Posts from June 2010

Some Thoughts On Foursquare

Our portfolio company Foursquare closed a second round of financing yesterday. This was a much covered financing process and also much criticized. I think it makes an excellent case to talk about some conventional notions and why they might not be right.

Back in the early spring Foursquare decided that it needed to raise more money to support its growth, both service growth/scaling and team growth. Foursquare identified about a half dozen venture firms that it thought would be ideal investors and opened discussions with them. A few backed out of the process because they had investments in competing businesses. But all of the other firms were eager to make an investment. The Company could have closed a financing at a very attractive valuation in two or three weeks if they had chosen to.

But as they kicked off the financing process, a fair bit of acquisition interest in the company materialized. So the founders made the decision to dig into what those transactions might look like. They spent the better part of the spring doing that and eventually determined that staying independent was the best thing for the service, the user base, the team, and the shareholders (pretty much in that order).

All of this was conducted in the glare of the public eye as the tech blogs and tech focused media was quite interested in how this story would play out. Kara Swisher called it "a very long and decidedly strange funding journey" in a blog post yesterday. She also said "the wrapping-up of what has been a very convoluted funding process comes after a series of missteps and switchbacks over what’s next for Foursquare."

I have great respect for Kara, who is one of the best journalists working in the tech sector, but I think she and many others who have voiced these sorts of criticisms are wrong.

The Company started this process when they had sufficient funds in the bank to operate the business for six months. They were not in a hurry and there was no need for any kind of interim bridge financing as Kara's post suggests. So closing the financing quickly, which is often advised as the best approach, was not necessary and in hindsight, the founders were wise to take their time.

The conversations with potential acquirers were very beneficial to the founders and the company in many ways. It helped them to understand what the risks of going it alone were versus the risks of selling. And both have risks if you are thinking about the service, the users, the team, and the shareholders (in that order). And it allowed the founders to develop close working relationships with some of the most important Internet companies who can not only be acquirers but also distribution partners and monetization partners.

I am a big believer in making quick decisions on most things. But on some things a bit of deliberation is important. In this case, the founders walked away from what Ben Horowitz from Andreessen Horowitz calls "generations of your people being set financially." Ben is also quoted in that same TechCrunch post saying "It is a really cathartic and emotional decision to make." Those kinds of decisions are best left unforced by the founders and the people around them.

In the end, the Company got a great financing with a great group of investors, including our firm, and now has the resources to invest in scaling the service, the team, and building out the feature set to make checking in an even better experience than it is today. 

So the moral of this story, if you will, is don't let conventional wisdom force you into making decisions you don't need to make and you aren't ready to make, particularly about very big decisions that you will be living with the rest of your life.

Linking To Google Maps

I have a recurring issue with Google Maps that I'd like to get everyone's take on. Either I don't know how to use the service properly or there is a missing feature I'd like to see Google fix.

When I do a search in Google Maps, like "915 Broadway, NYC" (which is the address of Union Square Ventures), I get a result like this:

Google maps result

If you do that search, you'll see that the URL is still http://maps.google.com/. The web app does not return a new URL for that search.

You can click on the "link" field on the upper right of the page and get a popup of a long url. In the case of the "915 Broadway, NYC" search, that URL looks like this:

http://maps.google.com/maps?f=q&source=s_q&hl=en&geocode=&q=915+Broadway,+New+York,+New+York+10010&sll=40.737143,-74.007627&sspn=0.007625,0.018389&ie=UTF8&hq=&hnear=915+Broadway,+New+York,+10010&ll=40.740933,-73.990002&spn=0.007625,0.018389&z=16

Not exactly the thing you want to cut and paste into an email or anything else.

So what I do is copy that URL (and there isn't even a button to make copying easy) and put it into the browser's URL field. I then let the Google Maps web app go to that URL and then I create a shortened URL with bit.ly.

That's a lot of extra work for something that I expect is a very typical use case for many people.

So here's the question. Is there an easier way to do this that I am just not seeing? Or should Google make this easier?

Please let me know your thoughts in the comments.

Hedging

This is the third in a series of MBA Mondays posts about risk and return. Last week we talked about diversification, my favorite form of risk mitigation. This week we are going to talk about another favorite risk mitigation method of mine – hedging.

There are different types of investors in any highly developed and liquid market. There are speculators who are looking to make risky bets and you can use them to reduce your risk by taking the opposite side of those bets. Doing this is called hedging.

Let's go through some real world examples. The simplest one is shorting a stock that you own. Let's say you own 1,000 shares of Apple that you bought during the 2008 market break at $75/share. The Apple shares are now at $267/share and you are worried that the iPhone 4 reception problems are going to hurt the stock in the short term. You could sell the stock, but you really don't want to. So you can short 1,000 shares of Apple for as long as you are nervous. 

The way shorting a stock works is someone who also owns the stock loans you the shares and you sell them. You promise to give them back the stock at some future date. You pocket the $267,000 you get from selling the Apple stock but you have a liability which is you have to give the stock back to the person or institution who loaned it to you. Fortunately, you still own the stock you originally purchased so you can always pay back the loan in the stock you own. If the stock goes down, you can use some of the $267,000 you got in the sale of stock to buy back the Apple stock at a lower price and use that to repay the loan. If the stock goes up, you are losing money on your short, but making exactly the same amount on the stock you originally bought.

In this scenario, you have hedged your risk of the stock going down, but you are also not going to make any money if the stock goes up. It is like you sold the stock except that you still have your original stock in your possession. You are perfectly hedged except for counterparty risk, which are risks brought on by the other party to your hedging transaction. In this case, counterparty risk is pretty low.

Another form of hedging involves options. There are two primary forms of options, puts and calls. A put option gives you the option of "putting" your stock to someone else at a specific price. A call option gives you the option of "calling" a stock from someone else at a specific price.

Let's continue this example of Apple stock at $267/share. Instead of shorting the stock you can use options to hedge your position. The simplest form of a hedge is to buy a put to protect your downside. Let's say you want to make sure you get $250/share for your Apple stock no matter what. You can buy a put that allows you to "put" your Apple stock for $250/share until August 10th (a little more than 5 weeks) for $27. If that happens, you actually are getting $223/share because you'll get $250/share but you had to pay $27 for the call. That is the purest form of downside protection. It is expensive, but you get to keep all of the upside on the stock. And there is counterparty risk because if the person selling you the put goes out of business, they won't be there to honor the call.

If you are willing to give up some upside, then a better approach is the "collar". In this trade you buy a put and sell a call. The August 10th Apple put at $250 is trading at $27 right now. To finance that cost, you can sell an Aug 10th Apple $280 call for $24. You are still out $3/share but it is must less expensive insurance. However, if the stock goes up to $280, it can get called from you.

I got all these option prices from the CBOE's website. These are the current prices as of Monday morning before the markets open. These prices will move around a lot, reflecting both the price of Apple stock, the remaining time until expiration of the option, and the volatility of the stock.

If you think about the collar, it is a lot like shorting a stock you already own. You are protected if the stock goes down but you aren't going to make much if the stock goes up.

When our venture capital firm finds itself with a lot of public stock that we cannot sell for one or more reasons and we want to protect ourself from downside risk, we like to use a collar. You can use traded options, like the ones I am quoting from the CBOE. Or you can get a trading desk at a major brokerage firm to create synthetic options for you. No matter what you do with collars, it is going to cost something. You are purchasing insurance and insurance has a cost.

It is important to remember the counterparty risk when you are hedging. No hedge is any good if the other party to the transaction is not there to settle up. It is like buying insurance. You want to buy insurance from a highly rated carrier and you want to do hedging transactions with financially secure and stable counterparties. What constitutes that these days is another issue.

In summary, when you have a large gain on your hands, think about taking some of that gain off the table by selling it and diversifying. If you can't do that for one reason or another (taxes is a common one), think about a hedging transaction.

Nations And Networks

I was reading the NY Times today on the excellent Editors Choice App on the iPad and came across this line in a piece by Scott Shane:

“We’re still focused on the nation and not the network,” said John Arquilla, professor of defense analysis at the Naval Postgraduate School. “You can do brilliantly in Afghanistan and still not deal with the Faisal Shahzads of the world.”

This is not a post about the US' strategy in its war against terrorism. I have very mixed feelings about it and don't feel that I can add anything to that debate.

This is a post about nations and networks. The Internet is a global network with 1.25bn people on it right now (comscore may 2010 numbers). The world bank says there are 6.7bn people on planet earth so that is only 20% of the total population but it's a meaningful number and it is growing fast (up 12% in the past year according to comscore).

And there are some networks that are as big as countries. Google's monthly user base is 70% of the population of China. Facebook's monthly user base is 150% of the population of the US. Twitter's monthly user base is larger than the population of Germany.

These are some of the largest networks but as Professor Arquilla points out there are all sorts of networks on the Internet and some of them are dangerous. Maybe more dangerous than countries in an age of mutually assured nuclear destruction and suicide bombers. There are rogue nations and there are rogue networks.

I think we are just beginning to understand the power of these networks and what they can become. My partner Brad penned a very thoughtful post on the USV blog a few weeks ago talking about web services as governments. He was using that analogy to think about the recent actions of Apple, Facebook, Twitter and other web-based platforms. But the analogy is more powerful than that. Internet networks span geographies, the have governance systems, they are starting to develop currencies, they are starting to develop large economies. Just look at the Meetup Everywhere widget to the right of this post to see what the AVC network looks like.

So when we think of global political systems and how they are going to develop in this century, we cannot simply think in terms of the traditional nation state. We also need to think about the emerging network state.

Everyone Can Be A Radio Advertiser

Our portfolio company Targetspot launched a new simplified self serve interface to their radio advertising platform this week. If you have a local business and want to reach hundreds of thousands of radio listeners in your area for a few hundred dollars, you should check it out.

It's one click to try a new form of radio advertising.

And to make things easy on everyone, they are offering a free voice ad, spoken by real voice over talent, to anyone who tries out the service for the first time.

I just tried it and made a voice ad for this blog. Yes, you may hear some on air advertising for AVC in the coming weeks. It's really simple. If you have a business you'd like to advertise on radio and internet audio sites like Yahoo Music, AOL Radio, Myspace Music, etc, you should check it out and let me know what you think.

Why I Don’t Like Stock Buybacks

RIM, the company that makes Blackberries, announced a weak quarter yesterday, and then announced they were initiating a stock buyback. I don't like stock buybacks and I figured this was an opportunity to explain why.

A decade ago, I was Chairman of the Board of a public company called TheStreet.com. It is still a public company but I have not been involved with the company for eight or nine years.

The company raised a huge amount of money in its IPO in 1999 and then after the market broke in early 2000, the stock was trading below its cash value. We talked about this at the board and decided to do a stock buyback.

For those who don't know what a stock buyback is, it is when a public company announces that they will be going into the market and start purchasing their own stock. When they purchase their stock, they typically retire it so that the number of shares outstanding goes down.

Stock buybacks are very popular with some investors as a way for a company to transfer value from the company back to the shareholders. It is like a dividend, except it is taxed as a capital gain, not ordinary income.

I don't remember the exact details of the buyback at TheStreet.com but we started buying the stock and it kept going down. We kept buying it. But we were losing money on each buyback because we were overpaying for our own stock as it kept going down. 

I didn't understand what was going on. We had more cash than it would take to buy back every share in the company and yet the stock kept going down. We eventually reduced the number of shares outstanding by a pretty significant number. I don't remember what it was but it could have been as high as 25% of all the shares that were outstanding before we started the buyback.

Eventually the market came back and the stock rose. And the company started making money and its reported earnings per share were higher as a result.

But I don't view that stock buyback as successful. It didn't fundamentally change the company in any way. We just gave back a lot of cash to the investors.

This was all happening in 2000 and 2001. If I think about what we could have done with $25mm or more of cash in 2000 and 2001 to transform that company, there are so many obvious ideas in hindsight. We could have invested in new lines of business. We could have bought a bunch of companies. We could have made a number of moves that would have fundamentally changed the company. And we had a lot more cash than $25mm. But we let the cash sit in the bank and worse we gave a lot of it back to investors in a manner that did not do much for the company.

So if you go back to the reason that the stock kept going down as we were buying it back, I think I understand why now. With our stock buyback we were signaling to the market that we had no good ideas about how to spend that cash. We were signaling that we didn't see much of a future in our business. And smart investors bet against those kinds of companies, managements, and boards.

So when I saw the headline this morning that RIM was doing a buyback, I was saddened. I've been a Blackberry user since 1997 or 1998. RIM has been a great company that has driven so much innovation in the past fifteen years that has made my life better and the lives of many others better. I have to believe that if they got aggressive, they could find uses for all of that cash they are sitting on. I wish they would do that instead of buying back their stock.

A Big Victory For User Generated Content

Yesterday, Judge Louis Stanton of the Southern District Court here in NYC issued his opinion in the long standing legal battle between YouTube and Viacom. It was the very threat of copyright litigation that forced YouTube to sell to Google, who had the resources to fight this fight.

This decision means that other user generated content services will not have to make the choice that YouTube had to make. Judge Stanton ruled that YouTube was operating within the framework of the Digital Millennium Copyright Act (DMCA) which says that web services that have infringing material in them must respond to take down notices but do not have to proactively weed out their services of all infringing material.

This is a huge victory for entrepreneurs and the web. I am ecstatic.

Six Slides

The CEO of one of our portfolio companies is working on a fundraising deck and asked me for some tips. I gave him my favorite, "keep it to six slides." He ended up with thirteen which I see as a moral victory.

The founder and CEO of another of our portfolio companies is wrapping up a large round and he showed me his pitch deck. Guess what? Six slides. I had nothing to do with his deck. But it was a work of art.

Like many things in life, less is more in fundraising slides. You can explain your business in mind numbing detail or you can inspire an investor and let them imagine. Guess what works better?

If you succeed in inspiring an investor, there will always be an opportunity to do a deep dive in a follow up meeting. If you must, you can put your other fifty slides in the appendix. 

I learned this lesson when Brad and I starting raising USV 2004 in the fall of 2003. We retained an advisor to help us raise the fund and they told us to keep our deck to "six slides." I was aghast. How could Brad and I possibly take all that we had done and learned in almost 20 years in the venture business and put it into six slides? 

But the advisor won that argument. Two things happened. We learned to simplify our story and we learned how to create six killer slides. And killer slides are not slides with a dozen bullets each. They are six powerful points that combine to tell the meat of the story.

So when you sit down and build your pitch deck, think of six slides that will inspire and leave something for the imagination. The best part of six slides is that you will get through them in time to have a real substantive conversation face to face about your business. Imagine that.

The Credit Card Expiration Blues

I am sure this has happened to everyone. My work credit card expired and I was issued a new one. Sadly, I forgot to update that info in Google checkout. And so yesterday at 6:55am, the extra 20gigs of storage I was paying Google for in Gmail went away. Emails started bouncing, even on the forwarded ones which I was actually getting. Email has been a mess for 24 hours and Gmail is still not working right for me even though I fixed the credit card and repurchased the extra 20gigs yesterday morning.

I can deal with a messed up email situation. In fact it is a blessing for me. I got so much work done yesterday that I was able to leave the office early and take a yoga class in the late afternoon.

But this credit card expiration thing is a big issue when so much of our commerce goes through stored payment credentials on web services. I must have stored payment credentials on between fifty and a hundred web services at this point. And I have a number of credit cards, a VISA and an AMEX for personal, and AMEX for several of our business entities. So this creates a lot of complexity when my credentials change.

I've blogged about this problem before and people have pointed me to various services that were built to address these issues. I've looked at many of them and have not found one that really works for me. Frankly, I think the credit card issuers should solve this problem for us. Why can't all these payment systems auto update the credentials when a new card is issued? That would save us all a lot of problems.

If the credit card industry can't fix stuff like this, new payment methods are going to come along that are easier to use and work better on the web. There is no shortage of entrepreneurs working on payments ideas. So I expect problems like this one will be a thing of the past a decade from now. The only question is who will solve these problems first.

Diversification

I was talking to a friend over the weekend and he told me a story about a person he knows who made hundreds of millions of dollars of net worth in his career and then lost it all. I asked my friend how that could happen. He said "he made a lot of risky bets and none of them worked out."

I don't get how anyone could do that to be honest. I don't understand how someone gives Madoff all of their money to manage for them. When someone has very little to lose, I totally get betting it all and going for it. But when you have accumulated a nest egg or more, you must be diversified in your investments and assets. You cannot put all of your eggs in one basket.

Last week on MBA Mondays, we talked about Risk and Return. I made the point that risk and return are correlated. If you want to make higher returns, you must take on higher risk. But you can mitigate that risk by diversification. And this post is about that strategy.

One of the things most everyone learns in business school is portfolio theory (that's a wikipedia link if you want to learn more). Portfolio theory says that you can maximize return and minimize risk by building a portfolio of assets whose returns are not correlated with each other.

Let's use some real life examples. Let's say you have a portfolio of stocks and all of them are tech companies. To some degree, they are all correlated. When the tech bubble blew up in March of 2000, every tech stock went down. So if you had that portfolio, your portfolio went down big. Let's say you have a portfolio that has some tech stocks, some oil stocks, some packaged goods stocks, some real estate, some bonds, and some cash in it. When the tech bubble bursts, you get hit, but your portfolio does not "blow up." That is the power of diversification at work.

I have my own tech bubble story that is similar to that example. When the Gotham Gal and I moved back to NYC in the late 90s, we bought a large piece of real estate in lower manhattan from NYU. We sold a big slug of Yahoo stock that we got in the sale of Geocities to fund the purchase. And then we sold another big slug of Yahoo stock to fund a complete renovation of that real estate. Beyond those two sales, we did not get liquid on most of our internet and tech stocks because our funds were locked up on almost everything else.

When the bubble burst, our net worth dropped 80% to 90%. But it could have dropped 100%. That real estate did not drop in price. It actually increased by 2.5x over the eight years we owned it. That is the power of diversification at work.

Of course, we learned our lesson from that experience. We now have a fairly diversified portfolio of assets that includes venture capital investments, real estate investments, hedge funds, and municipal bonds. I am not suggesting that our mix is a good mix. I suspect we could be much more conservative and more "efficient" with our asset allocation if we hired a professional financial planner to do this work for us.

But this post is not really about our portfolio construction or even about asset allocation. It is about the power of diversification as a risk mitigator. 

Let's talk about diversification in venture capital funds. Making "one off" early stage venture capital investments is a bad idea. The chance that you will pick a winner in early stage venture capital is about one in three. I've said many times on this blog that one third of our investments will not work out at all, one third will work but will not be interesting investments. And all of our returns will come from the one third that actually work out. If you are making "one off" early stage investments and make five or six investments over the course of a few years, you do not have enough diversification. You could easily pick five or six investments and not once get to the one third that work.

We put 21 investments into our 2004 fund and I believe we will put between 20 and 25 investments into our 2008 fund. With that number of investments, we have a good chance of finding one investment that will be good enough to return the entire fund. And we have a good chance of finding another four or five investments that will return the fund again. We can handle a complete wipe out on between five and ten investments and still produce excellent returns. That is how diversification helps to manage risk in an early stage venture portfolio.

So if you are building a portfolio of anything, be it financial assets or anything, make sure to fill it with things that are not too similar and not too correlated with each other. To do otherwise is not prudent.