2016: The Road Ahead

 

 

 

 

 

 

 

 

 

Before the last New Year’s Eve sparkler flickered out on January 1 there was already plenty of hand-wringing over the direction of the venture and technology markets and the apparent shift in mood since the heady days of, well, just a few months ago.

For the venture and technology markets, 2015 was a watershed year on many levels. The number of “unicorn” companies exploded which, by extension, gave rise to concerns that the term had lost some of its cachet since it appeared the logic behind according billion-dollar valuations had become somewhat unmoored from reality. 2015 also saw the first wave of valuation re-sets by notable and prolific venture investors and, with it, concern that this was a but a harbinger of what would become a wholesale value reappraisal across the venture landscape.

Judging from the recent gyrations in public equity markets, the first weeks of 2016 have certainly not calmed these fears. Technology stocks, and broad market indices, have taken a beating. Many seasoned observers would argue that this kind of market re-set in technology companies was long overdue and, as it happens, healthy and necessary. I would put myself in this camp. The market had gotten ahead of its proverbial skis. Many unicorns had failed to yet prove their businesses’ core fundamentals. Equity capital had been too readily available in 2015 and, thus, helped fuel “momentum investing” by some that perhaps perverted the economics of how startups should be funded, what they should focus upon, and how long-term success should be gauged.

With that preamble, here are some of my top-of-mind thoughts on what we might expect in 2016:

1. No bubble pop, but valuation resets abound.

   I am not of a mind that we are in a valuation “bubble”, per se — at least not in a circa 2000-2001 sense of the word. I don’t think we will see the kind of wholesale collapse in valuations as we did 15-odd years ago. The macro fundamentals are simply vastly different. What I believe we will see, however, is a continued reappraisal and level-setting of valuations across the board and, with it, the failure of a few unicorns that will be both unable to sort their unit economics issues and to continue to raise sufficient capital to buy them enough time to figure them out.

2. A Tougher Equity Funding Environment.

   Venture capital flowed freely in 2015; some might say too freely. For the highest profile companies, venture rounds were raised as if almost on a phone call. While I’ll submit that in 2016 the best companies will continue to have their pick of good venture investors with whom to partner, terms will not likely be as company-favorable, valuations will not be as rich, and the timing to close will not be as brief.

3. A return to traditional venture firms and processes.

   Traditional venture capital firms were certainly not on the sidelines in 2015. Far from it. However, there was certainly a trend of non-traditional venture investors—I dislike the term “tourists” –taking a more prominent role than usual participating in and sometimes leading venture rounds. This often lead to sniping and charges of irrational behavior between firms. Traditional “Sand Hill Road” investors would argue that the non-traditional firms were only winning marquee deals by “paying up” since, by definition, they did not possess a strong brand nor reputation within venture to win such deals otherwise. This, in turn, raised valuations for everyone involved and forced some Sand Hill Road names out of participating in financings entirely. While 2016 is barely a month old, we are already seeing a clear pullback in the investment activities of firms not traditionally associated with backing early stage tech companies. Expect to see that trend continue in 2016, with the advantages going to the more traditional venture brands.

4. A ferocious focus on unit economics and core fundamentals.

   In 2015, the growth of a startup in a new, exciting market–often by any means necessary–appeared to take precedence over the less sexy task of making sure a business’ fundamental unit economics were sorted. Given enough growth and enough users the hope was always that, eventually, all the right curves would intersect. But no matter how exciting a startup or its vision, one can get away with selling dollar bills for eighty cents for only so long. In 2016, while we will continue to see many well-funded startups with negative gross margins, the appetite of investors to continue funding upside down economics has likely peaked. This year expect to see a renewed–some might say, ferocious–focus on unit economics and fundamentals.

   Again, these are but a few macro thoughts as we close out the first month of 2016. By and large, this is not meant to be a negative or cautionary post. I remain firm in the belief that we are in a period of intense innovation and value creation across technology. While there will be some fallen unicorns this year, we will also see some breakout stars and new markets emerge that will fuel even more innovation and market expansion. That said, every market must first digest what it has already consumed. I suspect we will see continued volatility as tech markets rightsize and as we head deeper into an election year. I will post again shortly on some of the tech trends I expect us to see in the coming year.

 

Is The Daily Deal Backlash Overblown?

According to the business maxim, you can always tell who the leader is in a given market: it’s the one with all the arrows sticking out of its back.

While this axiom is applicable across the business landscape it is particularly relevant in the startup world given that most leaders in an emerging market end up taking as much incoming fire from me-too startups coming up from the rear as they do from incumbents threatened by the continued advance on their territory.

I raise this point because I’ve been surprised in recent weeks at the backlash in the media and across the venture landscape against daily deal sites, most notably Groupon and LivingSocial.

To be sure, the daily deals business has become ferociously competitive. There are now dozens of venture-backed businesses pursuing some configuration of the daily deal/social buying/demand aggregation business model. To this number add the emerging group of established web companies now brand extending into the deals business–Facebook, Yelp, Travelzoo, OpenTable, Amazon, and Google, to name but a few.

The birth of any new industry is rarely elegant, planned or pretty. With little argument, whenever one is dealing with the kind of torrid growth that both Groupon and LivingSocial have experienced one will find plenty of areas to criticize. However, I think some of this criticism is misguided. To call a marketplace with hundreds of competitors vying for consumer dollars emerging might be an oversimplification, but emerging it very much is. Let’s not forget that like the early days of social networking, the winning model in this space has not yet been fully realized. Constant iteration is underway, all being attempted at the breakneck pace one would expect in a marketplace still decidedly in its land grab phase. This means things are going to break — loudly and often. This is not altogether bad.

The daily deals space is the kind of web phenomenon we have seen before: Explosive growth, high user engagement, huge cash flow implications for the companies, lofty valuations, investors elbowing their way into funding rounds, and lots of media attention to fuel the frenzy.

In this environment, Groupon and LivingSocial have broken out as the market’s de-facto leaders and built robust businesses. Revenue growth has been nothing short of spectacular. In turn, the companies have responded by raising sizable funding rounds to further consolidate their positions and extend their reach into new markets. Investors and employees have every reason to be proud of these accomplishments. So far, so good.

This, however, is far from saying that their status as perennial leaders is a fait accompli or that they cannot be felled by either other participants or by their own strategic missteps. Indeed, it is still early days. This is perhaps why I find the latest hand-wringing over Groupon’s recent stumbles in the media somewhat disconcerting.

Massive customer churn is to be expected. Explosive growth, particularly as relates to web companies, raises the notion of the shiny new object theory. This notion should inform us that exponential growth and buzz brings huge consumer curiosity which, in turn, brings an influx of users that will try the product/service once and never return. Is this a reflection of a company that has provided a poor user experience? Or, is this simply the realization that 30-40% y/y revenue growth is likely unsustainable and that large swings in customer churn will be in evidence for a long time to come? I am in this latter school of thought.

The “churn” issue so often cited by critics is not simply a matter of consumers being fickle but one of SMBs and merchants as well. They are still trying to figure out how to work with deal sites and whether such marketing campaigns are right for their specific businesses. This will take time.

The Spaghetti Test. Additionally, daily deal sites are incented to build vast Rolodexes and cover wide areas of terrain to extend their brands. This means lots of offers are being written across broad categories of SMBs where the suitability of the daily deal model is still not thoroughly understood and where there is little historical frame of reference. While most managers are loath to admit it, the Spaghetti Test of  ‘throw it against the wall and see if it sticks’ inevitably drives a lot of iteration around determining which offers resonate and which do not. This results in a lot of mediocre offers that don’t perform well which can leave merchants and consumers with a poor experience.

Work to be done. Critics are right to point out that there is still a lot of work to be done in elevating the daily deals business to deliver on the full promise of its massive potential–both for consumers and for businesses. Merchants need better post-deal monitoring and CRM-like tools to help with yield management and provide better tracking and analysis. Merchants also want more control and flexibility over how offers are created, sold and redeemed so they can maximize profits while minimizing the impact on their organization when the “crush” of redemptions comes. [Fortunately, startups are already innovating around these themes to fill precisely these voids.]

Consumers, for their part, are demanding better offer targeting, more consistency in pricing and redemptions, and less intrusive appeals in order to fight against emerging deal fatigue now evident across the space. Personalization software needs to catch up so that users can better tag offers of interest and opt-out of those that are annoying or redundant (Cupcakes? Again?)  Also, Hyperlocal and Location-Based-Targeting need to demonstrate that they are more than just elegant theories.  Too many service-oriented SMBs (i.e. hair salons, etc) have gotten burned in money-losing offers for premium services to out-of-town customers with whom there is no opportunity to develop a long-term customer relationship. That kind of mismatch is being corrected but hyperlocal offer targeting has a ways to go.

Ultimately, the scale that Groupon and LivingSocial have achieved has likely put them beyond the reach of most competitors. The battles ahead, therefore, will be over how best to go vertical. The winners will be those most savvy at customer segmentation and in finding unique offerings positioned against specific themes and product categories. Predictably, there are numerous companies doing precisely that — tweaking group-buying mechanics and applying them to niche, premium markets and making a successful play in those areas. In another market in another time, this “go vertical” approach may have doomed a company to a market insufficiently large to support its efforts. However, as companies such as Gilt Groupe and One Kings Lane have demonstrated, the daily deals market is large enough that even pursuing a niche approach and a narrow customer segment can prove to be enormously lucrative.

Taking Stock of Our Netscape Moment

The LinkedIn IPO came out with a bang Thursday and in the intervening 72 hours the offering has already provoked sweeping re-assessments and re-appraisals of technology markets in general and the prospects for consumer web/social media IPOs in particular. It is hard to argue with success; and LNKD was nothing if not a wildly successful offering. Capital markets elites will bicker over some of the “inside baseball” issues having to do with “small float” mechanics or allegations of mispricing, but such quarrels are really just noise in the overall discussion.  LNKD was the largest technology IPO since Google in August 2004 and provided the much-needed confidence builder for the technology sector that market participants were hoping for. While there have been a number of well-received tech IPOs in recent years – OpenTable, Green Dot, to name a few — LinkedIn was arguably the highest profile name to go public in the past seven years and, as it happens, was one of the fabled five horsemen of consumer web/social media fame — a loose group which typically includes Facebook, Zynga, Twitter, and Groupon — that garner the greatest amount of attention from the media and the highest trading volume in the secondary market.

To be sure, it is hard to overstate the serious ramifications of a failed LinkedIn IPO. That the LNKD offering was an unqualified success bodes extremely well for the long-awaited offerings of Facebook and its peers and provides the proverbial rising tide to lift the respective boats of many lesser-known names in technology. The market validation accorded the LinkedIn offering will have a coat-tail effect across a broad swath of social media companies and venture investors will fast-track plans to find a public exit for many of these companies.

While it is still too early to divine what the long-term impact will be of the LNKD offering, it is undeniable that the morale boost it gave to founders and stakeholders is palpable. The IPO window for tech had been so constrained for so long that there will be some natural reassessment of IPO plans for dozens of companies that were all but assumed to be eventual M&A targets. This is a good and healthy exercise. The notion of “being a public company” has taken a drubbing in the past decade for any number of reasons — too expensive; too much regulation; required disclosures that would only help competitors; plenty of capital already available to good companies in the secondary market; management attention would be siphoned off to cater to Wall Street/institutional demands, and so on.

While the debate over being a public company vs. staying a private one is perhaps a topic for another post, I am in the camp that believes that many of the anti-IPO arguments most often raised in recent years are either overblown or are rapidly losing their relevancy. There are intangible benefits of being a publicly traded technology company that most criticisms — even the valid ones — fail to adequately counter. In the case of LNKD, getting a lofty public market valuation — and, by extension, validation — was critical for the company and for the dozens of social media/Web 2.0 companies that will all but assuredly follow LNKD into the public markets over the coming year or so. The LinkedIn IPO validated recent secondary market valuations of the company and provided the critical corroboration that venture investors and secondary buyers were not simply drinking their own Kool Aid. In time, owning a position in LNKD will become important for many large financial institutions and asset managers, which will in turn support the company’s and the sector’s long-term valuation as well as buoy the prospects of other talked-about social media/consumer web companies as they consider wading into the public markets. And that is a very good thing.

A Bubble over “Bubbles”

 

Perhaps no subject in the venture/tech start-up ecosystem over the past year has received greater attention–and been the focus of more collective hand-wringing–than the issue of bubble/not a bubble. With little argument, there are varied opinions on this and fairly good analysis on both sides. For my part, let me come right out and say it: Yes, we are in a bubble–it is primarily a bubble of prognosticators and market participants of all persuasions tripping over themselves to be the first to call what is occurring in technology markets a “bubble.” Taking a position on this subject might be great for bloggers seeking to drive traffic and for talking heads and Wall Street analysts looking to increase their respective profiles by saying inflammatory things but it hardly gets anyone closer to a reasoned understanding on what is occurring on the ground and, more importantly, on what lies ahead.

Like all good arguments, there are core issues worth having a spirited debate over; and then, there are lots of sideshow marginalia that have little bearing on what is actually going on and what actually matters. [AngelGate, anyone?]

FDR was on to something when he announced that the only thing we had to fear was….(wait for it)….fear itself. FDR knew something about the power of language. The power of language is particularly relevant here because I believe one cannot have a meaningful discussion about current market conditions and the behavior of some market participants without first clearly defining our terms. There are healthy, albeit heated, markets and then there are bubbles, and one does not necessarily beget the other.

I think I speak for many tech market participants in declaring that “the B-word” will be inextricably linked to the 1998-2001 boom/bust cycle that came to define the technology/venture landscape for many participants that were there to experience it first-hand. As such, given the negative connotations and the fairly brief historical context we are dealing with, the word “bubble” is loaded and, hence, problematic. This is not to suggest that one cannot use the word; I simply believe that tossing the word around cavalierly whenever a market becomes heated and — egads! — frothy is overkill and, as it happens, not terribly descriptive.

Fortunately, there have been a lot of smart, experienced people developing thought leadership on this issue. Diverse voices such as Mike Arrington, Howard Lindzon and Forbes’ Eric Jackson have all made impassioned arguments worth reading. I could get into an itemization of points and counter-points on where I am coming out on the question of bubble/not a bubble, but it would be a lengthy exercise and, at the end of the day, something of a transient position given the fast-moving environment we are in.

However, I am fairly confident that while there are some broad similarities between the current environment and the 1998-2001 period, few of the underpinnings behind the ’98-’01 bubble appear to be in evidence in the current environment. In short, there are far more dissimilarities than similarities and those differences are profound: much better companies, real (and often, huge!) profits, better monetization and distribution, true scalability, lower development costs, and on and on.

Additionally, the market froth that exists today concerning valuations is still contained within a relatively small segment of the broad technology landscape and among a select group of (largely) professional investors. By their very nature as “consumer-focused” enterprises, consumer internet companies capture the public’s imagination and garner the greatest amount of attention from the media. [Last I checked, no one was planning a major Hollywood film about the founders of SAP.]

Additionally, much of the current froth in valuations has been primarily directed at a handful of high-profile companies (Facebook, Zynga, LinkedIn, Groupon, et al). While it is true that we are now seeing soaring valuations for some very immature companies across the consumer web space, there is little evidence to suggest that this is driven by anything more than healthy competition among investors and by excitement over the rapid pace of innovation. Given the boomlet in new seed stage firms, “super” angels, and in legacy venture firms that have recently augmented their efforts in consumer web investing, this is to be expected.

All this aside, this does not suggest that I am somehow Pollyanna on the current state of consumer internet investing. There are certain areas that I am watching closely and I do have some concerns. As Fred Wilson has suggested, some investor behavior has become alarming. To my mind, certain investors — but still a minority of them — are getting skimpy on diligence and on the need to be methodical in an effort to move quickly to win certain hotly contested deals. Other investors are caving too quickly on terms or agreeing to extremely generous provisions for founding teams in order to win coveted deals. Again, this is just my opinion and is largely anecdotal, but I am hearing enough similar things from other investors that suggests that I am not alone in that view.

I am also wary about the rapid evolution of the secondaries market and with some of the private stock trading platforms that allow early investors/employees to sell their shares. I think these services are, by and large, great tools for investors and for start-ups but some discipline needs to be employed here so things don’t get misaligned. No doubt, regulatory agencies will get more involved as these secondary “paths” get further institutionalized and begin to bump up against current outmoded regulations concerning investor limits and the like. On balance, however, I think these issues, while concerning at times, are self-correcting.

In summation, I think the consumer web is perhaps three or four innings into an extended period of growth with the lion’s share of attention and the highest valuations being accorded companies that are innovating well and rolling out products and services that consumers are passionate about. Jeff Bussgang posited recently in a post that he felt we were in a “bubble,” but that perhaps the question we should ask was where in the bubble cycle we were–perhaps 1996, versus 2000. That is a clever way to nuance the issue although, again, I think employing the term bubble implies that once this market surge cools there will be catastrophic consequences. While there is reason for pragmatism, discipline and caution, given what I am seeing today in the marketplace, I am not finding evidence to support that.

The Art of the Pivot

With little argument, there has been much written recently on the revival in consumer internet. While there is no shortage of micro-themes behind the current innovation boom in companies focused upon the consumer sector, one area of particular interest has been on “older”, Web 1.0-vintage companies that have succeeded in two critical ways – (1) navigating and surviving the bruising post-2000 tech downturn; and, (2) continually innovating against rapidly changing market dynamics and consumer behavior to emerge as market leaders.

In many cases, the characteristics behind succeeding at point #2 lies in the ability for a company to pivot–jettisoning an initial business model, hypothesis or core focus for another approach or business that appears more likely to be successful. A quick scan of leading companies in the Web 2.0 sphere, broadly defined, reveals a high number of companies already on their third or fourth business model. Some of these pivots can be considered modest iterations on a principle strategic direction while others were wholesale changes to an earlier business model and a dramatic shift in focus.

Athleon, an online suite of coaching and team management applications focused upon the collegiate and prep sports market (where I serve on the Board of Directors), executed a fairly mild but ultimately essential pivot in late 2009 as it abandoned its freemium model for an all-pay platform. Predictably, some feathers were ruffled and there were early adopters upset at the change in policy and direction. That said, customer churn was modest and the change proved essential for the success of the business. 

In an example of a more extreme pivot, a Citron Capital company which began life as an image recognition software provider applying neural nets technology to eCommerce (i.e. finding every e-tailer offering, say, red cardigan sweaters with black buttons) dropped the eCommerce focus in the aftermath of 9/11 and became a security software company applying its facial and image recognition technology to help screen passengers and automobiles at high security checkpoints (i.e., airports, border crossings, etc.) 

Cases of successful pivots are myriad. As such, given the frequency with which early stage companies are often faced with the challenges inherent in pivoting, it is important to explore this topic to uncover lessons from successful pivots and best practices to follow when contemplating a pivot. Here are a few things to consider:

1. Everybody pivots. There was a time not long ago when the notion of pivoting was perceived in some quarters as an unmistakable sign of failure. Fortunately, with the recent and open discussions by founders and early employees about pivoting that went on at some of the biggest names in technology, this stigma has seemingly passed. There is seldom anything more destructive to a company’s long-term prospects than a management team clinging to a failing business model for fear that changing direction would be perceived as weakness.

Companies no less esteemed than Flickr and PayPal started off in very different businesses but pivoted to what the market was responding to and went on to become juggernauts in their respective areas of focus.

2. The initial idea/hypothesis about the business is probably wrong.  Yes, this is true whether or not the founders raised capital against the strength of that idea or not. Experienced angel and venture investors understand that a fair degree of iteration will occur at an early stage company and will, in most cases, support management’s plans to allow the company’s strategy and even its purpose to evolve dramatically provided those plans are well-reasoned. Just as there is seldom anything more destructive to a company than a management team clinging to a foundering strategy, there are few things more damaging than investors that insist that the company pursue the strategy that was the basis for the investment when all evidence seems to support that that strategy is not winning in the marketplace. Fortunately, most investors are properly aligned, first and foremost, with seeing the company succeed regardless of whether the strategy that ultimately works was the one that persuaded investors to initially commit capital to the company. (As a side note, this is why entrepreneurs hear so often how important the team is to an investor. The right team is what motivates an investor to participate in a company. As I like to say,  ideas are easy; execution is hard.)

3. Align Motivations, Not Just Incentives. In start-ups, particularly those with a prominent engineering-driven culture, one common problem can be that some at the company become enamored with building “cool” products first and a successful business second. This, of course, is never actually verbalized. Instead, it is something that becomes evident when the products are built, they are indeed “cool”, but few consumers outside a niche-y, tech-savvy community really care about them. As such, the management team might have succeeded on a technical level — i.e., can they build great products that actually work? — but at the expense of developing a business that is filling a market need and appealing to a broad base of paying customers. In these cases, the pivot has to happen simultaneously with a candid examination of company culture to ensure that everyone at the start-up has the proper goals in mind and are defining success along the same lines. Those that are not “on board” with the new strategy inherent in the pivot are not likely to be happy with the new direction and should be allowed to leave the company.

4. Once the pivot is determined, it should be executed quickly. While careful deliberation is critical before a pivot, once that analysis has occurred, and a new approach is determined, and the team is re-aligned or reconstituted along the lines of the new strategy, the pivot should be put into action quickly.

5. It’s OK to focus the business more narrowly . In many cases a pivot involves honing down a business to fixing a particular problem or serving a particular need. This does not mean the business opportunity is smaller, however. Often, a company launches (and receives funding) because of its focus upon a large market that is in dramatic transition. Almost by default, this means that the company is awash in opportunity. As the company evolves, however, it begins to learn the idiosyncrasies of its market and begins to identify areas where its solution will be most successful and where it will find its raison d’être. This allows the company to avoid the problem of boiling the ocean and/or trying to do too many things. Few start-ups fail because they were too focused.

Some Thoughts On Transparency

Last week I had one of those conversations that kept re-asserting itself in other discussions in the days that followed. The conversation itself was not confrontation nor was the subject matter particularly uncomfortable. Briefly, a colleague and I got into a broad discussion about companies leveraging user-generated content (UGC)–specifically consumer user reviews of and feedback on companies, products and professionals–in particularly novel and innovative ways. While it’s axiomatic that there are significant businesses being built collecting, analyzing and publishing this content (and a great deal of value being derived therefrom), we both struggled with some of the issues coming to light around the impact of this kind of information when propagated without strict quality controls and proper diligence to ensure authenticity and accountability.

With little argument, the notion of delivering “transparency”  — in whatever form – has been at the underpinning of so many web-based business models in recent years. Additionally, with few exceptions, that goal has been a noble and appropriate one. Opacity has been the bane of so many consumers in so many markets that it scarcely makes sense to examine whether or not technology-enabled solutions seeking to open markets to greater and fairer competition have delivered long-lasting value to consumers.  Let’s stipulate that they have and just move on. 

Where things get sticky for me–and, I would imagine, for a growing number of investors and market participants — is the notion accepted almost as religion in some quarters that transparency is always and everywhere a market good. Heretical as it may sound, I think it is time that many in the venture and start-up community have an adult conversation about where and how full transparency is appropriate and about whether enough companies are living up to the weighty responsibilities that come with publishing information that can profoundly damage the reputations of businesses, professionals and/or their products or services.

Regular readers of Adventure Capitalist may recall that I have raised these issues in some form before, particularly in a piece on the state of online reputations. In that post, I drew some examples from the current legal (at least at that time) problems facing Yelp and similar sites from aggrieved small businesses. While I give Yelp and other sites credit for continually refining how reviews are collected, filtered and published, it is clear to me that we are a long way from being able to glean the true benefit of anonymous user reviews and feedback without exposing people and businesses to the risks that reckless and unfair user comments can pose. I remain deeply committed to the notion that platforms that enable users to call out by name and rate/review businesses while those users remain comfortably concealed behind the cloak of anonymity creates a sweeping invitation for mischief.

In the months since that original post on online reputations, I have received an alarming number of reports–both confirmed and anecdotal–about consumers engaging in troubling practices akin to extortion whereby demands are made for deep discounts and freebies that those consumers are not entitled to from local businesses. The not-so-thinly veiled threat is that the consumer(s) will trash the online reputation of those businesses if the demands are not met.

Again, I firmly believe that the majority of users and contributors to online review/reputation sites act responsibly. That said, more work has to be done by companies that reside at the intersection of online reviews and reputation so that all participants are held to the highest standard of ethics and accountability. 

My hope is that this post will spur a discussion. I don’t purport to have an elegant solution to the problem inherent in user-generated reviews and feedback but I am becoming increasingly mindful of the backlash brewing in the small business community against online reputation and review platforms. I am also seeing some of the limits of transparency in specific marketplaces when the end result of that openness is not greater efficiencies and fairness in a given market but, rather, the same kind of unfair leverage, collusion and monopolistic power that transparency was meant to eradicate.

8 Tech Trends for 2011

This being January it is fitting that we take a look at the next twelve months and consider themes that will likely come to define the new year. Given the intense pace of innovation across IT broadly, I’ve kept these themes at a fairly high level.

Last month, we looked over our 2010 predictions and conducted a fairly detailed post-mortem. As such, let’s jump right into a discussion of the themes and trends that I believe will characterize 2011.

1. Globalization:  While many appeared not to notice, some of the biggest names in consumer internet enjoyed robust growth in international and emerging markets in 2010, in some cases dwarfing their US numbers. Expect venture investors in 2011 to spend a great deal of time thinking about globalization, studying the best practices of companies executing successfully overseas, and paying particular attention to web services that can scale effectively across both emerging and mature markets.

2. LBS 3.0: As I touted in my recent piece on the Consumer Internet revival, Location-Based Services is entering what could be considered its 3^rd wave of innovation—one defined not by “check-in” gaming mechanics, but by robust applications offering rich, customized user experiences via applications residing at the intersection of location data, identity and content with mapping technologies and couponing/revenue incentives as the connective tissue binding it all together. Travel is the most obvious segment, but expect to see LBS-driven tools and products penetrate a number of new and interesting markets in the coming year.

3. Demand Aggregation/Social Buying penetrates unconventional markets. Groupon and HomeRun are successfully focusing upon restaurants, salons and other SMEs that lend themselves particularly well to discounted group buying. Expect to see a number of new entrants cleverly leverage social buying/demand aggregation mechanics in less obvious ways. Examples of emerging categories are Travel and Events, where start-ups are developing ingenious ways of enabling emerging music acts to aggregate their global fan base to pre-sell venues in advance of tours—mitigating the risk of financial loss from engagements that don’t sell enough tickets to cover costs. If successful, this approach could revolutionize how live events are produced, promoted and underwritten. Are you listening, LiveNation?

4. Dramatic growth/influence of ad platforms/exchanges. I expect 2011 to be a watershed year for online advertising given the impressive growth and continued innovation in display ad exchanges, bidding platforms and the increased effectiveness and monetization of online marketing campaigns. Direct marketers are being more effective at reaching their customers than ever before. Moreover, traditional media buyers that until only recently eschewed some of the early exchanges and bidding platforms are refocusing on these channels and more readily embracing social media strategies and “promoted” ad campaigns and putting significant resources behind them. 

5. ‘Institutionalization’ of Secondary markets. Many regard 2010 as a year when the secondary market began to gain credibility as a legitimate exit path for companies, early employees and for direct investors themselves. While there appear some clouds on the horizon—i.e., potential regulatory entanglements and frothy valuations/new entrants putting a squeeze on performance—expect 2011 to further institutionalize the asset class. The stigma that was once often attached to being involved in a secondaries transaction seemed to lose its sting as well-known private equity names tapped the secondary market to either provide much-needed liquidity to their investors and/or to “rightsize” their portfolios to prepare for new investment vehicles.

6. E-commerce is sexy again. A new generation of innovative e-commerce companies has emerged in the past year that is pushing the proverbial envelope and turning the notion of traditional e-commerce on its ear. The two micro-themes behind this renaissance in e-commerce are The leveraging of the Social Graph and Customization/Long-Tail Economics.

Shopping online should be fun; it should be an experience of discovery, of sharing, and of leveraging the wisdom of crowds–ideally, crowds of people users already know and trust. A number of  startups are developing ecommerce platforms that cleverly stack recommendations and opinions from friends across one’s social networks with past order history; get instant feedback before the purchase decision; and, then layer in group buying/daily deal mechanics to drive urgency. 

7. Big data has its day: More data is becoming available as more computing devices come on-line through public and private networks. Moreover, the nature of information processing is changing as more analytic work (business intelligence, data mining, decision support) is being leveraged for competitive advantage.

The nature of data is changing as the number of “entities” in any given database has gone from millions to billions to, potentially, trillions.  Unstructured data is becoming the predominant data by sheer volume and is still relatively unaddressed. Traditional database implementations (Oracle, DB2, MS SQL Server) were not designed to handle these types of data, capacity or distributed nature. Finally, the success of Netezza, DATAllegro, Greenplum and others in taking on the big three (Oracle, Microsoft, IBM) and successfully returning value to their investors through acquisitions by IBM, MS and EMC indicate that there remains plenty of headroom in the sector. Companies such as Algebraix are well poised to exploit this market opportunity in 2011.

8. Tablet boom. The Apple iPhone was not the first smartphone, but it was an iconic, game-changing device that revolutionized the category and spurred a wave of innovation around software and services that is far from over. While consumers use tablets quite differently from smartphones, the tablet category is poised to continue on its torrid growth path in 2011. The Consumer Electronics Association estimates that some 30 million tablets will be sold in 2011, nearly double last year’s figure of 17 million. New entrants such as Motorola, Samsung, Acer and Toshiba either have tablets now in the market or will launch offerings shortly. Not surprisingly, expect to see a wave of innovation around applications and services delivered from and focused specifically on tablets.

The deepening penetration of tablets is impacting the launch of new applications and even new startups seeking to leverage the white space between smartphones and laptops. It is already evident that many companies consider tablets a clever way to extend their services and brands into environments where the options heretofore were unsatisfying. Companies such as Athleon, an online coaching and team management collaboration platform, are developing tablet applications that will enable ‘in-field’ use much more effectively than a smartphone application ever could.

Time To Rethink ‘Walking Dead’ VC Firms?

Recently, an entrepreneur I once worked with reached out to me for advice on raising his next round. During the conversation, he rattled off the names of a half-dozen or so venture firms that he was in discussions with. Evidently, these discussions were not progressing as well as had been hoped. I suggested two more firms particularly focused on his space that he should be speaking with. Upon hearing the firm names the entrepreneur responded that he had already dismissed the idea of approaching one of the firms because it had appeared on a list of “Walking Dead VC” firms on a VC/tech-focused blog. I was startled at the entrepreneur’s haste at dismissing the firm and his willingness to so quickly accept as gospel what he read on a blog without further investigation. This was particularly unsettling given the entrepreneur’s company hung in the balance. This got me to thinking…

Over the last few months I have seen various reports in the trade media about ‘Walking Dead’ VC firms and the apparent parlor game going on in some quarters about handicapping which funds will successfully raise a follow-on vehicle in the future and which firms will likely shut their doors. I understand the schadenfreude behind some of these exercises but I think it has reached a pitch that is troubling, possibly damaging, and certainly counter productive.

To be sure, the venture industry is going through challenging times. Some recognized firms are being wound down and more will undoubtedly follow. [I have written on this subject extensively and even called it a 2010 trend to watch earlier this year.] There are those that argue that this winnowing of firms is long overdue. There are others that posit that venture capital has been over funded for some time and that this is simply a Darwinian process that must occur so that the industry can emerge more healthy and so that limited partners can see regular distributions and more stable returns again. For the most part, I have no argument with any of that.  

What troubles me is the idea that there exists some sort of demarcation line between healthy firms that will successfully raise follow-on vehicles and those that will not. I have even heard one observer posit that if a venture firm has not raised a vehicle in the post-2008 financial crisis era, it is as good as doomed. This is nonsense. There are many firms with funds raised pre-2008 that have plenty of dry powder to make investments (both new and follow-on) and plenty of time to shore up their respective funds’ performance–that is, assuming that performance needs shoring up–in order to raise follow-on vehicles. These are hardly ‘walking dead’ firms. Indeed, one could make the argument that firms like these are precisely the firms most likely to be actively looking for new opportunities.

Unless a firm has publicly announced that it is winding down, it is better to avoid labeling a fund as “walking dead.” Tagging a fund in this way has consequences.  As in the case above, it can impact deal flow as companies seeking funding may think twice about approaching a firm believed to be in that category. It can hurt a firm’s prospects of being invited into syndicates and even potentially damage a firm’s existing syndicates. It can jeopardize relationships with current and prospective LPs if a forthcoming fund is even a notion among the firm’s GPs. Finally, and perhaps most troubling of all, it can even damage the prospects of portfolio companies backed by these supposed walking dead VCs.  

These same sentiments apply to start-up companies as well. Talk in the press of start-ups ‘circling the drain’ are often poorly reasoned and based upon shaky anecdotes and innuendo. Venture firms, like start-ups, can go through rocky patches only to emerge stronger and more successful than ever.

There exist many examples of firms thought by some to be ‘walking dead’ that went on to enjoy big exits and raised follow-on vehicles. It’s startling what one big exit can do. One significant success can reverse the fortunes of a moribund fund almost overnight. I’ve seen it many times.

It’s an old cliché that a rumor is often just a premature fact. However, the appearance of problems often brings about precisely those problems. The mere mention of troubles at a certain firm can too often become a self-fulfilling prophecy. Once the proverbial blood is in the water, things begin to take place that can hasten the demise of a firm that might have otherwise recovered from its challenges. Rumors have consequences. Ask Bear Stearns or Lehman Brothers.

Water cooler conversations have their place, but I prefer never to count anyone out until the lights go dark and they start selling off the furniture. Until then, it’s anyone’s game and it’s better to wish them well than predict fume dates and pink slips. The venture business is challenging enough.

My 2010 Predictions: A Look Back

Around this time each year we in the tech/venture community turn our attention to the year ahead and pick trends and themes that will presumably shape the coming twelve months.

To my mind, no view forward is complete without a retrospective on the year drawing to a close and, with it, a re-examination of themes that were ostensibly to define the year. From that perspective, let’s take a quick look at the trends I identified in my Ten Tech Trends For 2010 post from January and assess how I fared.

1. Green Shoots But No Chef’s Salad. Given an abysmal 2009 by most accounts, that 2010 demonstrated greater activity across the tech landscape—from rising public and private company valuations to overall investment pace—was hardly cause for jubilation. That said, the pace of financings, the froth in early stage valuations, and the continued strength of the M&A market surprised many of even the most bullish of observers. Grade A-

2. Physical Media dies..a little more. On September 23, Blockbuster dropped the other shoe and finally, unceremoniously—and mercifully—declared bankruptcy, thereby joining the ranks of now-defunct juggernauts Tower Records and Virgin Megastore  and putting a very public face on the continued disintegration of physical media.  Grade A

3. Strongest IPO market in (almost) a decade. We began the year with some impressive tech names filing their S-1s, or threatening to do so, but few of the most closely watched companies ended up taking the public exit route in 2010. While the pace of IPOs in 2010 was a significant improvement over that of 2009, Facebook, Zynga, LinkedIn and Silver Spring Networks all remain privately held entities, albeit very successful and very well-funded ones. To be sure, the vigorous secondary market and the continued institutionalization of that market played a significant role in enabling these companies to be cavalier about the prospect of going public. With no shortage of capital available at often sky-high valuations to companies like Facebook and Twitter, a key pressure point for CEOs seriously considering a public exit—providing liquidity to early employees and investors—was largely mitigated. Grade B

4. Entrepreneurs Reign Supreme. Facebook, inarguably the most closely watched privately held technology company, is still helmed by its 26-year old founder despite its torrid growth and its having raised hundreds of millions in capital. Groupon, which this past week reportedly turned down a $6 Billion takeover offer from Google, is considered the fastest-growing technology company in history and will reportedly generate $2 Billion in revenue this year. It’s CEO, Andrew Mason, is all of 29. The story of the ‘return of the entrepreneur’ cannot be told properly without remarking on the revival in consumer internet and how there exists renewed investor comfort and appetite for young founding teams that really understand consumer web services and products. Grade B

5. Changing of the VC guard escalates. Despite a frothy early stage market and big (still private) successes like Zynga and Groupon becoming household names in 2010, fundraising for venture firms remained challenging. One explanation offered in my January post was the lack of distributions from many venture firms for the better part of a decade. The fundraising picture did not particularly improve in 2010, despite a strong M&A market and some decent venture-backed IPOs. While first-time managers have long faced headwinds in the LP community, in 2010 many branded legacy firms struggled to raise follow-on vehicles as well. In cases where established funds were successful in raising follow-on vehicles, many of those vehicles were considerably smaller than their predecessors.  

Venture funds that moved too slowly to adapt to changing market conditions, or who have not managed partner succession adroitly, or who missed the boat on fast-moving areas of investment will continue to struggle to maintain relevancy in 2011. Grade B+

6. Vertical Social Networks Catch Fire. My position that users would “continue to demand rich content, ubiquity and connectivity of social networking platforms” has certainly been supported by the marketplace. However, the predicted boomlet in vertical social networks did not come to pass in 2010, although usage across the category expanded dramatically. That said, there were a number of recent product launches and acquisitions by the large “horizontal” social networking companies that appear to support the notion of offering robust vertical solutions with custom applications idiosyncratic to those vertical markets. Grade C+

7. EnergyTech has its Moment. The clean-tech community rang in 2010 with high hopes that a big-name IPO coming from the space would spur a wave of exits in its wake and finally quiet naysayers that felt the sector was overheated and would not generate returns to overcome the significant investments made there over the past decade. Twelve months in, Silver Spring Networks remains privately held and there is some speculation that investment pace and enthusiasm has cooled in EnergyTech as of late. Grade C

8. Early Stage VC Returns To Form. In perhaps the biggest story of 2010, early stage venture investing—particularly around consumer web, cloud computing, digital media and web services—came back with a vengeance. The year also brought new terms to the venture lexicon such as “Micro-VC”, “super-angel” and “Angelgate.” Personal note: Thankfully the BIN 38 kerfluffle has blown over and I can make the wine bar my regular post-dinner nightcap spot again. I don’t have a problem with what happened there (or didn’t happen there, as many insist.) I just wished the people in attendance that night had chosen an iHOP. Grade A

9. Alternative Fund Models Gain Momentum. 2010 undeniably brought creativity back to the structuring of investment funds. The clearest winner was the Pledge Fund, which never really went away but, rather, benefited from renewed interest in seed stage investing. While the emergence of novel fund models was partly an answer to a tough venture fundraising environment, 2010 also brought new categories of funds that were derived for specific purposes—such as to purchase early employee and angel investor stakes in popular technology companies. Grade A

10. RIP the 2 & 20 Fee Model. Tough fundraising environment or not, the 2 & 20 model is alive and well and remains baked into the subscription agreements of a majority of venture firms. That said, few new venture funds were actually raised in 2010, raising the prospect that should 2011 be similarly difficult for fundraising this debate may re-ignite. Grade C+

In summation, I’ll give myself a B+ average. A few items were clear winners and there were no glaring missteps. Share your thoughts here. In next week’s column I will issue my Top Tech Predictions for 2011.

Mary Meeker Talk at Web 2.0 Summit

Morgan Stanley’s Mary Meeker delivered an interesting speech at the Web 2.0 Summit on current market trends in the broad consumer internet/Digital Media space. Ordinarily, a talk on this subject from a banker/analyst would not move the news-worthiness needle enough for me to make it into a blog post, but Meeker has had a unique voice in the space for some time and the content-rich 18-minute clip gives a good overview on where the sector is and what macro trends are most in evidence.