceptable returns. I'll leave it to those who know something about them to comment.

I can't exactly explain why I am so fascinated by the Treasury's PPIP plan, but I am. I was also fascinated by the RTC back in the day but had no involvement with it. I love the idea that one man's toxic asset can be another man's (or woman's) gold.

Yesterday, I asked everyone for their opinions on this plan and I got a bunch in the comments. We also heard from JLM, who called it "Dr Tim's Excellent Elixir". I promised that I would publish links to posts everyone liked and I got a ton of them.

So here are some highly recommended posts from the AVC community. Just in time for your Sunday morning reading pleasure.

Umair Calls It A "Financial Coup D'Etat

Simon Johnson, former chief economist of the IMF, wrote the post that inspired Umair

Andy Kessler's Take

Brooks Jordan Says It's  Political Problem

Mark Sigal Outlines The Juxtapositions

Henry Blodget's Take

Whitney Tilson Talks About the ARM Issue

BlindReason's Take

Joe Nocera Says The Plan Could Work

Krugman Thinks It Is "More Of The Same"

Rortybomb on "Looting The FDIC"

Ritholz on the PPIP

Kid Dynamite on "seller financing"

Jeff Sachs on the "perils of price discovery"

I am sure I'll get more links sent to me and I'll try to post them here.

I've spent some time in the past few days looking at Geithner's plan to stimulate the purchase of toxic assets from banks. I've also spent some time reading what my favorite finance bloggers think of it. My friend Roger Ehrenberg is mildly impressed but concerned that there is no forcing function to make the banks sell. I have not spent much time reading the opinion pages other than to note that Krugman hates it (surprise surprise – he wants us to take over the banks).

But I am most interested in what you all think of it. We've got plenty of sharp investors and smart people who can read, think, and analyze here at AVC and I'd really like to know what you all think. You can leave a comment with your thoughts and if you leave a link to a post of your own, I'll link to it here.

To get the conversation going, I've turned to no other than my "treasury secretary" Jeff Minch (who I disagree with on all things politcal, but agree with on most everything else). You all know him as JLM and he was our first guest blogger a month or so ago. Here's his thoughts on the Geithner plan. Please let us know yours.
—————-

Dr Tim’s Excellent Elixir

The circus is back in town and Dr Tim is peddling a new potion promised to cure the problem of “legacy loans and securities” or toxic assets.  These bad boys have been creating gas and obstructing digestion at the banks and thereby have prevented the flow of loans as current values have caused painful deleveraging of balance sheets absorbing available capital and have exacerbated the natural unwillingness of these banks to extend credit to jump start the economy.  Whew!

The call to action of this plan is to finally and bravely (well, a four martini kind of bravery) attempt to PRICE the toxic assets.  There is a real timid, coy element at work here, not a bit unlike winking at the pretty girl across the bar.

To dispel the suspense, the plan — The Five Guys Toxic Assets Auction Plan — intends to do this by conducting a beauty contest to select five (5) Fund Managers to form, fund and manage Public-Private Investment Funds to competitively bid on packages of loans and securities offered for auction by banks which currently hold the toxic assets.  That’s it.  That’s all there is!

The rest of the plan is simply about how the government intends to co-invest on the equity side (match the equity raised), loan money to finance the transactions (up to 85%) and participate in the upside on the sale side (pari passu w/ the private equity).

As a plan, it is the recognizable journeyman-like work product of a competent investment banker complete with an executive summary, white paper, term sheet, FAQ and application to participate.  It is not a prospectus, it is a deal sheet.  You have to give them good marks for the general thoroughness of the communication.  Take a look at the Treasury’s website and you will see all of this.  The only thing missing is the Power Point presentation.  Hell, they even have an e-mail address to ask questions.

There are things to like, a few to dislike and a few to question.  In no particular order:

1.    We are finally doing something about the 800 lbs gorilla sitting in the corner and frankly the plan is well laid out from a communication perspective.  Any reasonably perceptive financier could understand and model the plan.  I leave it to you, the markets, the economy and the banks to decide whether it is a good plan.  It is an understandable plan.

2.    The toxic assets initially are only assets which were once upon a time rated AAA.  Huh?  This is not a huge portion of the universe of toxic assets and this is likely the low hanging fruit.  So I wonder how effective the process is really going to be.

3.    The big job of the “private” participants is to price the toxic assets.  This has always been the object floating in the punchbowl.  I don’t like the idea that only five (5) bidders will attend the auction.  My sense is that at a certain level of pricing there could be many more folks who would make a bid.  My market sense is that more bidders means higher auction prices.

4.    Here is a subtle point — as bidders exhaust their funds available, isn’t there the possibility that realized auction prices will go down dramatically?  Simple liquidity trap.  This argues for a wider set of bidders and a more expansive embrace of bidders who might bring their own financing.  Should a deal be viewed differently if NO public money is involved?

5.    In addition to the auction not being very broad, the sellers can withdraw the toxic assets from the auction if they do not like the prices.  Hmmmm, this kind of feels like a cheap way for a bank to get an appraisal on their toxic assets.  Maybe I am overly suspicious.

6.    The government financial leverage is huge.  The government will match the equity raised and will fund up to 85% of the deal.  The private Fund Managers therefore only have to contribute about 7% of all the money in order to get half of the upside and some negotiable fees.

7.    There even seems to be an argument that the private money could use NO public money on the equity side and thereby achieve a 6:1 leverage by providing up to 15% of the funding.  A 15% equity investment earns 100% of the upside.  That would be my personal favorite.  In for 7% to get 50% or in for 15% to get 100%?

8.    The expansiveness of the government’s funding also argues for a broader field of auction bidders because the government is “non-recourse” and secured solely by the assets.

9.    The Fund Managers — picked by the swimsuit and talent portions of a Treasury run beauty contest — are sure to be large firms and I worry that they are not nimble enough to deal with the vagaries of litigation, foreclosure, renegotiation or obtaining payment on a huge, huge, huge number of individual mortgages.  There is a skill set required to liquidate the underlying assets which is not the normal ken of big asset management firms.  Isn’t that how we got into this problem in part?

10.    OK, the line forms to the right for all folks who WANT to be partners with the government given the recent AIG/Wall Street demonization.  What happens if you make too much money?  Sure, the government gets their chunk but who wants to be successful and get demonized?  Perhaps there is a derivative security that can be developed to hedge this risk?  LOL

11.    It is not clear how this plan will coordinate with HASP and other mortgage plans.

12.    The Fund Managers can charge fees to run the deal with almost no restrictions on what they can charge the private money but the government — in a welcome display of savvy deal making — will only pay fixed fees from its share of the distributions or winnings.  Bravo!

13.    The banks find themselves in a very odd situation as it relates to their regulatory capital.  Without boring you with the details most of these assets are going to be Class II or III assets for regulatory purposes and if the selling prices are very low could cause real regulatory capital problems.  On one hand, the government flushes out the toxins and on the other hand the government must subsequently further shore up the bank’s capital.  Proving that no good deed goes unpunished.

14.    There is a 10-year mind set at work here while the real engagement phase of the RTC/S&L crisis was more like 5 years.  Note that almost everything this Administration tackles has a 10-year time frame involved.

15.    This needs to happen quickly to be effective and it clearly will not happen quickly.    There is a chemotherapy element to the timeline which troubles me greatly.  Right now, unfortunately, I would be long cancer.  A ghoulish analogy for which I apologize.

Let me conclude by saying — this COULD work.  This is the RTC but with a public-private wrinkle and with the financing pre-arranged.  The paltry list of bidders seems a real flaw to me.  It is difficult to imagine a rallying cry being:  “Rally around the asset managers, boys!  And give them hell!”  But, hey, it COULD just work.

Let’s give credit where credit is due.  While it has been easy to take cheap shots at the Secretary of the Treasury and he added a bit of fuel to the fire with his timing, this plan is the best piece of work that has been presented thus far indicating that he is teachable.

Who would have expected less from a guy who grew up in Zimbabwe, India and Thailand and has an Ivy League degree in Asian studies and government with a graduate degree in international economics and East Asian studies?  BTW, did you know that his father while in the employ of the Ford Foundation worked with Ann Dunham-Soetoro on Indonesian microfinance programs?  Who is AD-S, you ask?  Barack Obama’s momma!  Karma, kismet!  We are saved!

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Image by fredwilson via Flickr

Our portfolio company Etsy announced their API and developer community a few days ago and I've been remiss in blogging about it.

I am a big fan of web services that offer APIs to developers to build on top of and I am particularly interested in e-commerce services that leverage APIs. For those that don't know, Etsy is a marketplace for handmade goods like jewelry, ceramics, metalwork, etc. It's a very artistic community that is full of beautiful items for sale.

I am very interested to see what developers will build on top of the Etsy marketplace. Here are some examples of what has been built so far:

Heartomatic – from Craftcult

Shop Value – from Etsy Hacks

Makerspot – syndicate your Etsy store onto your own website

Soopsee – aggregate your flickr account, Etsy store, etc onto your own website

No one company can do everything for its customers. By opening up your webservice via an API and a developer community, you unleash the power of the web to do that for you. Bravo Etsy and Bravo to all the developers working on the Etsy API already.

If you want to join the Etsy developer community, here it is.

When Brad and I were raising our first fund in 2004, we’d plan to get to our pitch meeting an hour or so ahead of time and then go find a Starbucks for coffee and internet. We never even thought to try anything else. We just used the Starbucks store locator app and got bad cofee and better wifi.

But in five years, a lot has changed. Yesterday morning I drove from LA to Irvine California to pay a visit to one of the investors in our fund. As usual, I left plenty of extra time and arrived in Irvine an hour early.

There were plenty of Starbucks around but I ignored them, hit Yelp on my blackberry browser and did a search for espresso in/near Irvine.

That led me to a place called Javatini’s where I got a very well made cappucino delievered in a ceramic mug. It was a vastly superior cup of coffee and the wifi was free and fast too.

Today I drove up to Pasadena to see another of our investors. Again I left a lot of extra time and even though I sat on I10 for what seemed to me to be an eternity, I got there an hour early. I did the same thing, avoided Starbucks and sat outside in the sun and enjoyed a much better cup of coffee and a yogurt and fruit bowl courtesy of Yelp.

After my meeting I drove back to Santa Monica for a meeting at Mahalo with Jason and his team. I got back in no time and had a hankering for a fish taco (among my all time favorite meals). Yelp served up a place on the Santa Monica/Brentwood border call Kay’n Dave’s where I just finished a slightly spicy baja fish on light and fluffy home made tacos.

That’s three for three with Yelp in the past day and a half. I’m happy and I’m so done with bad coffee and bad food when I’m travelling.

Brands like Starbucks, Taco Bell, and McDonalds are powerful. But Yelp and services like it on a mobile phone have the power to disrupt the scale advantages of these national brands and allow the Javanitis, Kay’n Daves, and Father’s Offices of the world compete.

And that’s a good thing.