Posts from January 2011

Greed and Fear

My friend Howard Lindzon sent me this great piece by Carl Richards. It is now hanging in my home office right behind my desk:


I believe we are on the upswing in the web investing space right now. There could well be a fair bit more to go. But we will get to the valley at some point. If you still own whatever you bought on the upswing, don't sell it there. Hold on until the next upswing.

Markets come and go. Good businesses don't. Thanks Howard for my daily reminder of that.


Monetizing Mobile Audio

I'm going to the gym in a few minutes. I'll bring my android and stream some music while I'm on the treadmill. Maybe I'll listen to my soundcloud dropbox, or maybe I'll check out the popular tracks on hypem, or maybe I'll listen to some I stream music on my mobile phone all the time. I don't have a single mp3 on my android and I don't have any desire to put any on it.

This is the future. We won't be buying files, moving files, and listening to files. We'll be streaming audio from the cloud onto our connected devices in our homes and offices, and onto our mobile devices at the gym, on the bike, in the car, etc. And I think mobile streaming audio is going to be huge.

How will the mobile audio streaming services make money? Some will charge a subscription. But I believe, like the radio industry for the past 50 years, most will make money by running commercial messages in the stream once or twice an hour.

And yesterday, our portfolio company Targetspot, launched the first mobile audio ad network. Initial mobile streamers include AOL Radio, Yahoo Music, CBS Radio, and

Targetspot built and operates the largest streaming audio advertising network and has been the leader in this market for the past three years. This move into mobile is very exciting to me because it will allow advertisers to reach music and audio listeners when they are out and about. Imagine combining mobile audio advertising with geolocation and time of day targeting.  Imagine hearing a Starbucks audio ad on your morning run alerting you to a discount on expresso drinks at the store a block away?

But most importantly, this mobile audio ad network provides a much needed monetization system for mobile audio apps (and actually any mobile app that wants to run audio spots). I believe Targetspot's mobile audio ad network will allow developers to build and launch innovative new streaming audio apps and make money from them.

If you have a mobile app that streams audio or that you would like to run audio advertising in, please contact the Targetspot team and they will give you the tools to build audio advertising into your mobile app.

#Music#VC & Technology#Web/Tech

The Easy Trade

I am on a flight from NYC to San Francisco. I paid for business class but I am sitting in the way back of coach, right next to the rest rooms. Why, you might ask, would I trade a business class seat for the very back of the bus?

Simple. The power outlets in business class aren't working and they are working fine in coach. My macbook's battery doesn't give me 6 hours of laptop time, so I need power to work the entire way from NYC to SF. With wifi on most of the flights from NYC to SF these days, working from coast to coast has become a key part of my routine.

I personally think power in every seat and wifi on every plane ought to be the law of the land, but I don't make the laws. I hope someone who is reading this does. And I hope United gets the power working in business class before my flight back to NYC.

#Blogging On The Road

Building Better Social Graphs

I'll say right upfront that this may be a feature that many people don't need. But I need it so I thought I'd post it anyway.

As software becomes social, the creation of the social graph on each web service becomes a chore. I do not believe that you simply want to port your social graph from Facebook and Twitter into new web services. I believe you want to curate the social graph for each and every web service. And that's how I try to do it on each new social web service I encounter.

The people I want to follow on Etsy are not the same people I want to follow on Twitter. The people I want to follow on Svpply are not my Facebook friends. I don't want to share my Foursquare checkins with everyone on Twitter and Facebook.

I am slowly but surely building social graphs on Etsy, Svpply, and Foursquare (and many other services but I thought I would focus on these three for this post). Each service has a slightly different relationship model. On Etsy, you join circles. I am in almost 100 circles on Etsy, some of which I would like to join back. Svpply uses the Twitter follow model, and close to 100 people are following me, some of which I'd like to follow back. Foursquare uses the Facebook model and there are 3815 friend requests for me there. I am sure there are a bunch of people in the 3815 that I'd like to share my checkins with.

So here is the feature I want. I would like to be able to run these people through all my social graphs on other services (not just Facebook and Twitter) and also my phone contacts and my emails to help me filter them and quickly add those people if I think they would make the social experience on the specific service useful to me.

I don't want to get emailed everytime someone follows me or friends me. I'd like each service to build up a list of relationships and let me query that list against other social graphs. I think that would be a much more efficient way to build social graphs.

I do add people myself. I use Twitter's Who To Follow service to build my Twitter social graph. I join circles in Etsy when I see a seller who has a store I like. I follow people on Svpply when I see something they added that I like.

But the more people you have in your social graphs on these services, the more valuable they become. So making it easier to curate application specific social graphs is a big part of making the services more social and richer experiences for all of us.


M&A Case Studies: WhatCounts Sale Process

Last week we got a primer on the WhatCounts story and events leading up to the decision to sell the company. This week we are going to hear what a sale process looks like.

There are a bunch of great lessons that come out of this story but my two favorites are doing your diligence on the buyer and only doing a deal with someone you have shared values with and getting the deal worked out in the LOI stage. I see so many people make mistakes in these two areas.

As we did last week David Geller and I will be in the comments responding to questions and comments.


Last week I shared with you some of the history of WhatCounts, the company I started almost ten years ago that was recently acquired. The focus was that Brian Ratzliff, my cofounder, and I had self-funded the business. We didn’t refuse VC funding. We simply didn’t pursue it with vigor at any time during our tenure running the company.

Today’s post isn’t about the merits of self-funding or when it’s appropriate or wise to seek VC. Instead, it’s to share the experience we went through in selling the company. It’s a story I would have enjoyed reading myself had it been written just six months ago.

Just to set expectations properly, I’m not going to share financial details about the transaction. I’m bound by an agreement that prevents me from disclosing specific details. My company was engaged in a very competitive market with strong, well-financed players. It would be foolish for me to give our competitors additional ammunition.

Negotiating our deal started in June and ended in December. It took a month to negotiate the letter of intent (LOI) with the rest of the time devoted to performing due diligence and, eventually, negotiating the stock purchase agreement (SPA). The total cost of carrying out the deal was many hundreds of thousands of dollars. Some of that went to pay legal bills, some of it went to fees associated with our M&A firm, some went to paying bonuses tied to the deal.

Let’s roll the clock back to June. That’s when we received a call from a company named The Mansell Group asking if we would be interested in selling our business. It turns out that we were actually already considering selling our company. The economy appeared to be recovering and the M&A market was rebounding.

We had developed a relationship with The Corum Group, a Seattle M&A firm, and were planning to pursue all the steps necessary to sell WhatCounts. The process can take anywhere from a few months (rare) to as many as 8-12 months or even longer depending upon the size and complexity of the deal.

We were preparing for a long and complex process of attracting buyers for our company when one of them, The Mansell Group of Atlanta, initiated a call to us. At first our position was one of pragmatism. We would continue working toward finding one or more potential acquirers while, at the same time, continuing to nurture the opportunity that had turned up from Mansell.

After our initial call with The Mansell Group we gave a status report to Corum. This was a little strange because, certainly in the beginning of an acquisition process, the M&A firm generally provides updates to the seller. Here we were, essentially, driving the process with one particular, potential buyer.

The rest of June was spent running the business in a normal manner. It included preparing for an important customer summit planned for August and working with our M&A firm.

It is not uncommon for a company being acquired to go through a full financial audit. While these can certainly be conducted by one of the big accounting firms, we thought a regional accounting firm might serve our needs just as well and be less expensive. A full financial audit for a small company might run $35-50K using a mid-size regional firm. Expect to pay more with a big name firm. To a great degree, though, the timing of the audit, whether it is done before or after you begin looking for an acquirer, or even done at all, depends on your circumstances.

As I noted in last week’s article, our company was tightly controlled and profitable. The beauty of running a business in this manner is that when it comes time to have discussions with a potential buyer it is very easy to answer their financial questions quickly and precisely. Additionally, when it comes times to consider whether you actually need an audit you can conduct frank conversations with your M&A firm and potential acquirer and seek their opinion. If your business is like ours everyone might agree that the expense and time required for an audit isn’t necessary.

In mid-June we received a follow-up to that first phone call. The investment committee from Riverside Capital, the PE firm working closely with The Mansell Group, had approved plans to buy our company. New meetings were arranged and our first in-person event would take place when they agreed to visit our office the beginning of July.

Of course we were still working with our M&A firm to ferret out other, potential acquirers. We had not yet received a letter of intent (LOI) from Mansell. There was interest, but nothing concrete. So, logic dictated that we keep on with our original plan. Run the business but continue seeking other acquirers. The challenge we were facing in reaching out to other potential buyers was that things tend to slow down in the M&A space during the summer. Vacation schedules impeded efficiency of communications.

Conversations with Mansell and Riverside, though, continued. Plans were set so that principals from both firms were to visit Seattle in early July. We met in our main conference room and then again for dinner, inviting some of the executive staff to meet our guests.

At this point our plans to have the business acquired were known to only five  people in the company and our attorneys. It is almost certainly advantageous to maintain the utmost secrecy about acquisition deliberations for as long as possible, no matter the size of your company. Discussions of a merger or acquisition, while exciting, can be disruptive to both employees and customers. That situation benefits only your competitors. So, keep it simple by keeping it completely secret.

We already knew that our potential acquirers had previously reached out to some of our customers, trying to find out as much about our company and our management team as possible. Similarly, a few days before our first in-person meeting, I initiated a small due-diligence exercise myself. It was important for Brian and me to know who might one day be running the company and taking over relationships with our employees and customers. I contacted one of Mansell’s largest customers with the cover that we were considering entering into a business relationship with them (which we were). I was able to get what I believed was an honest, candid overview of the company and how they treated their customers. I liked what I had heard.

Had I heard horror stories would I have attempted to shut down discussions with them? Yes, without question. What if a formal offer had been made – one that matched our financial expectations? Same answer. We had invested considerable time and effort in developing our reputation with both employees and customers and were unwilling to risk diminishing that. It was paramount that we find an acquirer that held similar values of professionalism and dedicated service toward our customers.

The beginning of August brought the official letter of intent (LOI) for our company to be acquired. We had just a few days to respond. At this point we engaged the law firm that would end up representing our interests through the rest of the process.

Of course we already had several corporate attorneys. But, this was something new. Something different. We had been given a recommendation to work with a firm well known for helping technology companies. Besides a sterling reputation, the firm’s offices were in our building. We already knew there would be lots of meetings, both telephone and in-person, that would require privacy. Convenience and reputation were only two of the factors that convinced us to use the new firm.

It was also important that we fully understood all the potential costs to be faced in selling the business. Our new attorney understood our expectations and their prior M&A experience (from a cost and time perspective) allowed them to estimate costs for completing the deal. For a relatively small company to be acquired it’s safe to estimate something between $50-$100K in legal fees. The buyer will have their own attorneys and, depending upon their size, might end upon spending a great deal more money to complete the deal.

We eventually agreed upon a hybrid, fixed-fee structure with our attorney. We also set up some simple ground rules related to what work would require review and approval by us before being pursued.

Keep in mind that you can ask your attorney almost anything related to the deal. It could be about taxes, deferred revenue, non-compete agreements, the closing process – literally anything. Be aware, though, that he or she will do their very professional best to answer your question. That might require extensive research. It might require consultation with their colleagues or other expert attorneys. Something you may casually ask on a Friday afternoon might deliver a beautiful, succinct answer the following Monday. But it may have required ten or more hours of work over the weekend. If you’re not careful and willing to control the process tightly legal expenses can become alarmingly large.

Discussing these things with your attorney at the very beginning of the relationship is critical to determine expectations and understand and agree upon limitations. You don’t want to start working only to be surprised by an outrageously large bill the first month.

One of benefits of engaging The Corum Group for our M&A work was that they had extensive experience selling high-tech companies and had successfully completed several deals with Seattle firms with which we were familiar. Two of their deals had been done with Google and some of that work had shaped a philosophy to do as much detailed work in the initial LOI as possible. Once we had received the LOI it was up to us to review it and suggest and request changes. Our initial response was due quickly, but the overall process of negotiating and finalizing the LOI took nearly a month. There was lots of back and forth and this is where the Corum’s deal prowess proved particularly valuable.

At the very end of August the LOI was signed and delivered back to Mansell/Riverside. From this point forward things would begin to operate in a more structured manner. Deliverables would be assigned. Dates would be set. We suspended all efforts to find other acquirers. Our course was set and our goal of selling our business to Mansell had been cemented.

Another in-person meeting was scheduled for September. This time Mansell would learn even more about the inner workings of our company. Source code would be shared (in a controlled setting); our data center would be toured; and we would begin the formal due diligence process where pretty much everything about our business would be exposed – in detail.

What does due diligence look like? How is it performed? For our transaction it began with a shared data vault that everyone could access electronically. Mansell and Riverside delivered a document detailing requests for information relating to our finances, our agreements and contracts (with employees and customers), leases and examples of marketing materials.

Almost all of our contracts and agreements were not only archived in paper but copied and saved as PDF documents. This proved to be a huge time saver. We literally completed our early document delivery tasks within a couple of days thanks to our having kept electronic versions of our materials.

Everything wasn’t perfect, though. One of the things we neglected to do over the years was centrally organize notes about all our electronic documents. While all of them were organized within specific folders, there was no quick and easy way to, for example, determine which customers had which versions of our sales agreement (we had three over the years). Or, in the case of employee documentation, which employees had signed invention assignment documents? Which had executed NDAs? We literally had to go through and read our documentation, whether on paper or electronically, to answer some of the questions we had been asked.

As the end of September approached everyone seemed to realize and agree that an October close, even on the very last day, was unlikely. We were concerned because we were trying hard to complete the transaction in 2010 before any changes to the long term capital gains tax could be made. Similar to Summer where M&A activity seems to temporarily slow down while everyone vacations, late Fall events can be hampered by weather and Thanksgiving Holiday plans.

At the end of the first week in October the stock purchase agreement (SPA) was delivered.  The first few days of the next week were spent reviewing the document with our attorneys and M&A firm. Early efforts to detail issues in the LOI proved valuable as the SPA contained very few new issues of great concern.

We continued to review and discuss the SPA while documents continued to be prepared and delivered into the data vault. As November approached we were literally weeks away from a closing event. It was both thrilling and exciting.

Once the SPA had been agreed to by both sides the mechanics of the close event started to be discussed in detail. How would the funding take place? What would happen to the cash in the business? How and when would the attorneys and M&A firm be paid?

On December the 2nd previously signed signature pages were released by both sets of attorneys. Stock certificates that had been held in escrow were sent by Fedex to the new owners. All that remained was to complete the funding event by initiating a series of well-orchestrated wire transfers. These would occur the next morning on the third, which was a Friday.

The new buyers had flown out over the weekend and were present when news of the event was revealed for the very first time to our staff Monday morning. Approximately the same time our meeting was concluding a previously scheduled email was instantly delivered to every WhatCounts customer using our own platform. At 10am that same morning a story appeared in TechFlash, a regional Technology Blog run by John Cook and Todd Bishop, describing the event publicly. Congratulatory calls and emails from friends, former colleagues, vendors and competitors started to arrive moments later.

Two exciting additional items were revealed that morning. The first was that instead of WhatCounts operating as a Mansell Group Company, Mansell would be rebranding and adopting the WhatCounts name. Second, Brian Ratzliff was invited to join the new Board of Directors.

#MBA Mondays

Deficit Reduction

Christina Romer, formerly chairwoman of Obama's Council of Economic Advisors, has a column in today's NY Times Business section titled What Obama Should Say About The Deficit. She says:

My hope is that the centerpiece of the speech will be a comprehensive plan for dealing with the long-run budget deficit.

That is my hope too. 

Both the left and right can agree that we can't sustain deficits of $1.25 trillion for many years. Just in case you didn't know, that is Obama's proposed budget for 2011. One which projects revenues of $3.8 trillion. 

The thing that left and right find difficult is agreeing on how to eliminate the deficits.

The good news is we have a roadmap from the bipartisan National Commission On Fiscal Responsibility and Reform who issued a report with its recommendations last month

I thought I'd lay out a few things that many people don't want to admit.

1) The deficit will not be eliminated without dealing with military spending and social security, which are often mentioned as "untouchable." This paragraph from Newsweek tells the story:

In Obama's budget, Social Security costs $787.6 billion; defense costs $928.5 billion; debt payments cost $250.7 billion. Together they total $1.967 trillion. If you remove that $1.967 trillion from the equation, as Lee suggests, you're left with $1.863 trillion in spending to work with. At this point, balancing the budget—i.e., wringing $1.669 trillion in savings out of that last $1.863 trillion—would require slashing every government program that's not defense or Social Security (Medicare, Medicaid, veterans affairs, education, and so on) by 89.6 percent.

The US spends between $700bn and $900bn on defense (I see a bunch of different numbers), which is about 40% of the entire world's military spending and six times more than the next largest country, China. While the US is spending its money on military matters, the rest of the world, most notably China, is investing their capital in their economy, infrastructure, and growth. This is going to have to change. And it will require America rethinking its role in the world.

Social Security represents about 20% of the federal budget. Our country continues to operate a defined benefits plan while most businesses have moved to a defined contribution plan. The federal government has to recognize that Social Security, as currently constructed, is a bankrupt retirement plan. This will require some big changes, many of which are politically difficult. But until we are honest with all americans about the problems with the current approach, we cannot force the changes that are necessary.

2) The deficit will not be eliminated without raising taxes on some people. Letting go of the Bush tax cuts for those who make $250k and over would product $400bn which represents more than 10% of the budget. I recognize that this is a big political issue and one which Obama helped himself politically by letting go of recently. But I really don't see how the math works without getting the wealthiest americans to chip in some more money.

3) The rest of the budget, non military, non social security, non interest payments will have to be cut aggressively. The Tea Party wants to cut these areas by 40%. I suspect that is never going to happen. But a 20% cut in these areas, which is what the UK is doing, seems necessary.

If you cut military by 1/3, restructure social security, eliminate the Bush tax cuts on the over $250k crowd, and cut the rest of the budget by 20%, you can probably get the budget balanced. This would have to be done over a decade or so, in order to reduce the fiscal impact on the economy, which will be significant. But I don't think the US has another option, unless we want to choose bankruptcy.


The Opportunity Fund

We believe the venture capital business is a services business and the entrepreneur is the client. Over the past few years we have come across a number of entrepreneurs who we would have loved to work with but who had specific capital needs we could not satisfy with our fund structure.

Over the past several months we fixed that and we now have an additional tool in our toolbox. We call it The Opportunity Fund and we've described it and how it will work on the USV blog this morning

I'm very excited to have this additional flexibility and I am also very excited to be able to call John Buttrick a partner. John has been hanging around USV from the very start, advising us, and supporting us in so many ways. He will make us even better investors and partners for entrepreneurs. Which is a great thing.

#VC & Technology

The Second Coming Of The Internet IPO

Most of what I've been saying recently about valuations here at AVC has been negative. I think we are in a "focus on the upside" phase in the web investing sector and I've been pretty liberal with my thoughts on that.

But when friends have privately asked me whether they should take some of the Facebook shares their Goldman representative has offered them, I mostly tell them I think they should. I don't think anyone should bet their net worth on Facebook at $50bn, but I think it is a pretty good bet that Facebook will one day be worth more than $50bn. Is it today? Hard to say. I don't have access to Facebook's P&L, cash flows, and balance sheet. But from what I have heard Facebook should do between $1bn and $2bn of EBITDA in 2011 and possibly more. 25x to 50x EBITDA for one of, if not the premier Internet company in the world is not crazy. And if you just think how much market power (i'm talking driving traffic, audience, brand, attention, value) Facebook has relative to the other Internet services which are valued well north of $50bn, I think it is pretty obvious that there is more value to be created in Facebook stock.

My friend John Battelle has similar thoughts on his blog in a post everyone interested in the second coming of the Internet IPO should read.

How do I reconcile these conflicting thoughts, that the web sector has gotten overheated and that the coming Internet IPOs might in fact be good buys? Well, to be honest, I haven't completely reconciled those thoughts. First of all, we don't know how these deals will be priced. Will Facebook shares be offered to the public at $75bn, $100bn, even higher? We just don't know. And how will Groupon, Demand Media, LinkedIn, Skype, and other offerings be priced? Don't know yet.

But it is very possible that some or all of these deals will be good buys even in the face of an overheated valuation environment. The public Internet names, most of which went public eight to ten years ago (or more), are mostly carrying full but not crazy valuations. If this new crop is priced off of those comps, then they could be worth buying and owning. And, as John points out in his post, if these companies contiue to grow rapidly and throw off ever larger amounts of cash, then they could easily be worth well north of what they are worth today.

In the spirit of complete transparency, I do not plan to purchase any of these offerings. I have plenty of personal exposure to the web sector right now and am adding to it every day via our firm and other private deals and funds I am part of. I don't particuarly like to buy and own public stocks unless we are in a really down market and I see unbelievable values. So I am not going to be calling the banks and asking for allocations. But that doesn't mean you shouldn't. But whatever you do, make sure to do your work and understand what the price is and that it makes sense. Blindly buying something just because it is "hot" is never a good idea.


Skip The Water

I told this story to an entrepreneur last weekend and she loved it. So I figured I should tell it to everyone here at AVC.

I was a mechanical engineering major (course 2) at MIT. One of the best classes in the mechanical engineering curriculum at MIT is 2.70, Introduction To Design. And the highlight of 2.70 is the contest in which everyone is given a bag of stuff from which they need to design and build a product that will compete in a contest.

My year, the contest went like this. There was a huge water tank with diving boards on both ends and a rope swing in the middle. Two contestants would put their designed product on each diving board, jump into the water, and start moving toward the rope swing. The one whose product got to the rope swing first would move on.

The "bag of stuff" was a brown paper shopping bag with an empty large soda bottle, the spring mechanism for a music box, a bunch of rubber bands, and so on and so forth.

I did what you might imagine, with the help of my friend Jim. We cut the soda bottle in half to create a boat, used the spring mechanism to power a paddle boat style propulsion system, and used the rubber bands to launch the boat from the diving board. It worked and I made it past the first race.

In the second race, I came up against a student who had a different idea. His product simply launched, like a rocket, from the diving board, flew through the air, and grabbed the rope swing in about a nanosecond. He destroyed me and everyone else and won the contest.

The lesson is, of course, is to skip the water.

#VC & Technology

When They Are Throwing Money At You

Companies get hot. And investors start throwing money at them. Entrepreneurs get calls and emails all day long from investors wanting to invest. After a while, the entrepreneurs start to think that they should take the money. Not because they need it, but because they figure if people are throwing money at them, it's probably a good idea to take some.

Given that we are in the "throwing money at entrepreneurs" period in web investing, I thought I'd say a few things about this.

1) Don't take money you will never ever need. No matter what price and terms the money is offered, it has a cost. Money is never free. If you have absolutely no need for the money then don't take it.

2) Money lying around tends to get spent. It is a very hard mental exercise to sock away a bunch of money and forget about it. If you think you'll just raise the money and put it away for a rainy day, just know that will be hard to do. And if you have team members who have ideas about how to spend/invest it, it will be even harder.

3) If you need the money, then raise it now. I have not seen a better time to raise money for web startups since the late 90s.

4) If you don't need the money, but have some ideas about how you could put it to good use, then do some hard work on those use cases. Flesh them out. Size them up. Build a plan. Then raise the money and execute the plan.

5) If your company doesn't need the money, but you sure could use some, then think about selling some secondary shares. But don't sell a lot. Maybe 10-20% of your position. I've come to believe that entrepreneurs putting away some money to protect the downside is largely a good thing. It allows them to take bigger risks and play for more upside.

6) Do not let the fact that your competitors are raising money impact your decisions around fundraising. I have not seen one company beat another because they raised more money. Most of the time it is the other way around. The overfunded company loses most of the time.

7) Don't let this environment make you crazy. I understand the problem. We get calls and emails too. It is tempting to get caught up in the nutty market we are in. Focus on your business, your product, your team. Put all this stuff in perspective and don't let it take you mind off what matters. You need money to build a business but the money is a tool, the business is the mission. Focus on the mission.

The financial markets will come and go. Sometimes investors are focused on the downside. Other times they are focused on the upside. Right now it is the latter. But someday it will move to the former. That's how financial markets behave. End markets, the place all businesses get paid day in and out, don't whipsaw you like financial markets. Build a product and sell it to the end market and get profitable and create lasting sustainable value and you'll get to the pay window on your terms and your time frame.

#VC & Technology