Is the bloom off the User Generated Content rose?

Like many in the venture community much of my December date book centers around internal meetings and planning sessions for the coming new year. I’ve found that a number of these meetings ended with us having a fairly freewheeling discussion about User Generated Content (UGC), its implications for consumer internet companies in particular, and its place in the development of a number of companies we are specifically involved with. These internal discussions were punctuated somewhat by news items over the past week about the on-again, off-again talks between Yelp and Google. Today’s PEHub piece provided the latest dispatch in the saga.

While I wouldn’t want to speculate as to what issues would cause the Google/Yelp talks to snag, my own view is that a re-appraisal of UGC is underway among many early stage investors in consumer internet companies. UGC has proven to be far more complex and difficult to properly harness than many in the start-up community probably considered when initially drafting strategies for their companies that were highly dependent on UGC.

The ‘noise’ factor in UGC remains unabated. The somewhat Utopian vision — promoted by some when YouTube, UStream and others were in their infancy — that there would emerge a uniform way to manage, cleanse and tag UGC to control for noise never materialized. Our foray into Location-Based Services (LBS) a few years back, chronicled in a prior post about a GPS-enabled tour development and delivery platform company, was a good primer for us on the enormous potential and pitfalls of User Generated Content. LBS and UGC seemed a natural marriage to us then and is certainly a “hot” play now given the recent Gowalla and Foursquare funding announcements.

Weaving content into GPS waypoints and then embedding bits of information provided by users to those waypoints made a lot of sense. Our initial thinking was that licensed content — namely, content we’d get from tour book publishers — would provide the necessary backbone so that users would get a uniform, quality experience; over time, however, UGC was expected to dominate. In truth, that hasn’t occurred. The UGC contributions were almost unmanageable. The development team quickly learned that the amount of time required to cleanse it almost negated the benefits of incorporating it. The net result was that the UGC piece has been de-emphasized on the company’s product roadmap. Now, content available through the tour delivery platform will be primarily reliant upon licensed content. To be fair, the source of this content will go downmarket so that, over time, the company will become less dependent on the more expensive content from the travelogue publishers and more reliant upon small, local tour companies going after a more custom, hyperlocal experience.

Still too many competing interests/axes to grind. In addition to the usual spam, quality issues and overall noise with UGC, we were troubled by how common it was to find people using UGC to settle petty scores, rivalries or just to cause mischief.  In recent reporting on the Google/Yelp talks, there is a sobering itemization of the number of lawsuits filed against Yelp from irate merchants and others who feel they were unfairly maligned by anonymous posters on the site. Also a common problem was instances when, say, a restaurant would receive a scathing review only to uncover later through an investigation that the poster was the owner of a competitor restaurant across the street.

Conceptually, I have long been suspicious of sites that provide posters a forum to anonymously bash a restaurant, retail store or service provider without requiring anything from the poster in terms of supporting documentation. Ratings are fine and they have value, to be sure, but abuse has now become rampant on so many UGC-driven review and rating sites. Ask virtually any restaurant manager or small business owner about Yelp or a similar site and it seems they all have a story about an unfair review that they had no way of properly defusing, defending or responding to. One bad review can seriously damage a small business; however, a bad review that is also of questionable merit or is an out-and-out mischaracterization is altogether more disturbing.

Gaming the system. Almost as bad as unfairly maligning a business is the epidemic of hoaxes or “ghost” reviews, usually of the glowing variety, that so often pepper the ratings of certain businesses and skew rating scores to the point that they become meaningless. Stories have become legendary of business owners writing their own rave reviews and, in some cases, forcing their employees to offer their own effusive praise. Yelp and other rating/review sites insist that they are working diligently to address these issues and I have no reason to doubt their sincerity, but clearly this is a big problem.

To be sure, UGC is powerful and will ultimately drive a lot of successful consumer internet businesses going forward. That said, is it no longer the can’t-miss buzzword in an investor pitch. Consumers want unvarnished candid comments and feedback — whether they are restaurant reviews or travel tips — but even more than that they want to have confidence in that information and a consistent experience. With the exception of a few companies that have been able to selectively weave UGC into their business models and maintain that consistent, reliable product, most companies still fall far short of delivering that experience.

RepairPal hits accelerator with new $4m raise

I wanted to take a quick moment today to congratulate RepairPal and its indefatigable CEO David Sturtz on news of the company’s recent $4m funding, led by new investor Tugboat Ventures and some prominent angels. David is a longtime friend – he and I having shared an office some years ago at a technology-focused investment bank – and I have had the pleasure of watching RepairPal take shape from its earliest and humblest origins to the industry leading company it is today. Watching that maturation has been a rewarding experience and there have been a number of “teachable moments” – for both of us.

Virtually all early stage companies evolve dramatically as they add talent, sharpen their focus, and learn things about their respective markets and customers. Some become almost unrecognizable as they adapt their businesses to address market realities. Others still hew closely to the original idea but learn to make adjustments around how and where they choose to compete in their ecosystems. What has impressed me about David and his team is how they have held firm to their original hypotheses about their market, how they invested sufficient time and energy to prove (or disprove) those hypotheses, and how they have always sought to apply new insights and revelations in a way that the business has been able to leverage.

RepairPal, for the uninitiated, provides accurate auto repair and maintenance information for almost all passenger vehicles within every zip code in the country. The company has built patent-pending technology from a team of factory-trained and ASE-certified technicians, which generates more than 70 billion unique RepairPrice Estimates. It also has the most comprehensive directory of auto repair facilities in the U.S. and a proprietary database of each model’s common problems. [faulty timing chains, anyone?]. The idea, simply enough, is to be able to see the expected cost of a typical repair and then see all the local shops that can perform that repair, along with appropriate reviews and other content.

RepairPal is an attractive business on a variety of levels, but I am most excited by how the company is cleverly applying a host of new web and database technologies to remove the opacity that effects much of the $180 Billion auto repair market. However, unlike many other B2C and B2B web businesses of the past, RepairPal is delivering this new transparency without necessarily pitting repair shops against one another or enforcing price compression that can have the effect of undermining the participation of shops on the network. Bringing transparency to an infamously opaque and perplexing industry is not a simple task. Too many other web businesses that have sought to create this kind of ‘marketplace function’ in their respective industries made the mistake of going after quick and easy revenue by seeking to lock up service providers before they fully developed a product that was truly compelling. Too often the result has been an adverse selection problem whereby lower quality providers (dentists, contractors, plumbers, etc) are disproportionately represented while higher quality providers stay away — the logic being that higher quality providers don’t seem to require the additional business or marketing opportunities that inclusion in such marketplaces can sometimes provide.

I believe David and his team succeed because they chose to focus first and foremost on building a robust price estimating engine that drew users to the site and great early reviews by reputable auto authorities. In turn, those usage metrics organically created a network effect whereby shops felt compelled to be included in the RepairPal network. Solid, reputable strategic partners have followed closely behind and become part of the RepairPal network.

Kudos to the RepairPal team. Keep up the great work.

NVCA trends for 2010

The National Venture Capital Association issued a presentation today on VC-reported trends for the coming year, available here. For those who find these reports useful, there are probably a few things in there that could prove to be interesting. The data suggests that most investors are confident that while the industry at large will shrink in terms of the number of firms, the amount of capital deployed should increase in the coming year. There is also some suggestion that firms expect to either maintain current staffing levels or increase modestly. This is in somewhat stark contrast to what was being heard anecdotally earlier in the year concerning layoffs and partner turnover or forced retirements. Whether this is a function of many firms already rightsizing themselves is not clear, but the fear in some quarters seems to have abated.

Taking Money From “Strategics”

A good indication of how challenging funding has become for many startups in the current environment is the amount of capital being sought from (and extended by) strategic investors in rounds recently closed. The renewed influence of strategic investors is a function of a number of things. Some of the more traditional investors in start-up companies (i.e. VC funds and angel investors) have cut back their activities or receded from view altogether. Some funds have been quietly wound down, others have tabled their activities while they determine their future, and still more have been pre-occupied raising capital for their own funds and not yet in a position to deploy capital. Filling this gap have been other venture firms deploying fresh capital in new investment vehicles, other alternative asset groups (i.e. hedge funds) that are not traditional start-up investors but are looking for returns anywhere they can get them, and strategic partners.

Strategic investors, for certain, can be great partners for an emerging growth company. The cachet and validation that come from the investment into a start-up from a big, established player can have significant value and “signalling strength” across the start-up’s ecosystem. Beyond the obvious monetary benefits, having the seal of approval of a well-respected incumbent can accelerate the business and open any number of doors — to other strategic partners, to new hires, and new sources of funding. It can also have a chilling effect on that start-up’s competitors. Like the impact of securing a key endorsement in a political campaign, having an industry leader partner and fund a start-up can set off a wave of scrambling by others in the same space eager to “lock up” the remaining established incumbents lest they be lost to still other start-ups. 

This is all well and good and generally healthy for innovation and competition. However, I get concerned when I hear start-up teams boast about all the inroads they are making with established incumbents without their clearly weighing the significant costs and risks associated with taking capital from large incumbents. There is an uneasy alliance in many start-up/strategic investor partnerships that should not be underestimated or examined cavalierly. It’s good to remember that by their definition (in many cases) start-ups are often seeking to upset the apple cart in a given sector through a new technology. business model innovation, or other means. This is what VCs mean when they go on about their interest in backing disruptive technologies and business models. In many cases, “disruptive” means disruptive to established players and their franchises.

1. Weigh the impact of the capital against strings attached. Management teams should engage with strategics early and often, but they should never lose sight of the impact and costs of having a strategic investor in their company. There is no free lunch in life and certainly not in venture deals. Why does the team think the strategic partner is making the investment? What motivates them? Are there terms in the investment that could complicate things later? How is the investment treated — equity, debt, a blend?

2. Will having the strategic as investor prevent the start-up from working with the strategic’s competitors? Another big concern that should be weighed by management teams is whether taking capital from the strategic partner will jeopardize the start-up’s ability to partner with the strategic partner’s own competitors. In other words, if my mobile apps company takes money from Palm, can we expect to walk into the offices of Apple or Research in Motion (RIM/Blackberry) and expect them to become clients? Do we lose access to those marquee customers by virtue of selling a piece of our company to Palm?

3. Keep an eye out for ticking time bombs. What IP does the strategic feel entitled to as an investor in the company? Are their markets that the start-up might be prevented from entering or products that it may be prevented from launching as a condition of accepting the strategic’s capital? Are their ROFR (right of first refusal) provisions to be concerned about? All these issues could cripple the company later on as it tries to expand or raise additional venture capital.

As with all things related to taking investment dollars into a growing business, careful examination is key. There really are no “good” or “bad” strategics to partner with but there are good and bad deals depending on how they were struck and how the relationships were managed after the deals closed. The temptation to close rounds by any means necessary now is enormous, particularly given the tight funding environment. Some CEOs may be persuaded to simply accept capital from a strategic in order to get off the funding treadmill and back to running their businesses, but the risks of a poorly structured deal and a bad actor can be severe. Time invested now in examining all the angles before agreeing to take in strategic capital will be well worth it in the long run. Unfortunately, your company just might depend upon it.

HubSpot CEO Takes A Swipe At Business Plans

As recently reported in Venture Capital Dispatch, HubSpot Chief Executive and founder Brian Halligan recently lectured a group on the futility of writing a business plan if the ambition is to use it for fundraising purposes. Much of the content of his remarks is consistent with many of the points in my recent post on the subject, The Most Valuable Thing About Writing A Business Plan, so no sense rehashing them here. That said, it’s valuable to get the perspective of a former VC and current operating executive on what helped (and what didn’t) during the fundraising process.

I don’t think I was quite as sweeping in my rebuke of business plans as a tool, but it’s hard to argue with success and Mr. Halligan can boast  $30mm in raised venture funds over several rounds without the framework of a formal business plan to support his efforts. The 2min video is worth a peek.

Gowalla, Foursquare and the Location-Based Services boomlet

TechCrunch reported today on the new $8.4mm Series B round for Gowalla led by our friends at Greylock Partners. This announcement comes on the heels of recent news that Gowalla competitor Foursquare pulled in $1.4mm shortly after its much-publicized appearance at the SXSW conference.

Regular readers of this space may recall earlier pieces in Adventure Capitalist on the broad Location-Based Services (LBS) space and my bullishness on the emerging sector. In 2006, my firm, Citron Capital, was involved in a promising LBS venture, Open Planet, backed by the team that founded GoCar Tours, that was focused on the travel and tourism segment. The company developed a robust tour creation and delivery platform that enabled consumers to enjoy customized tours on their GPS-enabled cellphones virtually anywhere in the world, guided by GPS waypoints linked to the content. The experience was similar to that of a very robust navigation system in a top-line vehicle. The key difference was that instead of receiving mundane driving directions or locations of nearby bank ATMs or gas stations, the consumer would get the kind of rich content you’d expect from a good travel guide like Frommer’s or Fodor’s tailored to the route the consumer chose, and based upon preferences selected by the user. Because the content was delivered via GPS-enabled phone, the “tour” could be experienced in any number of ways – on foot, in a vehicle, on a bicycle, etc. The user would select the length of the tour, the route, their interests and preferences, and the software would create the tour, pulling together bits of content from a massive database of content linked to GPS-waypoints, and deliver it to the user’s cellphone. The preferences were so fine-tuned that a husband and wife could feasibly walk down the same streets in Paris and listen to entirely different tours. He would get content that interested him (sports, Renaissance literature, military history), while she received content related to her interests (say, music, sculpture, culinary, etc.)

The announcements on Gowalla and Foursquare and the attention they have received only serve to underscore how hot the LBS space has become. We wish them well and look forward to additional entrants to a sector that has long been bandied about as a “next big thing.” Unlike a lot of “next big things,” however, LBS actually looks like it’s poised to live up to its enormous potential.

Another Take On VC ‘Brands’

In a recent blog post, angel investor Chris Dixon posed the question of whether VC “brands” mattered any longer. He provided the context of a hypothetical entrepreneur who was in the enviable position of being able to choose between multiple term sheets from venture firms.

Mr. Dixon’s piece was a good one. Dixon’s principal points were that (1) brand matters only with the most august “ivy league” firms whose names alone can increase the probability of follow-on rounds due to the number of later stage investors that base their entire investment strategy on backing companies funded by the top decile funds; and, (2)  having a well-regarded venture investor can help in recruiting talent.

I do not dispute Dixon’s points, but would add extra color. Dixon’s use of the phrase “enviable position” is relevant given the environment we are in. So many entrepreneurs strive fruitlessly for one term sheet, let alone dare to hope to receive multiple term sheets. Discussions around comparing venture firms, therefore, smacks a little bit of  a “nice problem to have” for most entrepreneurs braving the current fundraising waters. Indulging in comparisons on the relative merits of different venture funds when so many entrepreneurs are just trying to keep their companies afloat is a bit of a luxury that few feel they can afford.

Brand still matters, but should be one factor among many. As such, if an entrepreneur is going to engage in this debate, I think there a few other questions that also require exploration. During the dot-com era, some believed that the weight of a top fund’s reputation could carry a questionable company through multiple rounds of financing. There appeared to be a juggernaut effect in evidence in a lot of deals – so many established firms were investors that a belief emerged that with all the reputations at stake there was no way that those companies would ever be allowed to fail. A colleague called this the Ovitz effect, in honor of former Hollywood superagent Mike Ovitz. The origin of this was that Mr. Ovitz was known for stacking his projects with so many big name Hollywood players that the perception emerged that the movie just had to be a blockbuster, lest big reputations be tarnished.

Evidenced by all the failed companies of the past decade backed by prestigious and lesser-known firms alike, this belief has now be soundly discredited. Even the most prestigious venture firm is unlikely to save a company that is doomed to fail.

1. Partner Quality. As Dixon states, there are good partners and toxic partners at all manner of firms, new or well-established. As such, the brand issue is now almost secondary to the matter of partner quality. Who at that firm is going to be on your board and championing the investment within the partnership? Does that partner have a reputation for rolling up his or her proverbial sleeves and adding value to company management or will that partner be tapping away on the Blackberry at board meetings and contributing little to key discussions and decisions?

2. Gauging a firm’s longevity is Critical. When weighing brand it is just as important to weigh internal factors at the firm that are not readily obvious. For this reason doing reference checks on prospective investors is critical. Where is the firm in its fund cycle? Does it have fresh capital from a recently raised fund, or is it at the end of its fund life? How likely will it be able to participate in a follow-on financing? [This is not insignificant. Broken syndicates and hung tranches are a real problem right now.] If it is almost fully committed on its current fund, how likely will it be able to raise another fund?

3. Ecosystem should be weighed. Finally, it’s helpful to evaluate your company and where it is in its lifecycle with the firm that has tendered the term sheet. Has that firm made many investments in your space, or is your deal one of its first? A venture firm well-established in a sector will likely have a deeper rolodex of contacts and more domain experience from which to draw from. The earlier stage the deal, typically, the more important this is. Speed bumps lurk everywhere. Having a partner on your board that has experienced them with other companies in your space can be a big advantage, regardless of brand.

Paying Customers – What A Concept!

This week one of our companies made the critical decision to start charging for its suite of online applications. Hardly earth shattering, one could argue, but it was a harder decision to arrive at than one might imagine. More broadly, given the funding environment, I suspect this is a frequent conversation taking place in the conference rooms of many emerging web services companies.

As a Board, after much debate we came to the conclusion that to fully validate the company’s value proposition we needed to accelerate the path to generating recurring revenue from customers, and that involved customers voting for the company’s solution in the most blunt and unequivocal way of all – with their wallets. Reliance upon a “freemium” or advertising-only based model was no longer sufficient in the eyes of the Board and management.

The notion of customer value is being re-appraised across the start-up community. It is hardly a news flash to say that investors and the market at large are no longer paying for eyeballs, click-throughs or other squishy metrics of a company’s value and overall viability. That said, there still exist many companies that continue to craft their strategies toward accumulating users for the sake of accumulating users without extracting any cost or imposing any particular burden upon them. What too often sustains these approaches is the notion that big media partnerships, sponsorships, revenue-share promotions, or other similar opportunities will eventually come along to monetize the company’s user base.

I’ve never been a big fan of this approach and the tightening funding market in the past year has only made me more wary of companies that are basing too much of their very survival on this kind of revenue model.

To be sure, migrating a company from what was initially designed to be a free model to an all-pay platform is fraught with peril. Customer churn can be significant and the threat of email inboxes at the company being filled with irate customer complaints is a real issue. More importantly, products can be rushed to market that are still somewhat undercooked. Asking a customer to pay for a skeletal, less-than-stellar product that was heretofore free is a tough sell on its own; in an economic downturn it’s even tougher, and the risk of customer backlash is significant.

All these real dangers aside, we are sensing a renewed focus on the investor side toward web products and services that are robust enough to begin charging customers for at launch or very shortly thereafter. Falling into the trap of giving things away for free with the idea that you will make it up on volume is a trap that is extremely hard to extricate yourself from later. Once acclimated to the idea of using web products and services gratis, customers are loath to pay for them — even customers that claim to love the company and evangelize it to their friends and colleagues. Given the tough funding environment and investor insistence upon clear paths to profitability, the better strategy might be to focus upon fewer, paying customers as early as is feasible for the company so as to hit those critical validation points and to prove that, yes indeed, customers WILL pay for the product or service; it’s not just a notion. If the market you are in is sizable enough, there should be plenty of opportunity to grow that paying user base, but at admittedly slower rates of growth because you are no longer giving away the store to anyone and everyone in cyberspace. As one of my CEOs put it, “My 30,000 paying customers beats your 300,000 non-paying looky-loos any day of the week.” At least that’s what his team has decided and the Board has gone along. Admittedly, it’s a huge gamble and it is not an overstatement to say that the future of the company rests on the wisdom of that decision. As to whether he is correct, the market will let us know soon enough.

The 1000-yard stare

There’s a riveting scene in the opening credits of Oliver Stone’s Platoon that came to mind today. Fresh-faced recruit Chris Taylor, played by Charlie Sheen, hustles off a C-130 transport plane along with other newly minted ground troops stepping foot for their first time on battleground soil. They are clearly disoriented. A finger juts into the frame pointing the new troops into the direction they need to move. Moments later a platoon of battle-weary troops approaches single-file toward Sheen and the awaiting C-130. Sheen’s troops are clearly their replacements and the grizzled veterans are heading home. They are ragged, dirty, and gaunt. The last soldier’s glazed eyes lock onto Sheen’s. No words are exchanged but the message is clear and unequivocal: You have no idea what you are in for.

What, you may ask, has this got to do with the venture world? Unfortunately, more than I would like. The funding environment for this year now at a close has been tremendously challenging. A CEO and friend of mine likened raising capital in the current market to waking up every morning, swinging his legs over the side of the bed, tucking his feet into his sleepers, and getting hit in the face with a shovel. Every day. With great prejudice. I thought it was an apt, if somewhat jarring, description of a day in the life of a start-up CEO trying to raise capital in the current environment. There is certainly the spector of the “1000-yard stare” in the faces of many start-up management teams that have had to brave the funding waters this past year and lived to tell about it. “It’s murder out there,” was perhaps never more apt.

For this, and for a thousand other reasons, I am one of many in the community looking forward to raising a glass at 11:59pm December 31, toasting an end to a remarkably difficult year, and hoping that 2010 ushers in an era of recovery, renewal and prosperity for our firms and for our respective portfolio companies. I have been struck recently by the candor of many folks who would ordinarily simply recite chapter and verse that “everything is fine” when clearly very little has been fine over the past year. Admitting that one has faced challenges is not a sign of weakness; indeed, it is a sign of maturity. I have enormous respect and admiration for start-up teams that persevere and that esteem has only increased these past twelve months as I have witnessed some remarkable acts of courage, altruism, leadership, and of great teamwork. In this season of Thanksgiving, I think this year’s may be particularly poignant. Even in tremendously tough moments, I am humbled and blessed to be able to work in an industry that, despite its many faults and shortcomings, can still bring out some of the best in people.