Okay..I Said it: This Time it’s Different, or How The Bubble WILL Come About

This Time It’s different

[Source www.500px.com]

We are entering a new era.   A time when great wealth is being created, and old fortunes destroyed (but not let us dwell there). A time of convergence and disruption that has not been seen in anyone’s lifetime.

In the late 90′s it was all about expectation and a belief that disruption of existing businesses was imminent; well, a decade or so later it now is. This is why the current (and upcoming) crop of Internet leaders are, well, generating revenues and profits. This is not about eyeballs anymore.

There are three main drivers, and their convergence is unlocking new money making opportunities at an increasing pace:

(1) existing established companies in many fields are being materially impacted by new secular disrupting technology;

(2) the establishments of new cheap, accessible distribution platforms; and

(3) the willingness of large (and small) enterprises to experiment with new way of doing things and work with unestablished companies.

Examples of new secular disrupting technology: SaaS services, cheap cloud storage and processing, powerful mobile platforms (phone and tablet), new touch and motion interfaces, ubiquitous API’s, social platforms (i.e. people giving up privacy for fun or ease of access/use), and location based services.

Examples of new cheap, accessible distribution platforms include iOS iTunes, Android, Facebook, Google Apps, and YouTube.

And, finally successful execution by high profile companies, low cost of experimentation, an ample supply of smart unemployed people and a societal recognition that tech is cool, as evidenced by The Social Network.

I cannot think of a time when so much disruption was happening from so many different technologies impacting so many different parts of the economy.  Thus I am not in the “It’s a bubble” camp, but in the the “It’s a bull market” camp.  Is this driven in part by cheap money, by a lack of investment returns elsewhere and by a sense of glamor, but those are the ingredients of a good bull market.  If I had to guess, I would say it is ’96 or ’97 again and we have a few more years before a blow-off top that will be called The Second Internet Bubble, or something like that.  Right now it is rational to invest in start-ups, though at some point it might make sense to step back.  As a professional investor I have to understand when to participate and when to pull back and now is the time to invest and help companies, not hold back.  Real wealth is being generated, real jobs created and real change is happening.

Innovation is very much alive in America and gives one great hope for the future of the country.

How The Bubble WILL Come About

[Source www.500px.com]

I co-joined these two blog entries as no discussion of what is happening does not involve someone raising the concern that we are in a bubble right now.  I think, and have argued above, that that is not the case…but, it most likely will be.  I can see such a thing happening three or four years from now, when everyone is sucked into the private markets and quite comfortable with their highly illiquid (but seemingly liquid) investments in companies they do not understand and yet they seem to be making money.

Bubble require liquidity and liquidity in private investments is restricted by many constraints, though the following are worth highlighting:

(1) regulation that only allows accredited investors to invest;

(2) regulation that restricts number of shareholders to 500, or burdensome reporting requirements kick in;

(3) lack of information related to how the company is performing; and

(4) institutional investing by mutual funds, brokers, etc. only make size in units of $10mm and so cannot happen until the market caps are sufficiently large (probably $500mm minimum).

I suspect that over the next few years (1) and (2) will be loosened, and (3) will stay the same, but investors will not care.  (4) is the real indicator of where the bubble will be.  It will be when mutual funds start to buy into private companies pre-IPO in a hot space, it will be when the public can participate pre-IPO through funds set up by the Bulge Bracket firms, it will be when secondary share trading grows to the point that “everyone” starts doing.  These will create a false sense of liquidity at the $500mm market cap level and above, and that will give everyone some comfort until it goes away.  Professional angels and VC’s will probably be more than willing to sell into this frenzy and take advantage of the liquidity provided.  Fortunes will be made and fortunes lost, but the bubble will have to be later stage.  Can this bleed down to the early stage?  Perhaps, but far less so.  The numbers are just too small.

Time will tell, but my thoughts are now date-stamped by this post.
[Note to self, check back in 3 years.]

Social Privacy

I was watching Mark Suster and Tom McInerney on This Week in Venture Capital mainly for fun, though Tom is a good friend.  If you have not watched it you should as it is highly engaging.  Well into the discussion Tom and Mark delve into privacy and Tom mentions that many teens have moved to having more than one Facebook account.  This was the same week that Hashable re-tooled their privacy settings, moving from a very open public followship model to an ‘Inner Circle’ model.  All of this got me to thinking further about privacy in the online world.

For many years people would designate themselves on the web using a pseudonym such as sexybear103@aol.com.  It was not until Facebook, LinkedIn and the like coerced users to register using their real name that the social network revolution really started to matter.  Since then people have be educated to be online using their real name.  This has been important for many reasons: (1) it allows social networks to function; (2) it builds trust and improves overall behavior – visit a comment stream that forces real names vs. one that does not and you will see a huge difference in civility and relevance/quality of discourse; (3) it allows algorithmic psyco-analytical companies to flourish, such as Klout, that are a benefit to consumer in many ways; (4) it enables information to find people via crowd-soiurced trusted networks (Okay I simply should have said Twitter!) rather than have to search for it, which is bad news for Google.

But, but privacy gets in the way, or at least defines the usage of the service.  Twitter is clear: it is open, there is no privacy (even DM’s can be read by 3rd parties from their API’s), it does not pretend to be private and so it is like walking up to the town square, picking up a soapbox and shouting.  There is no pretense that something tweeted is private.  Facebook pretends: it wants you to think that what you say/share/do is private to you and your intimate circle of ‘friends’, but it is not; and even if you shut down most of your privacy settings you are dependent, sometimes, on what privacy settings your friend’s have.  People want to share and so they are resorting to pseudonyms on Facebook which, well, reduces some of the utility highlighted above.  Hashable has moved from defaulting all people checkin’s from being public (or private) to being shared with your Inner Circle (or private).  This, for me, massively increases the utility and going forward all the CEO’s of my portfolio companies and my employees will be in my Inner Circle – we will share with each other our meetings and what we are getting up to and I am sure there will be many occasions where this serendipitous sharing will lead to new ideas, new connections and new business.  Hashable will add real utility from getting privacy right.  Others will be shut out, but that is fine, this information was not easily shareable before.  This seems to me to be the optimum level of privacy for me to get the most out of Hashable.  I am sure it will evolve, but I like this latest iteration.

Social privacy should mimic actual privacy, and so be different for different services.  In the real world you compartmentalize what you know/think and who you share it with.  We all have a private self that we keep, basically, to ourselves.  Then there is a public self that we are willing to share with everyone – though some people have multiple public persona that they like to keep separate, e.g. fraudsters and bigamists.  Then there is everything in-between: some people have just one setting for friends and family, and others have different settings for different groups that don’t intermix e.g. their guy friends, or work colleagues.  The online world has to mimic this, and so a service either has to address just one of these privacy groups, of be uber-flexible if it wants to cover more than one.  It is clear that I think Facebook is attempting and failing to do this.

Services will continue to evolve and getting social privacy right is essential for them to increase their utility to us as people and them for engagement.

There is No Such Thing as a Free Lunch

I really did not want to post about the Yuri Milner/Y Combinator/SV Angel announcement, but felt that there was something lacking in the debate.

Like Roger Ehrenberg I think this is a “ho-hum” announcement, but time will tell.  There are various surveys and analyses out there, and all the numbers are slightly different, but the order of magnitude is that there well over 100,000 angels making over 50,000 investments for a total amount of $15bn+/-, each year.  One angel’s investment in 43 startups for $6mm does not move the needle.  It makes GREAT news, however and there are already four TechCrunch articles about it.  It seems the valley is, well, narcissistic.

There is also the law of unintended consequences: does this mean that talented folks that are hands on and helpful to startups will avoid YC in the future if they feel that they cannot invest at fair prices.  Time will tell.  A rigged game does not attract talent, it attracts fools.  You also have to wonder if Yuri is buying options, then the companies must be selling them.  My time on Wall Street told me selling options can be a sucker’s game.  And then there is the questions as to whether there be a signaling issue?  Would you invest in a company that Yuri has decided to pass on in a later round?

Overall, I can understand the attractiveness of the money, but there is no such thing as a free lunch.

What is a StartUp?

An innocent question, and fundamentally too wide a question for an objective answer.  For me a startup is a new company run by bright, driven individuals that want to change the world.  The see the current set-up as wrong and that they can fix it, and make a ton of money in the process.  They are fundamentally unreasonable people, that face rejection, a lot of rejection.  In fact, the better the idea they have the more rejection they have – good ideas are not easily accepted, they seem to be strange or trivial or shocking.

“People won’t do that”, “I find that annoying”, “who would want that?”, are all signs that you are onto something big.

Never underestimate the weirdness of a big idea.

Feature or Product or Business or Defensible Business?

Sanjay Anandaram posted a great article in Plugged.in, and I suggest that you read the full article, though to get his full perspective.  The money quote for me is:

Today I know that a feature doesn’t make a product. A product doesn’t make a business; And most importantly, a business doesn’t make a company. A company is a means of organizing a business.

People who know me know that one of the first filters I apply when looking at a company is whether the offering is a feature, product or business.  It is the talent of management and the nature of the revenue model that converts it from something that can easily copied into something that can start to be defensible.  Being defensible is key.  Why?  Well, because let’s say that you have discovered a new market that others have not yet, and a way to extract profits from that market.  What stops others from following and dominating the market you discovered?  Financial services are full of new markets being discovered and where the margins are fat enough Goldman Sachs would move it as a fast follower, and often dominate.

So, how do you stop a fast follower?  Often you cannot.  You are left with two scenarios.  Either you have a structural advantage from being first.  eBay is a great example whereby the network dominance from being first sucked out the opportunity of others to catch up.  It was not that it was eBay that allowed them to dominate – personally I feel the site was designed by a sixth grader – but by being first with a sufficiently functional product.  In Japan they were second and lost to Yahoo Japan.  Alternatively, you simply have the best execution, which can involve a decent amount of luck at the right time.  Execution is a bit like pornography – tough to define but easy to identify.

So, if you are an entrepreneur think carefully if you have a defensible business model (when you execute) or not.  If not then the profits you could make will not be yours.   If you have a product then work out how to get it to be a business and if you have a feature, well, go back to the drawing board.

Life Mechanics

As a child I read books about Transactional Analysis and OneUpmanship, probably at the prompting of my mother.  I found these interesting in the way they described bow people play games in life and expect a reaction for every action.  Have you never been in a crowd and someone waived to you?  You probably waved back, even if you had no clue who there were.  Even so, I have generally thought that only part of society really runs with this quid-pro-quo mentality, and only for part of the time.  It is an interesting analysis but not core, mainstream or how we all live our lives.

It was not until I saw Inception with my wife that  I thought about these ideas again.  Inception for me was an indication of how far game mechanics have now infused society, and game mechanics are simply the modern-day representation of these ideas I was exposed to in my formative years.  What was it about Inception?  Well, my wife is not a gamer, and yet the movie was not “strange” to her.  It was just another romantic, thriller.  The plot, however, revolves around not just a gaming structure, but with rules espoused throughout the film.  This was not jarring as more and more of our experiences, online and offline are becoming rule-based with prizes, points, quid-por-quo built in.  We used to say that gaming would change computer interfaces and impact reflexes, and though that might still happen is it is the logic of gaming that is changing us first.  Some of the fundamentals of games are working their way into society at large.

Given that I am a VC does this perspective change how I look at companies?  In some way it does.  Game mechanics can affect adoption and are built into the business models of hashable, Identified.com, Klout, Livefyre, OfferIQ, ORCAone, and Phone.com.  I suspect that more will be built in in these and other companies over time.  To link buzz words from not to a decade a god: Game mechanics can increase the stickiness and viral adoption of your site as we are and have been trained, or re-programmed, to think this way.  Like Pavlov’s dog playing Wii.

Raising Money? Easy? Investing? Easy? – Why Not?

A few days ago Dave McClure posed this:

This was the consummation of a heated debate on Twitter regarding a blog posting by Niki Scevak entitled Angel Index Funding Bullshit.  Niki argues that Ron Conway and Dave McClure by investing in a large number of startups leads to them being more passively involved than if they focused on a smaller number of companies.  He goes on to argue that “handsome returns” will not be forthcoming due to high fees, the increasing number of startups, that if you invest in the market then you get market level of returns (i.e. median returns), and that if involvement leads to higher returns you ultimately will not get them as you are spread too thin.

This is an interesting discussion as it ties in closely with an increasing amount of capital being deployed in the early stage VC space, be it by funds like ff Asset Management and  even some larger traditional VC funds.  Entrepreneurs that have oversubscribed rounds are then forced to allocate, and when the allocate they then should carefully examine what is the motivation for the investor to invest in their company, as well as what is the quality of the money?  Many startups will not face this dilemma, but as the capital drought of early 2009 has been replaced by the glut of late 2010 more and more startups are having this “problem”.  This is despite the withdrawal of funds by angels themselves.  In 2007 $26bn or so was invested by angels.  In 2009 this fell to, perhaps $12bn.  This has recovered in 2010, but not to the 2007 levels.  VC’s, on the other hand, because of the long-term nature of their funds still have plenty of capital to deploy.

All funds are managed for return (or should be!), and return is a function of the size of investment and time devoted to the investment for any actively managed VC portfolio.  I personally think that if the fund is investing well less than 1% of the total fund’s size in an investment then there is a risk of misalignment of interests between the investor and the entrepreneur.  Remember, the investor is buying an option to participate if the company is successful, and walk away if not.  That is generally fine, but it can pose a risk for the startup if it is a large traditional well known VC where people will care if they do not re-up.  If the investor’s fund will end up with well north of 50 investments in the fund at maturity, then there is the question of whether the startup will get sufficient attention from the fund’s principal(s) for the money to be treated as “smart” money and not “dumb” money.  Finally, if the fund is spread too thin, then the fund will not have the capital for follow on investments, and new relationships will need to be developed at the next round – not a real problem, but something to understand.

Bottom lime, if you have an oversubscribed round then understand the motivation of each investor and their fund:  If there is alignment, great; if not, then think carefully if you expect your investor to invest not only money but also time.

If you are not oversubscribed then consider this article (which like most “news” overstates the situation):

One person we know who has a startup trying to raise money was floored at how easy it was to get a small slug of cash. It was basically a short phone call with a potential investor who said, “I’ve heard good things about you from people I trust. When you’re ready for me to invest, just call me back.”

Mad Men Made Mad by Marketing New Normal

On my last trip to San Francisco I happen to catch 10 minutes of Carlie Rose.  Jeff Bezos was being interviewed and there was something he said that I though was particularly significant:

Before if you were making a product, the right business strategy was to put 70% of your attention, energy, and dollars into shouting about a product, and 30% into making a great product. So you could win with a mediocre product, if you were a good enough marketer. That is getting harder to do. The balance of power is shifting toward consumers and away from companies…the individual is empowered… The right way to respond to this if you are a company is to put the vast majority of your energy, attention and dollars into building a great product or service and put a smaller amount into shouting about it, marketing it. If I build a great product or service, my customers will tell each other.

This resonated with inarticulated thoughts then, and it continues to do so.  The implications are huge: costs of getting to market are lower for products that your customers care about; companies should reduce friction in their products, and then reduce it more; social networks are not just valid but the “new normal” in marketing.

Laser Focus

Many VC blogs deal with fund raising and pivoting, but few cover just as important an area: managing a team in a high growth environment, ensuring that everyone knows what the firm stands for and what is expected of them.  It is easier in low growth companies as the challenges are often less dynamic.  High growth, however, needs constant reevaluation of needs, resources and priorities.

I have just returned from the offsite of one of my portfolio companies.  We came away with three simple things: a mission statement, long-term goals, and a set of  tasks for the the next three months and six months.  That does not sound hard, but it took us a day of meetings over two days to hash this out – we all knew it in general, but the meetings allowed us to clearly articulate it to ourselves and others as needed.  No confusion going forward.  At the end, every member of the team felt empowered, and knew exactly what they needed to achieve and what part they could play in the company’s success.  The CEO was able to communicate a laser focus on what the company wants to achieve and achieved buy-in from the entire organization.  Sounds simple enough, but in practice it is rare to see put in action.

For instance, how many start ups have a clearly defined mission statement?  Few, I suspect.  How many of those then articulate the necessary but sufficient goals that have to be met to enable the company to meet its mission?  Fewer.  And, how many of those then sit down and make sure that all the work is directed at tasks and milestones over the next six months to achieve those goals.  Big companies attempt this from time to time, but for startups it is critical as every resource is precious, missteps are costly and  the faster you run the more important this is.

We left the offsite with concrete tasks that we all knew would lead to meeting the company’s goals and be consistent with its mission statement.  Now comes the hard work: execution.

Management can’t simply leave it there.  They need to give everyone in the firm simple metrics to follow and targets related to those metrics that if met will achieve the goals.  Anyone on the team then knows how to measure their work as it relates to the company’s needs.  Again, laser focus.  How do you achieve this?  You make sure that everyone has access to these metrics, everyone has access to everyone else’s metrics and everyone helps everyone else on the team.  It is all about culture and team spirit and when it works amazing things can be done.

I left the offsite with the view that not only the CEO but every employee had a very clear understanding of what was immediately ahead of them and, with that, their chances of success are significantly enhanced.

My Love Hate Relationship with Google Docs, and by Extension Google

I have been a strong proponent of using Google Docs to create off-line storage of your important files.  No more.

What happened?  Simply put: it worked until it stopped.  I do not know if that is because  I reached 96% usage of the 1 GB of non Google Docs formatted files, or something else, but I found that it started to behave inconsistently.  Strange, strange things would happen.  For example: (1) a document would show in one view, but not another; (2) the number of documents in folders plus the number of documents not in folders were less than the total number of documents; (3) I would delete a document but it would reappear a few days later.  This opened doubts in my mind regarding if I would be able to recover my files when I needed them.  Doubt and critical file storage do not make good bedfellows.

The obvious solution was to see if buying more space would eliminate the problem.  But, you cannot do that.  You can buy more space for email by going pro, but that does not impact Google Docs – coming soon?  The next step was to reach out to customer service – oh, yes!  There is no customer service.  So, I went pro, found out via email over a day or so that they could not solve any of this and downgraded.   This might be a way for Google to run its business, but it was increasingly clear that it was not the right way for me to run mine.  I started to work out alternative solutions to Google Docs.  Fortunately, they have added a download feature recently so that I could extract my 1,000 or so documents.  The question now was where to transition to.

I spoke to some folk, researched on the web, made a few calls and decided to go with Box.net.  It is different, but has some good features that will help us share and run our business better.  It costs money, but also has customer service.  I also get the sense that the profit motive will encourage them to ensure that their service works and improves over time.

The key insight is that Google by giving products away for free does not have the same customer relationship as someone who sells their products.  As long as the area is of interest to Google (for their business needs) they will offer and enhance the service, but they are not offering the service for the sake of servicing customers with it.  They are offering it for other objectives, and ultimately that means that the service might need to be OK, but not great.  When you sell a service, for profit, you listen to your clients, you find out their needs and you meet them.  You work to ensure your customers are happy and you find ways to enhance the service so that you can up-sell features.  You worry when things do not work and you are scared about the competition.  I am not sure that this is the case for all the free products that Google offers.  It is free to use some of them, for some of the time, when they care.  If Google decides to end a service, well they can do so and lose no revenues!  Though customers might want a Google Voice desktop product, but if Google decides that this is inconsistent with its everything-in-the-cloud philosophy then it will not happen.  The profit motive is a powerful tool to align customer and service providers objectives – Google does not have that in may of its offerings.

So, do I love of hate Google Docs?  I am not sure.  I have replaced a lot of Google interaction with Box.net, but still love some of the sharing aspects of Google Docs.  Does this make me feel less positive about Google?  not yet as I rely on Gmail and it works great (until it doesn’t).