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The Open Internet Letter

I realize I’ve been writing a lot this week about the FCC’s decision next week on new rules for the last mile Internet here in the US. I promise I will return to the regularly scheduled programming soon. But this is a big issue and we need to keep up the pressure on the FCC to do the right thing here.

Today, about fifty leading VCs have signed onto a letter to the FCC asking them to keep the Internet free of fast lanes and slow lanes.

We are hoping that more angel investors and VCs will want to sign onto this letter today before we send it to the FCC tomorrow.

We pulled this together quickly over the past 24 hours, and weren’t able to directly reach as many VCs and other investors as we would have liked, so will gladly welcome additional signatories throughout the day today before we formally file this with the FCC tonight. Email nick [at] usv [dot] com if you’d like to join.

This debate is just picking up, and it will be critical for everyone who cares about innovation on the Internet to wrap their heads around this issue, and engage on it, as the FCC runs its rulemaking process through the summer and fall.

The Valuation Trap

There is a long article on Square and Box in TechCrunch this weekend. I am not sold on the arguments the author makes about the commodity nature of both products. But the author makes a point at the end in a section called “The Valuation Trap” that I very much agree with:

A second iron law of startups might be that the higher the valuation of a startup, the fewer options it has for financing and exits…… once a company has raised mezzanine capital and is valued in the billions, its options are essentially to go public or find a very interested buyer with deep pockets. There are few other options on this side of the startup pipeline.

The past three months have not been good for highflying tech stocks and now we are seeing IPOs being postponed. Both Square and Box have recently done that.

Another thing that Square and Box have in common is very high burn rates. The author of the Techcrunch post says that Square lost $100mm and Box lost $160mm in 2013.

The combination of sky high valuations, equally high burn rates, and a disappearing IPO market is not a pleasant one. I am fairly confident that both Square and Box can and will navigate the valuation trap, but it will require making some hard choices in the coming months.

So the moral of this story is that you can push valuations when you have investors knocking down your door, but unless you are cash flow positive and expect to remain so for the foreseeable future, you do that at your own risk. You will need to find someone to top that price down the road and that person may not be there.

Epilogue: I am a VC. I am talking my book here. I don’t like to pay sky high valuations. And I like to argue against them. So understand this post in that context. But I am also an investor in companies that have found, and may or will find themselves in the valuation trap. I have lived it, felt it, and suffered from it. It is a real issue.

Feature Friday: Voice Posting

It’s Friday and I’m in Middletown Connecticut and I don’t have a laptop with me. All I’ve got is my Nexus 7 and my phone and so I thought I would I try Google Voice Recognition to write a blog post and see how it goes.

So I just fired up the WordPress app on my Nexus 7 and I hit the little button at the bottom of the keyboard that’s the microphone and I’m just talking into the Nexus 7 now and this is what being recorded.

I think it’s pretty easy to post with voice. This is working out pretty great and I think Google has pretty much got it nailed. Anybody who doesn’t like to type but is happy to talk can start blogging.

I don’t really have a whole lot to say today other than this so I will quit now.

Feature Friday is Google Voice Recognition on Android.

PS – I did not edit any of this other than to do some punctuation and make some paragraphs.

Revitalizing Urban Cores

We’ve all seen the movie. A bustling inner city experiences the flight of people and businesses to the outer edges or suburban locations and then falls on hard times. The city becomes a suburban story and lacks the creative core that attracts younger people and new residents. The economy falters.

This could be the Brooklyn story, the Newark story, the Detroit story, the Buffalo story, the Cleveland story and many other stories.

We’ve seen that things can be turned around. The economic and cultural juggernaut that is Brooklyn right now is a perfect example. The grandchildren of the people who fled Brooklyn in the fifties and sixties are now coming back in droves, attracted to its lifestyle, its coffee shops, bars, restaurants, art and culture, parks, and affordable real estate. And the tech companies are coming too. Attracted by all the talent that is there.

I’ve been asked by civic leaders from places like Newark, Cleveland, Buffalo, and a number of other upstate NY cities that have suffered a similar fate how they can do the same thing. They all talk about tax incentives, connecting with local research universities, and providing startup capital. And I tell them that they are focusing on the wrong thing.

You have to lead with lifestyle. If you can’t make your city a place where the young mobile talent leaving college or grad school wants to go to start their career, meet someone, and build a life, all that other stuff doesn’t matter.

So it was really great to see what Tony Hsieh and his colleagues are doing at the Downtown Project in Las Vegas. The Gotham Gal has made a number of investments with Tony and his team and so she asked if we could get a tour of their efforts while we are in Vegas this weekend for our friends’ wedding. We spent most of Friday touring the work they are doing. And it is impressive.

The downtown Vegas story is a similar one. The hotels and casinos left downtown for the strip in the fifties and sixties and the city center faded leading to crime and decay. It was a tough place to live and/or work.

When Tony moved Zappos from the suburbs to the former City Hall in downtown Vegas a few years ago, he decided to invest $350mm in a massive urban revitalization project. He set aside $200mm to purchase land at bargain prices and the other $150mm to invest in three areas, arts and culture, small businesses (restaurants, cafes, bars, markets, boutiques, etc), and tech startups. $50mm is going into each area.

I was particularly impressed with The Container Park which opened late last year and houses food shops, boutiques, a playground, live music performances, and is a great place to hang out with friends and family. Here’s a photo I took while we were enjoying tacos at lunch on a sunny day in downtown las vegas.

container park

They have also taken a number of residential and hotel buildings and converted them into low cost and attractive housing for the hundreds of college grads who are moving to Las Vegas to work in the tech startups that are cropping up everywhere, largely funded by Tony’s Vegas Tech Fund.

You can feel the excitement and energy in the coworking spaces that are cropping up all over the place. There is a sense of purpose that goes beyond building a startup. They are also building a community and revitalizing a city.

It’s too early to know if this audacious project will work. But I think it has a decent shot. And mostly because Tony and his team focused on art, culture, lifestyle, housing, night life, parks, and recreation first and foremost. That’s the only model that I think can work and it seems like its working in Las Vegas right now.

Changing Clocks

I was in an elementary school in Brooklyn the other day and the clocks in the halls were an hour off. It was really bothersome to me. Maybe that school does not observe daylight savings time, but more likely the janitor or whomever is responsible for changing the clocks could not be bothered. Of course, the clocks in that school are now set correctly.

I’m a bit OCD about changing the clocks in our house and our cars. I hate it when a clock is set to the wrong time. And, each and every clock has its own system for changing the time. The clock in our double hung oven in our kitchen has a particularly complicated system. I had to find the manual on the Internet and look up the technique this morning after The Gotham Gal and I spent a few minutes hitting all sorts of combinations of buttons and got nowhere.

And then there are the cars. Whomever teaches people how to design user interfaces for car dashboards must have a perverse sense of humor. Each and every car has a different system for changing the clock time and each one is more clunky than the next.

But I go through all these machinations every six months because I can’t stand having clocks with the wrong times on them. Thankfully more and more of the clocks in my life are connected to the Internet and update automatically. I wish the clocks in our cars, on our ovens, and in our elementary schools would do the same.

The Pro-Rata Participation Right

I’ve touched on this subject before. It is one the “three things you must have in a venture investment“.

The “pro-rata right” is the right to continue to participate in future rounds so that you can maintain your ownership. Let’s make it concrete with an example. You invest $50k in a seed round at a $5mm cap and own 1% of the company. The next round is a $3mm round at $9mm pre, $12mm post. If you don’t participate, you will be diluted 25% and will then own 0.75% of the company. On the other hand, if you buy 1% of the round, a $30k investment, you will continue to own 1% of the company. Your “pro-rata right” in this situation is a $30k allocation in the next round.

I think this is the single most important term anyone can negotiate for in a venture capital investment. The other two in the post I linked to above are the liquidation preference, which helps on the downside but not the upside, and the right to a board seat, which is important to some investors (USV is one of them) but not to all of them. The pro-rata right helps on the upside, which is where you make all of your money in venture deals, and should be important to all investors.

The pro-rata right is something that is not typically offered in a note with cap structure in seed deals. When The Gotham Gal started investing in these kind of deals we had a long talk about it. I was negative on notes and she was positive on them. She convinced me that notes with reasonable caps are OK, but I convinced her to negotiate for a pro-rata right. She gets that on all of her deals because she walks without it. And that is just one of the many reasons I love The Gotham Gal.

I was discussing a Series A round with some founders yesterday. We talked about what they should do with their seed investors. I encouraged them to offer the seed investors the right to participate in the round. I don’t know if their seed investors have the right or not. But regardless, I feel that the founders owe it to them because their seed investors were there for them before anyone else. It just feels like the right thing to do to me.

The meta point I have come to understand about early stage investing is that a small portion of your investments produce all of the returns. In those investments, you want to own as much as you can. It’s hard to own more than your initial stake, particularly as an angel investor. But it should not be hard to maintain your initial stake. You should reserve funds to do this, you should negotiate for a pro-rata right, and you should exercise your pro-rata right when you feel like the investment is doing well.

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43North – A $5mm Business Plan Competition

The folks in Buffalo NY are serious. Last year I went up to Buffalo to visit a new business incubator and was impressed by the entrepreneurial talent and community engagement I saw. But they aren’t stopping there.

They have launched 43North, which is the largest (in terms of prizes) business plan competition in history. Here are the details:

With $5 million in cash prizes, including a top award of $1 million, six $500,000 awards and four $250,000 awards, 43North is setting out to turn the best new business ideas from around the globe into reality.

Winners also receive free incubator space for a year, guidance from mentors related to their field and access to other exciting incentive programs.

43North is open to applicants in any industry, with the exception of retail and hospitality, and winners agree to operate their business in the Buffalo, New York for a minimum of one year.

The competition includes three rounds of judging:
1.  Feb 5, 2014 to May 31, 2014: 43North accepts applications via – apply here.
2.  Sept 15, 2014 to Sept 20, 2014: Semifinalists present their plans via webinar
3.  Oct 27, 2014 to Oct 31, 2014: Finalists present their plans during a weeklong series of events in Buffalo, NY

This ambitious initiative is part of New York State Governor Andrew Cuomo’s historic pledge of $1 billion in state funding to ignite economic growth in the Buffalo, New York region.

I know the people behind this effort, Jordan Levy and Ron Schreiber. They are serial entrepreneurs and venture capitalist and are the real deal. The mentorship and coaching part of this program will be as important as the money. But getting $1mm for free to start your business isn’t a bad deal either.

If you want more information, the FAQ is here. If you want to apply, go here.

The Berkshire Hathaway Annual Report Letter

On Friday, Berkshire Hathaway published their annual report. I always like to read the shareholder letter that fronts the report. It is available here.

The Gotham Gal and I are not, and have never been, shareholders of Berkshire Hathaway. I guess that is a mistake but we’ve done alright anyway. You don’t have to be a shareholder of Berkshire Hathaway to benefit financially from the brilliance of their managers, Warren Buffet and Charlie Munger. I look up to both of them and have internalized as much of their thinking as I can. Reading the annual shareholder letters is a good way to get inside their heads.

In this year’s letter Warren tells the story of two real estate purchases he made in 1986 and 1993. One is a Nebraska farm and one is piece of NYC real estate in Greenwich Village. Here’s how he ends each story.

The Farm – I still know nothing about farming and recently made just my second visit to the farm.

The NYC Real Estate – I’ve yet to view the property.

But in each case, he went through an analysis of the earning power of the asset, concluded that it was much higher than current performance, and further concluded that it would yield an acceptable return on the purchase price on current performance.

Here is what Warren says about those two investments and the “fundamentals of investing”:

  • You don’t need to be an expert in order to achieve satisfactory investment returns. But if you aren’t, you must recognize your limitations and follow a course certain to work reasonably well. Keep things simple and don’t swing for the fences. When promised quick profits, respond with a quick “no.”
  • Focus on the future productivity of the asset you are considering. If you don’t feel comfortable making a rough estimate of the asset’s future earnings, just forget it and move on. No one has the ability to evaluate every investment possibility. But omniscience isn’t necessary; you only need to understand the actions you undertake.
  • If you instead focus on the prospective price change of a contemplated purchase, you are speculating. There is nothing improper about that. I know, however, that I am unable to speculate successfully, and I am skeptical of those who claim sustained success at doing so. Half of all coin-flippers will win their first toss; none of those winners has an expectation of profit if he continues to play the game. And the fact that a given asset has appreciated in the recent past is never a reason to buy it.
  • With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field – not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays.
  • Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important. (When I hear TV commentators glibly opine on what the market will do next, I am reminded of Mickey Mantle’s scathing comment: “You don’t know how easy this game is until you get into that broadcasting booth.”)
  • My two purchases were made in 1986 and 1993. What the economy, interest rates, or the stock market might do in the years immediately following – 1987 and 1994 – was of no importance to me in making those investments. I can’t remember what the headlines or pundits were saying at the time. Whatever the chatter, corn would keep growing in Nebraska and students would flock to NYU.

I don’t agree with all of those points, particularly the argument against macro thinking. I use macro thinking to find assets that will perform well in the future and avoid assets that will underperform in the future. But the basic idea that what matters most is the asking price of the asset and its future earnings power is something that I totally and completely believe in and I’ve learned that over and over and over from reading these letters over the years.

The Berkshire Hathaway Annual Report Letter is a gift to investors and if you are one, I would encourage you to read them. You can start with this year’s version.


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Online Identity and Brand

In celebration of the return of my avatar to the front page of AVC (and now integrated into the AVC logo), I thought I’d post about online identity and brand today.

I really like this slide from Disqus‘ presentation materials.

disqus slide

Obviously any slide with Fake Grimlock in it is a good slide. But beyond that, the idea that all three of these types of people can co-exist in an online community is important. I would argue that a healthy online community will, by definition, have all three types in it.

Pseudonyms like Fake Grimlock most obviously lead to the use of an avatar. Real names often come with a photo of the person. But I’ve always liked the idea of a real name (I am fredwilson on almost every service out there) plus an avatar. I think it builds brand in a way that a name and a photo cannot.

Like most things, I came to all of this without a lot of advance thinking. I was an early user of AOL and went with fredwilson for my username there. I still maintain [email protected] for some reason, but I never check my mail there. And when the web came along, I started using fredwilson everywhere. I’ve continued to do that and as long as I can get to a service early, I can get that username. It’s an incentive to get to services early which can be an advantage in my business.

The avatar was also an unplanned thing. I’ve posted the story of it here before and you can go read it if you’d like. But over time, I just started using it everywhere. And I do mean everywhere. Including LinkedIn.

The combination of my name and my avatar is now my online identity and brand. It could, of course, be faked. And Twitter’s verified accounts are a nice way to deal with that sort of thing. But when you come across a comment, a profile, or some other object online with my username and my avatar next to it, you can pretty much assume that its me. And that’s a really good thing. Because systems need some sort of identity to flourish over the long term. And users benefit from the brand they can build up around their identity over time. The two go hand in hand and work together to make a large global distributed system like the Internet work better for everyone.