Archive | February, 2010

“Angel Finders” Are Often Neither

28 Feb

As any lay student of economics will be aware, in times of market dislocation, “cottage industries” will pop up to fill the market need. In college, the dearth of available and affordable student housing created a seedy underworld of apartment brokers that would charge fees to students to secure them housing. Often times, these were hardly outside “finders” at all — they were often the apartment managers themselves. Rather than simply offer the apartment to the best applicant, as their job description would suggest, these managers carved out a nice little side business for themselves by effectively auctioning off the available apartment to the student — or typically, the student’s parents — most willing to pay the highest finders fee.

Fortunately, while securing funding remains challenging in the current environment, I have yet to hear of angel groups charging finders fees to invest in companies. Let’s hope it doesn’t come to that. Instead, there seems to be a bit of a boomlet of groups and individuals offering start-ups introductions to investors and charging for the service. This is nothing new. Some angel groups have long charged start-up companies to present at their conferences and many of these angel organizations continue to defend the practice as necessary to offset organizational and event costs. I would suspect that there is merit in a few of these cases, but I do not understand why these angel organizations cannot devise another compensation model so that struggling start-ups are not footing the bill.

Jason Calacanis recently opened a new salvo in this debate by taking issue with a few angel organizations that charge start-ups to appear at their conferences. Additionally, there are individual “finders” now openly offering introductory services to start-ups for upwards of $7,500. This fee is not a success fee, mind you, it is simply for the introduction to a venture fund or angel investor. Whether that introduction leads to an investment in the start-up or not is irrespective of the fee burden to that company.

Like most in the venture community who have opined on this, I take issue with any group or individual that charges companies simply for an introduction to a potential investor. However, where I part company with the other critics is that my opposition to the practice is not based upon some discomfort I have in fee-based services for start-ups as a whole. There are lots of good advisors and consultants out there that work with start-ups.  In the course of a year, I see many pitches for potentially promising companies that are a mess and could really benefit from an experienced set of eyes to refine them. This can be quite valuable. Refining a set of documents or helping on a young company’s strategy is enormously time-consuming and these advisors should be properly compensated. Equity is best, but one cannot pay the mortgage on equity alone given the high failure rate of young companies. Painting these professionals with the same brush as “angel finders” is quite unfair as many do good work helping young companies grow their businesses and attract funding. Rather, where I find the whole “fee-based introductions” that angel finders practice objectionable is that it seems to completely undermine itself with bona fide investors. Let me explain. 

“Finders” come in all shapes and sizes and even the most reputable professional services providers often either directly or implicitly dangle the carrot of investor introductions to secure their start-up clients. Some of this is legitimate; much of it dubious at best. The most common complaint I hear comes from start-ups themselves who engage high-priced Silicon Valley law firms for their legal work based upon the assumption that the law firms will tap their VC networks to help the young companies secure required funding. While this does happen in some instances, I would submit that this is more the exception than the rule. Many on the investment side receive daily email blasts from these kinds of firms hocking their latest clients and often times these cold pitches are a quick one-way trip to the deleted items folder.

Bottom Line: While many high-priced, pedigreed law firms do good work and are a value to the community, if you are a young, cash-strapped start-up and you’re hiring a $500/hr law firm to do your most basic corporate formation work mostly because you think that that law firm can get you in front of ivy league venture firms, you’ve already proved to me that you’ve flunked Entrepreneurship 101.

As to the looser confederation of intro-only finders out there, common sense should prevail here. Never pay for just an intro. If an angel finder or other intermediary loves your company so much that they feel it is fundable among their “network of angels and VCs” then they should either (1) prove that conviction by putting their own money in the deal; or, (2) get involved as a board director or in another capacity where they have equity and, hence, a stake in the company being funded.

Think about it this way: when a venture or angel fund is sent a deal referral from an intermediary, the first thing that is considered is the value of that relationship. If this is someone the fund has known for some time and that generally refers interesting deals, the fund will give that deal more consideration that if the opportunity came from an unknown person or “over the transom.” The second factor the investor looks at is what the interest of this person is in showing that investor this particular deal. The VC partner or angel fund deal manager would ask: Is he/she an investor? Why are we getting it? Why our firm versus the hundreds of other firms out there? However, If the VC or angel gets a deal from someone who is being paid just to make the intro, it’s pretty much a dead issue. For a referral relationship to be valuable, it has to be based upon reputation and reputation is only built over time by being associated with quality companies and quality entrepreneurs. A Rolodex of top venture firms can be wrecked almost overnight by sending out low-quality opportunities. If the angel or VC intermediary is being paid for an intro, that intermediary is not discriminating because it implies that any company that pays the fee will secure the intermediary’s services, which means the value of the referral to reputable investors is just about zero. Indeed, the intro from this kind of intermediary could be more damaging than no intro at all because the venture and angel community is very small and no investor wants to feel they are looking at an opportunity that is being shopped simultaneously to everyone else in the community from someone being paid to do so.

Eco-friendly: Finally Going Mainstream?

19 Feb

I spent a fascinating morning with the founding team of green product e-tailer Runka.com and I’m happy to see how well this eco-friendly product category is developing. For years now, those of us on the “coasts” often fell into the groupthink or bubble mentality that drove the flawed thinking that products and services that got traction in markets like the San Francisco Bay Area or New York would be embraced by the rest of the country. People with an interest in eco-friendly products and practices were reasonably concerned that these were “niche” areas for investment. Outside the “dark greens” – those that might grow their own vegetables, compost their waste, and eschew most things one might consider typical of an American lifestyle – there were not that many customer groups that could reliably support many green-oriented products. This was particularly the case when most anything bearing the “organic” or “eco-friendly” label came with a 30-50% price premium over more mainstream, branded products.

Any reasonably talented farmer or craftsman can create an eco-friendly, organic, or fully biodegradable foodstuff or knicknack of some sort of another, but the reach of that product would almost always end up being fairly local and the market for it miniscule. The challenge has long been for more mainstream manufacturers to provide everyday products — batteries, fabric softener, etc — that were both environmentally sensitive and price competitive to branded products commonly and traditionally available for consumers.

Happily, I think we might be getting there. While garden variety ‘green-ish’ household goods like low-watt light bulbs and eco-friendly detergents have been around for some time, we are now seeing some exciting new product categories come along that offer a ‘green alternative’ for most any household good or clothing item imaginable. Even product categories that would appear to be by their very nature ecologically hostile — auto care products and supplies, for example — are now offering greener, cleaner and more sustainable options.

If Runka.com is successful it will be in large part because the “crunchy, hacky-sack” connotations eco-friendly products have long battled are slowly being shed. There is also the matter of the greater reliability of green products. Growing up, I remember trying household cleaners, shampoos and other products that were ostensibly environmentally friendlier. Often times, they were terrible. They smelled bad and couldn’t clean worth a damn. I yearned for my Clorox wipes and my Prell. Fortunately, product efficacy has come a long way just as attitudes have shifted. To be sure, Runka’s site needs further refinements and the company could benefit from a tighter product mix, but if there is room for a “green” Amazon.com, Runka could be as ideally suited as anyone to be that kind of dominant market player.

Dare I say it, the green movement is growing up. This May 1st will be the 40th anniversary of the first Earth Day. Not quite an overnight success, but a major accomplishment nonetheless.

MySpace On Life Support?

11 Feb

MySpace CEO Owen Van Natta is unceremoniously shown the door nine months into his tenure and GigaOm‘s Om Malik and others begin calling it yet another irrefutable sign of the great and inevitable unwinding of a once-mighty web property. Malik’s piece is both persuasive and blunt. There is little argument that MySpace has been adrift for some time now and that parent NewsCorp‘s interest in shedding most of its web properties has been a poorly kept secret. Regardless of where MySpace goes from here, what should strike fear in the hearts of many Web 2.0 venture investors and acquirers of web properties is the inconvenient truth that once these companies begin to go bad, righting the ship is an almost impossible task regardless of who is deputized with that thankless duty.

A quick chronology of the broad social networking/social media landscape since early last decade bears some examination as it helps underscore a bit of the brutal Darwinism at work here. A “first wave” of Web 2.0 companies like ICQ, eGroups, Evite and others begat a “second wave” comprising companies such as Friendster and LinkedIn. As has been well-chronicled, Friendster captured early leadership in the burgeoning social networking space, going from 6 million to 20 million users in the space of a year and obtaining venture backing (and instant credibility) from storied firms such as Kleiner Perkins and Battery Ventures. During this nascent period, it was not entirely clear what users wanted and valued from a social network platform, so there was a good deal of iteration and guesswork on what features would be most important to users. The conventional view, offered with the convenient benefit of 20/20 hindsight, was that Friendster erred by not offering the rich user experience that users were demanding and had trouble managing its own growth. MySpace came along and effectively leapfrogged past them, offering pix, blogging, message boards, and other features that users were clamoring for. This clash of the Titans was all playing out at a time when Harvard undergrad Mark Zuckerberg was shuttling back and forth between Calculus and English Lit classes with what would later become current industry behemoth Facebook little more than a crude prototype on his dorm room laptop.

What a difference a few years makes. It’s been said that in the web space one lives by the sword and one almost always eventually dies by it as well. In my view, these words were never more true than when discussing social media/networking platforms. The current early obituaries for MySpace may strike some as a bit of gallows humor and crassly premature, but there is little denying that should MySpace succumb to its current troubles or be reduced to a shell of its former self it should serve as a wake-up call for companies such as Facebook and Twitter. MySpace almost assuredly hurried the demise of Friendster, and Facebook and Twitter could well be responsible for many of MySpace’s current woes, but the dynamics behind this Darwinism has not changed in any meaningful way. The ‘hot, new nightclub’ problem I wrote about some time ago that particularly afflicts social media/networking companies remains unabated without any particular company resolving this issue with any satisfaction. Social networking platform users remain tremendously fickle, are completely portable, and will almost assuredly drift to newer platforms, technologies, and devices.  The key question will be, ‘is there a second Act for these companies?’ Can today’s social networking/media juggernauts continue to expand their businesses fast enough so that once an emerging player begins whittling away users (as is surely inevitable) these companies will have successfully built other core products and services to evolve and remain relevant?

 Facebook and Twitter have made enormous advances and should be credited with continually exploring new ways for users to connect, share and (in some cases) transact on their platforms. Still, the elephant in the room gnawing on the ottoman is now starting on the curtains. Even the nicest, swankiest restaurant in town does not remain on top for long. New establishments pop up, cannibalize the business by wooing diners wanting a flashier, trendier experience, and the older restaurant must evolve or close. Savvy restauranteurs know this and always bake into their financial forecasts a honeymoon period of high growth and revenues followed by a twilight period of declining business and, typically, eventual closure of the business. It’s somewhat remarkable to me that social networking platform start-ups continue to pitch me and other venture investors with investor PowerPoints and financial plans that seem to imply that they will never be outmaneuvered by a newer competitor offering a flashier, if not better, mousetrap that will trigger an exodus of their users. They need to start.

Revenue ‘Quality’: All Money is Not Green

5 Feb

Dave McClure — entrepreneur, tech gadfly, angel investor and now venture capitalist — issued a blistering broadside to the industry in a recent blogpost on the impending death of a lot of ad-driven business models. To hear McClure describe it, except for a few acquisitions of interesting startups on the basis of enormous growth (eGroups, MySpace, Skype, YouTube, etc) or advertising potential (Admob, DoubleClick, RightMedia) “mostly the decade has been an uninterrupted string of uninspiring business models and small-time acquisitions of Web 2.0 startups filled with rainbows & unicorns, rather than those based on simple, transactional revenue models.” McClure follows that point with his belief that the start-up business model 2010 and beyond will rely, instead, on subscriptions and transactions-based revenue.

This issue touches on the topic of revenue ‘quality’ which I’ve grappled with for some time and that now (thankfully) I am seeing echoed across the investor and entrepreneurial community as a serious debate. As McClure points out well, start-ups have long been using some form of CPM and CPC ad-monetization as almost a given and it was accepted virtually without debate. This mantra has been showing its cracks for at least the past 4-5 years and has been truly under fire since about 2007.

Building web businesses whose sole purpose was to drive traffic, which would then hopefully be monetized through ad revenue, is just not the comforting and tenable business strategy as it was some time back. We have now seen multiple examples of web businesses that have built huge brandshare and mindshare through enormous, but temporary, spikes in traffic and usage only to see that traffic drop off dramatically through cannibalization by other market entrants or through user attrition. Attempts at stickiness and at building network effects through some facility can work to stem the exodus of users, but often those attempts by themselves rarely reverse the effects of a bad business model.

As regular readers of this space will be aware, one of our portfolio companies, Athleon, recently migrated to an all-pay subscription based revenue model. It was not a decision made lightly. That said, now with the benefit of a few months of hindsight, we can say that it was certainly the right decision for the company and was consistent with where the company needed to go in its evolution from a fun, free but somewhat noisy platform, to a professional-grade solution that delivered a best-in-class product to a serious community of users willing to pay for the benefits of membership. One of the hypotheses behind that decision was that the migration would naturally cause a significant user churn, but that those users were likely of minimal value to the company going forward.  We were hanging our hopes on the idea that 3,000 paying customers that loved the product were infinitely more valuable to Athleon as a company than 30,000 users who were unwilling or unmoved to pay for the service. As the company enters a new fundraising cycle, we maintain that this adoption of a subscription-based model will enhance overall valuation for the company because we posit that subscription-based revenue models are simply of a higher ‘quality’ than comparable ad-based revenue models. This is the case because many subscription-based businesses operate like a renewal business, so recurring revenue is far more predictable and certain, especially if the buying behavior of the customer set involves budgeting the cost of the service in their annual requisitioning process, as is the case with Athleon.

 As Dave McClure makes clear in his piece, the internet may strive to be the free, ad-driven egalitarian resource that has become so idealized in the culture but it certainly cannot work that way in most circumstances. Payrolls need to be met and, at the end of the day, goods and services need to be valued by the most obvious, crude and meaningful metric of all – hard-earned cash from users, not just advertisers. As the industry recovers, I expect to see valuations improve for many web businesses but I don’t expect to see a return to the kind of exit multiples of revenue some ad-based business were commanding pre-2008 market meltdown unless there are some significant changes in their core business models to expand far beyond just advertising.

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