Posts from VC & Technology

The Pro-Rata Opportunity

Mark Suster has a good (and long as is his wont) post up on the topic of the changing structure of the VC business.

Mark focuses on something important that is probably not getting talked enough about when people talk about the VC business these days. I like this slide from his post:

suster slide

“Capturing pro-rata” is sooooo important in early stage venture. You make 20 investments in a fund. One is going to return the entire fund. Two more are going to return it again. A few more are going to have strong outcomes and return it again. The rest are noise when it comes to fund returns (but you better not treat them like noise).

Guess what? Early stage VC is a lot like poker. You want to go all in on your best hands. And if you make a seed or Series A investment, you get something called the pro-rata right. That means you get to invest an amount in every private round going forward that allows you to keep your ownership at the current level. A pro-rata right in Facebook, Twitter, Dropbox, Airbnb, Uber, ……….. is worth a lot. And early stage investors get those rights for free in the early stage rounds.

At USV, we recognized this early on but did not know what to do about it. So we let our pro-rata rights go unused in Zynga and Twitter because we did not have the funds to take those allocations. Brad agitated about it. It bugged him. I was also unhappy about it but did not want to increase our fund size so that we could take these allocations. I strongly believe in small fund sizes. It’s a core of our strategy at USV.

So we came up with The Opportunity Fund. It’s a companion fund that is designed to “capture pro-rata” as Mark puts it. We raised our first one in late 2010 and our second one earlier this year. It has been a big success. It is now so much a core of what we do that we now raise an early stage fund and an opportunity fund as a pair. You can’t invest in one without investing in the other. They have different economics for the LPs because they require different amounts of work on our part and because we don’t want to commit to put the entire Opportunity Fund to work (we did not put the entire initial Opportunity Fund to work).

When a company hits escape velocity, the investors in the inside are the first (after the entrepreneurs) to realize it. And if you’ve watched hundreds of rockets go up in your career and dozens hit escape velocity, you start to be able to smell escape velocity coming. That means that “capturing pro-rata” is an opportunistic thing. Seeing something before others see it is one of the few legal and sustainable ways to make money that I know of in the investment business. And so having a vehicle to do this aggressively is a huge weapon in the hands of an experienced VC firm.

Yes it is true, as Mark points out in his post, that public market investors are also coming into the private markets in a big way to capture all of this valuation expansion that used to happen in the public markets. But they do not have the one thing that we have – the pro-rata right. And so using it becomes even more important.

I am glad that Mark took the time to write his post on this topic. It’s a big change that has happened fairly quickly in the early stage venture capital business (all post financial crisis) and the ramifications of it are important to entrepreneurs, VCs, public market investors, and LPs. I’m very pleased that USV has been early to this theme and a thought leader in it.

Platform Monopolies

There’s an article in the NY Times Sunday Business Section today that lays out a very important question we have all been dancing around but will increasingly be dealing with. The article is nominally about Amazon’s fight with Hachette but it is really about internet platforms and monopolies.

The author of the NY Times piece tells the story of Vincent Zandri, an author of mystery and suspense novels, who has moved all of his publishing activities over to Amazon’s platform and is enjoying the benefits of doing that.

This could easily have been the story of the journalist who moves her writing from The Wall Street Journal to her own blog, or the story of the filmmaker who moves from the Hollywood studio system to Kickstarter and VHX. It could be the story of the band that leaves their record label and does direct deals with SoundCloud and Spotify. It could be the story of the yellow cab driver who moves his driving business to Uber or Sidecar.

The story of Vincent Zandri is the story of our times.

The Internet, at its core, is a marketplace that, over time, removes the need for the middleman. That is very good news for the talent that has been giving up a fairly large part of its value to all of the toll takers in between them and their end customers.

Take Etsy for example. Before Etsy, if you made knit hats, you would sell them to a boutique for $10, and that boutique would turn around and sell them to your customers for $25. Now you sell them to your customers on Etsy for $25 and pay a 20cents listing fee and 3.5% of the transaction and a payment processing fee. In the old model the knitter made $10 per hat. In the new model, the knitter makes about $23 per hat. That’s a big deal. And you see it all over the place in the Internet marketplace economy.

But there is another aspect to the Internet that is not so comforting. And that is that the Internet is a network and the dominant platforms enjoy network effects that, over time, lead to dominant monopolies.

We see that with Google today. Google’s global search market share is around 70%. It would be larger if not for China and Russia, where the governments have given benefits to local players. But even with its current market share, Google is pretty close to a monopoly in search. It is a benign monopoly for the most part and, as such, has largely stayed out of the sights of regulators. I, for one, am happy with that game of chicken between Google and the regulators.

Amazon is increasingly looking like a monopoly in publishing. This part of the NY Times piece is how all of these Internet stories have played out:

At first, those in the publishing business considered Amazon a cute toy (you could see a book’s exact sales ranking!) and a useful counterweight to Barnes & Noble and Borders, chains willing to throw their weight around. Now Borders is dead, Barnes & Noble is weak and Amazon owns the publishing platform of the digital era.

The same could be said of Google, Twitter, YouTube, SoundCloud, Uber, and all of the dominant networks that are emerging around us. From laughable toys to dominant monopolies in less than a decade.

It’s strange for me to write this post because this is our playbook at USV. We invest in networks that can emerge as dominant platforms by virtue of network effects. We like things that are laughed at. The more they are derided, the more we want to invest.

But here’s the rub. When a platform like Amazon emerges as the dominant monopoly in publishing, who will keep them honest? When every author has left the publishing house system and has gone direct with Amazon, what does that world look like?

That is the question the NY Times is asking in their story this morning. And that is an issue that we at USV have been confronting for a while now and we are investing against it.

We have invested in Wattpad, which is a bottoms up competitor to Amazon, as opposed to Hachette which is a top down competitor to Amazon. We think its easier for a more open, less commercial platform like Wattpad to keep Amazon honest than it is for a legacy publishing house.

We have invested in Sidecar, which has built a true open marketplace for ridesharing. We think its more likely that true peer marketplace will keep Uber honest than the legacy fleets of limos and taxis that are fighting for their life against Uber right now.

But maybe most importantly, we are investing in bitcoin and the blockchain, which is the foundation for truly distributed peer to peer marketplaces without the Internet middleman.

For this is the truth that we are now facing. For all of its democratizing power, the Internet, in its current form, has simply replaced the old boss with a new boss. And these new bosses have market power that, in time, will be vastly larger than that of the old boss.

So, as an investor, when you see a dominant market power emerge, you should start asking yourself “what will undo that market power?” And you should start investing in that. We’ve begun doing that, but are not anywhere near done with this effort.

Silicon Valley: A Place Or A State Of Mind?

Marc Andreessen, as is his wont, posted a tweetstorm this morning that was a spirited defense of Silicon Valley. It starts with this tweet:

One thing I always think about in reading things like this is the use of the phrase “Silicon Valley” or SV as Marc uses in his tweetstorm. Let’s look at this tweet:

Does Marc mean “move to Silicon Valley” or does he mean “do a startup or join one and work on this stuff”?

I actually don’t know what Marc meant by his use of SV in this tweetstorm, but having spent 25 years in the tech/startup/VC sector and having done that time outside of Silicon Valley (the place), I am sensitive to the use of those words and always wonder.

We have about a third of our portfolio in the bay area. We have about a third in NYC. We have about a third elsewhere with a large concentration in Europe where I am heading in a few weeks to attend several board meetings. I like to think of the tech startup ecosystem as a global movement. We don’t invest in Asia, South Asia, or Latin America but I see more and more interesting things coming from those regions these days.

Silicon Valley is most certainly a mindset and it is one that is infecting large swaths of the global economy. I agree with Marc’s tweetstorm, in particular this one.

And I think, when applied to the global startup ecosystem, he is absolutely right.

Songza

So yesterday it was announced that Google has purchased Songza. Congratulations to Elias Roman and his colleagues. They build a great product and sold it to a great company.

But I’d like to take a second to tell the story of Songza as I know it. I am sure there are lot’s of parts of this story that I don’t know but the parts I do know make for a great story and now is a good time to tell it.

A few Brown University students had a great idea in 2006. They felt that mp3s should be priced based on demand not on a fixed price. So they started a company called Amie Street and built that service.

I first met them at some point after they had graduated from Brown and moved to NYC. I liked the idea a lot but was hesitant to invest. Others were not and they raised some money and chased that dream.

At some point Amazon got involved, I think as an investor. The Amie Street model ultimately did not pan out and in 2010 it was sold to Amazon. I don’t know the terms of that transaction but it did allow the team to stay together and work on a something else.

Long before the sale to Amazon, in October of 2008, Amie Street acquired Songza, a music app that was built by Aza Raskin and Scott Robbin.

After the sale of Amie Stree to Amazon, the team focused on Songza and iterated on it for a few years until they landed on the concierge user interface that helped popularize Songza.

I started using Songza in early 2012 and have been actively using it ever since.

I have three modes for listening to music and a primary services for each.

Passive – Songza, Intent Based – Rdio, Discovery/Social – SoundCloud. I use Songza the way most people use Pandora. And I use it mostly on my various Sonos systems.

But back to the story of Songza. Over time Songza built a popular music service and they raised some more capital in the fall of last year. We spent some time with them during that process but we were already knee deep in online music with Turntable (RIP) and SoundCloud.

Every interaction I’ve had with the Songza team has been fantastic. They are great people. And every interaction I’ve had with the Songza service has been equally good. Which furthers my view that great people build great products.

I wasn’t surprised to see that they sold to Google. The streaming music business is hard. And the big platforms understand that music is a great audience builder and retainer. And Google has been a great home to great products (YouTube, Android, Nest, etc).

So that’s the end of my story. It has a happy ending.

If there is a moral to this story it is that tenacity pays off. The Songza team graduated from college eight years ago and worked on two separate services over that time with a fair bit of success and failure. They hung together and built something that is very good. And they got a good exit. As JLM would say “well played.”

Video Of The Week: The YC Startup School Fireside Chat

This past week YC did their first Startup School in NYC. I was honored to be part of it. Aaron Harris and I did a fireside chat. It’s about 25mins long. I hope you enjoy it.

By the way, how awesome is the thumbnail they chose for the video? I need to get a copy of that image.

What Seed Financing Is For

Marc Andreessen posted a tweetstorm last week and he talked about how to think about seed financings and how they lead into Series A and Series B rounds.

Feature request for Twitter: Please make it possible to permalink to and embed a tweetstorm. You can call this the @pmarca feature.

I replied to item 6/ of his tweetstorm:

I feel very strongly that seeds should not be as large as they are these days and they should not be used to fund anything other than building product and finding product market fit.

It is possible to raise a large seed that, in theory, could fund all of that, plus a lot more. And all entrepreneurs are encouraged and interested in taking as much capital as they can given the dilution that they can stomach.

But I’m old school. I think of building a startup and funding it as walking up a flight of stairs. My partner Albert prefers the videogame (leveling up) analogy. Both work. I will stick with stairs.

The first step you need to climb is building a product, getting it into the market, and finding product market fit. I think that’s what seed financing should be used for.

The second step you need to climb is to hire a small team that can help you operate and grow the business you have now birthed by virtue of finding product market fit. That is what Series A money is for.

The third step you need to climb is to scale that team and ramp revenues and take the market. That is what Series B money is for.

The fourth step you need to climb is to get to profitability so that your cash flow after all expenses can sustain and grow the business. That is what Series C is for.

The fifth step is generating liquidity for you, your team, and your investors. That is what the IPO or the Secondary is for.

That is a very simple view of the world. Very few companies will walk up the stairs easily and hit each one perfectly. Shit happens. And we all know that and can deal with that.

But I will tell you that the companies that have performed best in all the portfolios I’ve been involved with over the years have climbed those stairs more or less like that.

I don’t think its a good idea to jump over the first three steps and land on the fourth even if you have the legs (and funds) to do that. It is risky. If you don’t land it right, you can slip and fall. And its hard to get up if you do that.

Learning From Brian

Brian Watson spent a little more than two years at USV and yesterday was his last day. He’s moving on to an operating role in a fast growing company that will remain nameless until Brian decides to tell that part of his story (soon). We have a two year rotational analyst program at USV that has produced an incredible alumni class and Brian is now a member of that illustrious group. He has a very bright future ahead of him.

Brian took the time to write a post on the things he learned at USV. I kidded him yesterday that it could have been a tweet storm because it’s chock full of 140ish character lessons learned. It’s a great collection of insights and I would encourage everyone to read it.

Our analyst program is a two way street. We teach our analyst things and they teach us things. Brian has taught me a lot. He was never afraid to walk into my office and say “we aren’t paying attention to this and we should” and he did that a lot.

I am a pretty directed person in the office and I am sure I put off a “don’t bother me” vibe. Brian ignored that and I appreciate it.

Here are a few of the things that Brian taught me in no particular order:

- Photos are the killer content type on mobile. Quick to consume like text, but easier to produce on a phone.

- Pay attention to what Apple does. It is more important than you think.

- Tech is fashion as much as you don’t want to admit it.

- If you insist on using everything we invest in, we will miss important things (Tinder).

I would also like to thank Brian for introducing me to Isaiah Rashad and many other great musicians. Brian’s soundcloud likes are here.

I am proud of many things about USV, and Brian noted a bunch of them in his post, but the thing I am most proud of is the people that collectively make up USV, past and present. Brian is a great representation of that and I wish him well.

Video Of The Week: Reid Hoffman and Joi Ito at The Churchill Club

My favorite talks are between interesting people who know each other well. This talk is one of those. Joi and Reid have been friends for as long as I’ve known them, which is over a decade.

Reid is the founder and Chairman of LinkedIn and a leading VC with Greylock. Joi is the Director of the MIT Media Lab and formerly the Director of Creative Commons.

Thanks to Tyrone who sent this one to me earlier this week.