Posts from October 2011

It's getting colder in NYC. Instead of walking home yesterday evening, I ducked into the Union Square subway station. I pulled out my android phone, launched the Rdio app, and looked through my collection for music to listen to. There is no wifi in the Union Square subway station, but that wasn't a problem. Because I have sync'd much of my Rdio collection to my mobile phone. I put on Keep Shelly In Athens and headed home.

The knock against streaming media services is "what happens when you don't have internet access?" It's a good question. But fortunately most of the streaming music services have "sync to mobile" enabled. When you add a song or album to your collection in Rdio (my favorite of the streaming music services), you simply check the "sync to mobile" option and your phone will pull that down onto your phone for offline listening. I have my Rdio app set to only sync to mobile when it is on a wifi connection, but you can set it to sync to mobile anytime it has an internet connection.

Someday we'll have wifi in the Union Square subway station. We've got it on the L train from 6th avenue to 8th avenue now. The list of places you don't have internet is getting smaller by the day. But until the day when we have internet everywhere, sync to mobile is a killer feature for streaming services. And that is why it is the feature of the day today.

Andy Weissman is a name that is surely familiar to many of you. He co-founded Betaworks, one of the crown jewels of the NYC startup scene. And his writing, his coaching, and his insights have been valuable to so many entrepreneurs in NYC and around the world.

Today Andy is announing his arrival at Union Square Ventures on the USV blog (where else?). Go give it a read and give Andy a big welcome in the comments.

We’ve had a vibrant political conversation on this blog this weekend (almost 900 comments and they are still coming). There is no question that our government and our politicans are failing us, particulary around innovation and the way forward.

But there is at least one Senator who has been an unfailing protector of the Internet and the innovators. His name is Ron Wyden and I am a huge fan (and donator to him).

This week at Web2 in San Francisco, my friend John Heilemann interviewed Ron. It is a terrific interview and if you have some time (35 mins), you should watch it.

I arrived in my office yesterday to find a package. I opened it and there were 10 numbered original edition Grimlock Chickens. This is my favorite of the bunch. I'm getting it framed for my office wall.

Back when we were doing our MBA Monday series on Financing Options For Startups, I got an email from my friend Andy Sack. Andy was one of the first entrepreneurs we funded by in the mid 90s with our Flatiron Fund. He's done something like a half dozen startups since then and he's a veteran in the very best sense of the word.

Andy said "You missed an important option Fred – revenue based financing. I've got a new firm called Lighter Capital that does just that". I said, "Can you write a blog post for MBA Mondays explaining how it works?" So today, we have a guest post/advertorial on Revenue Based Financing from Andy/Lighter Capital. I hope you like it.

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Fred’s series on alternative financing options has been awesome to follow, especially because it broadens the discussion of how companies can fund business growth when they can’t (or don’t want to) raise venture capital or bank debt. Fred’s original list missed one option – revenue-based finance – that's near to my heart and I’ve been encouraging entrepreneurs and angels to consider, and Fred graciously let me offer my insights here.
 
Disclaimer: I am founder of Lighter Capital and have a self interest in educating and promoting the use of this new type of financing called revenue-based finance.  I’m also a serial technology entrepreneur and believe this type of financing has real advantages to traditional debt and traditional real advantages over equity for the entrepreneur.

A revenue-based finance (RBF) investment provides capital to a business by “selling” an ongoing percentage of a company’s future revenues to the investor.  For simplicity, you can think of it as a revenue share type of arrangement. Investor gives capital to company in exchange for a small percentage of gross revenues. RBF lives as a hybrid of bank debt and venture capital. This kind of financing has been around for a while in non-tech industries such as mining, film production and drug development, but it’s recently been gaining traction in the world of growth finance and early-stage technology funding.
 
I want to explain how an RBF structure is different than traditional funding sources, detail what situations could be better suited for an RBF structure (for entrepreneur and investors alike), and offer a word of warning about the businesses that aren’t a good fit for the structure.
 
First, let me explain how a revenue-based loan works:

Instead of a typical bank loan which requires a business to pay a fixed interest payment, a revenue-based loan receives a percentage of revenues over a specified amount of time, allowing "interest" payments to fluctuate when a growing company has inconsistent cash-flows or lumpy or seasonal revenues. In a world where business costs such as software and infrastructure are increasingly becoming “as-a-service” and adjust with the ebbs and flows of a business needs, RBF payments automatically ramp up and down along with a business. It’s the inherent variability of RBF that makes the structure so appealing so appealing.  Imagine if your business loan payment reduced to zero if your business revenue dropped to zero for an unanticipated quarter, and then automatically kicked backed on when your revenue returned. Another way of saying this is RBF turns loan repayment from a fixed expense to a variable expense.

So, when does it make sense to raise revenue-based funding?
Revenue-based loans are, by nature, most appropriate for companies already generating revenues but without hard assets typically required to get bank loans. It’s especially applicable for companies that have lumpy, seasonal, or hard to predict revenues.

 
For entrepreneurs, revenue-based loans are attractive to founders who are allergic to dilution and loss of control.  The structure of RBF is often non-dilutive to founders and does not require a board seat. The financing is obtained without having to agree to a valuation, which leaves management in control of the company and typically requires no personal guarantees from management.

RBF means you can grow without swinging for the fences

For investors, funding using an RBF structure provides an opportunity to get a return on their investment without needing an exit. While this is clearly an advantage for investors, it also means company founders shouldn’t get as much pressure from investors to “swing for the fences” and the projected return due to the investor can be lower as the entrepreneur repays the investor more quickly.

As Fred has mentioned before, big exits are rare for startups. Some ideas have the potential to be home runs, but others are better suited to operate as smaller, standalone businesses. For the companies in the latter category, raising money from VCs who expect the big exits can misalign goals. A revenue-based loan has the potential to better align incentives for investors and founders in these cases. With that said, if you’re a pre-revenue, startup still figuring out your business model or considering some kind of “go big or go home” strategy, there can be realadvantages to working with the equity-based venture capital or angel investors. Similarly, certain businesses, especially brick-and-mortar and manufacturing-focused businesses may not have the margin profiles to pay monthly payments of 2-5% of revenues.
 
An RBF structure isn’t limited to specific funds – angels, VCs or banks could theoretically provide capital in this manner, but the risk/return profile of RBF doesn’t always fit the investor’s needs. Similarly, RBF may not be the best funding option for all businesses. In the right circumstances, the hybrid approach of revenue-based finance for startup funding can have advantages over traditional debt or equity, but there are admittedly situations where the more traditional options still make sense – such as restaurants or infrastructure-heavy startups.
 
If you’re considering raising money from angel investors, I’d suggest discussing this in the event that it may align your incentives better or at least help avoid some of the painful valuation negotiations. There are a few funds –Lighter Capital and Next Step in Texas, among others focused on this type of structure and I’d suggest taking a look at those options as well. There are clearly different scenarios where any number of Fred’s financing alternatives could prove more appropriate for your business, but the revenue-based loan structure can be a great option for profitable companies looking for a straightforward way to raise funding without dilution, change of control, or a personal guarantee.

I walked from the west side highway to chinatown yesterday in the early afternoon. I passed not one, but two marches uptown to Times Square and walked along with them for a while. New York City is in the throes of the OccupyWallStreet protests. What was most noticeable to me was not the protestors and their signs and chants. It was the amount of police accompanying them. It was a massive show of force. And it was scary to see. I just hope to god that this thing doesn't turn ugly. 

I've been thinking a lot about this movement, what it means, and what it could lead to. I talked about the inevitability of this kind of thing happening in the US last spring on stage at the Disrupt conference. I'm not the least bit surprised that it is happening. But I'm struggling to figure out how I can relate to it.

I spent a good part of thursday afternoon in Zuccotti Park. I hung out with one of the people who helped build the tech infrastructure for the occupation of the park. I walked around. I listened to the General Assembly. I talked to a few occupants. I want to understand what is on their mind. 

I empathize with the basic complaint of the #OWS movement – that the rich are getting richer and everyone else is getting poorer. It is impossible not to see that in our country. And yet I am in the 1%. How can I also be part of the 99%? 

And I've got issues with some of the subgroups in the #OWS movement. I saw a ton of union placards in the marches uptown and that bothered me. I talked to one person in Zuccotti park on Thursday. He told me how his paycheck gets cut up. After the taxes and union dues, he's left with very little. And what does he get for those union dues I asked? Not much.

Our institutions are failing us. The failing institutions are not limited to Wall Street. They are everywhere; our government, our political leadership, our unions, our health care system, our education system. The list goes on and on. 

And yet, I'm an optimist. I see a technology revolution in full force bringing much needed change to the world. It's not a coincidence that much of the success of the #OWS movement comes from their nimble use of technology to organize and get their word out.

So much depends on what we get out of this growing desire for change. It's good that people are getting angry. Whether it be the tea party on the right or the #OWS on the left, the citizens of the US are clamoring for change. I'd like to do what I can do to help make sure that change is intelligent progressive change taking us forward to a new prosperity, not backward into a false hope for a time that has passed and is not coming back. And I'm wondering if the #OWS movement is interested in that conversation.

I met Alex Ljung, founder/CEO of SoundCloud a number of times and each time he pitched me on his business. Each time I said no. Then in the summer of last year, we met at Soho House London and he showed me one slide. It had various media types (photos, videos, long form text, short form text) and underneath each was a large social platform that had been built on and for that media type. At the end was an empty space and it said "sound". That is Alex' vision. To build that large social platform to share sounds. That's what sold me. One slide. This 3min video expresses it well.

"Sound" from SoundCloud on Vimeo.

A few weeks ago I ran into Dennis Crowley in the USV offices. He whipped out his iPhone like the excited kid he still is and showed me Radar running on his phone. He was running a pre-release of iOS5 and a pre-release of the new Foursquare app. His phone alerted him, just like getting a text message, that he was at USV and he ought to check in there.

I said, “Dennis, this is the feature we’ve all been waiting for. This is what I’ve wanted Foursquare to do since the day I put it on my phone.”

There are features and then there are game changing features. Foursquare’s Radar is a game changing feature. Radar will prompt me to checkin more frequently, to use lists more actively, and to find people and places I need to know about while I’m out and about. Radar is one more bit of the big Foursquare vision being rolled out.

Here’s Foursquare’s post about Radar and another with answers to some frequently asked questions. It’s interesting to see that Radar is leveraging some new technology in iOS5 to make it work without draining the battery:

Radar uses a very battery-friendly location-finding mode that is totally new to iOS 5, the same one Apple’s own Reminders app uses.

Now, can we get Radar on Android and Blackberry please??

The Wall Street Journal has a story out today that says "Web Startups Hit Cash Crunch." There has been a fair bit of reaction in the tech blogs and I thought I'd toss into the discussion some things we are seeing:

1) There are so many startups out there raising money. I don't think this is a bad thing. It's a good thing. Entrepreneurship is in vogue. Innovators are innovating. Makers are making. But I cannot remember a time when we have gotten more inbound traffic. It is not just coming from entrepreneurs. It is coming from angels, seed investors, VCs, lawyers, accountants, friends, aunts, uncles, you name it. I'm waiting for the guy who sits at the front desk in our building to pass me a business plan on my way into the office.

2) There are a lot of "me too" investments out there. And the delineation between startups is getting narrower. Almost every investment that comes our way these days causes us to ask ourselves "is this too close to xyz?" with xyz being one of our exisiting portfolio companies. The startup market is hypercompetitive. The user base is finite at some level. The capital markets are finite at some level. And the number of startups chasing these markets seems to have doubled or tripled in the past couple years.

3) VCs are having a tough time raising money. The conventional wisdom is that 10-20% of venture funds produce 100% of the returns in the asset class. LPs (that's what we call our investors) are all chasing that top 10-20% and that leaves 80-90% of the VC firms struggling to raise money. The one bright sign in LP land is that emerging managers (what USV was a few years ago) are getting more attention from LPs. I'd rather be a new firm raising a first fund than a mediocre firm raising fund five right now.

4) Angels may be topping out, at least temporarily. This is more of a guess than the previous three. What happens to every angel is that they start making investments. They get excited. They make a bunch of them. And then two things happen. First, a few of their investments struggle and fail. And second, a few of their investments can't raise money and come back to them for a second round. They begin to realize that startup investing isn't so easy and that they have a finite amount of money they can invest or that they are willing to invest. They pull back a bit, see how things are going to play out, and become a bit more cautious. Given the massive amount of angel capital that has come into the market in the past few years, I wonder if we are seeing some cooling of that market as all the new investors take stock of where they are and where they want to go next.

5) The internet investing market is transitioning. Social was the driving force for the past three or four years. In the wake of Facebook and Twitter, how could it not be? Mobile has also been a hot theme. Both sectors have consolidated a few winners and a number of additional interesting emerging companies. But how many social platforms of scale will there be? Five, ten, twenty? And mobile is hard because distribution continues to be limited to the app store model where you get on the leaderboard and win or you don't and you don't. Investors are moving into new areas like cloud, peer to peer marketplaces, and trying to take what worked in consumer into the enterprise. There is no lack of interest in internet investing, but investors are having to learn new markets and new sectors. And that kind of transition takes the heat out of an overheated market.

So, is there a "cash crunch" for web startups? Not that we are seeing. Our portfolio companies have all been able to finance themselves when they have wanted to. And we have made more investments this year than any year we've been in business (maybe 10-20% more, not 2x more). But I do believe we are in for a bit of a reality check. We've had quite a run here and all big runs are followed by pullbacks. The public markets for stocks and bonds has been relatively weak all year and that has to have some impact. It is likely that we will see more startups having trouble going from the seed round to the A round, or from the A round to the B round.

That's a good reason to take money from a firm that stands behind its portfolio companies. At USV, we have never failed to do at least one follow-on round with the sole exception of Delicious, which sold to Yahoo! instead. We don't promise the next round. We don't commit to it. But we are supportive to a fault. And we are proud of it. Being an entrepreneur is hard. Having supportive and caring investors helps. In the market we are in (or heading into) it will help more.