Friday, January 30, 2009

Eight "Don'ts" for Entrepreneurs

The second part of the list I posted a few days ago. This is a short and to the point list of "Don'ts" for entrepreneurs -- it was compiled by Alexander Muse based on a presentation by Martin Plaehn, CEO of Bungee Labs. I agree heartily with its recommendations. Especially the last one. Good advisers are necessary for a start-ups success, but they are not sufficient.
-- Don’t hire of goodness of heart or friendship
-- Don’t hire anyone who you and your team are not genuinely excited about
-- Don’t tolerated mediocre engineers; for that matter, mediocre anyone. An early sign of mediocrity is when you downgrade tasks and expectations to align with an employee
-- Don’t count on your investors to take care of you when things get rough and/or protracted
-- Don’t over interpret or count on the stated operating “value-add” from investors during their solicitations during fundraising
-- Don’t build out your staff or infrastructure in expectation of rapid growth; be strong enough and tolerant of market back-pressure or order/service backlog
-- Don’t keep the same sales and marketing execs if the business isn’t growing or charging for growth; no sales and marketing VP was ever fired prematurely
-- Don’t over delegate to consultants, accountants, or lawyers; even the great ones are only as good as you are as an engaged client; read and understand everything; if left alone, you must have a point of view, right or wrong
Click Here to Read More..

Are there alternatives to VC/Angel Financing?

In a recent blog post, I discussed some questions that an entrepreneur should ask himself to determine whether his company is more suited to venture capital financing or angel financing. However, in doing so, I did not mean to draw a false dichotomy between the two or to imply that these were the exclusive ways to capitalize successfully an emerging growth business.

In fact, in some sectors (such as medical devices and biotech) many early stage businesses have at least as good, if not better, luck obtaining financing from strategic investors (such as big pharma or the large medical device firms) than they do with financial investors (such as VCs or Angels). Moreover, the strategic investors can provide more than just financial resources. For example, they can provide distribution support, OEM or manufacturing services and perhaps they may be willing to partner up/joint venture with the entrepreneur to pursue a particular technology.

Another possibility for an entrepreneur is to forego third party financing entirely and fund growth internally (with possible friends and family support). This "bootstrap" approach, although not always possible, may well be the best financing approach of all for an entrepreneur, since he will retain the vast majority of the equity in the business.

A third possibility, is venture debt. These sort of debt is available from a group of lenders that focus on growth stage companies which likely could also obtain venture financing. By taking an equity kicker in addition to their loan (often in the form of a warrant), these lenders are able to "juice" their potential returns and take a relatively lower return on their investment than a VC fund would expect. For a broader description of the typical emerging growth company financing stages and their relative target returns, check out my blog post here.

A final financing possibility for an entrepreneur is straight debt. This could be A/R or inventory based financing or it could be a bank line secured by the entrepreneur's personal assets (sometimes through a guaranty). Or it could be an SBA backed loan. In addition, the start-up field is filled with companies that finance their early growth using their founder's credit cards. Either way, when available to an entrepreneur, debt can be a much less expensive form of financing than any type of equity. Plus, by using debt instead of equity the entrepreneur maintains control. Click Here to Read More..

Thursday, January 29, 2009

"We all need to stop banking and go fishing again."



A YouTube clip from bigthink featuring Michael Lewis of Liar's Poker fame (among other things). In the clip he answers the question "what do you tell the average American to avoid catastrophe in this crisis?".

A few notable quotes:

1) Don't think of turning a little into a lot in the market, think of not turning a lot into a little.
2) When you think of making money, think of what you do for a living -- not what you do in the financial markets.
3) Never feel stupid asking a simple question. Be withering in your investigation.
4) If it doesn't make sense, it probably doesn't make sense.
5) Complexity is not intelligence.

Some very good and thoughtful advice.

If you like Michael Lewis, don't miss his excellent article on the melt-down found on portfolio.com. Click Here to Read More..

Wednesday, January 28, 2009

Eight "Do's" For Entrepreneurs

I came across this short and to the point list of "Do's" for entrepreneurs -- it was compiled by Alexander Muse based on a presentation by Martin Plaehn, CEO of Bungee Labs. I agree heartily with its recommendations.

-- Do ensure for yourself (as founder or chief) that you are addressing a real market and a sustainable one; where the exchange of value is transacted and measured in US currency
-- Do only hire for pre-identified expertise, operating need, and the energy to accomplish excellence; if you get more, great; don’t hire otherwise
-- Do always know your cash level, weekly cash spend and receipt rates, cash-runs-out date, and close-up liabilities amounts; start finding funding choices when you hit t-minus 6 months till operating cash runs out
-- Do money deals with money people (e.g. Angels, VC’s, banks, and credit unions); do product deals with product people (eg. Commercial companies); and do risk deals with risk people (e.g. Insurance companies). Don’t get these confused. If a product company wants to invest in your company, can they afford to take the whole thing? If not, then not.
-- Do ensure that at least one of your early formal investors has the financial wherewithal to keep investing in subsequent increasing rounds many years down the road; do make sure your different investors are really compatible
-- Do always accumulate choice; two by definition, three of four is better; then make decisions and have a back-up
-- Do let the stress of overload and/or capacity strain the triggers for expansion; demand flexing the edges of the system is usually the truest sign of real growth
-- Do track revenue and cost per employee; have trigger thresholds for when to add staff or subtract. Human efficiency and innovation is what creates value
Click Here to Read More..

Cleantech Already Doing Well, Expects to Reap Federal Benefits

Recently, I have been working with an entrepreneur that is investing heavily in a bio-energy concept. He is a firm believer that, in light of the winds of political change, businesses in the cleantech sector -- e.g. bio-energy -- are likely to have a decent chance of success.

I find it hard to disagree with him. Cleantech has been on a bit of a roll the past few years. As I mentioned previously, clean-tech was one of the few venture capital sectors that saw an increase last year. Further, in my first post to this blog I speculated that the cleantech model favors the larger venture capital funds raised in recent years. Moreover, the federal stimulus package currently being worked on by President Obama and the U.S. Congress may well contain additional incentives for cleantech venture capitalists and entrepreneurs.

The New York Times recently broke down last year's venture capital investments into cleantech as follows:
Investors put $4.1 billion into 277 clean-tech start-ups in 2008, 52 percent more than they invested the year before. Seven of the top 10 biggest deals of the year were in this sector. Still, by the end of the year, venture capitalists’ newfound caution affected clean-tech companies, too. In the fourth quarter, investment fell 14 percent from the third quarter to $909 million.

Venture investors continue to favor solar energy and photovoltaic companies, which received $1.8 billion in 2008 — nearly half of the money that went to clean energy companies. The top three deals were Nanosolar, a solar-cell maker that raised $300 million; Solyndra, a photovoltaic solar company that raised $219 million; and SolarReserve, which builds utility-scale solar power plants and raised $140 million.

Start-ups that make energy from other sources, including ethanol and nuclear energy, were next, getting $561 million, or 14 percent of the total. Companies that recycle chemicals and solid materials brought in $304 million, or 7 percent. Battery start-ups received $224 million, or 5 percent. That will likely rise this year, as lithium-ion battery makers are receiving increased attention from investors and car companies.

In addition to these large private sector investments, current discussions between President Obama and the U.S. Congress contemplate that "about $60 billion will be applied toward promoting clean, efficient "energy independence" and creating jobs in the process." This is heartening news to venture capitalists and entrepreneurs in the cleantech industry, as the recent fall in oil prices has dampened somewhat the near term appeal of certain cleantech efforts.

While the government's initial stimulus discussions have focused on smart-grid components, solar panels, electric cars and green building materials, there is no reason to believe that the largess will not extend to other cleantech fields such as bio-fuels.
Click Here to Read More..

The Rule of Thirds -- Where will my Angel Funding Come From?

One of the most common questions I am asked by entrepreneurs is "where will my angel funding come from?". Brad Feld, a VC with the Foundry Group, recently proposed a Rule of Thirds that I think accurately captures the macro funding structure typical for an emerging growth company.

He states that:
A third of your financing will come from one investor, the second third will come from a set of people following that investor and the last third will be random.

The gist of this is that your initial investor is crucial. If you can find an angel that is whole-heartedly behind you, it should ultimately take care of the first two/thirds of your financing needs. The final third can come from anywhere. So the early stage entrepreneur should be fully focused on finding his initial angel. For some ideas on places an entrepreneur could look for angel support, see my early blog post on Choosing between VC and Angel Financing. Click Here to Read More..

Tuesday, January 27, 2009

Will President Obama Continue to Embrace Social Networking?

Whether or not you agree with President Obama's politics, you have to appreciate the savvy he and his campaign exhibited in their embrace of social networking and other web technology. His campaign's extensive use of YouTube, Facebook, Twitter and other Web 2.0 engines may have proved crucial in turning out key demographics in key geographies in the election.

Further, his embrace of "open" comments and digg style voting on his campaign website provided a forum and focal point for his supporters and gave them the impression that their voices were being heard.

However, it remains to be seen if this embrace of emerging technologies will carry forward into the oval office. On the one hand, President Obama has apparently fought hard and won the right to keep his blackberry for personal use. On the other hand, President Obama's new whitehouse blog does not have the comment or voting features that were featured so prominently on his campaign site. Perhaps social networking and its inherent freedoms was more of a campaign tool than a permanent feature of President Obama's administration? Only time will tell. Click Here to Read More..

Sunday, January 25, 2009

Seed Financing Up in 2008?

While I admit I may be making a silk purse out of a sow's ear, so to speak, I found two glimmers of hope in the NVCA's 2008 annual report (as covered by Stacey Higginbotham of GigaOm).

First, the aggregate amount of seed financings was actually up in 2008. This may reflect the shift away from the standard deal and VC fund size towards the small that I mentioned here and here. This also makes sense, since seed financings are almost always long term -- the current economic environment is really irrelevant. I do have to note, however, that seed financings fell off a cliff in Q4 08 -- pretty much just like everything else.

Second, not all sectors saw decreases in 2008. The media and entertainment sector and the cleantech sector both saw slight upticks in deal volume. Again, this foots with my earlier posts on the shift of VC funds and deal size to the large -- of which cleantech is representative. Click Here to Read More..

No Business Plan, No Revenue, No Problem

Twitter Raising New Cash At $250 Million Valuation

Posted using ShareThis

It looks like everyone's favorite social networking company has raised a big slug of capital -- estimated to be at least $20 million. Proof that the old Web 2.0 strategy of build your user-base first and figure out how to make money on it later, is not dead yet. Twitter famously has virtually no revenues and no real plan at this point on how to generate any. But hey, they have a huge and growing user-base and now they have a lot more money to spend on figuring out how to generate revenues.

One other quick note, the latest financing allegedly values Twitter at $250 million. While a huge amount of money, it is still substantially less than the $500 million Twitter turned down last year from Facebook (though, admittedly, that included mostly Facebook stock). Click Here to Read More..

Choosing between VC and Angel Funding

In a recent article in Entrepreneur Magazine, Brad Feld laid out some very helpful advice on how to determine if you are ready to raise venture capital. His points amplify the concepts I laid out in my earlier blog entry explaining the general funding stages an early stage company can go through in its life-cycle.
The main questions Brad recommends you ask yourself are very good ones and are as follows:
The amount of money you're raising in this round: If you're raising less than $1 million, you're likely wasting your time targeting venture capitalists, with two exceptions: 1) you specifically target funds that do seed rounds, or 2) you have a preexisting relationship with a VC firm and want to put together a seed round to get going quickly.

The total amount of money you're looking to raise over the life of your company: If you think you can get your company to a point where it's cash-flow positive on less than $3 million, stick with angels.

The type of company you're building: Venture capitalists love to fund businesses with the potential to be enormous. Angels love this, too, but they're much more willing to fund smaller companies that will presumably require less capital. In addition, most venture capitalists want to fund businesses that have clearly defined economies of scale (such as software companies) vs. ones that scale linearly with some factor (such as service companies).

Your experience: Successful serial entrepreneurs always find it easier to raise money from venture capitalists. If you're a first-time entrepreneur, that doesn't mean you can't raise VC money, but you're going to find it more difficult than an experienced entrepreneur will.

So, what do you do if you find yourself on the angel side of the foregoing questions and yet do not personally know any wealthy financiers? There are several good resources out there you should consider.

First, even if you do not have connections with potential angel investors, it is likely that your professional advisors do. While even the best lawyer cannot make an angel invest in your business, he should at least be able to get your business plan in front of a few of them. Further, by asking your advisor to help you with this, you may receive very good constructive criticism on your business plan that your advisor may otherwise have kept to himself. No professional wants to forward on a business plan that he does not feel good about.

Second, consider whether your local government or university has established an incubator program. For example, in Richmond we have a biotechnology incubator that is co-sponsored by VCU, private companies and state and local government. Typically, these sorts of incubator programs provide extensive support and resources to emerging growth companies. Moreover, they often have formal or informal angel networks that keep tabs on the companies in incubation. Some incubators even offer seed funding as part of the package when you are accepted.

Third, look into whether there are any regional angel networks at which you can present your business plan. These are usually clubs of angel investors that meet monthly or so to hear entrepreneurs present their business plan for potential investment. Oftentimes, in addition to angel investors and VCs interested in seed round financings, these types of organizations include lawyers, accountants and other professionals in their membership. This increases the network of people who are exposed to your business plan, as these professionals often know other investors that might be interested in your sector. In central Virginia, the largest club of this sorts is the Venture Forum, but there are several other informal networks too.

However, the best advice of all is to only raise the money you need and to not raise money until you need it. If you can bootstrap your company to profitability, you will be in a much better place than if you have to bring in outside investors and ultimately lose control of it.
Click Here to Read More..

Saturday, January 24, 2009

Epic Fail

I found this website a few months back and keep it cued up at the office for when my colleagues have an epic fail. I'm sure they appreciate it ...

For the technologically savvy among you, it also can be turned into a widget on your website, Google desktop or Mac dashboard. Click Here to Read More..

More Gloom and Doom on Venture Capital

In my first post on this blog, I speculated that although the popular press has a gloom and doom perspective on venture capital fundraising, in practice, there are plenty of factors that give me hope for a strong year.

Interestingly, it appears that the John S. Taylor, Vice President of Research at National Venture Capital Association, agrees in part with my thinking. In an interview he did with Venture Capital Experts on 1/21/2009, he echoed and amplified many of my sentiments.

Q: The NVCA released data in October 2008 that indicated institutions that invest in venture funds put less money into fewer funds in the third quarter of 2008. In fact, 55 venture capital funds raised $8.1 billion down from 83 funds that raised $8.6 billion in the same period the prior year. What do you believe the factors are that are contributing to this decline, and do you see the trend continuing?

A: There are conflicting dynamics happening here. Investment trends would suggest larger funds going forward. For example, international deals and investments in clean technology, medical devices, and biotech call for larger deal amounts and therefore more capital to launch the companies. On the other hand, there is a stronger downward force. The institutional investors who invest in alternative assets in general are tapped out. Venture is regarded as a good place to invest for those LPs which can, however, many cannot. For example, say that you are an endowment manager and you target 10% for alternative asset investment with 4% of the total going to venture capital. Assume you invest and attain this balance. Then the public markets which drive the other 90% fall in value by 40%. The portfolio is now over-allocated to venture capital. Because of this denominator effect, many LPs simply cannot commit to any such funds at this time. Compounding this effect is decreased liquidity in institutional portfolios having to cover the capital calls already committed to over the next several years.

If new capital were more plentiful would VC firms take it in? That's not clear. The industry has already shown great restraint post-bubble. Existing funds last longer. Capital efficiency is the name of the game. These days $10 million buys you more "runway" than it did a year ago. It buys much more than it did during the frenzied period of the bubble.

Just because there is less money going into venture capital funds, does not mean that there is not plenty of money out there -- many funds are sitting on large amounts of dry capital. Further, the trend is toward a greater number of smaller funds and a few very large funds, with not the large number of medium sized and large funds that have been common recently. This may mean that the absolute dollars raised is decreasing, but it does not mean that there are not deals being done. Click Here to Read More..

Get Lost on Boxee!

A few days ago, Avner Ronen, Boxee's CEO, announced on his blog that a new version of Boxee is available for download.

What is really cool about this new version is that it enables Mac users to directly stream ABC content to their television. While I am sure the majority of you said -- sweet, Desperate Housewives on demand! I am actually more excited for Lost episodes on demand and in high definition. As soon as a particular episode is available on ABC.com, it is available on Boxee. Earlier today I watched the season premier from earlier this week and also Season 1, Episode 1. Still gives me chills. (Apparently, Boxee was scrambling all last week to get the update out in time for the season premier .)

At this time, the ABC content is only available on Mac, but it sounds like the Boxee guys want to roll it out for the PC alpha version soon.

As a refresher -- Boxee is a free download that allows you to watch online content and content saved to your computer directly on your TV through an interface that is controlled by your remote control. You just plug your computer into your TV and roll. Click Here to Read More..

Friday, January 23, 2009

A Day to Remember



From the wsj. Click Here to Read More..

The Flora and Fauna of Venture Capital

I have found that many entrepreneurs are confused by the differences between the various flavors of angel and venture capital. This is not surprising since the categories used are overlapping and are often used inconsistently by different investors. However, there are some broad generalizations that can be drawn – typically based on the timing of the proposed investment and the typical purpose of the investment in the company’s lifecycle. Depending on the timing, you can also draw some basic conclusions as to the type of investor that will be involved and, in each category, generalizations can be made as to the type of security the company will sell and the magnitude of return the investor will seek.

The earliest stages of investment are usually characterized as seed rounds, proof of concept investments or angel investments. These investments usually do not occur until after the investor has tapped out his friends and family (in what is often characterized as the “friends and family” round). The money invested is intended to allow the founders of the company to do their initial research, to complete the initial programming or to apply for the initial patent(s). Companies at this stage usually do not have a saleable product and do not have very many employees, other than the founders/inventors. The investors are almost always NOT traditional venture capital funds. Rather, they consist of wealthy individuals or groups of individuals that are willing to invest their own money and take the extreme risk involved in making equity investments into companies that often only have a good idea. Alternatively, the investor may be a government or university funded incubator that was established to help entrepreneurs or scientists get their ideas off of the ground. In this stage, the amount of the investment is typically relatively small – e.g. $100,000 to $500,000, seldom more than $1,000,000 in total. Also, the investor usually takes common stock in the company – the same stock that the founders get. Alternatively, the investor will take a convertible note that allows them to have the protection of debt at the beginning and also allows them to convert at the valuation established by later investors. Investments at this stage are extremely risky and are subject to significant dilution when new investors come in during later stages. Consequently, angel investors look for returns of at least 10x their initial investment, and sometimes as high as 20x or 30x their initial investment.

The next stage of investment in a typical company’s life cycle is early stage venture capital. This type of investment usually is not available to a company until it has a proven product and a business plan. However, it is not necessary that a company be profitable or even be producing its product. The funds the company raises will be used to mass manufacture the product, market the product, build a sales force and further develop the product. For this investment, the company will be able to attract early stage venture capitalists. These venture capitalists often have smaller funds which are more suited to making the relatively smaller sized investments found at this stage of a company’s life. In this stage, the amount invested is typically in the $1,000,000 to $5,000,000 range. The early stage venture capitalist will almost always be investing in Series A preferred stock of the Company. This security will be superior to the common stock held by the founders and any angels and will typically come with dividend rights, liquidation preferences, some form of anti-dilution rights and a right of first refusal on stock sales by the founders and angels. Sometimes it may also come with pre-emptive rights, redemption rights and drag along rights and other rights and preferences. The venture capitalists at this stage will look for returns of at least 5x their initial investment and would gladly accept higher returns.

There may be multiple additional rounds of equity financing after the Series A round. These types of funding are often called growth capital or mezzanine financing. Usually, the company will either be close to profitability or will have a clear path to profitability and the funds are meant to allow the company to expand its sales force and marketing efforts and ramp up its revenue growth. The money may also be used to develop additional products or to research expansion ideas. These investments are usually made by the larger size venture capital funds and the amount invested can range from $1,000,000 to $25,000,000 or higher – depending on the company and the market opportunity. The investment will typically be made for additional rounds of preferred stock – for example, Series B or Series C preferred stock – and each successive round will generally having superior rights and preferences to the prior rounds. Venture capitalists at this stage of investment may still look for 5x investment returns, but depending on the opportunity and the trajectory of the company, will often settle for 2x or 3x returns.

Occasionally, a company in the growth phase of its life cycle, or that is on the cusp of the growth phase, will raise bridge capital. This is typically debt that “bridges” the gap in funding between rounds of venture capital financing. Usually, it takes the form of a convertible note that will automatically convert into the next round of preferred stock, sometimes at a discount. The lender may be an existing investor in the company or it may be a new venture capital fund that is contemplating making the follow on round.

Another type of financing that is available to companies in their growth phase is venture debt. This is a loan from a bank that is often securitized by the company’s accounts receivable, inventory or equipment. The venture lender will take warrants in the company to help increase its return on the loan. Typically, these lenders seek combined returns in the 12 to 18% range.

The final type of financing that a company may seek can be characterized as acquisition or buyout capital. This type of capital is used to purchase the assets or stock of other businesses that will then be adsorbed into or added onto the company. The investor may be the company’s existing venture capitalists or it may be a private equity fund that is building out a platform in the company’s industry. In the later case, the investment may come with a right to purchase the company outright in the future. This type of financing also occurs when a company’s venture capitalists start planning their exit strategy. By putting together the right pieces it may make the company more attractive as an acquisition candidate or perhaps more eligible for an IPO.
Click Here to Read More..

Wednesday, January 21, 2009

Please Consider Bathing, K THX BYE

The second of two lighter posts in honor of our new president.

Ever have a friend or workmate that just did not bath as often as is socially acceptable? Or who from time to time wears too much make-up? Or what about the neighbor with the dog that barks at all hours? Have you wished you could send them an anonymous email politely pointing out the shortcoming without being mean?

Well, this website has a service that you may want to look into. It allows you to send any of approximately 400 pre-set messages anonymously to the email address of anyone you know. The pre-set messages range from the very important, to the useful, to the mundane. And all are presented in very polite fashion. Connie Loizos at the peHUB has a short interview with the site's founder here.

A few examples:

- Washing your hands after using the restroom is a wonderful way to not spread germs.
- A breath mint would be beneficial today.
- There's a significant stain on your tie.
- You may not realize it, but you tend to touch the monitor screen when you are pointing at something and it leaves a smudge.
- Stories about your kids are not as interesting as they used to be.
- You may want to consider taking down your holiday decorations.

Here is one that I hope I don't receive:

- Your use of the Internet seems to be affecting your workload. Click Here to Read More..

What to get the person who has everything

The first of two lighter posts, in honor of our new president.

Do you have a friend or family member that seems to have every mechanical or electronic gadget that there is? Finding that person just the right gift is always a struggle. Up until now.

Consider buying them an iPod mount for their sniper rifle. I'm just saying... Click Here to Read More..

Private Equity and VC Funds Should Review Their Indemnification Agreements

Private equity and VC firms usually appoint representatives to serve on the board of directors of their portfolio companies. These directors provide strategic guidance and expertise. Typically, they would receive two layers of protection from personal liability for their services to the company by signing indemnification agreements with both the company and the PE/VC fund.

While indemnification agreements protect the director against personal liability, they do not usually specify the priority of the director’s indemnification rights. That is, the agreements do not specify whether the company or the PE/VC fund should be tapped first for indemnification. Many PE/VC funds assume that the indemnification they are providing is second in line to that provided by the company. However, in the recent case of Levy v. HLI Operating Company, the court allowed a board member to seek indemnification from the private equity fund without first seeking it from the company. The court suggested that the private equity fund pursue a contribution action against the company.

Although the Levy case was in the Delaware state courts and involved a Delaware corporation, the underlying legal concepts may well apply with equal force to contracts and cases under the laws of other states.

This decision highlights the importance of carefully managing multiple indemnification agreements. When creating layers of indemnification protection, it is important to designate who will be the primary source of payment for directors’ out-of-pocket expenses. It could be either the company or the PE/VC fund, depending on the circumstances. For example, when a PE fund wholly owns its portfolio company, it may be irrelevant which entity provides the first indemnification. On the other hand, a VC fund would be very concerned about this issue since it typically only holds a minority position in a company. By designating the desired result ahead of time, no one will receive a nasty and costly shock if it does not come out the way they had assumed. Click Here to Read More..

Tuesday, January 20, 2009

A Possible Revolution in Music Downloads

On Monday, the New York Times featured an article describing what could very well represent a paradigm shift in the music industry -- unlimited legal "free" downloads. Really the holy grail for a music fan.

Historically, the music industry has been violently opposed to any sort of unlimited free downloads of music -- and consequently, these sources have been made illegal. This is most evident in the suppression of peer to peer file sharing sites such as the original Napster, Gnutella, BitTorrent and the like.

In response, other business models have arisen. From the buy one song at a time model of iTunes and Amazon. To the subscription based download model of the new Napster and Rhapsody. To the streaming net-radio concepts of Pandora, Last.FM and iLike. Unfortunately, none of these models has managed to stem the steady deterioration in the music industry. The most successful, iTunes, has apparently reached a plateau in sales. The least successful -- the subscription based models -- have not been able to gain traction because of a perceived prohibitive cost. And the streaming net-radio concepts do not even allow you to listen to the songs you want, when you want to listen to them.

The new business model, which is being introduced in very limited foreign markets, has some third party hardware provider paying the subscription price for the unlimited download model. That is, your cell phone handset manufacturer or your cable provider would pay the cost for you to have unlimited downloads from entire music catalogues, on demand and at no additional cost. Likely they would pass some or all of these costs on to the end user, but it would be blended in with the monthly rate. Further, competitive pressures should make it difficult for these hardware providers to exact the entire cost (or even most of it) in additional fees. In competitive markets, this would be a loss leader for other more lucrative product offerings.

The end result to the consumer is that when you buy your new Sprint phone, for example, it would come pre-loaded with software allowing you unlimited downloads. (Perhaps limited only by the memory capacity of the phone.) It is unclear if the song DRM would permit you to play and store the music on your desktop or laptop computer, but it would certainly cover you for your on the go listening needs.

The only thing missing from the article is a discussion of when and where this will happen. However, it is probably safe to guess that it will be rolled out in smaller foreign markets long before we get a sniff of it here in the United States. But, nonetheless, it is an enticing dream.
Click Here to Read More..

Monday, January 19, 2009

Can VCs Get Early Liquidity by Selling?

In a recent post by Dan Primack on peHUB, Dan proposes a new "third leg" exit strategy for venture capital funds. In addition to 1) IPOs and 2) M&A, Dan proposes that VC funds directly sell their equity position in a company to another later stage venture fund. For example, an early stage VC fund could make an initial investment in a company and grow the company for 2 or 3 years, then sell its position to a growth stage VC fund for a multiple of the first fund's initial investment. This type of exit strategy will not generate the spectacular returns that VC funds hope for from IPOs, but it could potentially generate consistent smaller successes. Swinging for singles rather than the fences, so to speak. Also, with the IPO market effectively shut and with middle market M&A a basket-case, any sort of liquidity could be good liquidity for some VCs.

While Dan -- and the commentators to his post -- examine the business factors that may influence a VC fund's decision to take this sort of exit, what they do not touch on are the potential legal obstacles to this sort of exit. More on this after the break.


In addition to the business obstacles noted in the original post, there may also be legal obstacles to a VC fund selling a minority position to another fund. Not only would the transferee have to comply with federal and state securities laws, but also there are typically contractual rights in the VC setting that could hamper any transfers.

The federal and state securities laws dealing with this sort of transfer are complex and cannot be summarized here. However, the basic issue is whether the first VC fund that wants to make the sale will be treated as an "underwriter" under securities laws. Any transferring VC will want to be very careful that they have held the securities for a long enough period of time and that when they made the original purchase they did not make that purchase with a view to further distribution. The VC and its lawyers will have to carefully consider whether the VC always intended to transfer the shares to another VC -- which could make the original VC seem like they are acting as an underwriter.

In addition to these securities law issues, there are also potentially contractual limitations on a VC fund exiting its investment. Unlike a PE portfolio company where the PE fund is the owner of the whole company and basically can do what it wants, in the VC context the fund usually holds a minority position. These shares are typically subject to various contractual restrictions on transfer such as First Refusal Rights and Tag Along Rights. Also, there are potentially Drag Along and other forced sale rights involved. A quick glance at the VC industry's sample forms at the NVCA website shows that these sort of provisions are common.

The company's other institutional shareholders and founders may not take kindly to one VC exiting without providing pro rata liquidity. By refusing to waive their contractual rights and allowing the VC to exit without a Tag Along or Right of First Refusal, the founders and other investors could scuttle the VC's potential deal. That is, the prospective purchaser of the minority position may not want to honor these contractual rights and buy different types of equity or a smaller share in the company. Also, depending on how the board seats are apportioned, the transferred shares could be entitled to a board seat which could create an uncomfortable situation on the company board if the transfer is not friendly.

A VC with foresight and pre-planning could easily negotiate for the flexibility to do an early exit. However, the vast majority of VC investments as they are currently structured would not work for an easy exit unless the other investors and founders approved of it.
Click Here to Read More..

Sunday, January 18, 2009

Should you try Boxee?

Boxee is a multi-media tool that allows you to connect your Mac to an HDTV and navigate the web and also the video and music content on your Mac seamlessly on your TV. I had the good fortune to be an alpha tester of Boxee and, as noted in the NY Times on Saturday, Boxee is now in open beta testing for anyone with a Mac (sorry PCs are still in closed alpha). So anyone (with a Mac) that wants to can try it out.


People in the telecom industry speak of the "last mile" problem. The phone companies have super fast fiber-optic cable running down the main streets of every town, but there is only copper wire connecting most homes to these lines. Consequently, the end-user has a slow connection to the very fast pipeline. If the phone companies could just lay the "last mile" between the main roads and the actual homes of their users with fiber optic lines, then everyone could have super high speed internet and television connections for relatively cheap prices.

There is a similar "last mile" problem between most people's computers and their televisions. On your computer, you have your home videos, maybe some ripped movies and all of your music. If you have a decent internet connection, you can view high definition videos on your computer streamed from Youtube, Hulu, CBS.com or whatever, and now you have connectivity to streamed movies through Netflix. Chances are, you also have a TV in your home, maybe even a HDTV, with a nice big screen. And it is probably in a comfy room with a couch. Wouldn't it be great if you could cross the "last mile" between your computer and your HDTV and watch all the video and audio content stored on your computer on your TV. Also, wouldn't it be great if you could stream Youtube or Hulu on your HDTV? That is what Boxee does.

If you connect your Mac to an input on your HDTV, Boxee will let you take over the media contained on, or available over the internet to, your Mac and control it so that it broadcasts on your HDTV. It has a simple to use and intuitive interface. Most important, it is controlled with the little white remote thing that comes with every Mac. You can easily select any movie on your Mac's hard drive and play it directly on your TV. You can also easily access the latest Britney Spears video on Hulu and stream it to your TV.

Even better, Boxee has a social networking/Web 2.0 overlay that allows you to see what your "friends" are watching and also quickly access those media elements. For example, if you friend is streaming a hilarious SNL digital short, this is displayed on your launch pad and you can select it to watch as well. This is especially cool if your friend has his or her media files in a "shared" file on his or her Mac, because you can actually watch a movie that your friend has stored on his or her hard drive. Of course, you can control which of your viewing habits is broadcast to the world. You might not want everyone to know you are watching the Little House on the Prairie boxed set.

One of the few drawbacks in the Alpha phase was somewhat glitchy access to iTunes and the content you've downloaded from the Apple store. Perhaps it is the DRM, but I had trouble getting movies in my iTunes to play correctly. However, I did not have these problems with MP4 files (which are DRM free).

All in all, this is the best solution I have seen for getting your media played on and streamed to your HDTV. If you have a Mac, I would recommend you try it out. You can download it here link.
Click Here to Read More..

Friday, January 16, 2009

Private Equity to Make a Comeback in 2009?

An article in yesterday's Wall Street Journal notes the TRILLION dollars of dry capital that PE funds have under commitment.

Putting aside any issue as to whether the LPs will honor their commitments in this economic environment, this is a huge amount of capital sitting on the sidelines. You have to think that with equity (and debt) prices as depressed as they are, there are large nubers of appetizing targets out there. Heck, there are plenty of public companies that have an equity value that is less than their cash on hand. If you could get a bridge loan (no small task) you could basically buy these companies with their own cash.

However, there is also the reality that the high yield debt markets will simply not be there to support $1B plus buyouts which means the middle market is where the focus will be.

The PE guys that I talk to (the ones that aren't having other problems) agree with this sentiment, but feel that there is a disconnect between the valuation that the target's management thinks they are worth and the valuation the current equity markets would impute. The former may be at 9x EBITDA while the later may only be at 6x. However, there will be pressure on this gap fom both sides, the PEs need to start deploying funds and targets at some point will need liquidity events.

The long and the short of this is that middle market PE backed M&A could really go on a tear in the second half of 2009. Click Here to Read More..

Wednesday, January 14, 2009

Restricted Stock: a Superior Alternative to Stock Options?

A colleague (thanks Seth) recently asked whether we should recommend a restricted stock program to our start-up company client instead of an option plan. His question was a good one and bears some consideration.

Technology and other early stage companies frequently use stock options to compensate their officers, directors and other key personnel. Options are popular because they do not require free cash to issue, they are easily granted and they align the interests of the exec with a Company’s long-term success. However, in light of the recent period of depressed equity prices, many option grants are ‘underwater.’ Further, the violent gyrations in equity and debt markets make it difficult to fix baseline valuations for new option grants.


Restricted stock is actual stock (as opposed to an option, which is just a right to acquire shares of stock in the future), so it gives an executive ‘skin in the game’ and aligns the exec’s interests with his or her company. Further, shares of restricted stock are never “underwater” because the shares are fully issued at the time of grant.

Shares of restricted stock are almost always subject to vesting provisions of some sort, which encourages the exec to remain with the company and work to maximize the company’s value. For example, the vesting could be tied to the passage of time, the achievement of certain milestones, or both. A simple outline of a time-based vesting scheme could be:

• the company grants shares of restricted stock to the exec and, simultaneously, they enter into a separate agreement, which contains the vesting provisions;

• the agreement gives the company the right to repurchase the shares of restricted stock from the exec at par value (or some other insignificant price); and

• the company’s repurchase right sunsets over time (i.e. the company's repurchase right expires with respect to 25% of the shares each year, over four years).

Of course, before an early stage company issues restricted stock as equity compensation, it should consider the tax consequences. With restricted stock grants, the exec is eligible to file an “83(b) Election” under Section 83 of the Internal Revenue Code and thus obtain capital gains treatment for appreciation in the value of restricted stock. However, if this election is made, the exec must include the fair market value of the restricted stock in his or her income for that taxable year. This could be a problem if the exec does not have available cash for this additional tax burden. The company’s tax consequences will mirror those of the exec and thus largely depend on whether the exec decides to file an 83(b) Election. (Note that, as always, I urge anyone to get proper tax advice before issuing any sort of equity.)

In sum, it may make sense for an early stage company to consider issuing shares of restricted stock instead of stock options.
Click Here to Read More..

Tuesday, January 13, 2009

Stealth Mode Resurrected?

Often, when a start-up company is in an emerging growth field, it will spend as long as possible in “stealth mode.” That is, the company will purposefully avoid disclosure of its existence, purpose, products, personnel, funding, brand name or other attributes so that it can avoid alerting potential competitors to what it is up to. This is especially the case in industries where products are not easily patentable and trade secrets or programming execution are the primary way to gain a competitive advantage. A head start may make the difference between success and failure. The greater the head start, the better jump the start-up will have on its competition. It can wait to enter the market with a splash and a fully developed product.

As has been noted before Link, raising capital while in stealth mode can be tricky. All offerings of securities must be either registered with the SEC (i.e a public offering) or exempt from registration with the SEC. The easiest way to ensure that your private offering is exempt from registration is to comply with the SEC’s safe harbor under Reg. D. Unfortunately for stealth mode companies, a central component of the Reg. D safe harbor is the requirement that a company file with the SEC a Form D. These Form Ds were required to contain (among other things) the amount raised, the identity of any person controlling 10% or more of the company’s stock, a description of the company’s business and a relatively detailed ‘use of proceeds’ analysis. Typically, any VC investment would exceed the 10% threshold, thus requiring disclosure of the names and addresses of a company’s VC investors.

Below I will discuss some changes at the SEC that may make stealth mode easier to maintain.



The reason a Form D filing often jeopardized a company’s stealth mode is that the SEC makes Form Ds available to the public in a central data room. (Unlike most items filed with the SEC, these forms were not posted online.) Any enterprising news service could regularly monitor the paper filings in these data rooms and thus would be able to “out” the stealth company.

While it is possible to complete a private placement without relying on Form D and thus maintaining secrecy, the benefit of having a very solid safe harbor often prevails over consideration of maintaining stealth mode – this is especially true for companies contemplating an IPO, as IPO diligence typically requires a very in-depth review of the company’s past securities offerings.

However, the dynamics of this quandary have been altered. The SEC has amended the Form D rules so that these Form D filings are available to anyone online. A company has been able to opt for its Form D to be available online on a voluntary basis since September 15, 2008. After March 16, 2009, all Form Ds will be available online. For more info on the mechanics of filing your Form D online, see my release on this subject here.

While at first it would seem that stealth mode will now be even harder to maintain if a company needs to rely on the Reg. D safe harbor, there is more to the story. When the SEC mandated electronic filing, it also amended the requirements of Form D. A company is no longer required to describe its business – instead it can refer to its very general “industry group.” A few examples are “Computers,” “Telecommunications,” and “Other Technology.” Also, a company is no longer required to disclose the names and addresses of shareholders controlling greater than 10% of its stock. Thus, the names of the VC funds backing a stealth company can be kept out of the newsfeeds. In addition, the Company is no longer required to give a ‘use of proceeds’ analysis. Finally, depending on a company’s circumstances, if the total amount of the offer is not set at the time the offer is made and if no sales have closed, it may be possible to not disclose the total amount of funds to be raised.

The net result of all this is that, although a company in stealth mode would have to disclose publicly the fact that it is trying to raise money, it may be possible to avoid disclosing virtually all other interesting information. The SEC has made it so that less information will be more widely available. A company in stealth mode that carefully plans its offering timing and terms could for the most part avoid losing its mantle of secrecy. Further, through use of a temporary ‘dummy’ name, the company could even make the fact that it is raising money have no real significance to its competitors.

Reports of the demise of stealth mode are greatly exaggerated!
Click Here to Read More..

Friday, January 9, 2009

Macbook Wheel Debuts on the Onion


Apple Introduces Revolutionary New Laptop With No Keyboard

The Onion posted this excellent newscast earlier this week -- I don't know what I find funnier, the clip itself or the fact that apparently thousands of people on the internet thought it was an actual product and got excited about it. It is well produced and bears repeat watchings -- note in particular the list of suggested sentences generated by the "predictive sentence technology" and the news crawl across the bottom of the screen.

Some highlights for me:

"At Apple our policy is to make products that are simple to use -- and nothing is more simple than a simple giant button."

"Everything is just a few 100 clicks away."

"It remains to be seen if the wheel will catch on in the business world where people use computers for actual work and not just dicking around."

And the quote "Jobs: People who use keyboards 'standing in way of human progress'."

Enjoy! Click Here to Read More..

Wednesday, January 7, 2009

Understanding Derivatives

If you are like me, the financial crisis that brought the world to its knees in October was somewhat mystifying.  I understand the basics of how to securitize a loan, but did not really understand how all of this could bring down the titans of wall street and bankrupt whole nations (Iceland comes to mind).

A couple of weeks ago I finished reading a great book named "FIASCO" by Frank Partnoy.  It was published in 1997 and is an autobiography of a derivatives trader on Wall Street during the mid 1990s.  The book is full of the usual wall street trader bravado and anecdotes -- but it also provides a very clear and easy to understand description of securitizations, derivatives and how it all works.  It was the first time I had someone explain to me exactly what a CDO (collateralized debt obligation) or CDS (credit default swap) was (among other things) and how all of these types of instruments work.  

More importantly, the author provides a very critical review of the securitization process and the house of cards that he helped build.  He pointed out (back in 1997!) that the entire rating agency process was flawed and that ratings were being bought by the investment banks.  That is, the investment banks were gaming the system by taking junk B and C rated debt and adding a thin layer of Aaa rated debt on top -- and the rating agencies (Moody's; Standard and Poors) would give the resulting derivative a Aaa rating.  This meant that it could be sold to a wider range of customers because most pension funds and insurance companies are forbidden from buying debt that is less than investment grade.  An entire market was created and it grew into the trillions of dollars.  

The rating agencies went along with the scheme because the investment banks were the ones paying their fees.  Sort of as if you were in a high school class of one and were also the person directly paying the teacher's salary.  Correct me if I am wrong, but that teacher might be incentivized to give you a good grade.

Anyway, the author predicted that the whole thing was in imminent danger of collapsing on top of itself.  He noted the Orange County bankruptcy (caused by derivative losses) as the first sign that the financial system was about to collapse.  Unfortunately, he was about 10 years too early in his predictions -- and no one paid attention to him anyway.  However, it is still a very enlightening read and I highly recommend it to anyone that wants to understand the situation we find ourselves in.  Also, it is a relatively fast moving and painless 280 pages, so you can bang it out without too much grief.  


Click Here to Read More..

Tuesday, January 6, 2009

Blue Ray Already a Failure?

http://www.nytimes.com/2009/01/05/technology/05bluray.html?_r=1&th&emc=th

The New York Times today ran a piece with the premise that Blue Ray (BR) is only a bridge technology with the endgame being HD content delivered over the internet directly to your HDTV.

Initially, was not sure how to react to this. I have a BR player and love it. The picture quality is amazing and it even makes old DVDs look better. However, I am a generally an early adopter and I also am getting HD content from Netflix online (I am using my HDTV as a second monitor for my iMac) and I also get HD on demand through Verizon's fios service (a fiber optic replacement for cable tv). As the library of releases available for HD streaming increases (especially the library of new releases) I question whether I will be motivated to plunk down the $20 for a BR disk. BR may end up like music cds -- they will try to sell me on extra gizmos and content which I don't really want. The result being that I haven't seriously invested in music cds (as opposed to iTunes) in over 5 years.

On the other hand, the penetration of broadband into US households is finite. It is often not even available. Or when available it exceeds the household budget. (I recently saw a NetZero add hitting this exact point -- the gist of it was, why spend so much on broadband when it takes you to the same internet as dial up.)

This would seem to create an opportunity for BR -- however, it may only be an illusory one. This is because the average household still does not have an HDTV that would benefit from the additional clarity found on a BR disk. These households are perfectly well served by the DVD format. Thus, you have an interesting ven diagram -- the future of BR would seem to lie with people who do not (or are unable to) have broadband in the home, but who do have an HDTV. In these recessionary times, this might be limited to the rural markets.

Perhaps BR does not have as bright a future after all. But at least for the time being I get to see some movies in incredible clarity. Click Here to Read More..

Monday, January 5, 2009

Gloom and Doom for VC

Another gloom and doom article today in the Financial Times about the VC industry in 2009. However, I don't think it is as clear cut as the popular press would like it to be.

What I am seeing is a trend towards the two ends of the spectrum, early stage and later stage. The first is characterized by micro investors using the techstars/Y Combinator model, the second is characterized by the heavy infrastructure investments required by the cleantech buildout or bio/pharma. Both (if done right) are less dependent on near- or mid-term liquidity events. The first favors a fluid and nimble investor -- with a smaller pool of available capital. The second favors the massive pools of capital that were amased in 2006 and 2007.

Either way, with the right mindset there is no need for a shake out. The vulnerable investors will be the ones either with an out-dated vision/model or without any clear vision at all. Click Here to Read More..
 
Creative Commons License
Dividends and Preferences by Hank Heyming is licensed under a Creative Commons Attribution 3.0 United States License.