Five Years Too Late

October 3, 2009

Thoughts on Jury Selection

Filed under: Uncategorized, venture capital — fiveyearstoolate @ 9:43 am
Eric Wiesen

Eric Wiesen

I spent the last two days at “jury duty”, meaning I was part of the pool of potential jurors used to select juries for civil cases in New York state court. While it did nothing to improve my estimation of our civil justice system, it did foment a few thoughts along the way.

First off, as an attorney you’d have to be basically insane to pick me as a juror. As most of the readers of this blog know, I used to be a lawyer, but that by itself isn’t sufficient these days to ensure that you aren’t selected to serve on a jury. In fact, many of my friends from law school and practice have served as jurors, and some even enjoyed it. No, what most of you probably don’t know is that for two years in college, prior to starting my first company, I worked at a trial consulting firm whose business was figuring out how to game juries.That (of course) isn’t how they market themselves – I think their language is “formulating, testing, refining, and implementing effective trial strategies and themes”. But the business is picking winning juries for their clients and figuring out how to present to those juries in a way likely to win them over.

It bears mentioning that I told the attorneys all of this as soon as they began to question me. Part of the reason I loathe going to jury service is the knowledge that no sane attorney would want a guy like me in the deliberations. Juries have a tendency to play “follow the leader” and you put a person with my background in there, it’s inevitable (even if it’s not necessarily sensible) that other jurors would look to the “expert” for guidance on how to interpret the law (never mind that juries are primarily fact finders, most jurors don’t understand the distinction). These attorneys, however, didn’t seem to understand this.

And that’s ultimately what I found a little bit interesting as I went through this process. Once you get past the waiting around phase of jury duty and are put in the pool for a particular case, most of your time consists of listening to the attorneys conduct void dire, the questioning of potential jurors. Some of this will be you answering questions, but mathematically the larges majority will be you listening. So I listened to these attorneys (who were exactly the type of lawyers you’d expect to see trying a personal injury case at the state trial court level) try to pick a jury by asking questions, I started to think about how picking a jury is somewhat analogous to assembling a venture portfolio (cut me some slack, I was bored and the defense attorney gave me very dirty looks every time I tried to sneak my Kindle up onto my note pad).

As early stage investors, no matter how much diligence we do, we only know a little bit about a company in which we invest. Hopefully we know we’re backing a great founder and team, solving a real problem in a big market and with an innovative product. But at the early stages of any of these businesses there are far more unknowns than knowns. That’s why we’re in the risk capital business. We do our best to understand the capabilities and attitude of entrepreneurs, to develop a thesis around the market in which they’ll play and the likely fit of their product(s) to that market. But it’s certainly art as well as science.

Picking a jury isn’t so different. As we try to assemble a portfolio that will, in aggregate, produce returns, trial attorneys try to pick 6 or 12 jurors (depending on the trial format) who will, in aggregate, produce a favorable judgment for their client. They get a few hours to question the randomly-selected potential jurors and then they have to make their choices and live with the results.

As I wrote about last month, asking great questions is a big part of being a great early-stage investor, particularly on the deal selection piece of early stage investing. Similarly, trial attorneys will live and die by the questions they ask. In fact, much of the work we did when I was a trial consultant was coaching and construction of questions to best help attorneys understand how to elicit likely trial bias one way or the other. And I assure you, simple common sense/stereotyping is NOT a reliable way to do this. The nice old lady in the corner can be the staunchest defense juror you ever saw and the guy in the suit can be the plaintiff’s best friend. You just don’t know unless you ask questions that tease their biases out of them, quickly, an without them knowing.

Which brings me to the questions asked by the attorneys in this case, who had clearly never had the benefit of working with my old firm or another like it. The plaintiff’s attorney asked every single juror, “Do you think people have a right to sue?” and “Are you comfortable awarding large money damages?” and “Are you biased against plaintiffs? Am I starting out at a disadvantage with you?”

These are the wrong questions. This (presumably inexperienced) attorney was asking for output, but jurors almost never know their own biases and can’t accurately provide that output. It would be like if we asked potential portfolio companies, “Are you going to have a lot of customers? Will they pay you a lot? Will your business be defensible via expanding network effects or other barriers to entry?” Those are the questions we ultimately need answered, but asking them directly is a waste of everybody’s time. In our world, every company is going to say yes to every questions, and in the jury world virtually every juror, when asked directly, “Can you be an objective and impartial juror in this case?” is going to find a way to say no, because very few people want to serve on juries.

Ultimately, the trial attorney and the venture capitalist are procedurally analogous. We ask questions do perform diligence not because we think the answers lie therein, but because we’re hoping to stack the deck in favor of our portfolio and our LPs. By investing in Ron Gonen, Sam Lessin or Ted Morgan, we think we get a built-in advantage over those who invest in competitors to these businesses. By choosing large and growing markets with fluctuating competitive dynamics we think we improve our chances of earning a return by investing in startups. Attorneys get a few questions per juror to try to figure out if, at the end of the trial, this juror is someone that’s likely to side with their client (because let’s be honest – no one is looking for objective, impartial jurors. Plaintiff’s counsel is looking for plaintiff jurors and defense counsel is looking for defense jurors). They hope to assemble a jury that returns a positive outcome for their client.

Watching these attorneys ask terrible questions certainly got me thinking about whether I’m asking the right questions when I meet new companies. And if that’s what I got from my two days at 71 Thomas St., I’ll count myself lucky.

April 25, 2009

Venture Beta

Filed under: venture capital — Tags: , , — fiveyearstoolate @ 4:53 pm
Stuart Ellman

Stuart Ellman

Eric Wiesen

Eric Wiesen

The Q1 numbers on Venture Capital investing were released last week. As is often the case with VC numbers, especially when they’re bad, there was no shortage of press and blog attention to the drop in both venture investing (in terms of capital deployed) and venture liquidity. And the general narrative that initially emerged was largely one of panic and, schadenfreude.

Shortly thereafter, however, people started to dig into the data a little bit further. We want to give big kudos to our NYC brethren, Fred Wilson, for his blog post on this topic. Two interesting analytical slices have emerged from this further examination. First, there was a meaningful disparity amongst geographies, with Silicon Valley seeing a much larger drop (even as a percentage of capital) than sectors in the Northeast like New York or Boston. The second was that certain sectors (like CleanTech) saw a far larger decline than other sectors (like health care).

And in looking at these second-order narratives that have emerged from this major change in venture behavior on both sides of the equation, it starts to become clear that there may be a sort of “beta” attached to different sectors within venture capital, much like there are differing levels of beta within sectors of the public market.

Beta, for those who aren’t familiar with the term, means that while most securities move in the same direction as the overall market, some tend to move more than the market while some tend to move less. A stock with a beta of 2.0 will generally increase by a percentage twice that of the overall market when the market is up, and correspondingly will decline twice as much as the market when the market is down. A stock with a beta of 0.5, by contrast, will only be up (or down) half the amount of the overall market. High-beta stocks are great in a go-go market and really bad in a down market. Low-beta stocks are generally less exciting when things are good, but hurt much less when things turn south.

The data emerging out of the down numbers for venture capital start to suggest that perhaps certain sectors (like health care, thought by some to be a safe source of “singles and doubles”) will generally act lower-beta than others (like CleanTech or the consumer web, which enjoyed massive momentum in the years prior to the downturn). Similarly, areas like New York and Boston start to look generally lower-beta than Silicon Valley. There have been fewer massive high-priced companies in New York, but the fall has been far less precipitous. We can only assume that the beta may be directly correlative with the supply of capital in those regions. In NYC, where there are fewer venture firms, there tends to be less upward (and obviously downward) pricing jumps because there are fewer firms to both jump in and jump out of the markets when sentiment changes. In the NY venture market, we have seen pretty rational pricing over the past few years, while other regions were seeing significantly higher pricing as the funding markets picked up steam. Since our region’s pricing never got too high, it has not fallen nearly as dramatically either. It is reassuring to see Fred’s analysis back this up.

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April 1, 2009

Liquidity Perspective

Filed under: downturn, venture capital — Tags: — fiveyearstoolate @ 10:17 am
Eric Wiesen

Eric Wiesen

Courtesy of this morning’s VentureWire, the numbers for venture liquidity in Q1 are out. And I’m sure you will all be shocked to hear that they aren’t very good. In fact, overall liquidity across the venture industry was just $3.2B, the lowest for any quarter since 2003.

Full stop. Lowest quarter since 2003. So in the midst of the worst financial contraction of the modern era, venture capital liquidity was bad, but better than it was in 2001 or 2002. I think that, while not to be a Pollyanna about where the industry is today, it’s important to note that during a quarter where the public markets had their worst Q1 in 70 years, the venture liquidity numbers are bad, but better than they were the last time things went badly.

Further, and also of interest, median hold times were down dramatically in Q1, from an average of almost 8 years in Q4 to about 4.7 years in Q1. Part of this is just a shifting “market mix” where more companies are getting taken out early. It will be interesting and important to see if this trend continues into Q2 and beyond.

Ultimately, this data is not dispositive about where venture capital is headed. When I was at the most recent Kauffman Fellows module in Palo Alto last month, we had a number of high-profile industry experts offer a range of perspectives on where the venture business is going, and some of them were powerfully pessimistic about returns, shrinkage within the industry and the amount of capital that will be deployed over the next few years. Here at RRE we continue to believe that there is a core need for this type of capital, and that while this cycle is worse than any we’ve seen, the fundamental business purpose behind the venture business remains vital.

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March 31, 2009

If You Build It…

Filed under: venture capital — Tags: , , , , , , , — fiveyearstoolate @ 10:38 am

Stuart Ellman

Stuart Ellman

Eric Wiesen

Eric Wiesen

“Should I build my company to be a profitable, standalone business or should I be aiming to fit into the long-term plans of my likely acquirers to facilitate an M&A exit?”

This is a question that entrepreneurs ask themselves every day. If you asked a hundred venture capitalists this question, I suspect the overwhelming majority of us would give you the canonical answer – build for long-term profitability and a standalone business, because the tides of M&A can come and go. In the previous era, many VCs liked to see every investment as an IPO candidate. And that made sense in an era when a pre-revenue web company burning cash could actually go public. But in today’s market, when even nine-figure companies with positive EBITDA can’t go public, it is worth asking this question again.

The argument for the traditional answer is simple and compelling – when you go to start your company, you don’t know what Google or Cisco or Dell will be buying in 3-5 years when you achieve sufficient scale to be interesting to them. As a result, if you build toward M&A, you’re likely to build toward whatever they’re buying when you start, and that will likely change significantly over the build period of your company.

There is also a huge issue of stage and valuation. Acquisitions tend to happen in two lumps. First is the “cheaper and quicker” route. This means that Dell can buy something for $10 to $25mm because it is cheaper and quicker than building it themselves. The second is “they already have scale” route. Obviously, a company like Dell can pay a great deal more for a company that sufficient scale that cannot be reliably replicated simply by recreating the technology. A good example of that would be the acquisition of Pure Digital Technologies (creator of the Flip video camera) by Cisco. Could Cisco build its own version? Sure. But they paid almost $600mm because Flip already had brand and scale . (BTW, kudos to Jonathan Kaplan, CEO of Pure Digital and a former RRE CEO). If you are selling in the “cheaper and quicker” category, it better be at a single-digit valuation. Nothing past a Series A.

The emerging counterargument is that the IT landscape has so significantly consolidated that the it’s become easier to project the tectonic movements of the “continental” companies like Microsoft, Google, Cisco and Dell. But is this true? Can you forecast what these companies are going to do? We sold MessageOne to Dell because it wanted to make a big move in hosted services. Could we have forecasted this in 2001 when we funded the company? Again to the Pure Digital example, how could you have guessed that Cisco would be going after the consumer market in 2002 when Jonathan was raising his first round.

We think this question is being answered in real-time. The standard advice to build for the long term is still good advice, but if all the exits are going to be via M&A for the foreseeable future, we’ll be thinking pretty hard here at RRE about what the big guys are really looking for. We still want to fund great entrepreneurs solving big problems in growing markets. But we also want to know what acquirers are looking for. Time to get smart in this area.

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February 12, 2009

Rolling 8 the Hard Way

Filed under: Startups, venture capital — Tags: , , , , — fiveyearstoolate @ 5:45 pm
Eric Wiesen

Eric Wiesen

Stuart Ellman

Stuart Ellman

Experience in the venture business teaches many lessons. One that is often painfully learned is very easy to see from a distance but hard to see when down in the trenches. There are easy ways to make money and there are hard ways.

At one level this is intuitively obvious, but at another level, it’s clear that a lot of folks (founders and investors alike) don’t necessarily see the world through this lens, and as a result, a lot of businesses get started that are just not really geared to creating excellent investment returns.. At this point, we must make it clear that making money (i.e. generating profits), is not the same as successful deal exits. Many companies come in the door to our firm with clear paths to go from $10mm in revenues to $50mm in revenues and they are much less interesting as investment than some companies that have no revenues and fuzzy plans for profit generation but can solve large problems and will be highly sought after. This may seem confusing, but lets dig a little deeper. It really comes down to markets and competitive positioning..

What’s the easy way to make money? The easy way is the traditional way: solve a problem that lots of people have (or a very big problem that a few people have) and offer them a really good reason to pay you lots of money for what you made or do (we might call this a “value proposition”). Hopefully you’re doing it in a way that isn’t being done by a dozen other companies, and in a way that isn’t easily replicable by others. The easiest business in the world is one where you have something everyone needs and you’re the only one that has it. So if you could manage to situate yourself over the world’s biggest undiscovered oil well, you’d be set – you have something people need and (milkshakes not withstanding) you are very hard to displace. To use an example closer to home, a startup came to us looking for money. They had four people and an idea. The idea was a technically elegant way to create additional money for e-tailers with little downside. They had nothing built and two pilots lined up. They wanted a high valuation and they got many competing term sheets. They also had $0 revenues and it was unclear when they would really start to make money. Why was this deal “the easy way?” Because it was a hard ROI, created money in a sector that needed profits, was reasonably hard to copy, and whatever e-tailers used it had a competitive advantage. Therefore it would either get big very fast or get bought very quickly no matter what the financials looked like.

A friend recently asked, when told about this way of looking at companies, whether Google was an easy model or a hard one. And the truth is – Google was a hard model that turned into an incredibly easy one. If a startup came in the door and said, “we’re going to become the primary destination for search on the web, then sell ads against that search activity”, my guess is they’d have a hard time convincing us (or anyone else) how they would accomplish the first part of that, since changing consumer behavior around search is extremely challenging and expensive. However, if Google came in the door in 2001 and said, “We are already the primary destination for search on the web – now we’re going to sell ads against that search activity”, it would be moderately obvious how easy it would be for them to make money at it. Because the hard part of the model – building a huge stream of consumer activity – had already been accomplished.

So with that backdrop in mind, we’ve been looking at new deals that come in the door explicitly with this question in mind – does the company have an easy model or a hard model? This has particular resonance around B2C companies. While a lot of people in 2009 view the web as synonymous with “software”, B2C web companies that give their service away and monetize with ads (or other behind-the-scenes streams like lead generation) are media businesses, not software businesses. Those that charge for web services are software businesses. So – salesforce.com is a software business while Yahoo Finance is a media business. And startup media businesses are challenging, especially today. The really tough part is how many of them there are. As previously mentioned, there was an explosion of B2C web companies a couple of years ago, along with an explosion of ad networks launching to try to monetize them. This crowding, along with the current collapse in display ad rates, makes a web-based media startup (especially one starting from a dead stop) a very hard way to make money.

Let’s look at another example to compare the startup that sold to e-tailers above. A different startup came in selling a useful but inexpensive enterprise solution. It had $5mm in revenues, a clear pipeline for more sales up to $10mm, a very solid and earnest CEO and management team, solid reference accounts and well known VC backers. This is the “hard way.” Because this is a specific industry with large players that dominate the competitive landscape, the exit possibilities are few. The existing players are large and trade at about 1X revenues. Even if the startup struggles and really succeeds for the next five years, it will not be large enough to remain a standalone company and there will only be two to three potential acquirers who will not have the stock multiples to pay much more than the money being put into the company. And this is if everything goes right.

Without turning this into a portfolio survey for RRE, one thing we’ll note is that many of the companies in our portfolio that are continuing to do well even throughout this difficult economic period are those that have easy models – they make something someone (either businesses or consumers) need (or at least really want) and sell it in a relatively lightweight way. They are also answering unique problems and are changing the competitive paradigm of the industries in which they compete. And this learning will likely inform how we look at new opportunities that come in the door.

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February 5, 2009

Is Capital Efficiency the Enemy of Innovation?

Filed under: venture capital — Tags: , , , , , , — fiveyearstoolate @ 2:17 pm
Eric Wiesen

Eric Wiesen

I’ve been thinking about two themes that have generated a lot of discussion lately. The first is a growing sense that we are in a period of weak innovation; that Silicon Valley (and the rest of the US tech ecosystem) is broken, and that most of what’s being invented today is incremental, with no real innovation taking place. The second is strong focus on capital efficiency within the technology startup world.

At this point, given both the trends in web development and the macro economy, it’s practically a race between the entrepreneur pitching and the investor being pitched as to who will bring up how capital efficient the business is. The large majority of companies we see these days make a point of how capital efficient their models are, and the majority of investors (VCs and angels alike) are quick to dismiss companies that are viewed as capital inefficient.

Let’s step back for a moment and talk about what capital efficient means, and then we can get to the heart of the question. Capital efficient, in its simplest form, means you can accomplish a lot with a small amount of capital. And of course if you stop there, it sounds like an unadulterated good thing. More for less, right? And as a first-order question, I think the answer is yes. Doing more with less is a good thing.

But the second theme contextualizes the first for purposes of our question. We are in a period where much of the technology innovation taking place is in “soft technology”, be it software, web services, technology-enabled services or data businesses. And while it’s certainly an enabling environment that so many of the tools required to create these businesses have become commodity and free, there is an increasing concern that people are simply using free, easy tools to create slightly better versions of things that already exist.

Because how many of the really innovative technology companies throughout history were actually capital efficient? Whether we’re thinking about Edison Electric or Google, Amgen or Intel, Nvidia or Nucor, we often find that companies that really transformed industries with new technology or approaches took a large amount of capital and significant time to achieve it. And while these are clearly cherry-picked data points, I think that even on the web most of the really significant, innovative companies have taken in quite a bit of resources along the way.

I was recently on a panel with a friend of mine who’s an angel investor. And what shocked me was when he said that his group was looking primarily to invest in businesses that could, from a dead start, achieve profitability on significantly less than a million dollars of capital. And while, on its face, this sounds amazing – who wouldn’t want to invest in businesses like that? – another part of me really had to wonder, can you build anything interesting or important if that’s the hurdle you establish at the outset? Would any of the companies who have significantly raised the innovation bar have fit that screen, back then or now?

So I don’t think there’s a clear answer – we at RRE Ventures are clearly going to continue to seek businesses that can accomplish their goals with as little capital as possible, because it’s essentially obvious to do so. But I also agree with the criticism that “Web 2.0” has been at least in part an exercise in excessive capital efficiency, and that people were building incremental products and services with no real innovation in the hope of a quick flip or tuck-in acquisition. In the back of my head, I’m still going to be thinking about opportunities to create something really transformative, even if the road is a little longer and tougher.

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January 27, 2009

Pitching 101: Be Prepared

Filed under: Pitching, venture capital — Tags: , — fiveyearstoolate @ 8:28 am
Eric Wiesen

Eric Wiesen

Today’s installment of Pitching 101 was motivated by a great recent presentation I saw. The message this time is – be prepared for each pitch. Two young entrepreneurs had been referred to RRE by one of our portfolio companies and we set up a time for them to come and tell me about the business and what they think it can be. These are guys a couple years out of college who have bootstrapped the business for the first year and who have achieved significant proof points while working on the company part-time and holding down “day jobs”.

Separate from the business itself (which I liked), it was immediately clear that these entrepreneurs were well-prepared for this meeting. They were prepared not only to present the business in a systematic, thoughtful way, but they had clearly looked at RRE’s current and previous investments and were prepared to talk about investment themes that we had already explored and where they might be an intersection with their business and its model. They had gone through the bios of the different investors at our firm to see ways in which we might be a good fit for their company, and had even read this blog and worked some of the ways we’ve indicated we like to be pitched into their presentation.

Is it work to do what these guys did, especially if you are pitching a lot of firms? Absolutely. But think about it the other way – you’d prep for a major sales meeting, partnership meeting or other significant line-of-business presentation. When a company pitches a potential investor, you are typically asking to be one of the two to five (depending on fund size) investments that firm is going to make that quarter, and are asking the VC to get involved with you and your company for a period of several years (and potentially as many as eight or nine years, although few want to admit that hold times can be that long). If you come in with a presentation that shows you were thoughtful and prepared, it’s a huge positive indicator of other things we can expect from you.

If you’re wondering what happened, the company doing the pitching isn’t going to be an RRE investment, for a few reasons. On the one hand, it’s not in a sector that’s of particular interest to us. On the other hand, the company doesn’t need very much money, and have quite a bit of their round already spoken for by angels. It would be a very small investment for RRE even if we took the whole thing.

And in most cases that’s where the story would end, but in this case I’ll be actively referring this company to either firms who specialize in seed rounds or to angel investors I think might be interested, because I want to see these guys succeed and because the level of professionalism and preparation for our meeting lends me confidence that I can recommend them to others.

In sum, take an hour to know the person or people you’re pitching. It will improve your odds of getting to next steps with them, and will generally help you form a relationship with that investor that may be helpful down the road.

December 12, 2008

Go to War with the Army You Have

Filed under: venture capital — Tags: , , , , — fiveyearstoolate @ 12:18 pm
Stuart Ellman

Stuart Ellman

Eric Wiesen

Eric Wiesen

We recently had the opportunity to talk about the current funding environment with a bunch of smart people at a brown bag lunch hosted by our friends at Betaworks. A lot if important angles were discussed, including best practices for entrepreneurs, the mindset at different VC funds and tactical suggestions for getting a funding done in the current climate.

One point that’s worth stressing was raised by several people (including us): When you raise money, make sure you have investors who are prepared to continue to support you the next time around.

Backing up somewhat, let’s acknowledge that when times are good, fundraising usually follows a fairly standard pattern. An investor or group of investors funds a company at the Series A level for a given amount. When the company has reached sufficient proof points in the business and when new capital is needed, the company will raise an additional round of financing. A new investor usually leads this round, with participation (on a pro-rata basis) from the existing investors. The new investor is brought in for a number of reasons:

• This investor may be more oriented toward a later stage of the business and can add additional value;
• New investor may bring needed capital for future rounds of funding; but most importantly
• A new investor can set the price for the company. Prior investors may have conflicts relating to the prices of prior rounds.

When a new investor can’t be found, then the current investors face the choice of whether or not to do an “inside round”, meaning fund the company themselves. The point today is that many if not most follow-on financings are being done as inside rounds right now. The new investor who comes in and prices the company and puts in fresh capital is, in many instances, very hard to find. They are either trying to figure out how they are going to fund their own portfolio companies (and doing inside rounds for them) or they are struggling to raise their new fund and aren’t making investments in new companies.

All of this rolls up to the original point: when you build your syndicate for your Series A round, make sure you have a group of investors who will continue to support you when you need to raise more money. It’s fine to have an investor involved whose charter is solely to make Series A investments and then participate pro-rata down the road, but you should ALSO have an investor who is comfortable making Series B investments. Because as a lot of startups raising Series B and Series C rounds are learning, new investors are very hard to come by right now.

At RRE we are currently looking at funding two very promising early-stage deals. In both cases we could easily (given the amount of capital being raised) take the entire round ourselves, but we aren’t just thinking about today. Both of these companies are likely to raise more money later on, so in both cases we are bringing in partners who can both add value to the company, and who we believe will help us ensure that the company continues to be funded should the current climate last longer.

They say you go to war with the army you have, and the same is true for your venture syndicate. If at all possible, bring in investors you think can go the distance with you. It can make a big difference.

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December 2, 2008

How Deep is too Deep?

Filed under: downturn, venture capital — Tags: , , — fiveyearstoolate @ 6:24 pm
Stuart Ellman

Stuart Ellman

Now that the markets have tanked and pensions and endowments are selling off their private equity holdings to rebalance their portfolios, many people have gotten religion. VCs realize that the environment for raising new private equity funds is not great. If they are near the beginning of their new funds, as RRE happens to be, it is a very fortunate position because they have plenty of fresh cash to put into companies at attractive prices. If they are near the end of their most recent fund, it is not a pretty time. With little fresh capital to put in their existing companies, the first word out of their mouths is to cut costs at their existing portfolio companies. This makes sense, but only up to a point.

For some of our portfolio companies, especially web 2.0 companies that exist “in the cloud”, it’s realistic to burn very little money and grow virally. But, this model simply doesn’t work for companies in other sectors and with other cost structures. I sit on the board of a terrific company in an extremely attractive space. Given the current environment, some of their large contracts have been pushed out. With valuations down and the company on a path to burn through its cash, it seems obvious to cut the expenses and make the cash last as long as it can. This company will only remain the leader in its space if it continues to have engineers crank out the hardware and software that constitute its solution. It will only be a winner if it participates in most of the beta tests, trials and RFP‘s that most of its large customers are demanding. It needs to partner with many of the Fortune 500 companies and support these relationships. These things are not cheap. But we can only create value for the company if these things are done. The key is spending enough to remain on the “leading edge” without going overboard and hurting ourselves on the “bleeding edge”.

The takeaway here is that the board of directors (and each individual director) has to set aside the desires of their specific class of shares and do what is best for all shareholders. If, for example, my fund is out of fresh capital to put in a company but the company needs to spend money to retain or create value, I must vote to dilute myself in order to be doing my duty as a director. This is not obvious to all board members, but reflects that Director’s duty to the company. Directors must work to maximize value to all shareholders, unless the company is in distress and worth less than the amount of debt. Then, the duty of a board changes and the directors must work for the benefit of the debt holders. This is tough medicine, but we have all lived through this before in 2001-2003. Things will turn around but we must all do the right things now to let these companies survive and flourish in the future.

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November 17, 2008

Kashless

Filed under: venture capital — Tags: , — fiveyearstoolate @ 7:19 pm
Stuart Ellman

Stuart Ellman

We recently made a decision to invest in the Series A round of a new company called Kashless. This investment is one we’re very excited about, and reflects a lot of our investment philosophy here at RRE. The company is still essentially in stealth mode, although certain details leaked out via SEC filings we did around the financing. Rather than go into a lot of detail about what Martin Tobias, the CEO of Kashless, is planning on doing with the company, we’ll talk a little bit here about our process and thinking that led to this investment.

As we’ve mentioned in this space before, at a highly abstract level, we (and most investors) look for excellence in three key areas: people, markets and technology (the order depends on which of us you ask). In certain sectors, technology will be the key differentiator (materials science-based cleantech or semiconductors), in others it will be the vision and execution capabilities of the management team that will primarily distinguish the big successes. In all cases you need a market that’s capable of supporting interestingly large businesses.

Two major positives intersected to make us very excited about the opportunity here. The first was the opportunity to back Martin Tobias again. As the writers of this blog discussed offline the other day, Martin is a winner. We don’t just know him in a business relationship, we know him as a friend as well. Stuart stays with Martin when he travels to Seattle. They ride the 200 mile Seattle to Portland bike ride each year. Stuart and Martin have spend a great deal of time trying to figure out what business to start. Kashless is the culmination of this strategizing, much of it done during bike rides. Martin has demonstrated a great nose for the very beginning of trends, and that’s a terrific quality in an entrepreneur. He’s also extremely good at building organizations and getting them to scale. We know Martin’s strengths and weaknesses. We know that we can work with Martin and we know that there is mutual respect. We also know that he has lived through bubbles and busts before and we have a shared history on the appropriate ways to react to new market information.

The second is that (true to form for Martin), we think Kashless is poised to catch a big wave. Often times when we evaluate companies that seem good, but don’t quite feel right, one question we ask internally is, “what wave is this company riding?”, which helps focus the conversation around large, meta-trends that can propel a company and its target market into a high growth trajectory. Kashless is riding a big wave – call it “green”, “sustainability” or what you like, but economic, cultural and social forces are all moving us toward a world where issues of sustainability are more important than ever. Kashless looks to enable people to live more efficient, sustainable lives, and that’s an objective of which we are both supportive and optimistic. Also very important for RRE, as we mentioned in previous posts, Kashless can achieve these objectives in a capital efficient manner.

Stay tuned for more from Kashless, but we think big things are coming.

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