Apparently Even VCs Get Confused Over Ratio Ownership Compared To Total Value

from the and-those-are-the-VCs-you-don't-want dept

Venture capitalist Fred Wilson recently had a great post where he calls out a bunch of his colleagues in the venture capital business (not by name) for insisting on owning a certain percentage of a company in order to invest. Fred notes, correctly, that it's not the percentage that matters, but the actual value (and the appreciation of it) of the equity that one holds. In simplest terms: owning 10% of a $1 billion company is always going to be a hell of a lot better than owning 40% of a $1 million company.

But, what I find amusing -- and what Wilson doesn't mention -- is that this very argument is quite commonly presented to entrepreneurs from VCs. That is, when an entrepreneur frets about giving up a portion of his or her company, a VC will often make the point that "with our investment, we can take your company's valuation way up -- so even if you own a smaller percentage, your absolute value will increase." And it's a true argument (if the value increase happens). And, in many cases, it's the very same VCs who will use a line like this that then insist on owning a certain percentage. It makes you wonder if they believe what they're saying themselves, or if they're just using all of it as a negotiating tactic to take a larger cut of the deal.

6 Comments | Leave a Comment..

Venture Capitalists May Be Left Out Of Burdensome Regulations On Private Equity

from the good-news dept

Last month, we were a bit worried that an admittedly clueless Congress might lump venture capitalists in with other private equity firms in putting forth new regulations. Venture capital is quite different from basic private equity, and the proposed regulations would be quite burdensome for VCs without having any benefit. These "systemic" risk rules don't make sense for VCs who aren't investing in public investment vehicles for short times, but instead do long term strategic investments in private startups. VCs have been pushing Congress on this, and it looks like they finally got through to someone, as it appears that Barney Frank is looking to exempt VCs from any such regulation. This makes a lot of sense as venture capital and traditional private equity are very different animals, and putting them both under the same regulatory rules makes little sense. Putting VCs under systemic risk regulations makes even less sense, considering how unlikely it is that VCs investing in startups are involved in any sort of systemic risk issues.

5 Comments | Leave a Comment..

Venture Capital: A Part Of The Ecosystem, But Not The Ecosystem

from the understanding-vc dept

This happens every so often, but in the last week or so, there's been a spate of "VCs are bad" types of discussions happening on various blogs. It kicked off with a blog post from Jason Fried at 37Signals, blaming VCs for pushing Mint.com to sell to Intuit. VC Fred Wilson did a nice job responding to that charge by pointing out the usual calculus in figuring out when to sell. Amusingly, very few people seem to notice what Fred was basically saying in his post. The undercurrent was that Mint.com likely wasn't doing nearly as well as its cheerleaders have assumed -- and thus, selling out made a lot of sense, not from a VC perspective, but from the founders' perspective.

Still, it's pretty popular in Silicon Valley to knock VCs, and TechCrunch has a post from Vivek Wadhwa pouring on the VC bashing, complaining about VCs taking way too much credit for innovation. Now, I'm a big fan of Wadhwa and his research on startups and innovation, and I'm among the first to bash VCs when it's warranted (and, yes, there are plenty of times when it's very, very warranted), but I think Wadhwa's piece goes too far. He's right that it's a little silly that the the National Venture Capital Association (NVCA) seems to be taking credit for all of the revenue and jobs created from any startup that has ever taken any venture money, but that doesn't mean that venture capital is meaningless in innovation.

While I'm actually a huge fan of building companies without venture capital (and am doing that myself), I think what people need to realize is that venture money is quite useful in enabling certain types of businesses. The problem is when people (very often Silicon Valley people) get into the mindset that raising venture capital is an end goal in itself, rather than looking at the overall business and seeing if it even needs venture money. During the dot com bubble, there was a time when people looked at venture capital like revenue -- the more you raised, the better you were doing, rather than recognizing that it really meant you just had a bigger hole to dig yourself out of. However, in some cases, where a company really does need investment capital to take a business to the next level, smart venture money can be a great help.

The nice thing today is that more and more businesses can be started, built and can scale without that need. That doesn't mean that there's anything wrong with venture capital. In fact, it's better if it's easier to build businesses. But that also doesn't mean that VC is somehow bad or isn't really a key part in accelerating certain innovative businesses. Venture capital is a part of the ecosystem, and that's a good thing. There are times when people give it too much credit, and there are other times when it doesn't get enough credit, but the real trick is just in understanding where and when it makes sense.

8 Comments | Leave a Comment..

Congress Clueless About Venture Capital... Still Wants To Regulate It

from the this-makes-no-sense dept

Following the financial crisis there's obviously a lot of interest in more carefully regulating aspects of the private equity markets, given that behind-the-scenes financial efforts have been seen (rightly or wrongly) as part of the cause of the mess. But, of course, Congress can barely understand what caused the problem, let alone other aspects of the the financial system, so they end up regulating by shooting in the dark. The latest is that the various attempts to put regulations on hedge funds and private equity firms that invest in public companies (which in many cases really were sneaky ways to get around regulations) may be applied to venture capitalists as well, despite the fact that venture capital is a totally different beast. It doesn't invest in public companies. It doesn't aim for sneaky quick flips. It's true long term investment capital, directly investing in private startup companies to help them grow. It's real investment -- not gambling. But Congress doesn't seem to realize that.

In a recent Congressional hearing where venture capitalist Trevor Loy explained this to our elected officials, Senator Jim Bunning of Kentucky apparently told Loy that he didn't believe him that VCs invest in private companies rather than companies likely to be rated by the various ratings agencies (I'd link to the story where this was noted, but the publication that wrote it, put it behind a paywall and apparently doesn't want traffic -- there's a Google cache for now). And, yet, these are the folks writing the regulations. This is why some of us get nervous about gov't regulations. Yes, in an ideal world, perfectly knowledgeable regulators might possibly be able to divinely create regulations that work. But that's not what we have.

6 Comments | Leave a Comment..

Treasury Department Meddling In Venture Capital For No Good Reason

from the not-all-private-equity-is-the-same dept

The Wall Street Journal has an important editorial pointing out why it's a mistake for Treasury Secretary Timothy Geither to include venture capital funds in his new regulatory plan to deal with "systemic risk." There's no doubt that highly leveraged hedge funds contributed greatly to the current economic situation creating a level of systemic risk that we're only just coming to terms with. However, it's not at all clear what venture capital has to do with that. Yes, both are unregulated funds of private equity, but that's about where the similarities end. Venture capital relies very little on debt, and is usually a way for wealthy investors to bet money more long term on new innovations, rather than the sort of short-term speculation that is more common with hedge funds.

Yet, for some reason, they're being lumped together and will have the same regulatory burdens. This could significantly hinder venture capitalists, similar to some other recent regulatory changes, creating unnecessary and wasteful burdens that are more for show than any actual effort to protect the economy. As the editorial points out: we've already stress tested the venture capital world, when the dot com bubble burst, it didn't cause any systemic risk. No banks failed because of the bubble bursting. So why is the government suddenly acting like VCs are a threat to the widespread economy now?

14 Comments | Leave a Comment..

Throwing Money At Problems Usually Is Not The Solution

from the time-to-work-smarter dept

Thomas Friedman has stirred up some controversy with his suggestion that the government (instead of giving it to dying automakers) should give $20 billion to top venture capital firms and have them invest in new innovation. The initial thought makes sense, and, in fact, we discussed something quite similar a few months ago -- though, concerning a new venture fund in the UK, rather than giving money to existing funds. Indeed, if we must throw money at the economy, it should be to invest in new innovation, rather than throwing good money after bad. However, Fred Wilson points out that the top VC firms don't want or need the cash, and in fact, adding more money to the venture investing pool at this point might cause a lot more harm than good.

And, that brings up an important point, worth discussing, that the government seems to be missing: throwing money at problems is very rarely the best solution. Often the problems are caused by too much money sloshing around (see: Wall Street). Dumping more money into the system just encourages the same inefficiencies and bad decision making. The real fix to problems is to wipe out the broken parts of the system, not fund them further. Yes, letting some of these businesses fail will have rippling effects into other parts of the economy -- but shouldn't the focus be on helping out those aspects, rather than rewarding companies like GM and Chrysler that have screwed up dreadfully?

While there's something to be said for taking money when it's available, plenty of experienced entrepreneurs know that having too much money on hand is almost as bad as not having enough. Having too little money makes you focus and makes you creative out of necessity. Having too much money makes you lazy and puts you in a position to hide or ignore the real issues for way too long. What we should be working on right now is fixing the systemic problems throughout our economy -- not papering them over with cash.

23 Comments | Leave a Comment..

Universal Music Group Slapped Down (Again) In Case Against Veoh

from the can't-sue-the-investors dept

The ongoing lawsuit between Universal Music Group and online video site Veoh is seen by many as a precursor to the various lawsuits against YouTube (or, more specifically, the "big" lawsuit from Viacom). So far, it's not going well for the content companies. In another lawsuit, filed by an adult video company, Veoh won easily. In the UMG case, the judge has already shot down Universal Music's arguments for why Veoh shouldn't get DMCA safe harbor protection.

The latest news is that the judge has also dismissed Universal Music's attempt to include Veoh's investors as a part of the lawsuit. Universal's attempt to do this matched Universal's decision to sue Bertelsmann, a competitor who was also an investor in Napster. This made little sense to us at the time. Making an investor liable for actions of a company they invest in seems to open up a pandora's box of problems. Think of all the "shareholder lawsuits" you now see against management for corporate misdeeds... and turn that around, whereby anyone hurt by a company's actions could sue all of the investors. If investors are liable for a company's misdeeds, then suddenly it becomes a huge liability to invest in anything.

Eventually, Universal Music bought Bertelsmann... and rather than continue suing itself, Bertelsmann "settled." Bertelsmann (now UMG) later settled similar lawsuits brought by other labels, so the full issue of investor liability wasn't really addressed. In this case, the judge found that the only way Universal could make a credible claim that the investors were also liable was to show that they were actively encouraging increased copyright infringement after it was established that Veoh was infringing. That hasn't been established yet, at all, and it appears that the investors were actively pushing Veoh to block infringing content. So, Universal's claim against the investors has absolutely no merit whatsoever.

10 Comments | Leave a Comment..

Venture Capitalists: Buying High, Selling Low

from the not-the-greatest-strategy dept

We were a bit confused following the last dot com boom when various venture capitalist went into hiding when it came to new investments. Suddenly they said that since the market was bad, they wouldn't make any more investments. That didn't make much sense. After all, VCs are supposed to be investing for the long-haul -- usually in the range of five to seven (plus) years. What the market is doing today is rather meaningless. In fact, investing heavily during a downturn is often a good strategy. There are fewer competitors investing, you can invest at lower valuations (buy low!) and your investment has more time to mature against less competition. Yet, it looks like many venture capitalists are taking that same strategy again, with many deciding that it's time to hold off on doing new investments until the wider market appears to improve. The worst stat in the bunch is that VCs are particularly shying away from seed stage deals -- which are the cheapest deals that need the most time to mature anyway. That's effectively a strategy that says says they'll wait until it's more expensive to buy again. Venture capital is called risk capital for a reason. If VCs don't want to take risks, they shouldn't be in the business. About the only reason I can see why it might make sense for VCs to hold off investing is if they really think their own investors will default on capital calls -- meaning they really don't have as much money to invest as they thought they had. But, if that's the case, VCs are in bigger trouble anyway.

11 Comments | Leave a Comment..

Invest In Innovative Companies; Not Failing Ones

from the well,-there's-an-idea dept

While the US is looking to bail out its biggest businesses, it looks like the UK is working on a plan for the other end of the spectrum: creating a £1 billion "emergency" venture capital fund for startups. While it's not clear how this money will actually get doled out, this could make a lot of sense. With increasing rumors that existing venture funds are having some trouble getting limited partners to actually meet the capital calls they committed to, there is some worry that the next generation of innovation (which may be necessary to get us out of this economic funk) will be stymied. While folks like Paul Graham are correctly pointing out that many internet startups these days really don't need venture capital to build success stories, that's not true of all startups. There are still innovative startups that will need risk capital to get anywhere, and having more money focused on those early stage, innovative companies with high growth potential seems a lot more intriguing (and useful) than dumping hundreds of billions into mismanaged behemoths who will quickly squander what they're given, and come back asking for more.

16 Comments | Leave a Comment..

Are Venture Investors Not Meeting Their Capital Calls?

from the or-just-threatening dept

Last month, we talked about how the financial crisis might impact the venture capital community, noting that many more limited partners (LPs, or the folks who put money into venture capital funds) were looking to sell their stakes in the aftermarket. Bloomberg is now taking a look at the issue, noting that more than double the amount of stakes is up for sale compared to a year ago, basically confirming that a number of LPs are looking to get out of their commitments. One interesting tidbit is that, in many cases, this has nothing to do with losses from venture capital, but due to the rules that the LPs (pension funds or institutional investors) have on allocation. As we mentioned in the original post, most of these investors set aside a certain small percentage of their money for such high-risk alternative investments. The problem is that with the rest of the market collapsing, these investors overall portfolio has shrunk, driving the venture investments over the self-imposed limits -- forcing them to sell off to rebalance. Partly, this shows the silliness of forced rebalancing under such principles. It's forcing firms to get out of investments that might be okay, just to keep percentages intact.

However, the bigger issue is hidden at the very bottom of the Bloomberg article. It's the question of whether or not any of these LPs are defaulting on their commitments to VCs. That's been the big fear. Since LPs merely commit to venture capital funds, and then wait for "capital calls" before actually handing over the money, the worry is that LPs would default. However, the article notes that there's no evidence that this has actually happened yet. It may still just be early, as the real market collapse is only a few months old, and there probably haven't been many (if any) capital calls in the last few months. But, does anyone know of any LP that has actually failed to meet a capital call? It would be interesting to hear if it's actually happened, or if it's just a concern at this point.

2 Comments | Leave a Comment..

The Risk To Venture Capital And Startups From The Financial Crisis

from the capital-calling dept

When I wrote my first post about the financial crisis, I noted that venture capitalists and startups were probably more protected than other areas of the economy, noting specifically that I didn't believe limited partners (also known as "investors" in VC funds) would fail to meet their capital calls. The way venture capital works is that the general partners (the folks who run the fund) go out and raise money from limited partners (LPs or investors), who agree to invest a certain amount. However, they don't just hand over the money. The VCs let the LPs hang onto their money until they need it and make a "capital call." For many of the bigger VC firms, the LPs who make up a large chunk of their funds come from huge institutional investors, such as pension funds and university endowments. I thought it was unlikely that they would fail to make their capital calls, because (a) they're huge and (b) they tend to only set aside a rather small percentage (5% is what I remember being told is standard) to put into high risk investments like venture capital. So, even if they were having trouble elsewhere, it seemed unlikely that they would bail out on the money they committed to VCs.

That might not be true, however. Immediately after the post, I heard from a few VCs who indicated it might be much tougher to get LPs to meet their capital calls than I expected. First, especially with smaller VC firms, the LPs might not be huge institutional investors who can shrug off losses elsewhere. Second, my original statement was before two straight weeks of a tumbling stock market (though it's bounced around since), meaning that the hurt put on the rest of the LPs portfolio may have been much bigger than originally estimated. Finally, while these big institutions may focus on only putting about 5% into high risk offerings like venture capital, they may have just realized that a much larger percentage of their money was already in high risk investments -- it's just that they didn't realize it. Thanks to badly rated collateralized debt obligations (CDOs), many people who thought they had put money in super safe AAA rated investment vehicles, quickly realized that they had actually invested in high risk vehicles. That might make them think twice about throwing any more money after high risk ventures.

And, indeed, that appears to be happening. Firms that are willing to "buy" the obligations to fund VCs are finding strong demand as various LPs look to get out of their obligations before the capital calls come. Unfortunately, there's a pretty small market of folks willing to take on these obligations, so there's a chance that the "fund" that a VC has officially raised, may turn out to be much smaller than they really believe. If an LP is unable to meet a capital call (or simply refuses to do so), the VC firm is basically stuck holding the bag. It effectively means that the size of the fund that they raised is actually smaller than announced. While that can mean fewer investments (especially if the GPs are nervous about their LPs), it can be a lot more disconcerting for startups on the funding conveyor belt. Usually startups go through multiple rounds of funding, which the VC firm bakes into its calculations when doing the initial funding. That initial firm may not lead later rounds (in fact that's rare), but it usually will participate, and now that may be more difficult. That could cause some VCs to push their portfolio companies to sell off or close up shop much faster than they normally would.

My guess is that this is still a temporary phenomenon. After the dot com bubble burst, there was lots of talk about how VCs would have trouble raising new funds, and that didn't happen. The big institutional investors know they need to allocate some portion of their holdings to high-risk/high-return vehicles, and venture capital is always a good place for that bet. Given Wall Street's implosion (and the resulting impact on east coast private equity and hedge funds as well), it's likely that venture capital will still appear as a good long term bet for high risk capital -- perhaps even better than in the past few years when there were suddenly many more options. In the short term, it may be a bit painful for startups (and VCs worried about not actually having the money they thought they had), but it still doesn't seem likely to have a huge impact on Silicon Valley. As for all the headlines you're seeing about layoffs at startups these days, don't read too much into them. A lot of companies are using the market as an excuse to effectively dump underperforming employees in a big "layoff." This way they get rid of the bad employees, and there's no negative connotation associated with the layoff like there might be in normal times.

6 Comments | Leave a Comment..

The Fine Line Between A Venture Capitalist And A Con Man?

from the ah,-silicon-valley dept

One of the things you learn about Silicon Valley after you've been here for just a little while is that there are some folks around here who are really, really into the technology and innovation aspect of things -- and then there are those who are only around for the money. Sometimes it's not as easy to tell the two apart as you would think, and that's opened up tremendous opportunities for con men. I recently read the novel Con Ed by Matthew Klein, which shows what a fine line there is, at times, between a startup and a confidence scam in Silicon Valley. While it's a bit extreme, if you've worked at a startup in the Valley you'll probably recognize many of the characters in the book. Klein certainly knows about his stuff on the Silicon Valley startup side -- a decade ago he ran his own Silicon Valley startup that employed me, among other folks. While I can highly recommend Con Ed to anyone who enjoys a good con book, you don't even have to dip into the fiction pages to keep up on the latest cons of Silicon Valley.

The latest true story appears to be about a "venture capitalist," Moses Joseph, who convinced a bunch of big institutional investors to give him money for his fund... and then used it for a bunch of personal stuff, while lying and forging documents to explain to the investors what he had done with the money. This isn't the first time we've seen such "fake" venture capitalists either. A few years ago, there were a few stories of "fake VCs" that were incredibly successful in separating money from investors who believed they were investing in the next hot thing.

Of course, the guy is claiming that he wasn't a con man at all, but just a real VC who got in over his head. My favorite rationalization, though, is from his lawyer, who claims that it's not like Joseph "took money from little old ladies. He didn't. It was from big institutional investors." As if that makes it okay?

The problem with these stories, unfortunately, is that they make people skeptical of the real VCs and real entrepreneurs who aren't scamming. It would be nice if these stories were confined to fictional accounts, but it seems like that's not going to happen any time soon.

8 Comments | Leave a Comment..

Finding The Last Sucker To Invest

from the how-the-game-is-played dept

Valleywag points us to a rather scathing profile of late stage "investment" firm Advanced Equities in Chicago. Valleywag refers to the operation as a venture capital firm, but the details suggest it's a bit different than a traditional VC firm, which tends to raise a fund and then invest it as deals come up. Instead, it looks like AE is more of an investment hunter. While it does appear to have some money under management, it sounds like other VCs come to AE to go out and find investors to invest in the latest round. Tellingly, rather than referring to these investors as "limited partners" like a regular VC firm, AE refers to them as "customers." And, from the Forbes story, it sounds like those "customers" are basically unsophisticated investors who don't recognize what they're getting into.

Rather than billionaires, say former AE brokers, many clients are doctors, lawyers and dentists who lack the sophistication of typical institutions and ultrarich VC investors.

As an example, they cite one such case:

In 1999 AE sold Constance Kamberos, now 82, $330,000 worth of "bridge" notes issued by Hymarc, a firm it backed. Kamberos says the notes were pitched as a relatively safe way to earn a 12% yield. When she didn't get paid by Hymarc, Kamberos visited AE in Chicago's Loop. After she had a heated exchange with Daubenspeck, AE had the cops haul her away, Kamberos says (AE says she visited repeatedly and was hauled out by building security)

These aren't stories you hear with a typical VC firm. These sound more like stories you hear from "boiler room" operations tricking unsophisticated investors out of their hard-earned savings. Yet, as Forbes notes, big Silicon Valley VC firms like Kleiner Perkins and NEA love to talk up AE. Hmm. Then, let's recall that the IPO market has pretty much dried up for startups lately, and you can start to put two and two together.

In the bubble years, the "business model" of certain venture backed startups, was basically to sell equity to the last sucker. In the late 90s that was the public market -- consisting of a bunch of unsophisticated retail investors who would overpay for junk. But it's harder to get access to the public markets, and at least a few of the suckers have learned at least some of the lesson. However, if you can convince those suckers that they're getting in on a special deal -- say a "late stage, pre-IPO startup backed by the biggest names in Silicon Valley" the lessons learned from the last bubble go out the window. Reading this, it would appear that AE's function is to bring those "last suckers" to these startups and their VCs without going through the painful public market IPO process.

What's not clear is whether or not the VCs (and startup founders?) are taking money off the table directly during these late stage financings -- but it wouldn't be all that surprising (such deals are increasingly common these days). And, it would explain situations like the one in the Forbes article where AE helped gather up $45 million from "customers" to invest in a company called Agami. Five months later, the company no longer existed. Even people who worked at the company had no idea what happened to the money. The Forbes piece also notes that AE often pumps up the valuation of the startups in question, meaning that an earlier stage VC could be selling its shares as part of that "investment" (i.e., the money would go straight to the earlier investors, rather than the company), allowing them to still get a positive ROI on a company about to go broke.

If the Forbes report is accurate, then it certainly sounds like VCs may have figured out a different way to find that "last sucker" it needs to cash out certain investments without having to take a company public. It doesn't necessarily sound illegal (though that may depend on the details -- and there are apparently a bunch of lawsuits floating around AE). Never underestimate the ability of early stage investors to eventually find a bigger sucker to take their bad investments off their hands.

17 Comments | Leave a Comment..

Be Careful What You Subpoena. It May Turn Up More Than You'd Like People To Know

from the oops dept

Remember the VC firm, EDF Ventures, which brought a lot more attention to a negative review on the website TheFunded.com by sending a subpoena to find out who wrote the negative review? Well, it turns out the decision keeps getting worse and worse. VentureBeat has the details that were turned up by the subpoena -- and the result is more details of the criticism, but no identifying information of the poster. Since TheFunded allows parts of comments to be public, with other parts designated as "members only," the subpoena has now made the "members only" content public, and it trashes the deal terms offered by the firm and criticizes a partner who has no operating experience. Also, the details suggest that this wasn't a spurned entrepreneur, but an adviser or partner in some manner. Either way, beyond drawing more attention to a negative review, now the firm has made public even more critical info.

7 Comments | Leave a Comment..

Trying To Sue Someone Who Criticizes You Isn't The Best Way To Boost Your Reputation

from the apparently-the-streisand-effect-isn't-known-in-the-michigan-vc-community dept

And here we go again. Less than a year after a venture capital firm tried to sue the VC ratings site, TheFunded.com, another VC firm, EDF Ventures in Ann Arbor, Michigan, has sent a subpoena to the site to try to identify a critical commenter.

This is, of course, the exact wrong response.

First off, TheFunded doesn't keep records of who its anonymous commenters are, so the subpoena won't help much. But, much more importantly, in filing the subpoena, EDF has now broadcast to the world this anonymous review on TheFunded.com:

Worked with these people on several deals and they are to be avoided unless you are desparate. Beaus Laskey, the only honest straightforward person in the bunch, has left the firm.

That's pretty clearly the opinion of one anonymous commenter, and most readers of TheFunded.com would take it as such -- an anonymous ranting from someone who had a bad experience. Look at the listings on TheFunded.com and you'll see that almost every VC firm has a few such comments from an angry entrepreneur. People looking over the site understand that and take that into account. It's hard to see what's actually libelous about the statement, as it's pretty clearly just this guy's opinion.

But, of course, beyond drawing a LOT more attention to this one silly angry post than it ever would have received otherwise, EDF has also shown the world how it handles a little bit of criticism. If entrepreneurs didn't have a reason to avoid the firm before (even after reading the reviews on TheFunded.com), I'd imagined this thin-skinned guaranteed-to-backfire response that shows little understanding of how to respond to internet criticism will probably convince many other entrepreneurs to stay away. Which, of course, is exactly the opposite of what the firm probably wants.

7 Comments | Leave a Comment..

Advice For Google's VC Arm: Don't Be Boring

from the Another-Me-Too-VC dept

Last week, there was a lot of skepticism surrounding Google's VC effort as observers pointed out all the pitfalls of corporate venture capital funds and the historic performance (or lack thereof) of other companies that have tried to do what "real VCs" do. And since Google is often painted as an unconventional company with its Google.org efforts for philanthropy, the search giant may also face some pressure to do something unconventional with its VC investments.

So what is a company with $12.7 billion in cash to do? Ignore its compulsion to do things differently and simply try to maximize its own investment profits... would be the boring answer. The more exciting answer would be to throw caution to the wind (as well as a lot of money) and try to become a VC with a bit less of a singular profit-taking mindset. It's been noted that corporate VCs don't have the same profit motivations anyway, so why try to mimic pure venture capitalists? Perhaps Google's VC arm should try to offer more of a helping hand to its employees (who may be just counting the minutes until they're ready to jump ship with their own business ideas) and try to preserve a startup culture inside Google. Doing so might foster innovation within Google's campuses and shift the profit-making incentives more towards the existing innovators at Google -- instead of the fund manager(s).

Google's opportunity to do something different could have other possibilities as well. Google already sponsors the Lunar X Prize, and it could create its own series of challenges that might benefit Google's existing businesses (similar to the Netflix Prize). Google's giant pool of money could also be put towards small developer teams (a la Y Combinator) to create a "minor league" of future Google engineers. Basically, Google's VC arm may want to create other metrics in addition to a monetary return on investment -- so that its efforts are not judged solely on the performance of creating the next Google. That way, Google's VC arm might develop stats like the number of Google employees hired via its VC efforts or the number of projects based on Google's platform technologies.

In any case, the direction of Google's VC arm could be a telling signal for Google's maturity -- and whether Google is settling down and becoming another corporate giant that will eventually put an end to the bean bag chairs, free M&M's and child care or if it still has that under-30 spirit to try out different angles.

3 Comments | Leave a Comment..

No VC-Backed Companies Go Public In Q2

from the first-time-in-30-years dept

It's rather surprising to find out that, for the first time in about thirty years, not a single venture-backed company went public last quarter. Even in the worst of the various downturns that have happened over the past thirty years, there were always at least a few venture-backed companies that were able to make it out. This news has some folks fretting about what it means for the VC community -- with many pointing out that a bunch of VCs have moved away from "quick flip" internet investments into more long-term alternative energy bets.

I'd also guess that Sarbanes-Oxley has a lot to do with this. Going public is a lot less appealing these days thanks to the expenses required under that law. Rather than "cleaning up" the market, it's basically made going public a toxic process, so that everyone stays private and looks for acquisition opportunities. That said, it was obvious during the boom years that companies were going public way too quickly -- and being a public company is no picnic, with the required short-term thinking it demands.

So, what happens instead? There's been some talk of creating some sort of middle road. Rather than taking companies fully public, or selling them off to big players, what about a limited market of private equity investors who would let some of the original VCs and founders cash out, while keeping the company away from public market reporting requirements? This could potentially make a lot more sense for all involved. It basically adds another layer between VCs and the public markets where the private equity guys could either eventually take the company public or sell it off themselves. Even if this doesn't really work out, one thing is pretty clear: VCs will find a way to get money out of investing in startups, even if it's not in taking companies public.

6 Comments | Leave a Comment..

Why Do So Many People Freak Out When They See 'Free' As Part Of A Business Model?

from the divide-by-zero dept

A bunch of folks have been sending in a blog post by entrepreneur Hank Williams apparently attacking the concept of "free" and blaming venture capitalists, saying that they're overfunding a bunch of startups allowing them to give away stuff for free and distort the natural market. There's a lot of things that are incorrect in his analysis. Let's go through a few of them. He kicks it off by suggesting that it's "inherently impossible to start a small self-sustaining business," though there are numerous small online business owners who would disagree with him. It's not inherently impossible at all. In fact, I'd say it's rather common.

He then claims "in the digital world, advertising, the only real revenue stream, cannot support a small digital business." This appears to be wrong on two counts. First, there are numerous small online businesses that are supported by advertising revenue. But, more importantly, the idea that advertising is "the only real revenue stream" is inherently wrong. Advertising certainly is one revenue stream -- and an important one at that -- but there are many business models where you can make money by leveraging "free" to make scarce goods more valuable. Advertising is one such business model (using "free" content to make someone's scarce attention more valuable), but it's hardly the only one.

Williams then yanks out the old line that "it is very hard to charge when your competition is free." That, of course, is ridiculous. It's the same thing as saying you can't compete. In a competitive market, prices will get pushed down to marginal cost, no matter what (driving out all profit), so businesses that survive innovate, in order to get an advantage above the marginal cost in order to profit. That doesn't change if the marginal cost is $0 or $10,000. The trick is merely in knowing what scarcity you can sell that can't easily be copied. If you're trying to sell something that is easily copied, then you're selling the wrong thing. You have no competitive advantage. That's not anyone's fault but the business owner. In fact, the only fault I'd pin on VC's is if they pushed their portfolio companies to go against these basic economics.

Finally, he says that a bunch of these companies embracing "free" need to die and then "with less "free" floating around, a more regular supply and demand dynamic can take hold." But that, too, is incorrect. The supply and demand curve includes a price of $0, and when the supply is infinite, the supply curve is flat at the $0 line. So, the proper supply and demand dynamic has taken hold: and it says the price should be free.

This isn't to pick on Williams, as others have made similar arguments in the past, and I'm always interested in understanding why people are so confused by this. In the end, I can only assume that it's a "divide by zero" problem. For most of history, it's been shown that people naturally have trouble understanding the concept of zero. We may think we do, but as soon as a zero enters an equation, people tend to freak out and assume a model is broken. Yet, if we trust the model and realize it's not broken -- good things start to happen. Many businesses have learned that they can embrace "free" not because of a bunch of VC funding, but because that's the natural economic state of the market, and it allows them to make many, many other things more valuable. The real business trick is in making sure those things that are made valuable are what you're selling.

61 Comments | Leave a Comment..

The SEC May Want To Have A Word With The Latest Venture Capitalist On The Block

from the not-quite-legal dept

A few weeks ago, we discussed why the idea of a P2P venture capital firm didn't make much sense. Having lots of people invest is the same thing as going public -- and doing that requires complying with all sorts of SEC regulations. Simply opening up shop and asking lots of people to invest is bound to cause problems. Apparently, that's not stopping some folks. Wired has an article about how the founder of Powerset (the massively hyped up search engine startup that hasn't even launched yet) has moved on to try to start a new venture capital firm that would take small investments from many people and use those funds to invest in "greentech" investments. This is a little different than the P2P VC firm that we talked about, and actually seems to resemble something from the dot com bubble: a company called meVC, that allowed the public to invest money, which was then invested in startups. Of course, the folks at meVC at least realized that soliciting funds from the public meant going public itself first, so as not to run afoul of SEC regulations. Even then, things didn't work out so well. From the sound of things, it's not clear that the guy behind this new effort even realizes that, as described, the fund itself is probably very much in violation of SEC rules, but I'm sure the SEC will be kind enough to inform him pretty quickly if he moves forward with those plans.

3 Comments | Leave a Comment..

Isn't P2P Venture Capital Just Going Public?

from the the-SEC-might-have-an-issue-with-that... dept

As there appears to be a growing market for p2p lending services, that has some wondering if there's also a market for p2p venture capital as well. In p2p lending, a group of ordinary folks all team up to lend people money. The various players in the space have had somewhat mixed results so far, but there's a lot of attention. However, for most companies, getting access to capital involves options between taking out a loan (which needs to be paid back plus interest) or selling equity (usually to venture capitalists). In that case, the money comes from someone who takes some percentage of ownership and hopes to cash in not on the interest, but on the growth of the value of his or her shares. So, it might make sense to wonder whether the p2p lending companies might eventually move into p2p venture capital as well... except that we already have p2p venture capital: it's called the public equities markets. If you actually tried to do that with private companies, you'd quickly run into all sorts of trouble with the SEC, which is pretty strict in terms of regulating how a company goes about raising money in exchange for equity. In fact, there are many who believe that a startup may be toeing the SEC's line simply by saying that it's out raising venture money. So, for a variety of reasons, both regulatory and because public equities markets already are p2p venture capital offerings, it's hard to see there being a huge market for companies to get into offering p2p venture capital.

12 Comments | Leave a Comment..