Posts from 2014

CB Insights published a “teardown” of USV’s investment strategy last week. It’s a pretty solid piece of work considering they did not have access to any of our internal data.

The got some stuff wrong, however.

1) We did not participate in Zynga’s “megaround” in Feb 2011.

2) We only have six main investment vehicles;

USV 2004 – $125mm

USV 2008 – $160mm

USV Opportunity Fund – $125mm

USV 2012 – $200mm

USV 2014 – $175mm

USV Opportunity 2014 – $175mm

3) We have invested in a lot more than four YC companies. I think the number is closer to ten. I think YC is by far the investor we follow the most, particularly in recent years.

But, as I said, they did a pretty good job considering they don’t have access to our internal data. And I do not believe our limited partners are sharing our reports with them.

What this shows is that the venture capital business is becoming more transparent because so much of our investment activity, and the activity of our peers, is being tracked as it happens. When we raise a fund, that is reported (we must disclose that fact due to securities regulations). When we make an investment, that is generally announced by the portfolio company. And there are reporting requirements for that too. It is possible to do a stealth financing, but it’s not easy. When we make a follow-on investment, that is often announced and/or disclosed. And most exits are disclosed.

What is harder to figure out is what our ownership levels are in our portfolio companies. If you knew the amount we invested and the valuation of the round, you could figure that out. But that would be very hard to do accurately and consistently. I don’t think anyone is going to be able to do a teardown of a VC fund and its returns any time soon.

But even so, it’s impressive what CB Insights and others are doing to track and measure and report on VCs and their investment activities. Entrepreneurs should be able to get some third party assessment of the quality and performance of the VCs they might work with. That’s totally possible now and I think that’s a good thing.

Our portfolio company Etsy is helping Rockford Illinois build an entrepreneurial economy in their city. Here’s a short (3 min) video that talks a bit about what they are doing and how it got started.

Since the very beginning of Twitter, users have wanted to take tweets from their timeline and tweet them out to their followers. Initially it was just users copying the original tweet and pasting it into the tweet box. Quickly the user convention became to put the initials RT in front of the pasted text. And the retweet was born. Birthed by the users like many of the best things about Twitter.

When I showed up at Twitter in the summer of 2007, there was a debate about how to productize retweets. Some wanted retweets to be hard coded so that the only thing that got retweeted was the original text. Others wanted to continue to allow users to mark up the tweet while retweeting it. The argument in support of the hard coded retweet was that would treat the original tweet as the atomic unit and retweets could be tracked as a signal of super valuable and popular content. The argument in favor of the marked up retweet was that users wanted to editorialize with stuff like “this is awesome” and such.

The timeline is blurry to me, as is so much about those early years at Twitter. But I think that debate raged on and was not resolved until Ev took over as CEO. It is my recollection, although I could be wrong about this, that one of the first product changes that happened under Ev’s leadership was the hard coded retweet was launched and this button started appearing underneath tweets in your timeline.

Users could still cut and paste and manually retweet but if they wanted it to be counted as a retweet, you had to use the retweet button which did not allow manual editing. Like all product changes at Twitter, that created a fury of outrage from the users. But Twitter stayed the course and the productized retweet has become an enormous success.

At some point, clicking on the retweet button started to support the idea of adding some text to it. I can’t really recall when that change happened.

But recently Twitter has added another solution to the “share this tweet with my followers” need. You can now embed a tweet inside a tweet.

I started seeing embedded tweets in my timeline yesterday. My favorite was this one from Dick Costolo:

NBA adds their Twitter handle @NBA to the game ball for the 2014-2015 season. #NBAGameBall https://t.co/bBlQ9lsmxm

— dick costolo (@dickc) August 1, 2014

So this morning I decided to embed a tweet inside a tweet. It’s really simple. You just grab the permalink of the tweet and insert it into your tweet. Here was my first embedded tweet:

testing out embedding tweets in tweets https://t.co/Topt4FKaoh — Fred Wilson (@fredwilson) August 1, 2014

You will notice that when you embed a tweet on a blog that has an embedded tweet in it, the embedded tweet doesn’t render. My first embedded tweet looks like this in the timeline:

So Twitter isn’t finished completing this feature. This blog post will suffice as a feature request to Daniel and the product team to do that.

But I’m quite excited about this feature. Sometimes you don’t want to do a hard coded retweet. You want to editorialize the tweet. This is a very elegant way to support that. Well done Twitter.

It seems like every week I read another article about a mobile carrier offering some incredible deal to eat the mobile data costs you rack up using certain apps.

The most recent was the news that Sprint will sell at data plan that “only connects to Facebook and Twitter”.

Many on the Internet are up in arms about “net neutrality” amid concerns that the wireline carriers will discriminate between or block applications on their networks. I’m a supporter of net neutrality regulations, but it’s worth pointing out that wireline carriers haven’t done a lot of discriminating and blocking on their networks over the past 20 years of the commercial internet.

And yet in mobile data, there is discrimination and blocking all over the place. The main kind of discrimination is called “zero rating” in which a mobile carrier makes a deal with certain applications to eat the mobile data charges a user racks up when using certain apps. A good example of that is T-Mobile’s deal with a bunch of music apps announced back in June.

The pernicious thing about zero rating is that it is marketed as a consumer friendly offering by the mobile carrier – “we are not charging you for data when you are on Spotify”.

But what all of this zero rating activity is setting up is a mobile internet that looks a lot more like cable TV than our wide open Internet. Soon a startup will have to negotiate a zero rating plan before launching because mobile app customers will be trained to only use apps that are zero rated on their network.

I strongly encourage policy makers, policy wonks, internet activists, and anyone who cares about protecting an open internet for all to take a hard look at zero rating. Like all the best scourges, it’s a wolf in sheep’s clothing.

I’ve been telling this fictional story about Dentist Office Software for years to describe why we are so focused on our “networks” investment strategy. Yesterday I told it at a HackNY event we did at the USV office and my partner Albert provided a finishing touch that really drives it home. Since I’ve never told the Dentist Office Software story here at AVC, I will do that and then I will add Albert’s alternate (and better) ending.

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An entrepreneur, tired of the long waits he is experiencing in his dentist’s office, decides that dentist offices are badly managed. So he designs and builds a comprehensive dentist office management system and brings it to market. The software is expensive, at $25,000 per year per dentist office, but it’s a hit anyway as dentists realize significant cost savings after deploying the system. The company, Dentasoft, grows quickly into a $100mm annual revenue business, goes public, and trades up to a billion dollar valuation.

Two young entrepreneurs graduate from college, and go to YC. They pitch PG on a low cost version of Dentasoft, which will be built on a modern software stock and include mobile apps for the dentist to remotely manage his office from the golf course. PG likes the idea and they are accepted into YC. Their company, Dent.io, gets their product in market quickly and prices it at $5,000 per year per office. Dentists like this new entrant and start switching over in droves. Dentasoft misses its quarter, citing competitive pressures, churn, and declining revenues. Dentasoft stock crashes. Meanwhile, Dent.io does a growth round from Sequoia and hires a CEO out of Workday.

Around this time, an open source community crops up to build an open source version of dental office software. This open source project is called DentOps. The project takes on real life as its leader, a former dentist turned socialist blogger and software developer named NitrousOxide, has a real agenda to disrupt the entire dental industry. A hosted version of DentOps called DentHub is launched and becomes very popular with forward thinking dentist offices that don’t want to be hostage to companies like Dentasoft and Dent.io anymore.

Dentasoft is forced to file for bankruptcy protection while they restructure their $100mm debt round they took a year after going public. Dent.io’s board fires its CEO and begs the founders to come back and take control of the struggling company. NitrousOxide is featured on the cover of Wired as the man who disrupted the dental industry.

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That’s the story. I hope to fine folks at YC, Sequoia, and Workday don’t mind me using their names in this fictional story. I picked the very best companies in the industry and my use of their brands is a compliment. I hope they take it that way.

This story is designed to illustrate the fact that software alone is a commodity. There is nothing stopping anyone from copying the feature set, making it better, cheaper, and faster. And they will do that. This is the reality that Brad and I stared at in 2003 as we were developing our initial investment thesis for USV. We saw the cloud coming but did not want to invest in commodity software delivered in the cloud. So we asked ourselves, “what will provide defensibility” and the answer we came to was networks of users, transactions, or data inside the software. We felt that if an entrepreneur could include something other than features and functions in their software, something that was not a commodity, then their software would be more defensible. That led us to social media, to Delicious, Tumblr, and Twitter. And marketplaces like Etsy, Lending Club, and Kickstarter. And enterprise oriented networks like Workmarket, C2FO, and SiftScience. We have not perfectly executed our investment strategy by any means. We’ve missed a lot of amazing networks. And we’ve invested in things that weren’t even close to networks. But all of that said, our thesis has delivered for us and we stick to it as much as we can.

So here’s Albert’s alternate ending (with my editorial license on the colorful aspects of this story):

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A young dentist, named Hoff Reidman, just starting up his own private practice, decides that he wants to network with other dentists. Because Hoff went to CMU before going to dental school, he’s pretty technical and he hacks together a site in Ruby called Dentistry.com. He emails all of his friends from dental school and they sign up. Every dentist wants to be on Dentistry.com and the site takes off. Hoff realizes he has to quit his dental practice to focus on Dentistry.com. Albert Wenger, who happens to be a patient of Hoff’s, convinces him to let USV do a small seed round of $1mm to help build a company around Dentistry.com. Hoff comes up with a product roadmap that allows patients to have profiles on Dentistry.com where they can keep their dental records, book appointments, and keep track of their dental health. It also includes mobile apps for patients to remind them to floss and brush at least twice a day. While Dentistry.com is free to use for anyone (dentist or patient), it monetizes with native advertising, transactions between dentists and their patients, and transactions between patients and providers of consumer dental health products, and transactions between dentists and providers of dental equipment and products. Dentistry.com ultimately grows into a $1bn revenue company and goes public trades at a market cap of $7.5bn. Wall Street analysts love the company citing its market power and defensible network effects.

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I hope you enjoyed this fictional story. I find it explains our network thesis simply and easily. I will keep telling it to groups I talk to, but now with Albert’s ending. I like it very much. Thanks Albert.

Here’s a great podcast featuring my favorite analyst Benedict Evans, talking about macro and micro stuff in mobile.

There are some “truths” in the venture capital business that I have been hearing since I got into this game in the mid 80s. One of them is that getting “third party validation” by going outside of the current investor syndicate to find a new lead is good for the investors. I have come to believe this “wisdom” is nothing more than lack of conviction on the investor’s part.

What “super powers” do VCs have that allow them produce above average returns year after year after year? Well you could argue that some of us have the ability to see things before others see them. That might be true but it is hard to sustain that for a long time. You might argue that some of us have brands that allow us to get into the conversations with the best entrepreneurs when others can’t. That is most certainly true. You could argue that some of us have a tight focus on an investment strategy and work it tirelessly and don’t veer from it. That is most certainly true.

But short of those three things, I am not aware of a sustainable model that produces above average returns on investing in “new names”. However, there are two “super powers” that VCs have at their disposal that can produce above average returns year after year if they use them correctly. Those are the right to a board seat and the right to invest in round after round after round. I talked a bit about the latter one last week.

Taken together, these two rights put VCs in a position to intelligently invest in their existing portfolio companies. I believe that you can turn an average portfolio producing average returns into an average portfolio producing above average returns by intelligently investing in your existing portfolio companies.

It is one thing to take your pro-rata, and I talked a lot about that last week. But it is another thing to lead the next round and increase your ownership. It’s this latter move that I think many of us in the VC business instinctively avoid for fear that we are “falling in love with our companies.” Anyone who has been in the VC business for a long time has made the mistake of believing too much in a portfolio company and supporting it beyond when you rationally should. I have made that mistake so many times I can’t count them on two hands. It is my signature failure and I have not been able to stop doing it.

But, I would argue, the worse mistake is to know you’ve got a winner in your portfolio long before anyone else knows it and you allow a new investor to come in and lead the next round when you easily could and should. The upside on your best investments is the thing that allows an early stage VC to take so much risk and lose money on so many investments. Increasing the upside on the best investments is a rational move in light of the distribution of outcomes in a VC fund.

I would caveat all of this with a few things:

1) You have to let the entrepreneur do what they think is best for them and their company. If they want an outside lead, then by all means you should support that and work as hard as you can to make it happen.

2) You have to think about the amount of “dry powder” the current syndicate has and make sure that you aren’t using all of it up by leading a round when you should really be bringing in a new investor.

3) If an insider is leading a round, you should put a very fair deal on the table for the entrepreneur and the company. An inside lead is not about getting a “sweetheart” deal. It is about putting in place a fair deal for everyone.

4) If the valuation expectations of the founder and the company are unrealistic, then you should suggest that they go test the market. If there is a better offer out there at a better price than you would pay, that is always a good outcome for everyone.

There is a lot of signaling risk in all of this. If you are known to be aggressive in offering to lead inside rounds, and you don’t make that offer, then that puts the entrepreneur in a tricky spot. Of course the entrepreneur can say that they don’t want an inside lead and they want to expand the investor base. But even so, smart investors may know. Truth be told, there is signaling risk in everything that the existing investors do and anyone who thinks otherwise is just not seeing straight.

Two of my favorite examples of this strategy are YouTube and our portfolio company Etsy. At YouTube, Sequoia led the Series A and as far as I can tell (I’m not 100% sure), they led every round after that until the company sold to Google. That allowed Sequoia to allocate more and more capital to what was an incredibly great company and investment and get a massive return on a sale that sure felt like a monster at the time. At Etsy, USV participated in the seed round with some angel investors. We led the Series A and the Series B and increased our ownership substantially by doing that. On the Series C, Rob Kalin decided to get an outside lead and we were totally supportive of that decision. In both cases, I expect (or know) that the VCs had a better idea of how things were going (well!!!!) than anyone outside of the company.

There was a meme in the comment thread on my post last week (104 comments) about “insider trading”. I’d like to say something about that without getting legal or technical. In my view, insider trading is taking advantage of someone buying a stock from you or someone selling stock to you when you know something that they do not. It is illegal and should be. Purchasing stock from a portfolio company is unlikely to be insider trading because how can anyone suggest that you know more about a company than the company knows about itself? I guess that’s possible, but it’s a hard argument to make with a straight face. So while this insider lead thing may smell to some as insider trading, I am very confident it is nothing of the sort.

So in summary, when you have conviction that one of your investments is doing really well, you should have the courage to offer to lead an inside round (assuming you have sufficient capital including future reserves to do that). You should make the case to the entrepreneur and the board why that is a good idea. And if they decide to go outside and find a new lead, you should support that decision and do everything you can to make that strategy a success. I don’t think enough VCs do this and I think they should.

We’ve been investing in the education sector for a few years now. We started our exploration of online education in early 2009 with an event called Hacking Education. The takeaways from that event have informed a lot of what we’ve invested in since then.

One of the key takeaways was that learning could and should become free. Our friend Bing Gordon said this at Hacking Education:

From an economic point of view, I would say the goal… is to figure out how to get education down to a marginal cost of zero. 

We have invested with Bing in online education. Bing and his partners at KP led the most recent round in our portfolio company DuoLingo. DuoLingo is the most popular language learning mobile app in the world. And one of the reasons for that is that DuoLingo is free.

So you might ask “how can you make money giving away a learning app?” This past week DuoLingo answered that question with the commercial release of the DuoLingo Test Center.

The DuoLingo Test Center is currently free but it won’t be for long. Give it a try if you’d like to see how it works. Once the DuoLingo Test is accepted at schools and employers, the company plans to charge $20 to take its test.

There’s an established incumbent (monopoly) in this market called TOEFL. If you’ve come to the US to study, you’ve probably taken this test. It’s a lot more expensive than $20 per test and DuoLingo is out to prove it can do this testing less expensively and better.

But what this example shows is something more than how one company plans to monetize its free app. It’s a model for freemium in online eduction. Provide the education for free but charge for the certification (testing). This is a very elegant implementation of freemium as its an easy on ramp and the customers who get the most value are the ones who pay.

I am pretty sure this will become the dominant monetization model in online education. We are already seeing it emerge in other sectors. A number of the attendees at Hacking Education predicted this over five years ago. It made sense to me then and it makes even more sense to me now.

Here’s a talk that my partner Andy did with our friend Jason Hirschorn last year about the changing landscape of filmmaking. It’s about 45mins long