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When Investing Too Early Isn’t “Wrong”

28 Jun

I recently had a twitter exchange with early stage venture investor Mark Suster over the issue of being “too early” as a venture capitalist and what that means in the current climate. While I genuinely like and admire Mark and am not one to publicize my disagreements (or would that be disa-tweetments?) with other investors over what are primarily philosophical matters, I thought the content in the exchange was valuable and supported some re-examination.

Mark made what I would consider a somewhat sweeping statement–namely, that investing too early was the same as being wrong. I responded that this entirely depended on the perspective being considered. Let me explain.

There scarcely exists a technology sector that became vibrant and consequential that did not experience a great deal of stops, starts and stalls early in its evolution. Most of the early “failures” in a space — i.e., companies that had a piece of the solution figured out but perhaps not the entire solution — were venture-backed companies. Many of the same venture investors in those early failures learned from the experience and went on to back later entrants that became juggernauts in that given sector. Were those investors wrong? Would those investors have developed the insights, market knowledge and ecosystems critical to their becoming investors in the eventual market leaders without those early experiences? Would the sector have developed as it did without the flame-outs?

My answer to those rhetorical questions is emphatically “no.” As has been evident  across technology markets for decades, technology advancement occurs in waves of innovation that beget other waves of innovation, and so on. The early failures provide formative experiences for the investors that were involved and for future entrepreneurs behind new entrants in that sector that can plainly see what worked and what didn’t for the previous class of market entrants.

Take, for example, the notion of Pattern Recognition among venture investors. Much has been written about the concept, including an earlier piece in this forum. Tangential to pattern recognition is the idea that a venture investor’s early forays into a sector provide a great education — wanted or unwanted — about what will ultimately be successful in the space and what simply doesn’t work. It also provides the investor a great deal of market knowledge and an ecosystem of supporting companies and entrepreneurs that will serve that investor well for years to come in his or her chosen area of investment, and even in other areas. This is called active cross-pollination and it is critical for long-term success as a venture investor.

To pull on that thread a bit further, venture investing is not a discrete, narrow vertical exercise. Good investors are constantly influenced by outside factors, parallel markets, advancements in technologies that appear unrelated until an epiphany occurs and interesting combinations can result. From the embers of a previous failed investment can come a dormant technology or a seasoned manager that can be re-potted into a new venture and can enable that venture to become enormously successful. The point I make in raising this is that the future success would not have likely occurred without the early mis-step. I have several examples of this in my own career.

There is an oft-told piece of black humor among attorneys about a veteran attorney counseling a young protegé. The senior attorney remarks, “When I was a young attorney like you I lost a lot of cases that I should have won. Now, with my years of experience, I win a lot of cases that I should probably lose.” No one is suggesting that venture investors new to a sector should message to entrepreneurs that they are “learning” on their deals. That said, to maintain that experiences on early investments do not positively inform decisions made on later ones is simply folly.

So, can one be “wrong” by investing too early in a sector, as Mark suggests? Most definitely. This occurs when an investor develops an investment thesis, makes an investment in a company against that thesis, leaves the sector after that company fails to never invest again in the space and never leverage the lessons learned from that experience into other investments. Hopefully, this does not occur very often among professional venture investors. The mere statement that anyone invested “too early” in a sector implies that the given sector did ultimately develop into something substantial. With any luck, the earlier investors that helped shape the sector with early bets were able to prosper by participating in the eventual winners. Historical venture returns seem to bear that out.

Taking Stock of Our Netscape Moment

22 May

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.

My 2010 Predictions: A Look Back

5 Dec

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.

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.

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