Posts from August 2010

I've written a bit about net neutrality on this blog in the past few years. Every time I do, I hear about problems with regulating the Internet. The readers of this blog are a fairly "laissez faire" bunch. Guess what? So am I.

Somehow net neutrality got painted as "regulating the Internet" when it is really all about not regulating the Internet. Net Neutrality is about keeping the way the Internet works today; an open Internet where innovation is allowed and freedom reigns.

In the past ten years, the on ramp to the Internet has changed. Hundreds, maybe thousands, of dial-up providers have been replaced in the US by a handful of broadband providers with local duopolies. And we now have a wireless Internet in the US with an on ramp controlled largely by four carriers (two of which have the dominant market share). And these access providers have invested heavily in packet detection systems that will allow them to use their dominant positions to "manage their networks".

So now we have a situation where the access providers want to change the game. And they are seeking the regulatory approval to do just that.

Venture backed startups and venture capitalists don't use regulations and lobbying as competitive advantages. We don't have armies of lobbyists. We don't have congress on our payroll. But the access providers certainly do. They have been regulated for a long time. They know how the game is played and they use it to their advantage. Regulation is their game. They want our government to regulate the Internet and they want those regulations written in a way that allows them to do what they want to do. A regulated Internet is a comforting thought to the access providers and a frightening thought to entrepreneurs and the ecosystem around them.

I don't want to see the Internet regulated. I don't want rules that require oversight and adjudication. But given that we now have an on ramp that is tightly controlled by a small set of access providers with almost identical interests, I would like to have one basic rule that is so simple that everyone understands what it means and we can simply follow it.

Our firm are fans of the work of Barbara Van Schewick, Professor of Law at Stanford, who argues for the following simple rule:

A non-discrimination rule that bans all application-specific discrimination, but allows all application-agnostic discrimination. Discrimination is application-specific if the discrimination is based on the specific application or content (e.g. Skype is treated differently  from Vonage), or based on classes of applications or content (e.g. Internet telephony is treated  differently from e-mail).

That is all we need. Nothing more, nothing less. That is net neutrality. A policy that maintains the way the Internet works today. That has brought us Google, Amazon, eBay, Yahoo!, Facebook, Twitter, and many many more innovative web services.

There is a lot of debate and discussion going on in Washington, Silicon Valley, New York City, and all around the country right now about net neutrality and regulating the Internet. We have big companies with huge vested interests making proposals that are heavyweight and are not startup friendly. We don't need Google, Verizon, AT&T, or anyone else telling us how to regulate the Internet. We don't need pages and pages of rules written by lawyers that will employ lawyers for years to come.

We just need to choose not to discriminate on the web and thereby maintain the way the Internet works today. I hope that everyone will come to their senses and realize that is the simplest, easiest, and best path forward.

The Gotham Gal and I have our assets spread across a number of asset classes and money managers and our allocations and managers have changed a fair bit over the years. We’ve seen a bunch of managers in action up close and personal.

Right now, my favorite money manager is an optical surgeon named Robert Freedland. Robert is 56 years old, he’s been managing his own investments for 42 years, and he’s been blogging and podcasting about stocks for the past seven years. I invest with Robert on Covestor (which in the spirit of full disclosure is a portfolio company of Union Square Ventures).

About a year ago, we put a modest but non-trivial amount of cash into a Covestor account. We only invest with model managers in risk tiers 1 and 2 to keep our capital at lower risk. There were about five or six model managers in those tiers at that time so I put the minimum on all of them. I would check each month and slowly I left most of the managers. But I kept putting more money with Robert. And he kept performing. Now we have close to half of our Covestor portfolio with Robert and I am thinking of giving him even more.

We are up about 11% on the money we’ve had with Robert in the past year. Since some of those funds went in a year ago, but most went in more recently, I suspect our annualized returns are closer to the 17% return he’s annualized since he started on Covestor.

I like that Robert has delivered excellent performance with an emphasis on value investing in highly liquid stocks. I like that he doesn’t short stocks and doesn’t own anything I don’t understand or recognize. I like the fact that he has a strategy and he sticks with it. And most of all, I like that he is investing his own capital as well as mine.

If you want to invest with Robert, you can. He has a $5,000 minimum and you’ll need to open a Covestor account to do it. This is not a recommendation to invest with Robert, but it is an acknowledgement that there are great investors out there who don’t work on Wall Street and that thanks to the Internet they can manage your money as well as their own money and that is a very good thing.

Our portfolio company Zynga has been running campaigns in their games to raise money for Haiti and a number of other causes. Mark Pincus, Zynga's founder and CEO, calls this "solidarity not charity." Zynga describes this approach to giving back in this way:

Solidarity
not charity is a culture that is not seeking a handout but instead is seeking a partnership, and a culture that had demonstrated by its past that it is worthy of our respect, of our collaboration and our sustained commitment.

To date Zynga.org has raised more than $3.6 million for
Haiti in more than 13 separate campaigns, along with hundreds of thousands of
dollars for Gulf relief, and other causes. Almost all of these funds have been raised since the launch of Sweet Seeds For Haiti in October of last year. The Zynga.org effort is an ongoing part of Zynga's business operations.

The biggest beneficiary of this effort is a school that Zynga is funding called L’École de Choix (The School of Choice) in Mirebalais, Haiti.

Zynga, in partnership with FATEM (Mirebalais’s community organization), along with local representatives, global NGOs and others, have broken ground on a K-12 school and community center, intended from its inception to meet the most pressing and critical needs of those living in extreme poverty in Haiti, with a focus on quality education, income generation and financial literacy. Programs include traditional K-12 academics (in partnership with DePaul University and Francis W. Parker School), and will also include ESL, work skills for adults, and a youth center with a focus on psycho-social development, and even its construction will create jobs for the local community and use local sources and materials.

Here is a quick 5min video that showcases this effort:

Here are a list of the games and campaigns that Zynga has run. If you play Zynga's games, you may have helped fund these efforts.

 

I've written about this effort before. I am a huge fan of sustainable ways to give back and I love that we can all do that by playing games with each other.

Last week I mentioned that sometimes I am at a loss for something to post about on MBA Mondays. Andrew Parker, who got his MBA at Union Square Ventures (largely self taught) from 2006 to 2010, suggested in the comments that I post about the differences between Enterprise Value and Market Value. It was a good suggestion and so here goes.

The Equity Market Value (which I will refer to as Market Value for the rest of this post) is the total number of shares outstanding times the current market price for a share of stock. To make this post simple, we will focus only on public companies with one class of stock. The Market Value is the price you are paying for the entire company when you buy a stock.

Let's use Open Table, a recent public company as our real world example in this post. Open Table (ticker OPEN) closed on Friday at $48.19 and has a "market value" of $1.1bn according to this page on Tracked.com. According to Google Finance, Open Table has 22.77 million shares outstanding. So to check the market value calculation on Tracked.com, let's multiply the market price of $48.19 by the shares outstanding of 22.75 million. My desktop calculator tells me that is $1.096 billion.

So if you purchase Open Table stock today, you are effectively paying $1.1bn for the company. But Open Table has $70 million of cash and has $11.6 million of short term debt outstanding. So if you paid $1.1bn for the company (as would be the case if your company purchased Open Table), then you would be getting $70 million of cash and a debt obligation of $11.6 million.

So the Enterprise Value of Open Table, meaning the value of the business without any cash or debt, is a bit less than $1.1bn. To get the Enterprise Value, you calculate the Market Value and then subtract cash and add debt. When we do that, we find that Open Table currently has an Enterprise Value of $1.038bn. Not much difference in percentage, but almost $60mm in difference in dollars.

There are some companies that have a lot of cash or a lot of debt relative to their Market Values and in those cases it is really important to do this calculation to get to Enterprise Value.

We do a lot of valuation analysis on our portfolio companies, particularly the ones with a lot of revenues and profits. We do them mostly for our accountants as part of something called FAS 157 or "mark to market accounting". I am not a fan of FAS 157 and I've blogged about it here before. But regardless of whether or not I think "mark to market" is the right way to value a venture portfolio (I do not), it is the current practice and we need to do it.

When we do valuations, we often use public market comps to get "market revenue and profit multiples" and then we apply them to our portfolio companies. When you do this work, it is critical to use the Enterprise Values to get the multiples. Then when you apply the multiples to the target company, again you need to get an Enterprise Value and then work back to get Market Values.

If you use Market Values to calculate multiples, you may end up with some really screwy numbers for businesses with a lot of cash or a lot of debt. So use Enterprise Values when you are doing valuations and calculating multiples.

We are heading back to NYC today. The Gotham Gal has been in Europe since July 4th. Our kids have been here for parts of that stay. I have been here for most of it with one trip back to the states in the middle of the month. The Gotham Gal has been travel/food blogging the entire trip and there is a treasure trove of advice on Rome, Tuscany, Zurich, London, and Normandy on her blog for those interested in visiting those places.

Our family rented an apartment in London and my daughter Emily did a program at Central Saint Martins the past month. The rest of us tagged along for parts of the trip.

I was able to get a fair bit of work done over here. I'd like to thank the people at Index Ventures who provided me an office, wifi, and a few lunches too. I enjoyed doing meetings at VC hangouts like The Wolesley and The Soho House. The Wolesley reminds me of Balthazar and I vastly prefer the London version of The Soho House to its NY cousin.

Speaking of cousins, London feels like NYC's cousin. The cities are very similar in many ways. The language, the culture, the nightlife are all close to each other. It's easy to live here if you live in NYC.

But there are some interesting differences. The most striking is the Middle Eastern, Russian, and Indian wealth that is resident in London these days. I was walking up Bond Street in Mayfair one afternoon by myself. I was walking faster than everyone else and passed at least a dozen groups in a four or five block span. And I noticed that hardly any of those groups were speaking english. When you walk into the most expensive stores, there aren't many brits or americans in them. But they are full of people from countries to the east of europe. It is a stark reminder of where the wealth is being created in the world today.

I believe the tech scene is alive and well in London and growing throughout much of Europe. I covered a bit of this in my post on Seedcamp. London feels like NYC did five years ago. There are a bunch of strong entrepreneurs and startups but the investment community is still pretty thin and there aren't enough active angels. Like NYC, London entrepreneurs are commonly recruiting engineering talent in less expensive locations and there are plenty of those places a few hours plane time from London.

Throughout our month in Europe, I was using Foursquare to checkin. Since we left NYC on July 4th, I've checked into 133 locations in five countries (including my trip back to the states). That's roughly four checkins per day. I have found that Foursquare is actively used in Europe. We found checkins and mayorships in almost every venue we visited. However, it is much easier to gain mayorships in Europe. I have no mayorships in the US right now but I have accumulated six while we've been in Europe.

I really love the ability to map my checkins that I blogged about a few weeks ago. Our apartment was in Mayfair but we traveled all around London while we were here. And yet, you can see that my checkins are very much centered around Mayfair and Soho.

 

We are excited to be going home. We've missed our apartment, our beach house, our friends, and most of all our dog Ollie. But we really enjoyed our time in London. I hope to be back soon.

A reader asked me to blog about the "Venture Partner" role in VC firms. I thought it was a good suggestion so here goes.

A Venture Partner is a person who a VC firm brings on board to help them do investments and manage them, but is not a full and permanent member of the partnership. The "full and permanent" members of the partnership are often called General Partners, Managing Members, or Partners. Lawyers don't like the term General Partners and more and more firms are avoiding that term.

Venture Partners are different from "Entrepreneurs In Residence" (EIRs) because they are expected to source multiple deals and manage them whereas an EIR is expected to source a single deal and then leave to run it.

There are examples of Venture Partners who have been with VC firms for many years so they can be a fairly permanent part of the team. But for many reasons the Venture Partner term reflects the fact that the firm and the individual are not as tightly committed to each other as the members of the partnership are.

Some common examples of Venture Partners are; former partners who are semi-retired but still want to be able to do deals, former entrepreneurs who have multiple business interests but want to be able to do deals with a VC platform, and a partner in waiting who is headed to become a full partner.

My partner Albert Wenger is an example of the latter. Albert was the President of Delicious and when it was sold to Yahoo!, he left Delicious and started a company with his wife Susan called Daily Lit. Brad and I thought that Albert would make a great partner for us, but did not have room for a third partner in our first fund. We did want to work with Albert right away. So Albert joined us as a Venture Partner for about 18 months and then when we raised our second fund, he became a full member of our partnership. That was a great way to bring Albert into our partnership.

Venture Partners' compensation varies by firm and by role. Some Venture Partners receive cash compensation and some do not. A lot depends on how much time they spend at the firm and how deeply they are involved in day to day operations. All Venture Partners receive carried interest on the deals they source and manage. The amount of carried interest also varies a lot from firm to firm. The high end of the range is about 25% of the total carry on the deal, which would be 5% of the profits in most firms since a 20% carry is most common in the VC business. I have heard of firms where 1% of the profits or 5% of the total carry is what a Venture Partner gets. I feel that is way too low but I guess others do not.

One thing to be careful about if you are joining as a Venture Partner is the fact that a firm cannot share carry that it does not have. What I mean by this is that if you generate a $50mm gain for the firm on a deal and so you earn some percentage of the $10mm of carry on that deal, you may not get paid that carry if the firm's other investments are bad and the total gains on the fund are non-existent. I have seen this happen to friends and it is more common than you might imagine.

So if you are an entrepreneur, why should you care about Venture Partners? Well from time to time, the sponsor of your company inside a venture firm might be a Venture Partner. And so you need to understand the pros and cons of that. 

On the plus side, many Venture Partners are very experienced, either as VCs or successful entrepreneurs. They are not likely to be "wet behind the ears newly minted MBAs." So you when you are dealing with a Venture Partner, you are probably dealing with a secure and successful and experienced individual who can help you out.

On the negative side, they are not full members of the firm so their weight inside the partnership may not be as full as you might like. This can result in difficulties in follow on rounds and other important decision points. And they might not stay affiliated with the VC firm for the entire life of your company's existence. Which means you might get someone else managing your investment down the road. And in my experience, that is almost always a recipe for disaster. There aren't many things worse for an entrepreneur than someone else taking over an investment they did not sponsor. 

So if you are dealing with a Venture Partner, you really need to understand his or her specific situation. You need to asses how likely they will be with that firm for the seven to ten years you are going to need from them. And you need to assess how influential they are in the firm and how likely they will be able to support you when you need it.

I am a fan of the Venture Partner model. We used it with great success with Albert and I can easily see us doing it again. It works well in the right situation with the right people. But there are risks with the model, for the Venture Partner, the VC firm, and most importantly, for the entrepreneur. So it is important to understand the role and what it means for you.

I get a lot of heat every time I mention that I won’t invest without a liquidation preference. People say that it means I don’t want to take a risk. I am happy to take a risk. We do it every time we make an investment. We lose money on some of them and I can live with losing money. It is the price you have to pay for the opportunity to make money.

What I am not OK with is an unfair deal. And investing in common stock when the founder controls the company and the exit is not a fair deal.

Let’s look at who got what from the sale of Slide to Google. From Techcrunch:

 

Max Levchin  – $39mm

Scott Banister who also took part in the series A made $5m from the sale.

BlueRun Ventures, who invested $8m in the series B round made $28m.

The Founders Fund and Mayfield Fund, both investors in the series C, each made their money back.

Fidelity Investments, part of the series D: also made their money back.

The reason Fidelity, Founders Fund, and Mayfield got their money back is they had a liquidation preference. Otherwise they would have lost money in a transaction where the founder made $39mm.

I have no issue with Max making $39mm. He took the ultimate risk, started the company, invested his own capital, and I am sure he created the exit opportunity. He should get the biggest payday. But to suggest that Founders Fund, Mayfield, and Fidelity, who invested a significant amount of capital and backed Max, should not get their money back in this situation is nuts.

Those who hang out in the comments frequently may have noticed that Disqus has been slowly rolling out some new features in the space at the top of the comment thread. The latest new feature arrived last night and looks like this.

If you open the comment thread and click on that button, you'll get a popup called The Community Box. This is a real-time dashboard of what is going on in the community. The data is still getting filled out on the back end so it is not entirely accurate yet, but based on my quick look, it seems pretty accurate.

The leaderboards are based on a trending algorithm so they will change over time based on who is active and who is not.

Let me know what you think.

I’ve said a bunch of times on this blog that the perfect pitch is a very short intro to provide context followed immediately by a demo. Last night at the NY Tech Meetup, John Britton of our portfolio company Twilio showed how it is done. If you do a lot of pitches, spend the six minutes to watch this.

It sure helps to write code live if you are pitching to developers. John got a big nod from the audience for doing that.

But the important point is that when you show your product live in front of people, they can get what you are doing way faster than working through a bunch of slides. Kudos to John for an excellent pitch. Apparently Business Insider called it “the best demo we’ve ever seen.”