The Internet of People

Since the mass adoption of services such as LinkedIn and Facebook people have increasingly come online using their real names.  There has been a shift from representing yourself as angrybear101@aol.com to using your actual identity.  This phenomenon is culturally more important.  I like to refer to it as the Internet of People, compared to the the original Internet of Data or The Internet of Things.  It is significant: it involves people that have rights, emotions, intentions, and other attributes that toasters, phones, and databases do not.  It will lead to a changed understanding of information rights, privacy, and what is creepy and what is acceptable.

At its core I see four fundamental pillars: Identity, Trust, Reputation and Influence.   Yes, social networking is part of this, but this perspective gives a different, and I would say more informative, way to look at the space.  Here are a few thoughts:

• These four pillars will become increasingly important to two different constituencies: advertisers that want to reach consumers, and individuals themselves;
• Game dynamics can be applied to “manipulate” or “guide” people into certain behaviors that can then be measured in real-time – shopping and flash-deals come to mind;
• Regulation will have to play catch up – this is not longer cookie tracking it is stalking;
• People will be rewarded for the data  they surrender: a better table at a restaurant, front row seats, free goods, if they can influence others to follow their lead.

Companies will grow up over the next few years to address these needs.  Watch this space as it is going to be very, very interesting.

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Is it a Business?

My run-rate for looking at businesses is over one a day, and rapidly approaching two.  I enjoy almost every meeting, and in fact cannot think of one that I have not found useful.  As a firm we end up investing in a very small proportion of what we see, perhaps one percent or so.  Of late, I have been meeting with a number of companies that in effect are features, and not businesses and a number that would work great if everyone would adopt their product.  Both of these are red flags to me.

So, what is a “feature”?  It is a business that is not a business, it is something that in itself is neat or cool that improves fun or efficiency.  It has no revenue model, and if successful can be copied by existing players or new entrants in the space.  It probably can’t be patented effectively and if could you would not have the resources to defend yourself.  It is the stuff dreams are made of, but often not businesses.  It is narrow in its application, or something that could be wide if everyone changed what they do today and do it differently using this new wizbang feature.  Businesses that start as features often spend a lot of energy looking to back into a business model.  A few make it.  Twitter?

This brings me to adoption.  The biggest area I have difficulty with, and where I am likely to disagree with an entrepreneur,  is with user adoption.  Start-ups want to change the world, and to do that effectively they often need to change behavior from “I would never Tweet” to “Twitter is where I get all my cool news” or from “the iPad will never take off” to “I watched two movies on my last trip and read 5 books, all on my iPad”.  The question is when you try to change the world will it change with you?  This comes down to user adoption curves and entrepreneurs’ vision as to the ease of take-up/deployment of their product.  Often they simply underestimate the difficulty of gaining customers.  The key question that they do not have a perspective.  Is this a problem?  Yes and no.  On the one hand they have to have an unreasonable belief and passion for their idea, because if they do not it will never happen.  On the other hand this can border on the delusional.  What is most essential is that the entrepreneur tries to understand why others question their adoption assumptions and then communicate effectively their perspective.  If you are raising money this can be the most difficult idea to get across.

I do not have a checklist when I meet with investors, but if I did these would be top of the list.

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The Fed is to Blame!

For what, you might ask?   For the mess the current financial system is in, and the wealth destruction that has ensued.

Well, in fact, we all are to blame in some interconnected way, but it is clear to me that actions taken by the Fed a decade ago have been the prime determinant for the path we are on.  They never should have cut rates to such low levels and allowed them to stay there for so long.  They never should have indicated stability in rates and “measured” changes.  They never should have reached for quantitive easing.

Low rates have led to misallocation of capital on a scale never before seen.  This has “forced” savers to reach for yield and make poor investments.  This has allowed people and peoples to borrow money hand-over-fist and spend it unwisely.  There is a fantastic quote from Michael Lewis’ article in Vanity Fair:

When you borrow a lot of money to create a false prosperity, you import the future into the present. It isn’t the actual future so much as some grotesque silicon version of it. Leverage buys you a glimpse of a prosperity you haven’t really earned.

Leverage buys you a glimpse of a prosperity you haven’t really earned.  This encapsulates the problem we have.  A decade of easy money not only allowed people to become over-leveraged but also gave politicians the tools to go out and make promises that can’t be met; whether they are in Greece, California, or my local town school system.  A bailout will only kick the can down the road for someone else to face.  Borrowing more to solve a debt problem is not a solution that can work for the long term, as the debt is not borrowed to supercharge growth.  We are now entering the Decade of Defaults as it becomes clear that there is no other solution.

Why are the authorities so wary of defaults?  Because it will wreck the banks, pension funds, insurance companies that own this debt and want to treat it as money good.  I suspect it would have been better to take the losses and re-cap the banks and start to explain to people that their pensions and other “entitlements” are not entitlements rather than continue the charade.  Politicians do not have the stomach for this – they, like investors, are increasingly myopic.

I am in a small minority, and it is increasingly clear that banks, politicians and regulators have interests that are mis-aligned to what is best for the rest of society – they will continue on with their make-believe asset valuations and hold onto power beyond any reasonable expectation.

Ultimately, there will be a reconciliation and such a reconciliation will be political as much (or more so) than economic.  Political reconciliation can sometime be peaceful and through the system, but often than not it is neither.  Don’t blame me when it happens, blame the Fed.

Postscript: The ECB is just as bad, given their capitulation this weekend.

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Online Reputation

[Okay, this post refers to a portfolio company, and hopefully is not seen as a shameless plug]

During the due diligence for a recent investment in Klout by my fund, ff Asset Management, we have been thinking about  online identity and reputation and trying to understand what is changing here.  Recent posts by Fred Wilson and other are scratching at the surface.  It is clear to me that something changed with the mass adoption of Facebook, LinkedIn and other real-name social networks.  Facebook Connect has further extended it to the non-social web.  People moved from being anonymous to leaving real footprints on the web.  People are no longer hiding behind “anonymous” or “cutiebear107@aol.com” but are leaving traceable marks as to what they think, who they know, who thinks what they have to say is important.

This real-name web will lead to a host of services that connect-the-dots and help manage their identity, reputation and influence.  We are moving from the Internet of idea to the Internet of things to the Internet of people.  Clearly privacy, gossip, reputation, influence, trust, all are relevant here.

We invested in Klout as they are working on the influence aspect of the influence of people.  They people-rank tweets real-time and give people, for the first time, a measure of their influence on the web.  Fred Wilson has a Klout Score of 70, I have one of 12 - so you can clearly see who carries more weight on the web!

Over time we think that people will want to know who they are dealing with on the web in a simple manner, knowing their influence and their reputation.  In the same manner there will be companies that will work to help people manage them.  This is an evolving space and one which will be of increasing interest to venture capitalists and the media at large.  Thank you Facebook.  Thank you LinkedIn.

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Investment Landscape – in 10 Soundbites

On Change: Everything is in flux.  Everything is a “fad”.  Nothing is constant.  Change comes, so accept it and embrace it.

On Capitalism: Capitalism is about efficient allocation of capital.  Regulations that get in the way distort capitalism and lead to inefficient allocations, often to the financial supporters of government.

On Social Democracy: You cannot borrow and tax your way into growth.  Pushing public debts onto Sovereign balance sheets for good reasons, ends up staying there for bad reasons.  Sovereign defaults is the expected outcome as politicians avoid hard solutions.

On Bureaucracy: The Fed has 20,000 employees.  20,000!

On American Democracy: Taxpayers want small government, as they pay for it.  Non-taxpayers want large government programs.  Only time will tell who will win out in the “grand experiment” of American democracy.

On Contrarian Investing: To make money you want to be where others are not or fear to be.  Be illiquid when others are not, own loss making ventures when others want dividends, be contrarian.

On China: China’s growth is amazing.  If only their government was driven to generate economic growth.  It is not, it is driven to stay in power and growth gets them there, for the time being.

On The Next Big Thing: China’s growth saved the world economy post the dot-com bubble.  Who/what will save us when the China ceases to?

On Investing Long-Term: There are two ways to invest; one involves constantly picking the right asset, and moving to the next one as soon as the money has been made in the first.  It is frenetic and involves thousand of investment decisions in a short period of time.  Another one is boring and patient and simply requires investments that fit a longer time-frame.

On Investment Horizon: In the investing game, time is your friend.  Invest so that your wealth can compound at the highest rates over the cycle, and remember that the gains in the out years are where the money is really made.

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Should an Entrepreneur Pay to Pitch?

No.  They never should, and if they do then it indicates a lack of drive, verve and creativity in reaching angels and VC’s.

Here is how I see it:  VC’s make money by investing in successful companies, and like to believe that their input along the way with regard to ideas, best practices, contacts and reputation bias the outcome – I certainly do.  To ensure that they get to see good ideas they meet a lot of people, and will invest in a single digit percentage of those they initially meet with – the funnel.  Every VC tells me that the best ideas they get are vetted by people the trust and not the result of receiving a presentation in the (e)mail.  I can personally attest to that.  If someone smart that you trust says “look at this”, you will.  I think in the past year I have had over 300 hour-plus conversations with entrepreneurs pitching their ideas – and this is just the initial meeting or call.  Some subset have led to multiple meetings, calls, research hours and the end result has been less than a handful of investments in the fund this year ~ about a 1% pitch-to-investment ratio.  Time will tell how many great ideas were passed on.

Why do we reject 99% of ideas presented to us?:  There are many reasons, some can be articulated and some not.  There are probably a handful of common reasons that account for the majority of the non-invest decisions; portfolio fit, people fit, management, size, terms, and addressable market.  A random selection of some of the questions we think about are (in no particular order):  Does this fit our investing criteria?; Is the idea big enough, yet the execution focused?; Does management listen?; Is this a team and an idea that we want to spend then next 5-7 years being around and thinking about?; Is the investment at a reasonable valuation?; Are the terms reasonable?; Does the capital raise get them to profitability and if not then do we care for the risk?; What is the operating leverage in the model?

What entrepreneurs should do to increase success?: In fact there is quite a lot here.  In fact how a management pitches an idea and manages the fund raising process is telling of itself, and something we listen to.  In simplest terms know who you are talking to and what you want out of the conversation.  Your objective should be to find the VC that has the best fit for you.  To do that start by leveraging your contacts and the web to identify potential VC’s.  If you have direct contacts use them to get a personal referral to a VC.  Before your first conversation with a VC review their website and see if they describe their investment philosophy, list their portfolio and describe their ideal investment.  If they do, then are you a fit?  If not then ask the VC if they know of another VC that might be a good fit.  It is a job in itself, and so paying to pitch seems to be a good shortcut, but in reality there are no good shortcuts here.

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When to Duck and When to Catch

After Google I/O, my wife and I visited my eldest, Rich, who is a graduate student at Stanford, and he suggested that we sit in on one of his lectures.  It was a treat, and not just because Professor Mehran Sahami throws candy to his students.  The class was on probability theory.  So here I was sitting at the back of a lecture hall, which I have not done for 27 years, being taught about “Modeling Uncertainty and Utility” – so, why was it such a treat?

Well, first of all, Sahami is a great teacher.  He keeps his students involved and awake, and not just from a sugar high.  He tied the subject back to the real world, talking about betting games, and micromorts, an idea core to life insurance.  It was his discussion of the behavioral aspects of utility that grabbed my attention.  Why would one person make a bet (or an investment) where the long-term average outcome (the “certain equivalent”)  makes it a “bad” bet.  Part of the answer lies in the relative amount of the bet vs. the person’s net worth and well being.  Sizing up/down the size of the bet changes the attractiveness of the bet in a way not immediately apparent from the numbers.  A billionaire is more willing than a multi-millionaire to bet $1mm for the fun of it, even if the odds do not make sense.  Psychology and Maslow’s Hierarchy need to be factored in.

The lecture made me think about the outcome of an investment in a private company.  Say that you invested $1mm 10 years ago at $1 per share and the company just had a successful IPO.  You also believe that it is capable of growing 50%  a year for next few years.  For sake of argument assume that there was no dilution and the company went public at $10 per share and traded to $15.  Assuming the market is rational (Okay, bad assumption) the stock could rise 75% a year for the next few years, if multiples do not contract.  You $1mm investment is worth $15mm today, $26mm in one year, $46mm in two year and $80mm in three years.  What is the utility value of profit?  When do you take money off the table?  Situations like this are are the subject of bar discussion by angel investors.

Sahami’s lecture helped me solve this problem.  It all depends how rich you are.  If you are just getting by, then $15mm today is very valuable to you, you can’t risk losing it (the market being irrational and all that) and so you probably sell a lot of it so that you can have money to live on.  If you are worth $100mm, you probably let it ride, not because you need it, but because of what a great story turning $1mm into $80mm would be.

This perspective helps solve another question I have been pondering as well.  If early stage venture capital and angel investor returns CAGR north of 15% (and there are a number of studies that support this view, but let’s just take it as a given) then why do more people not invest in this space?  Well, part of the answer is that if they did then the returns would not be as strong – which I wholly agree with, but part of the answer is that there is a small group of people to draw from that both have enough money to make such an investment and tie up their money for 3-8 years, but do not have so much money that the investment is too small to be worth their time.  Thus the space is left to a subset of rich angels and the handful of early stage venture capital firms such as ff Asset Management.

I was attentive throughout the class, and gained a lot from it.  We had a great weekend touring Alcatraz and walking amongst the sequoias at Muir Wood National Monument – some of these trees predate Christianity.  Both worthy uses of time, and good places to clear one’s head.  But the 50 minutes I spent listening to Professor Sahami and dodging candy was just as special.  Thanks, Rich.

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