Posts from January 2009

I don’t post much about Twitter even though I think about it a lot. First of all, being an investor and board member makes it complicated. Second, there’s way more chatter about Twitter than is necessary, and if anything the hype machine should crank down, not crank up even more.

But I saw this slide in a deck this week and it struck me as so right. Twitter has never been about technology, certainly not during its fail whale period, and not even now when the tech team at Twitter is doing a great job. Twitter, like all social media, is about the people who use it.

Dan Frommer has a post up on Techmeme this morning where he talks about the great citizen journalism that produced this photo yesterday.

And in the comments of that post, there was a discussion between Nicholas Carson (another Alley Insider blogger) and some readers. One of them, Ari Herzog, wrote this:

Ari Herzog
said:

       

            
Surreal stuff, Janis.

And Nicholas, I’d argue Twitter isn’t awesome. Rather, it’s the
combination of people using it, services supporting it, and buzz about
it that make it awesome.

You can follow me @ariherzog.

That’s the same point the slide I saw this week is making. Sure the technology allows all of this to be possible, but the technology behind twitter is not what makes it special. It’s the people who are on it and the way they use it that delivers all of the value.

It’s also, as Ari points out, the services that are supporting it that make twitter what it is. Twitpic, which Janis Krums used to post that photo to twitter, is a great service that I use from time to time. And there are literally thousands of other services built on top of twitter that we can use to do things that the twitter service itself doesn’t do.

That’s the trick, an open social platform that allows people, including developers, to do what they want with it. And that is what allows for the triumph of humanity that is twitter.

I’m all for transparency and mark to market. As Roger Ehrenberg has blogged about consistently, investors need to know what the underlying securities are worth inside banks, brokerage firms, insurance companies, hedge funds, private equity funds, and yes venture capital funds.

The FASB (which governs accounting standards in this country) recently issued a new rule called FAS157. I’m not going to get technical on you and the accountants in the community can weigh in via the comments if they feel the need for more rigor in this discussion. 

In layman’s terms, FAS157 says that you have to value your investments at ‘fair market value’.

I’ve been dealing with valuing venture investments every quarter since I got into the VC business in the mid 80s. One of the big roles I had at my first VC job was the help manage the annual audit process and I’d prepare the schedules of investment for our firm’s funds every quarter

Back then, we did it the old school way. We’d carry our investments at the ‘lower of cost or market’ and rarely write them up without a new financing event. Even with a new financing event, we’d often continue to carry the investments at cost if we felt that the markup to the next round price was ‘shaky’. That could be because it was an internal round, a round led by strategic investors, or just a wildly inflated valuation that we were uncomfortable with.

On the other hand, we were quick to mark things down when the investments soured. We’d often mark an investment down to one dollar to signify that it was still unrealized but we felt it had no upside potential.

The net result of this approach is that the fund would always be undervalued until the investments were realized and the distributions had been made in full. And everyone was mostly fine with that approach because almost all LPs at that time held their fund investments to maturity and didn’t care about interim valuations. They cared about cash out/cash in and not much else.

All that has changed and the venture business is a different place now. Interim valuations (and the associated returns) matter quite a bit when you go out to raise another fund. Also, the LPs are now selling their positions in the secondary market and this year we’ll likely see more of that than ever before. So the carrying value of the investments is starting to matter.

And then comes these new rules from FASB. Our auditors, and I suspect every VC firm’s auditors, want us to be rigorous about our valuation methodology and try, each quarter, but particulalry at year end, to come up with a calculation of ‘fair value’ for every company we’ve invested in and every underlying security we own in those companies.

Over the past week, as the audit season hits, I’ve had a number of conversations with other VCs about how we are valuing companies we share an interest in. And from those conversations, its clear to me that there are a lot of different approaches being taken out there.

So I thought it would be a good idea to blog about how we do it. First, we start with two crack members of our team, Andrew and Eric, who do most of this work. I hope they’ll weigh in with comments and correct me where I’ve mis-stated something.

They have created a spreadsheet template that we use for each company. We then go out and find comparable private and, ideally, public companies for each of our investments. We like to have at least three ‘comps’ and often use four or five.

Then we calculate multiples of revenues, ebitda, and sometimes other measures of ‘traction’ like size of audience (UVs per month) for all the comps. We then take an average and get a baseline comp for each portfolio company. We back out excess cash less debt from the market prices when we calculate these comps.

When we use private companies and M&A transaction values that happened some time ago (we don’t use comps that are more than 18-24 months old) we’ll apply a market factor to them. For example, we’d take the Bebo sale price of $850mm and cut it roughly in half because the market has dropped in half since Bebo was sold.  We do the same with comps for venture deals like the latest private round for WordPress.

We then collect the financial and other important data points for our companies for the current and next fiscal year and apply the relevant comp to that company and calculate an enterprise value. If the portfolio company has a significant amount of excess cash on its balance sheet we will add that minus any debt to the enterprise value to get a market value.

Then we assume we sold each and every company in an M&A transaction at that market price and do a liquidation analysis and determine the value in that scenario of each underlying security. And that’s what we carry them at each quarter.

This is a tortuous process and produces some very non-intuitive results. For example, we are going to mark down the unrealized gain of the two companies in our portfolio that had the best fourth quarters of all of our companies. Seems strange that we be marking down the carrying values of our two best companies doesn’t it? But the reason is that even though they both significantly beat their plan in Q4, the comps we use for both came way down in the fourth quarter.

So we take the adjustments and explain it to our investors in the reports and on the investors calls we do every quarter.

We also have the opposite problem that sometimes we are forced to write our investments up to levels we are not comfortable with. When their comps have big and probably temporary increases in stock price, our companies get written up. Which inevitably leads to a markdown in a future quarter.

The public market investors who are reading this are probably laughing right about now and thinking that it’s about time the private equity and VC firms had to deal with vagaries of the market.

But I’m not sure this is all good news for the investors in VC funds. We are going to see a lot more volatility in fund valuations and the ways of the past where you had slow but steady increases in fund value are gone. VC interim returns are going to get more correlated with the market and we’ll all end up spending countless hours explaining away certain numbers that are on the books but make no sense.

And, like has happened to me over the past couple weeks, VCs are going to have to talk more to our colleagues about how we are valuing our common investments so we can take the phone calls from our common LPs and explain why we’ve marked something up but our colleagues have marked it down.

There’s a silver lining in all of this, including the IRS 409a pronouncement of a few years ago that has created a whole industry of private company valuation firms and, if anything, even lower stock option grant prices, and that is that we are starting to collect a huge data set of private company valuations over time.

This, combined with the efforts of a few brave souls to create secondary markets for private company stock is going to lead to more data, more transparency, and more liquidity without having to register and do an IPO or sell your company.

But right now, it all feels like major pain in the butt.

For as long as I’ve been blogging (5+ years), I’ve been posting mp3s to the Internet. I do all of that now at fredwilson.vc but you can always click on the black banner at the bottom of this blog page and listen to the latest tracks I’ve posted.

I mainly blog music to share it with the people who read this blog and my tumblog. I love new music and discovering it and sharing it. And there are a ton of people I know who share this love of music blogging and they are constantly turning me onto new music. It’s like we’ve recreated the dynamic we had in our college dorms when we would take turns putting vinyl records on the turntable.

But there’s another reason I love music blogging. From time to time, I actually hear from the artists themselves. I’ve never stopped being a fan. When I get to meet musicians, I am always like the little kid pinching themselves wtih disbelief. I’m a groupie and proud of it.

Back at the end of last year, I was tipped off by a blog reader named Luke to a band called The Rural Alberta Advantage. I blogged some of their music at fredwilson.vc and you can listen to a bunch more of it at the Hype Machine. And I gave the record honorable mention on my top ten records of 2008 post.

This morning I picked up an email from Amy, one of the three band members:

Hi Fred,

It’s Amy from the Rural Alberta Advantage here…I just wanted to send a belated THANK YOU for putting us on your Honourable Mention list for your Top Records of 2008!  We received an email out of the blue from someone saying "just a heads-up that one of the most popular websites on the internet gave you a shout-out"!  and directing us to your site. So awesome! We really can’t believe how many people have heard our record now. It’s a pretty exciting feeling to know that almost every day we’re going to be hearing from someone else, from a place we’ve never played, talking about our songs. So thank you for helping us get our record out there!

I also wanted to invite you to come see us play in New York City (our first time out of Canada!) – we’re playing at a place called Piano’s NYC (on the lower east side of Manhattan) on Tuesday, January 27th. Then we are 99% for sure playing again in Brooklyn at Union Hall on Friday, February 6th.

Thanks again for listening Fred, and hope to see you on the 27th! (or the 6th!)

Cheers,
–AMY

Now how freakin awesome is that? A thank you note and an invitation to come see them play their first gig in NYC. Of course, I’ll be there at the Piano’s show, along with the Gotham Gal. Tickets are $8, so if you like their music as much as I do and you live in NYC, you should come too. And while you are at it, get the record, called Hometowns.

As a bonus, I am doing something I rarely do these days. Here’s an mp3 of my favorite track on the record:

Edmonton – Rural Alberta Advantage – Hometowns

All the links at the bottom of the posts on this blog below the date/category/comment line are served up by FeedBurner/Google via a tool called FeedFlare. FeedFlare was built back in late 2005 well before AddThis and others built out a whole category around social sharing services for the web.

I’ve stuck with FeedFlare even though, like many of the FeedBurner services, it has languished under Google’s ownership. I really like having an identical set of engagement links on the blog and the feed and that’s the beauty of FeedFlare.

A few weeks ago, someone (can’t recall who) sent me a link to a service that puts a "tweet this" link at the bottom of a post. That reminded me that I didn’t have such a link on this blog.

So yesterday, I went into FeedFlare and searched for a service that would do that for me. I found one, called "twit this", and added it. You’ll see it now under all of the posts on this blog. For the life of me, I don’t know why it’s called "twit this" and not "tweet this" but in all other respects, it seems to work well. So if you like a post and want to tweet about it, you can use that link now.

I have noticed that FeedFlare has been on and off on this blog recently. I don’t know what that’s all about and I sure hope Google is committed to maintaining this service and it’s reliability going forward.

Like I do every morning, I logged into Techmeme to find this news:

That’s an image, sorry about that, here’s the link to the WSJ story, but I wanted you all to see how I heard the news.

This is so great on so many levels. Let’s start with the first reason. The new head of the FCC reads this blog. He’s heard me talk about the issues he’ll now make policy on. And he’s heard your views on those issues.

Here’s the second reason. He’s a venture capitalist, at least that’s what he’s been doing for the past couple years.

Here’s the third reason. He’s an internet executive, at least that’s what he did for most of this decade when he helped Barry Diller assemble and build IAC.

Here’s the fourth reason. He’s the guy who talked me into meeting Barack Obama back in 2007 and ultimately supporting Obama. He went to law school with Barack and has known him for 20 years.

Here’s the fifth reason. He’s not new to the FCC, having worked there during the Clinton administration.

Here’s the sixth reason. He knows his way around Washington. Before the FCC, he clerked for Brennan and Souter on the Supreme Court.

Here’s the seventh reason. He’s smart as shit. I suppose you didn’t need me to tell you that given his resume.

Here’s the eigth reason. He’s right on all the issues. But don’t take it from me, here’s a snippet from the WSJ piece:

During the campaign, Mr. Genachowski served as the top technology
adviser to Mr. Obama, putting together a detailed technology and
innovation plan that expressed support for open Internet or "net
neutrality" protections; media-ownership rules that encourage more
diversity; and expansion of affordable broadband access across the
country.

Here’s the ninth reason. He’s one of us (I guess you didn’t need me to tell you that either). He’s even got a Wikipedia entry.

Here’s the tenth and final reason. He’s a super nice, decent, honest guy.

This news, while not unexpected, made my day and made me smile a mile wide. A friend of tech and the Internet and the startup ecosystem running the FCC. Just think about that and smile with me.

Peter says in this video that I am "constantly blogging about Boxee" and I suppose that’s true so I am going to continue that behavior and reblog his interview of Avner at CES last week.

Here’s the blog post from All Things D where the video was originally posted.

The most interesting news on Techmeme this morning (to me) is that Yodle is operating at a $30mm revenue run rate. I don’t know Yodle’s competitor Reach Local‘s annual revenues, but I suspect they are at least double that and probably more. When you add up all the competitors in the market for selling search solutions to the "local" and/or "SMB" markets, it’s probably at least a couple hundred million in revenues and growing fast.

On one hand, we are bemoaning the potential loss of local news organizations and on the other hand we are witnessing a significant new market getting built selling search and other tools to local small businesses.

As more small businesses find channels and tools to buy targeted media, this market is going to start to benefit from scale economics just like Google and the display ad networks and exchanges have in the past few years.

We talked about all of this in the revenue breakout group at the Networked Journalism Summit last fall and I just found Scott Meyer’s notes on our breakout group. Scott called it "How Joe The Plumber and Google Saved News". That sort of sums it up.

But the big point here is that Google is not an end to end solution although it’s a critical component and there are many innovative new companies building some pretty big businesses on top of and around Google in the local small business market. There is an opportunity for all local media companies including newspapers to do this. But sadly most of them aren’t interested in reselling Google and other scaled and targeted advertising systems to their customer bases. Apparently they should be.

A good place for any local media company with such an interest to look for a solution is our portfolio company Clickable‘s services offerings. Clickable’s partnership with Lexis Nexis is an example of the kind of thing that local media companies should be doing today.

There’s been something unsettling to me about Paul Krugman’s Great Depression II op-ed piece and I’ve struggled for a week to figure out what it is. And then today, I came across Umair Haque’s piece from last month called Do Economists Matter?

I don’t want to disparage Paul Krugman. He’s way smarter than I am, he has degrees from Yale and MIT, he’s taught at MIT, Stanford, Yale, and now Princeton. He received the Nobel Prize last year in Economics. He’s one of the most influential economists, thinkers, and writers in the world.

And yet, Krugman’s Depression II piece is essentially a debate and discussion of Keynes vs Freidman, tax cuts versus infrastructure investment. It’s a 20th century economics model being applied to a 21st century crisis. And I think there’s a really good chance that these models the economists are using are outdated and focused on the wrong issues.

Haque, on the other hand, sees this economic crisis differently. He says:

We can’t fix today’s problems unless we change yesterday’s rules. But
economists — and the models they rely on — are bounded by yesterday’s
rules.

I wrote a long piece over the holidays called Bits Of Disruption where I argued that technology has fundamentally changed the economic model of most, if not all, industries and we are witnessing the destruction that goes along with that disrpution.

That’s one big vector of change, but it’s not the only one. Globalization is another huge impact. The most influential book (on me) I read last year was Fareed Zakaria’s The Post American World. Surely the economic models our leaders are using incorporate global money flows and other important global factors. But we’ve never been in a world where you can hire someone anywhere in the world in a matter of days, where you can transact instantly with companies all over the world, and where global factors weigh so heavily on economic issues. I just don’t think our models fully incorporate the global world we live in today.

But neither of these vectors are what Umair is obsessively focused on. He sounds more like Marx than any current economist to be honest. Umair’s interested in DNA, not what makes each of us unique, but what makes companies, institutions, and even governments unique. And he points out that the old models don’t work anymore.

Starbucks, for example, pursued a
textbook approach to strategy; growing from a strong core defended by a
powerful brand, value chain control, and scale, into adjacent markets,
like food, music, and events. All of which led it directly and deeply into strategy decay – by robbing it of purpose, vision, and empathy.

Microsoft, perhaps the ultimate hardball player, focused on ownership
of a standard at all costs – and is now struggling to compete in an
industry whose fabric has been riven by open standards and open code:
its own domination games have returned, like the ghost of strategy
past, to haunt it.

The old rules certainly don’t work for many (most?) businesses anymore and they probably don’t work for the economists either. So Obama will spend upwards of a trillion dollars of stimulus in a combination of tax cuts, building roads, bridges, and hopefully public transportation. And it can’t hurt and maybe it will help.

But what matters more is how we change our culture, our society, our government, our economy and the companies that help make it up. A good place to start are Tim O’Reilly’s three rules:

1) work on something that matters more than money

2) Create more value than you capture (that’s the kind of DNA that’s winning the day now)

3) Take the long view

I had dinner last night with some friends, all of whom were big supporters of Obama and his vision of change. All of us were at least a little (and in some cases a lot) concerned that in the transition from candidate to President, Obama was getting sucked into conventional thinking. Spending a trillion dollars may work, but helping change the DNA of america and the world would help a lot more. And he doesn’t need economists to tell him how to do that.

There was an exchange between RickG and me in the comments to the "A Focus Group Of One" post I did on thursday.

Rick said the following:

First, you don’t report. You opine. That’s fine and I very much like
reading the site, but it’s not a substitute for news reporting. For
example, in Seattle we’re debating a large transportation project… a
good reporter will talk to various sources from the governor to urban
planners and city officials, then synthesize that into a story. They’ll
do this over and over. Bloggers almost never do that. They won’t have
access to the officials and they might not even know who the urban
planners are to talk to them.

Second, the blog approach does
NOT scale for the reader. One advantage of blogs is that the urban
planner in Seattle could offer their opinion directly on a
blog…that’s great, but it is one piece of a story and I as the reader
have to find that. Again, a good reporter will bring together a lot of
sources into one place and present the information from them in one
article. With online stories, I’d like to see them link out more to
things like an urban planning blog too.

So blogs aren’t doing
reporting for the most part. For the ones that do… what’s the
aversion to finding a model to actually pay the people who are doing
real reporting? We seem to have gotten the idea that we should get
value for nothing, not only in this case, but in music, etc. I don’t
think a direct translation of the subscription/local ads model will
work for newspapers, but if we want people to spend time digging into
stories vs commenting on them we need to find some way to pay for that.

As I was reading Rick’s comment, I thought of that great song "Big Yellow Taxi" by Joni Mitchell:

They took all the trees
Put em in a tree museum
And they charged the people
A dollar and a half just to see em
Don’t it always seem to go
That you don’t know what you’ve got
Till its gone
They paved paradise
And put up a parking lot

I think all the hand wringing about the death of newspapers comes down to this very issue. Are reporters/journalists like the trees in Joni’s song? Will we miss them when they are gone? And if so, what can we do to ensure they don’t go away?

As much as RickG has got me thinking, I’m not sold that microjournalism (aka blogging) can’t get the job done. Look at what Henry Blodget is doing at Alley Insider for example. He’s doing a lot more than opining. He’s doing real work on a lot of the issues he’s covering. The same is true of many other bloggers. And as reporters/journalists leave the big papers and start writing for their own blogs/brands, I think they’ll keep doing what they’ve been trained to do their entire career. Can they all make good money doing this? That’s not nearly as clear. As we talked about in the "scale economics" post (I do mean we, read the comments), revenue per ad impression is going to be a dollar per thousand not ten or twenty dollars per thousand. I make about $30k per year on this blog and it is read by 150,000 people per month (web and feed) and gets around 250,000 page views per month (web and feed). So that means I am still getting ten dollars per thousand on this blog running only one ad unit. If I was getting one dollar per thousand and running three or four ad units, I’d be making around $10,000 per year on this blog. And my numbers are pretty good for a one man band. And $10,000 to $30,000 per year isn’t enough for most reporters/journalists to live on. So even if the microjournalism approach works from a content production point of view, it doesn’t seem to work from an economic point of view.

As to Rick’s point about blogs not scaling for the reader, I think that’s a solvable problem. We’ve got a few investments, like zemanta and outside.in, that are working on aspects of smart aggregation and there are a host of other startups working on it. We’ll get that problem solved.

So to me, avoiding the Big Yellow Taxi moment comes down to solving the business model question for microjournalism. Is there a way beyond ads to compensate microjournalists? Subscription seems like one approach but what can you charge for online? Participating in expert networks might be another approach. Speaking and writing books could be a third. My gut tells me that microjournalists are going to have to do more than just post to their blog to earn a living. In fact the blog will probably be the loss leader that keeps them in the game.

I am not sure that anyone has the answer to this question and that’s why it’s bothering so many people right now. I’m an optimist and I think we’ll work it out. And our firm is investing in the services that play  a role here. And we’d like to do more of that.