Urgent Speed

More Networked than Cisco? Angel and Venture Syndicates

I like the thinking behind Yael Hochberg, Alexander Ljungqvist, and Yang Lu’s research on predicting venture investment return.  Their study, “Whom You Know Matters: Venture Capital Networks and Investment Performance” shows how, historically, Angels and VCs that make a habit of co-investing outperform funds that tend to participate in more limited syndicates.   As TechCrunch explains:

A venture firm’s network in the study was defined as being made up of all the other venture firms who co-invested with it in funding rounds. The more co-investors a venture firm has, the better its network. The better its network, the better its overall returns. The correlation between the size of a venture firm’s network and its returns may have something to do with better access to deal flow, talent, advisers, potential customers, and potential exits.

If this is true, then who are the most connected venture firms and angel investors today? Vijay Dondeti , a graduate student in bioinformatics, applied the analysis in the Hochberg paper to about 2,700 investors in CrunchBase  who participated in over 3,300 startup funding rounds between 2006 and 2008. He scored each investor based on how well connected they are to other investors as well as how well-connected their co-investors are to other investors. “In summary,” says Dondeti, “to get a high score, you need to co-invest often with others that also co-invest often.”

In my experience, larger more-connected syndicates are more likely to be able to help a start-up as it grows. As an Investor, I like having other smart heads looking out for my Angel investments, as an Entrepreneur, I like having a diverse group of minority investors I can turn to for guidance and perspective.   I agree with the study’s hypothesis that the outperformance of networked VCs is due to the increased likelihood that the syndicate can also contribute relevant intellectual capital.

But I think the “Whom You Know” study is missing an important correlation. Networked investors tend invest earlier, often at the seed stage, and seed investments, on average outperform the VC investment class.  Small funds and Angels need to co-invest, because they don’t have huge funds. Without a huge fund, an investor runs the substantial risk of being unable to meet the needs of the portfolio company. This is why small investors ban together to make sure they can invest a meaningful amount, while still keeping funds in reserve.   Small funds make their money on the upside; large funds often make substantial money on their management fees.  The result is not a big surprise; small funds tend to obsess on helping their portfolio.   Don’t get me wrong, I respect several large funds. There are several great large funds that have a proven track record both participating at all stages and also adding value beyond simply writing a check.  DFJ and Sequoia are good examples, and are ranked high on Vijay Dondeti's ranking.

So I salute Yael Hochberg, Alexander Ljungqvist, and Yang Lu.  I hope there is a next version of their study where they try to statistically separate Alpha from “stage” from Alpha from “network” (a hard task given the opaqueness of venture returns).  As for Vijay Dondeti, I salute you also…your analysis was excellent. I don’t claim your ranking of me (at 63) above Cisco (at 65) is perfect, but if someone knows a better statistical predictor of venture/angel performance… please speak up.

BTW, when reviewing the "Whom You Know Matters" study in the Journal of Finance I noticed an outcome tree for 16,315 venture investments from 1980 to 1999, following their outcome through 2003.  For my own edification, I created a pie chart showing outcomes. 

Only 18.5% of all deals resulted in an exit over the course of the dataset. So the takeaway for Angels: if you can't see at least a 10X+ return on investment, don’t make the investment, unless you have some method of avoiding the other 81.5%.  If you have a method of avoiding exitless investments… please speak up. 

Perhaps the folks at Sharespost will help create exit opportunities for early shareholders? Til then I am sticking to co-investing with a 10X+ hurdle.

2006, 2007 and 2009 list of VC Blogs

It’s good to see Larry Cheng has posted a list of current Blogs by Venture Capitalists.  It’s interesting to compare the 2009 list to the VC bloggers list from 2006 and the VC Blogger List from 2007.

The Next Bubble – Alternate Energy

Eric Janszen does a masterful job articulating the conditions needed for a massive innovation bubble.  His article is required reading for any entrepreneur looking change the world.     The move away form oil will be as big as the transformation from animal power to steam, or transformation from steam to oil.  
 

Publish at Scribd or explore others: Business economy crash

There are two types of bubbles; asset bubbles and innovation bubbles.  The Asset bubbles are a zero sum game that doesn’t offer anything new to society, but innovation bubbles are critical to rapidly deploying new technology.  

The Tulips Bubble of 1637 is the classic example of an asset bubble.   More recently the assets of real-estate, oil, and gold have all had their bubbles.  I believe asset bubbles are a natural occurrence given our collective human nature.  (I wonder if algometric trading amplifies or dampens our human propensity for froth and panic.) 

But innovation bubbles are a different organism. Innovation bubbles are the markets (our collective intelligence) realization that technological change is afoot. Canals and Railroads are the classic example form the 1800.   More recent examples include Radio, Automobiles, TV, and the Internet.   Fortunes will be made and lost, but in the wake of the bubble a new technology will have taken root. 

I can’t wait to see what technologies replace oil and coal, and even more so; I can’t wait to see what entrepreneurs make it happen.  Will it be microbiologist hackers modifying algae to produce cheep fuel? Maybe nanotechnologists will invent cheep solar cells that are super efficient.  Perhaps some grad student is about to drop out of college to commercialize his ultra-capacitor thus ending the need for batteries.
  
Moving away from oil will take dozens of new inventions and business models; I am just glad Eric Janszen gives us a roadmap.

To Blog or To Email, Climate Change makes the jump

I have a group of friends that are passionate about solving global warming.  We e-mail around articles, observations and opinions.  These friends are mostly tech-entrepreneurs, economists and wall-street-types, so the conversation is usually very action-oriented… as opposed to political or academic policy/theory.   But this week something changed.  Now that the election is over, even my political-policy-wonk friends started talking about climate change. 
 
My theory is that now that the election is over, global climate change will start to get the attention it deserves.   Looks like the new administration agrees, because they seem poised to appoint a “Climate Czar”   
 
Global climate change is as big as a problem as problems get. To solve it, we are going to need innovation from everywhere.  Historically, I have trumpeted the innovation form industry, scientist and entrepreneurs.    (Full disclosure am a huge fans of Joseph Schumpeter’s theory of creative destruction).  However, climate change demands innovation in public policy (translation: governments).  Let’s hope that now that the election is over, we can move the conversation about climate change off the listserve and onto the web. 
 
I predict Global Climate change will get solved:
    By technology,
        Invented by scientists,
            Commercialized by entrepreneurs,
                Spurred on by investors,
                    and supported by public policy.
 
Let’s hope a more public discussion adds fuel the fire, (Wow, that is a bad use of metaphor).

Sales as R&D

After years of talking to start-ups and fellow seed stage investors, I have noticed that the smart ones understand that in a startup environment, the selling process doubles as a research and development process.  In my mind, learning how to sell a new product is one of the defining differences between a technology startup and an established business. 

Great startups not only invent a new product, but also invent a way to sell that specifically benefits their product or service. As Geoffrey Moore points out, most great startups are innovative when it comes to their products and  when it comes to how they market.

I would add that startups can benefit by implementing the same steps for a new sales process as they would for a r&d process.

How do I propose you find the overlap? 

• Like product R&D, don’t invest too much too quickly.  Innovation is an iterative process. Be sure to budget for the time to experiment.
• Like product R&D, don’t put all you eggs in one basket.  You will likely need to experiment with pitching to different market segments, different occupations, and different demographics.  Staff accordingly
• Be ready to commercialize, but don’t commercialize prematurely.  Once you think you have a grasp of your target market and resonating value proposition, scale the sales team.

Many engineers I talk to have the misguided “if we build it, they will come,” approach to sales.  To this I say: Bull.  In 1999, I had the chance pleasure of meeting most of the Google sales team in a hotel bar.  Let me tell you, they weren’t talking about algorithms.  While the PHDs at Google deserve a lot of credit for building a great product, we can’t forget that the innovations of the sales team developed for the company.  They are very responsible for getting Google to where it is today.

"Discovering" how to sell your product is as important as coding your software. No one likes to hear "no i won't buy from your company" any more than they like to that their code won't compile, but both are important vital parts of the development process.

Of Start-Ups and Battles

I like to have a detailed business plan in place before committing serious resources to a new venture… I figure it is a lot better to catch mistakes on paper, as opposed to discovering them once cash and careers are on the line. 

A business plan should not be viewed simply as a funding document. Even if you don’t expect to have outside investors, it is a great way to solicit feedback from people you respect and trust.  Writing a plan is hard work, but it makes execution easier.  I am surprised how many start-ups don’t invest the time to write down their plan, yet still expect an outside investment. 

Why should an investor risk their cash if the entrepreneur is not willing to think through her idea?

Over the last few years, I have witnessed an increase in the number of entrepreneurs who expect to raise funds with nothing more than a prototype and a PowerPoint.  The general consensus in Silicon Valley is that funding is about to be a lot harder to come by.  I hope that one of the upsides of the nuclear winter  is startups that are more thoroughly thought out. 

There will always be capital available for good management teams with well thought-out plans… Perhaps the ability to think through an idea is the mark of a good management team?

Of course, planning is no substitute for actual selling.   For pitching, Prototypes and PowerPoint reign supreme.

"No battle plan ever survives contact with
the enemy"

Field Marshall von Moltke

"No business plan ever survives
contact with the customer"

Steve Blank

Moltke: 

Market Crashes, Defaults, Urgency and the Long View

There is something about a market crash that makes me wants to write.  I guess it is a cathartic way to deal with loss. 

Given the huge drop in Japan and London, we might expect the US market to drop substantially this morning.  Though I weep for the NIKKEI, I fear for the DOW.

I think it is easy to lose track of the BIG picture…the long-term view.  This may seem ironic, given my obsession with speed and urgency, but I don’t confuse urgency with short-sightedness.  Rather, I think small improvements implemented urgently can have huge impacts on the long-term outcome.  

I guess you could say my long-term view increases my urgency.  Furthermore, a long-term view needs to be long…maybe 10 years, maybe 100 years, maybe even 1,000 years?  1,000 years really puts things in perspective.  Let’s look at these long-term views:

The 10 Year View:

Because growth compounds, decisions today impact the future in non-linear ways.   If, for example, you have a start-up that is growing 10% a quarter and you decide to invest $10,000, in 10 years your investment will have become $411,000.  If you decided to delay that investment for 180 days, however, you would only accumulate $340,000.  That lack of urgency would have cost you $71,000.

The 100 Year View:

Stock Markets fluctuate, but overall they have done fairly well over the last 100 years.  Despite my belief that the stock market in 2009 – 2010 will struggle due to massive debt and population demographic shifts (baby boomers are moving out of peak earning and spending), pulling out of the market does not make “cents” (bad puns for bad times).    Multiple examples prove that history is on our side… over the long term, including:

• In January of 1970, a bear market started that lasted until May of 1970, during which the market fell 35.4%. In May, a bull market began that lasted until January 1973 and brought a 124% gain in stock values.
• In April 1981, another bear market commenced that lasted nearly a year and brought a 24.7% decline. Then, in March of 1982, the market began to rise and continued doing so until June 1983, bringing an overall gain of 71.7%.
• July 1990 brought a downward market that lasted three months, until October 1990, at which point equity prices had fallen 22.4%. Then, in the same month, a new, now legendary, bull market took hold and lasted nearly eight years, until July 1998, delivering a 330.7% gain for the market.
• Since 1975, 8 of the last 15 bull markets have started in the autumn months of September, October, and November.
• Since 1957 there have been 15 bear markets, as measured from peak to trough, and on average they have lasted 10 months and brought an average decline of 29.4%.
• The duration and degree of these bear markets were significantly less than the duration and magnitude of bull markets. During the same period, there were also 15 bull markets, which lasted, on average, 30 months and brought average gains of 112.5%.

Markets could only drop to ZERO, but they have unlimited upside (the cup is not only half full, but it could overflow).

The 1,000 Year View

Given my long-term view of opportunities, you can imagine how pleased I was this morning to find an 800-year economic data set. 

Here’s the summary of from the study:

In a recent paper co-authored with Kenneth Rogoff, we introduce a comprehensive new historical database for studying debt and banking crises, inflation, currency crashes and debasements.3 The database covers sixty-six countries across all regions. The range of variables encompasses external and domestic debt, trade, GNP, inflation, exchange rates, interest rates, and commodity prices. The coverage spans eight centuries, going back to the date of independence or well into the colonial period for some countries.

In what follows, I sketch some of the highlights of the dataset, with special reference to the current conjuncture. We note that policymakers should not be overly cheered by the absence of major external defaults from 2003 to 2007, after the wave of defaults in the preceding two decades. Serial default remains the norm; major default episodes are typically spaced some years (or decades) apart, creating an illusion that “this time is different” among policymakers and investors. We also find that high inflation, currency crashes, and debasements often go hand-in-hand with default. Last, but not least, we find that historically, significant waves of increased capital mobility are often followed by a string of domestic banking crises.
The big picture

What are some basic insights one gains from this panoramic view of the history of financial crises? We begin by discussing sovereign default on external debt.

Default cycles

For the world as a whole (or at least the more than 90 percent of global GDP represented by our dataset), the current period can be seen as a typical lull that follows large global financial crises. Figure 1 plots for the years 1800 to 2006 the percentage of all independent countries in a state of default or restructuring during any given year. Aside from the current lull, one element that jumps out from the figure is the long periods where a high percentage of all countries are in a state of default or restructuring. Indeed, there are five pronounced peaks or default cycles in the figure. The first is during the Napoleonic War while the most recent cycle encompasses the emerging market debt crises of the 1980s and 1990s.

Serial default on external debt—that is, repeated sovereign default—is the norm throughout nearly every region in the world, including Asia and Europe.

Our dataset also confirms the prevailing view among economists that global economic factors, including commodity prices and centre country interest rates, play a major role in precipitating sovereign debt crises.

The Study goes on:

Another regularity found in the literature on modern financial crises is that countries experiencing large capital inflows are at high risk of having a debt crisis. Default is likely to be accompanied by a currency crash and a spurt of inflation. The evidence here suggests the same to be true over a much broader sweep of history, with surges in capital inflows often preceding external debt crises at the country, regional, and global level since 1800, if not before.

In the past few years, there have been massive capital flows as the US borrowed billions from abroad while simultaneously sending billions for oil and imports.  These old data sets provide useful insights into the likelihood of inflation. 

So in conclusion:

1.     Looking at markets/business from a 10, 100, and 1,000 year perspective can be helpful to reduce the panic over today’s markets.

2.     Urgency and an obsession with speed are complementary, not mutually exclusive, to a long-term view.

Jeff Stewart, Alan Meckler, & Kevin Ryan, to speak at Early Stage Summit

I guess I get to give myself top billing on my own blog!   The Early Stage Summit is the premier Startup Showcase & Investor Conference for the East Coast PE/VC Community. ESS will be held on October 2nd, 2008 in NYC and will feature 15 rigorously vetted companies, across 5 tracks (Seed Spotlight, Digital Media, Mobile & Telecom, Enterprise, Cool Concepts) and will be open to just 100 investors.

Sponsored include Mashable and NY Angels.  Attendees include dozens of Angels and VCs.  More is at:  www.EarlyStageSummit.com

Moving from Oil-based to Electricity-based Economy

My guess is we can look to history for clues.  This is what I did in 1994 to understand the then-emerging web transformation.  I locked myself in a cabin and studied how technology drove economic transformations in the past, such as:

- The Printing Press
- Steam Power
- The Rail Roads
- The Telegraph
- Electricity (1.0)
- Broadcast
- Motion Pictures
- The Phone
- Automobiles
- Personal Computer

This self-education was not only fascinating, but also gave me the mental framework to profitably navigate the internet revolution. (Maybe I should sequester myself again in preparation for the coming clean-tech transformation).

Look at each transformation and four clear patterns emerge:

1.) Many Fortunes will be made
2.) Incumbents will be disrupted
3.) Change will impact everyone in multiple ways
4.) Average citizens will benefit

So where are we?  Or, even more important, “when” are we?  Which innovation wave most resembles the clean tech wave?  Many of the technology entrepreneurs I talk to say it is like 1995 and the internet; investors I talk to say it is like 1998 and telecommunication…but I disagree.  I think it is like 1982 and the PC.

Why?  Because like the PC:

- An entire ecosystem needs to be developed (distribution channels, supply
chains, sales channels)
- Technology (often semi-conductor) is at the heart of much of the innovation
- There is a “big iron” legacy

In 1982 the mainframe still ruled the computer roost, but nimble “micro” suppliers like Lotus, Compaq, Apple and Microsoft were really driving the innovation.  I think the same is true today.  In Alternative Energy, big utilities and project finance companies are building big instillations, but the innovation at household scale (at the node) is breathtaking.  Small scale solar innovations, Fuel Cells, and break-through efficiencies have the potential to change the game in energy, much like the PC changed the game in computing.

The good news is there is lots of talent that still remembers the 80s, and much of that talent is in the Valley and up on route 128.  My advice to any young clean tech entrepreneur is to listen to the 80’s guys.   When 80’s guys ranging from a semiconductor expert like Andy Grove or an oil man like T Boone Pickens are all floating thought provoking new ideas for clean tech, something transformative is happening.   If founders can involve advisors or investors that made their fortune in the PC revolution, I think their knowledge and perspective will prove valuable in ways we don’t yet understand.

HP steals from government playbook..or.. How to get impressive sounding market size

Early stage entrepreneurs and investors almost always want to understand “The addressable market”.

As a general rule of thumb, bigger is better.  Growing beats shrinking, and global trumps local (especially if it includes everyone online and/or all of China).

Ambitious entrepreneurs want to understand how their company will become a multi-billion dollar world changer.   Investors want to understand how their investment is going to keep their kid’s kids in extended inheritance disputes well in to the twenty second century. 

How you define the market is KEY to attracting talent, and capital. 

Defining the market can be tricky because often the best markets don’t even exist.  That is; don’t exist yet.

Think of a world before Radio, TV, Automobiles or Personal Computers.  Early on, how would you define those markets?

In the 40s one executive defined the global market for computers as "maybe a dozen".

Truly pioneering companies often sell something the world is not yet demanding.  This can be discouraging for an entrepreneur, but the great ones persevere.   Just think of it as “unencumbered by predefined demand”.

Radio, Automobile, TV, and Personal Computers all were developed in the HOPE that a larger market would emerge.

In the 60s many people thought the entire addressable market for cell phones consisted of only Maxwell Smart!

 

In the late 1970s, the market for micro-personal-pocket-sized-headset-music was about zero.  Sounds risky!

This was before Sony launched the “Walkman”.  Yet even then, the market for consumer electronics, radios, or cassette players was Billions.

 

When the Sony Founder was describing the WalkMan opportunity to potential hires and investors do you think he pointed to zero or to billions? 

So size does matter, but is how you talk about it can matter even more. Which brings me to government, they sure know how to talk. 
(BTW; I would have titled my post “size matters”, but I did not want a red flag from the ant-spam-algorithms).

When government talks about saving (or investing) they don’t say $10 billion a year.   Yearly numbers may be practical for executives who are accountable to quarterly projections, but it’s not going to generate press inside the beltway.  Savvy Politicians say “$100 Billion dollars by 2017”,   Sounds impressive!   Adding a few more years can really pad the numbers.

I am not recommending you use this technique as an entrepreneur, but HP decided to try it out.  It looks like it worked.

Recently HP announced:

“A continuation of their Print 2.0 strategy. The strategy is heavily focused on leveraging Web-based services in trying to capture a significant share of the growing number of digital pages printed each year. According to HP, 53 trillion digital pages are forecast to be printed in 2010, creating a market valued at more than $296 billion.”

Bravo HP, plenty of media pick up.  They could have said a trillion dollars by 2017. Just as accurate, but a trillion would have been ignored as over-hype. They could have said billions a month. Just as accurate, but that also would have been ignored as underwhelming.  HP got it just right.

Any way you measure the market for printed business documents (i.e.; Business Plans, proposals, PowerPoint presentations, training material, etc.) is large and growing. However in 1999, when we were first raising money for Mimeo.com, we had some trouble convincing investors there was a market for printing documents over the internet.  Luckily, we were able to convince a few investors of the market potential, and today Mimeo has over 450 employees who profitably services thousands of companies, delivering documents to a market that could have been defined as “almost nothing” a decade ago.

For entrepreneurs worn down by accusations that their market is too small, I encourage you to persevere.   Ignore those potential investors that are too small mined grasp your market’s potential.    For entrepreneurs building next generation music sites; your market is too small, give up.