Here's a link to the entire video. It's long but for those who have an interest in this topic, well worth watching. For those who just want to get a taste of the conversation, here is a ten minute section that was in the middle of the discussion.
Posts from October 2010
Mark Suster wrote a long investment research report on the "The Future of TV and Digital Living Room" opportunity on his blog last night. I don't know how he has time to crank out these amazing blog posts on a regular basis. But he did it and it is very comprehensive. You should read it.
We've got a horse in this race with Boxee. I spend a lot of time thinking about where this sector is going. And I agree with almost all of Mark's analysis and conclusions. This is an investable space with big outcomes. But you have to swim with sharks (content owners) and walk at the feet of elephants (Google, Apple, Microsoft, Sony, Samsung, etc).
The Internet has mostly been a level playing field where the best product wins. That has not been the case in the world of big media and CE. Money talks loudly in that world. So it is still unclear whether Internet economics will work in this sector. But I am hopeful. If it prevails, this will be a very interesting market sector to invest in for the next decade (at least).
Yesterday I was at Sony's offices in NYC and got to play with the new GoogleTV powered big screens. Here's a screen shot of my twitter stream on the Sony GoogleTV (with the tweet I wrote on it on top).
Sony has some cool products coming out that are powered by GoogleTV including big screens like this one and blu-ray players that double as GoogleTV boxes. If you are working in this sector or are interested in seeing where all of this is headed, you should go to a store and play around with them.
I don't think AppleTV, GoogleTV, and Boxee are yet what they can be and will be. There is more high quality streaming content available every day. These software/services for managing, navigating, and discovering it will improve a lot in the coming years.
But I do believe that the old model of TV and Film creation, distribution, and consumption is changing rapidly. Mark's "report" outlines how and why. And with change comes opportunity. In this case big opportunity.
Sometime around 4pm yesterday the comment thread on my Android post from Saturday lit up. It was a bunch of Apple fanboy haters that aren't part of this community and don't have any manners.
This happens every time I write a post that is critical of Apple or complimentary of a competitor (ie Android).
It feels like an organized group, like some website they all hang out proclaiming their love for Apple to each other, that posts a link to the post and says "go get 'em." If I had the time, I'd try to figure out where this 4pm comment surge came from. But I don't have the time this morning.
I'll say this. It is impressive. I hope they don't start a denial of service attack when I write my next negative post on Apple.
A stock option is a security which gives the holder the right to purchase stock (usually common stock) at a set price (called the strike price) for a fixed period of time. Stock options are the most common form of employee equity and are used as part of employee compensation packages in most technology startups.
If you are a founder, you are most likely going to use stock options to attract and retain your employees. If you are joining a startup, you are most likely going to receive stock options as part of your compensation. This post is an attempt to explain how options work and make them a bit easier to understand.
Stock has a value. Last week we talked about how the value is usually zero at the start of a company and how the value appreciates over the life of the company. If your company is giving out stock as part of the compensation plan, you’d be delivering something of value to your employees and they would have to pay taxes on it just like they pay taxes on the cash compensation you pay them. Let’s run through an example to make this clear. Let’s say that the common stock in your company is worth $1/share. And let’s say you give 10,000 shares to every software engineer you hire. Then each software engineer would be getting $10,000 of compensation and they would have to pay taxes on it. But if this is stock in an early stage company, the stock is not liquid, it can’t be sold right now. So your employees are getting something they can’t turn into cash right away but they have to pay roughly $4,000 in taxes as a result of getting it. That’s not good and that’s why options are the preferred compensation method.
If your common stock is worth $1/share and you issue someone an option to purchase your common stock with a strike price of $1/share, then at that very moment in time, that option has no exercise value. It is “at the money” as they say on Wall Street. The tax laws are written in the US to provide that if an employee gets an “at the money” option as part of their compensation, they do not have to pay taxes on it. The laws have gotten stricter in recent years and now most companies do something called a 409a valuation of their common stock to insure that the stock options are being struck at fair market value. I will do a separate post on 409a valuations because this is a big and important issue. But for now, I think it is best to simply say that companies issue options “at the money” to avoid generating income to their employees that would require them to pay taxes on the grant.
Those of you who understand option theory and even those of you who understand probabilities surely realize that an “at the money” option actually has real value. There is a very big business on Wall Street valuing these options and trading them. If you go look at the prices of publicly traded options, you will see that “at the money” options have value. And the longer the option term, the more value they have. That is because there is a chance that the stock will appreciate and the option will become “in the money”. But if the stock does not appreciate, and most importantly if the stock goes down, the option holder does not lose money. The higher the chance that the option becomes “in the money”, the more valuable the option becomes. I am not going to get into the math and science of option theory, but it is important to understand that “at the money” options are actually worth something, and that they can be very valuable if the holding period is long.
Most stock options in startups have a long holding period. It can be five years and it often can be ten years. So if you join a startup and get a five year option to purchase 10,000 shares of common stock at $1/share, you are getting something of value. But you do not have to pay taxes on it as long as the strike price of $1/share is “fair market value” at the time you get the option grant. That explains why options are a great way to compensate employees. You issue them something of value and they don’t have to pay taxes on it at the time of issuance.
I’m going to talk about two more things and then end this post. Those two things are vesting and exercise. I will address more issues that impact options in future posts in this series.
Stock options are both an attraction and a retention tool. The retention happens via a technique called “vesting”. Vesting usually happens over a four year term, but some companies do use three year vesting. The way vesting works is your options don’t belong to you in their entirety until you have vested into them. Let’s look at that 10,000 share grant. If it were to vest over four years, you would take ownership of the option at the rate of 2,500 shares per year. Many companies “cliff vest” the first year meaning you don’t vest into any shares until your first anniversary. After that most companies vest monthly. The nice thing about vesting is that you get the full grant struck at the fair market value when you join and even if that value goes up a lot during your vesting period, you still get that initial strike price. Vesting is much better than doing an annual grant every year which would have to be struck at the fair market value at the time of grant.
Exercising an option is when you actually pay the strike price and acquire the underlying common stock. In our example, you would pay $10,000 and acquire 10,000 shares of common stock. Obviously this is a big step and you don’t want to do it lightly. There are two common times when you would likely exercise. The first is when you are preparing to sell the underlying common stock, mostly likely in connection with a sale of the company or some sort of liquidity event like a secondary sale opportunity or a public offering. You might also exercise to start the clock ticking on long term capital gains treatment. The second is when you leave the company. Most companies require their employees to exercise their options within a short period after they leave the company. Exercising options has a number of tax consequences. I will address them in a future blog post. Be careful when you exercise options and get tax advice if the value of your options is significant.
That's it for now. Employee equity is a complicated subject and I am now realizing I may end up doing a couple months worth of MBA Mondays on this topic. And options are just a part of this topic and they are equally complicated. I'll be back next Monday with more on these topics.
Apparently anyone who gets their Internet connection from Cablevision was blocked from accessing Fox programming on Hulu yesterday. Here is a screen shot a Fortune columnist took and shared on the web.
This is the kind of stuff that happens in the world of cable television every once in a while when cable companies and the programming companies have a fight over their contracts.
This is the kind of stuff that should not happen on the web. The way this should work on the web is each and every consumer should have a subscription (via Hulu or direct with Fox) to recieve programming. And once that contract is entered into, they should be able to get that content regardless of how they get their Internet connection.
If you want to know what we are fighting for, this is it. I see more signs every day that we need some basic rules governing Internet access. Maybe we shouldn't call it Net Neutrality. Maybe we should call it a bill of rights for consumers on the Internet.
I am getting more and more bullish on Android every day. I starting carrying an Android phone about a year ago. I made it my one and only phone over the summer. I absolutely love it.
My sister in law who is an iPhone user tried it out last night. She said "it lacks the fit and finish" of an iPhone. That is true.
Windows lacked the fit and finish of the Macintosh. But it didn't matter. Because there were hundreds of Windows machines whereas there was only a few variations of Macintosh, all controlled by the same company and priced at a premium.
My father in law told me he wants a tablet but $500 for an iPad seems high to him. I asked him if he'd pay $199 for an Android tablet. He said "where can I get one"? When he told me his primary uses of the tablet will be Google Docs, Gmail, and Google Calendar, I told him he'll be better off with Android.
Six months ago Android apps were second citizens. Either you couldn't get an Android app at all or the Android version sucked compared to the iPhone version. That is so less true today. My daughter's friend was claiming her love for her Yelp app on her iPhone. I loaded up my Yelp app on my Android and we compared them to each other. You couldn't tell the difference. And the most recent Android Foursquare build has finally delivered the awesome Foursquare iPhone experience to Android.
I am encouraging every company we work with to invest as heavily in Android as they invest in iPhone/iPad. I actually think they should invest more because Android is still wide open and the iPhone/iPad marketplaces are leaderboard driven and the leaders have been established and it's hard to crack into the top ten anywhere.
iPhone and iPad have been amazing products that have opened new markets. But I do not think they will own either market in a few years. Android will.
When things go wrong in startup companies, the VCs often reach for the easy answers:
– Let's get a "world class CEO"
– Let's sell the company
– Let's fire the VP Sales
But in my experience there are no silver bullets. Fixing a bad investment is really hard. First and foremost, you have to accept you've made a bad investment and then you need to decide if you want to do what it takes to fix it. And you need to accept that even if you do fix it, you will probably be left with a subpar investment from a return perspective. So be prepared to invest additional capital that will not meet your hurdle rates.
The one and only thing that will save you in the end is building a sustainably profitable company. If you think you can get there, do that. If you don't, let it go. The hail mary passes won't be caught, so you shouldn't even try to throw them.
I've been using Gmail's Priority Inbox for a while now. I like it very much. But it has one impact that is worth pointing out.
If your email gets into the third section of the main page, called "Everything Else", I most likely won't see it unless I see it on my Android phone. And hopefully Google is working on bringing Priority Inbox to Android. When that happens, I won't ever see it.
Everything Else is like the spam folder with one exception. The email will come up in the search results.
This may not be everyone's use case. I get a lot of email and I can't get to all of it regardless of what email client I use. Other Priority Inbox users might actually read through Everything Else. But I don't and can't.
Google has solved a huge problem for me and potentially created a huge problem for emailers.
The email deliverability business, where we have an investment in the market leader Return Path, will be impacted by Priority Inbox and related services. Deliverability will increasingly mean getting into the Priority Inbox. And that's a hard thing to do.
Yesterday my partner Brad told me that he thinks something special is going on in two cities, San Franscisco and New York. That something special is a creative culture that is leading to an explosion of new web services.
This post from Om Malik bears that observation out. Here is the money quote:
If you want to talk about capital efficient web servics, then there are two ideal places to start them, San Francisco and NYC. How about the valley? Well, there you apparently need to spend more money. The average Internet deal in SF and NYC was $3-4mm. In the Valley, it was over $8mm.
I'm pleased to see NYC getting the attention it deserves. NYC hasn't been a technology hotbed since Bell Labs left town in the 50s, but now in the age of Internet startups, it sure is.
One of my mentors in the VC business used to say "the success of an investment is in inverse proportion to the number of VCs on the board."
I love that line and use it often. One or two VCs on your board is OK. Four or five is a disaster.
But beyond the board, what about the syndicate? I've seen some recent financings where there were six or more VCs firms in the syndicate. And that doesn't include the angels.
We've been asked to participate in first round syndicates with four or more VC firms and we have not done that, at least yet. I thought I'd explain why.
Most entrepreneurs don't want to dilute more than 25-33% for a single round of financing. And good for them. They shouldn't.
Let's take the high end of that band (33%) and divide it by four, or five, or six. If you have that many VC firms in your syndicate, then each one will own something like 5-7.5% of the company. That's not a lot of equity for most firms.
Each firm will want to increase their ownership in the future rounds so there will be pressure to do an inside round. That can be a good thing. But there will not be much room for a new firm to price and lead the round. So you've basically pre-built your syndicate for the long run without the ability to add new investors.
And you've also created a dynamic where no one firm has enough equity to be totally focused on the investment. The various firms may all be looking at each other expecting someone else to do the work.
Some will say that VCs will just have to learn to live with less equity and that sub 10% ownership is OK. I've posted before that you can make good money with sub 10% ownerships so I totally buy into that argument. But that will require the company to be a big hit. You can't make good money with 10% ownership on an average investment.
We prefer to invest alone, with one other firm, or with several firms with one additional firm being added in each round. That's the traditional approach and I think it is still the best approach. The pile on seems to be gaining attraction for both entrpreneurs and VCs. But I don't think it's the best way to finance your company and hope that our firm can avoid them.