The Ponderings of Woodrow

Jeff gets the Microsoft/Facebook transaction exactly right...

Jeff reflects on a recent VC industry event he attended, and addresses the Microsoft/Facebook transaction; getting it exactly right.

Lot’s of grumbling about Facebook being valued at $15 billion and “how could Microsoft do this to us?”. Let’s be clear about something, Microsoft didn’t pay $15b, they paid $240 million out of their well stocked bank vault for pole position and, as Jim Long speculated, it doubtful they spent much time on the valuation. Will Price made the most salient point about this in questioning why FB would do this to themselves considering they have made their future employees options worthless.

Think about that for just a minute, if you already have options in FB the news that the company is worth $15b in that calculation (and it’s unavoidable irrespective of what people think FB is really worth, company valuation insofar as options calculation is a rigid event driven process) is great. I would imagine there were a lot of private wealth managers descending on FB HQ to tell employees how they could collar their options even though there is no market for them at the moment.

If you have yet to be hired by FB this news is no good news because it’s not like FB is going to give you $10m in options for being a senior product manager. I can only imagine some of the awkward conversations FB has been having with prospective employees about options these days. Basically, FB made it a lot harder for themselves to hire good people who understand cap table math.

I was on a blog hiatus at the time of the Microsoft's investment in Facebook but I can tell you that I was baffled at how many people were looking at that transaction through the wrong lens. I kept hearing about the "absurdity" of the $15B valuation as though that valuation has any real-world value. As Jeff says so well, the REALITY is that Microsoft used an infinitesimal amount of its cash hoard to secure:

• A relationship with the fastest growing social network
• A call option on potential future negotiations with Facebook
• A much needed "win" against Google

Now, there are also plenty of reasons why Facebook agreed to the deal, but Jeff (channeling Will Price) does bring up an interesting point as to what this does for Facebook's ability to hire in the future. Then again, that's a problem that all companies face that scale. I'm not a VC, but intuitively it strikes me that it's rare for employee #500 to get rich on stock options at any company. Maybe my VC friends can put some meat on those bones?

Note: This is not a recommendation to buy or sell MSFT or any other security, but is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over, did maintain a long equity position in Microsoft but reserve the right to alter our holdings at any time. We also may, at times, carry derivative options on underlying positions as a hedge.

microsoft facebook jeffnolan vc software woodrow enterprise irregulars

Preparing for a downturn in software spending...

As many of you know, my partner and I recently moved offices and are now sharing space with Insight Venture Partners. Insight is one of the largest and most well-established venture capital firms in New York and the team has always maintained a keen eye on the world of enterprise software.

I've just recently had the chance to meet Peter Sobiloff, who coincidentally this week penned a timely post  at Sandhill.com on what software companies must do to survive an economic downturn.

Ready for a Downturn? by Peter Sobiloff
Software companies with a plan for bad times will not just survive a downturn– they will emerge stronger than before.

I encourage everyone to read Peter's post in its entirety as I think he hits on many of the issues facing software companies of all sizes in the coming year or two. With that said, I'd like to highlight a few of his points specifically and react to them from the perspective of a public-equity investor in the space.

Point 1: A Downturn is Likely

Peter cites a confluence of factors for his cautious outlook:

• Weakening credit conditions
• Consumer confidence
• Rising gas prices
• Housing market woes
• Weakening dollar
• The upcoming Presidential election

I wholeheartedly agree with all of Peter's points, but would add two more to the equation:

• Employment trends -- The third leg of the U.S. consumer fallout relates to employment. Thus far, employment trends have been surprisingly resilient, but this week's rumor of massive layoffs at Citigroup is, in my view, a harbinger of things to come.
• Beijing Olympics -- I'm a believer in the BRICS phenomenon as a long-term secular growth driver; but given the valuations being afforded the Chinese equity market (and other emerging markets); it would be foolish to think that the MARGINAL rate of economic growth isn't vitally important for global IT spending trends. With the Beijing Olympics coming next year, there is a very real catalyst for China to slow down its torrid growth (with little thought of inflation) in the second half of next year.

Point 2: This Downturn will be Different from the 2001 Bubble

...It is impossible to talk about a downturn without comparing it to the dotcom crash of 2001 and the subsequent recession. But if a downturn comes next year, the drop will be different and not nearly as steep. Here’s why.

The dotcom boom was characterized by immature and unproven business models which exposed tech companies across the board. A startup that wasn’t making money would buy Cisco equipment and Viant’s consulting services. That cycle of economic activity based on immature models was bound to fail.

Today’s software companies are much more mature. All tech companies have learned a lot of lessons which set them on much more sound footing than during the dotcom era and will help them during a future downturn...

There is no question that the technology markets (and the U.S. equity markets on the whole) are far better positioned than we were in 2000; when "irrational exuberance" was a stark reality. Software valuations are in-line with historical levels. That is to say, publicly-traded software companies are neither particularly expensive nor cheap based on historical comparison (both relative to the market indices as well as measured against absolute earnings, cash flow and revenue growth multiples).

That said, I do worry a bit about Peter's second analogy; i.e., the issue of immature bubble companies spending money on Cisco hardware and Viant services. Although we don't have that to worry about this time, we do have a tremendous amount of spending coming from the emerging economies. All of those companies in China, India, Indonesia, Brazil, Russia, etc...have been building with extremely cheap access to capital. That certainly argues for a lot of froth (and poorly managed enterprises) that could very quickly close off their spending spigots. That's a risk that is also impossible to quantify, because we have very little reliable data on the true econometrics driving many of those countries.

Point 3: Downturns can be an Opportunity

...Economic cycles – both up and down – are always an opportunity. Like anything else, the more prepared a company is, the better it will ride out either cycle.

Executives must communicate with management about a potential downturn, have a specific action plan, have “buy in” for the plan at all levels, and build the business in a “componentized” way that enables progress during tough times. Savvy companies can use an economic trough to execute strategic M&A deals and gain ground against their competitors.

The software companies that operate strategically during a downturn will emerge as stronger businesses for the long term.

Peter is spot on here. The software industry has matured considerably since the late 90s. Growth rates, in aggregate, have slowed but that's as much a function of the industry gaining scale and importance (it now figures in at about 25% of IT spending). Well-run software businesses are attractive in good and bad times. With unbelievably high gross margins; software companies that are pragmatic can effectively control their spending and protect margins in downturns (i.e.,slow down hiring, pare back poor-performing sales reps, consolidate G&A through M&A and outsourcing). In addition, while license revenues can fluctuate considerably, maintenance revenues remain predictable and sticky. Subscription revenues (an emerging line item as SaaS gains popularity) are, as well. Many software companies are sitting on boatloads of cash.

Software companies with a plan in place; and a pragmatic, forward-thinking executive team will come out of this downturn better off.

sandhill sobiloff insight insightventures vc software best practices downturn investing woodrow enterprise irregulars 

VC is to Optimism as Public Equity is to...

Last week, I had the chance to catch up with Brad Feld over lunch while he was camped out at Union Square Ventures. It was great to finally sit down and chat with Brad face to face, as we'd played "email tag" far too often in recent months. We missed each other when I was in Boulder in March, and then I couldn't get free in July when he was last in the city.

Alas, good things come to those who wait and we riffed about myriad topics in between bites of delicious sandwiches at 'wichcraft. One of the topics we touched on was a recent post Brad made on AskTheVC:

Q: What is the one common element you’ve seen in successful VC’s?

A: (Brad) This is an easy one.  Before the snarky ones in the crowd answer “nothing”, I’d suggest that its “optimism.” I have yet to meet a successful VC that isn’t optimistic about the future and the companies he is involved in.  I particularly like the Wikipedia description of optimism, which is “the overarching mental state wherein people believe that things will more likely go well for them than go badly.”

We were in agreement that Optimism is a quality universally required by successful venture capitalists. But what about public equity investors like yours truly? Is SKEPTICISM the appropriate analog for public equity investors?

From Merriam-Webster:

Skepticism

skep·ti·cism

Pronunciation:

      \ˈskep-tə-ˌsi-zəm\    

2 a: the doctrine that true knowledge or knowledge in a particular area is uncertain b: the method of suspended judgment, systematic doubt, or criticism characteristic of skeptics

There is certainly an argument to be made for skepticism as a necessary trait of successful public equity investors. Company management will always tell you things are going great, until they're not. The next time a management team signals problems BEFORE a thoughtful analysis of the fundamentals warns us will be the first. Aspire for the best, but prepare yourself for the worst.

But the more I think about the idea the less convinced I am that skepticism, by itself, fits the bill. I also think successful public equity investing requires pragmatism, decisiveness and circumspection.

What do you think? And what qualities do you believe all investors share? I can think of many qualities that successful venture, private equity and public equity investors have in common.

bradfeld vc optimism traits skepticism investing publicequity woodrow enterprise irregulars 

SuccessFactors IPO a Success

Amidst the ongoing market turmoil, SuccessFactors (SFSF) was able to price a successful IPO this week. The offering (co-led by Morgan Stanley and Goldman Sachs) priced at the top end of its proposed range ($10) and stands at $12.75 after the first two days of trading. Considering how bleak the market has been over those two days, it's an auspicious debut.

SuccessFactors is the latest in an ever-increasing number of SaaS IPOs. The company raised just over $100mm in the IPO and carries a market cap north of $500mm. My good friend and HCM analyst Jason Corsello has weighed in on the company several times:

• The Looming SuccessFactors IPO
• SuccessFactors IPO - My Take and What It Means
• Why SuccessFactors is the Hottest Vendor in Enterprise Software

I'd like to extend a congratulations to Lars and the team; as well as the VCs involved in this successful deal. One of the funds I manage is a passive investor in SFSF by way of Granite Global Ventures; congratulations to them on yet another winner.

With a successful offering comes real opportunity to grow the business; but being a publicly traded company also brings with it new challenges. SuccessFactors competes in a niche of the market that already has several successful public companies; including Taleo (TLEO), Kenexa (KNXA) and Ultimate Software (ULTI). Authoria is also probably not far off from a public listing potentially. In addition, SFSF will need to deliver on quarterly expectations and must dance the delicate balance of maximizing growth and market share, while at least showing a push toward profitability and margin leverage. I'll be keenly interested in whether the company can use its newfound capital to fill out the whitespace in its services offerings and, in turn, prove itself the equal to Taleo; who has tremendous momentum among customers and the financial community.

Note: This is not a recommendation to buy or sell SFSF, TLEO, KNXA, ULTI or any other security, but is merely a personal analysis to foster discussion for informational purposes only. At the time of this writing, I and/or funds I maintain discretionary control over, did not maintain a direct position (long or short) in any of the companies mentioned but did maintain a passive investment in SFSF via our participation in Granite Global Ventures. We also may, at times, carry derivative options on underlying positions as a hedge.

successfactors sfsf saas hcm talent management investing jason corsello woodrow enterprise irregulars

Don Dodge muses on the imbalance between VC-backed inflows and exits

Don Dodge consistently puts out thought-provoking content on his blog, and today is no exception. Don serves as Microsoft's liaison with the venture community, handling business development between VCs and startups.

Today, he takes a stab at the ever elusive question of how one reconciles the imbalance between VC and angel capital investments versus the sparsity of identifiable exits. 

I encourage you to read his piece in its entirety, but here is the key finding:

• Exits have averaged $18B over the past 6 years while investments have averaged about $40B over the same time period.

In Don's piece he combines venture and angel investments, with venture making up $24.2 billion of the $40 billion figure. I would be interested in hearing from some VCs on what percentage of the exit data would be attributed to venture-backed entities versus angels. I was frankly startled to see that angel investments comprise such a large annual nut.

It's also important to remember that Don chooses arguably the most difficult vintage in venture history for this piece. Given the long-term nature of venture investments, we really can't judge 2002-2006 vintages for several years to come. And certainly the 2000-2001 vintage is one most of us would like to generally forget.

That said, even if we normalize for a bad starting point, I agree with Don that it's awfully difficult to look at these numbers and come away with an overtly positive viewpoint. The IPO market is loosening up a bit it seems, and there are certainly some interesting companies in the pipeline. But will this be enough to reverse the negative IRR trends Don's data points toward?

One friend of mine in the VC business [who shall remain nameless] suggested that this data points toward the oft-cited "80-20 rule". That is, the top decile or quintile of venture funds generates a preponderance of the returns. Is this true? I can't say; but I would love to hear from the VCs who read this blog on where they think Don's data measures up and where it might fall short.

Note: At the time of this writing, I and/or funds I maintain discretionary control over, maintained  long equity positions in MSFT and YHOO but did not maintain a position (long or short) in GOOG or IBM.

don dodge venture capital exits vc microsoft google yahoo ibm M&A woodrow enterprise+irregulars

Brightcove raises a trove...

Quite a week for Brightcove, the online video publication and distribution provider backed by Jeremy Allaire. First, Senator Barack Obama used the Brightcove platform to announce an exploratory committee for a potential 2008 presidential run. Then today, the company announced a whopping $59.5mm Series C round.

This deal strikes a cord for several reasons:

• The size of the round is notable...total paid-in capital is now north of $81.2mm.  Bambi Francisco reports the deal carried a $220mm post-money valuation. This may seem like a huge amount of money for such a young company, but it may be necessitated by the increasingly competitive market Brightcove competes in.  With more than 60 online video sites in play, and with the culmination of GooTube, Allaire and his team are making the bet it's "now or never."

From Jeremy Allaire's blog: If the Google/YouTube deal was any indication, 2007 is clearly going to be a major year for online video, and also a year of consolidation as many of the hundreds of online video startups seek a place in the new ecosystem.  We also expect 2007 to be a year where established media companies make more bets, and continue to partner with leaders they can trust and who are well aligned with their desire to maintain choice and control over how their video is used online, while also empowering consumers.

• A diverse, non-traditional group of investors is piling in...I fundamentally believe we're in the early stages of the blurring of the lines among traditional alternative investment classes; and today's news reinforces that hypothesis. AllianceBernstein, a publicly-traded megacap that managed more than $650 billion led the round. Maverick Capital, the $10B hedge fund participated, as did buyout firm Brookside Capital.

Related Posts:

• Youtube, Metube, Everyonetube
• Brightcove's Latest Publicity...Missing the mark somewhat?
• AOL invests in Brightcove...what about Kontiki?
• Light the 'tiki Torches...Verisign nabs Kontiki

Note: At the time of this writing I, and/or funds I maintain discretionary control over did not maintain a position (long or short) in AB, VRSN or any other company mentioned.  

 

brightcove iptv vc convergence woodrow

AskTheVC launches...

Congratulations to fellow Enterprise Irregular Brad Feld and his partner Jason Mendelson who have launched a great new service, AskTheVC, which effectively institutionalizes a lot of the VC-work they've been doing on their own blogs for years. If you're interested in learning more about the VC industry, or simply have a question you want to throw at them, I encourage you to check out their site and add the feed to your reader.

Brad assures me that my question (submitted about a few days ago) is in the queue and will be a topic of discussion in the near future. I don't want to steal their thunder but suffice to say it involves the growing trend of hedge funds as co-investors in venture deals.

askthevc brad feld jason mendelson blog enterprise irregulars woodrow

The Virtuous Cycle of the Blogosphere...

A few months ago Jeff Nolan left SAP to become CEO of Teqlo; embarking on a bold ambition to reshape the way software-based processes are developed, assembled and architected. Not long after, fellow Enterprise Irregular Rod Boothby announced his resignation from Ernst & Young to pursue a new opportunity.

Well, if there was ever any doubt on the power of the blogosphere to shape one's circle of influence and personal brand, take a look at today's announcement. Rod has joined Teqlo and will be working with Jeff to help build out the library of Teqlets in addition to more traditional business development work. Rod really captures the power of the personal brand in his post from a few days back:

My wife and I just arrived home from a 6 day trip to Kauai.   The reason for the trip?   We were celebrating my new job.

For me, one of the most amazing things about my new job is that the job found me through my blog. I am going to be writing more about the job and the amazing company I am joining over then next few days, however, in the short term, I'd like to focus on describing how this blog has helped me move on to the next stage in my career. [continued]

Congratulations to everyone involved. Getting to know Rod over this last year, not only have I found him intelligent and competent, but his enthusiasm and passion for the power of social software within the enterprise is unmatched. Rod embodies what Teqlo stands for in so many ways.

Meanwhile you already know where I stand on Jeff and the Teqlo team. It's great to see the Enterprise Irregulars fostering a virtuous cycle, allowing one another to explore opportunities they otherwise wouldn't have been able, or willing, to pursue.

rod boothby new venture teqlo innovation enterprise irregulars irregulars good luck woodrow

YouTube, MeTube, EveryoneTube and another few dozen video sharing companies...

Paul Kedrosky is fond of saying the venture business is a bubble business. This ties into the truism that competition in a segment "validates the opportunity." Intuitively, it would be silly to think that any idea with real merit wouldn't invite multiple startups and VC backing; particularly in an environment where there's too much capital searching for too few deals.

Perhaps no segment better exemplifies this paradigm than the online video distribution and sharing market.  Just a few months ago, there was plenty of debate about which company and approach was the best. I had profiled a few of them including Kontiki [since acquired by Verisign] and Brightcove, but obviously the tour de force has been YouTube and it's $1.65B acquisition by Google. YouTube's massive takeout is quite likely going to be the best exit in the current vintage [regardless of segment]; or at the very least right near the top; and that means plenty of other people are going to try to ride the crest.

Light Reading, best known for its coverage of telecommunications equipment and networking news, has a fantastic profile of the video sharing space. Phil Harvey profiles 61, yes, SIXTY ONE!!!, companies that are attacking the space in some way, shape or form.

• Web Video Cheat Sheet [Light Reading]

I also threw the data into an EditGrid spreadsheet. Please make sure to give credit to Light Reading though if you re-use the data for any reason.

• EditGrid Live Format
• PDF Format
• HTML Format
• Excel Format

It would be fascinating to tally how much venture money has gone into these 61 companies; if anyone out there had access to this information and would be inclined to run the numbers, I would be most interested in hearing the outcome.

Note: Hat tip to Tom Forenski, who first made mention of this article in his own blog

Note: At the time of this writing I, and/or funds I maintain discretionary control over, maintained long equity positions in MSFT and YHOO. We did not maintain a position, long or short, in TWX, GOOG, VRSN, NWS or SNE. We also may, at times, carry derivative options on underlying positions as a hedge.

lightreading video sharing excess capital content video VC web video youtube brightcove google yahoo grouper veoh videoegg editgrid revver sharing woodrow

Kawasaki learns the youngins'...

Guy Kawasaki is very fond of lists, and for my money I find his posts hit or miss. That said, he knocked one out of the park today with his friendly advice for the soon-to-be post grads who are oh-so-interested in jumping aboard the VC freight train now that the industry is solidly back in a fund flow upcycle.

• The Venture Capital Aptitude Test (VCAT)

The entire piece is funny yet poignant, so give it a read (if you haven't already). Here's a highlight...

The ideal venture capitalist has an engineering or a sales background. Engineering is useful because it helps you understand the technology that you’re investing in—for example, is the entrepreneur trying to defy the laws of physics? Sales is useful because every entrepreneur has to introduce a product and sell it. For the third time in this blog, let me say, “Sales fixes everything.”

The three worst backgrounds for a venture capitalist are management consulting, investment banking, and accounting. Management consulting is bad because it leads you to believe that implementation is easy and insights are hard when the opposite is true in startups. Investment banking is bad because it leads you to believe that everything can be reduced to cells on a spreadsheet and that companies should be built for Wall Street, not customers. Moreover, investment bankers are oriented towards doing deals, not building companies. Accounting is bad because it leads you to believe that history not only repeats itself, it predicts the future.

Guy's a smart guy and obviously he knows that successful VCs come from all walks of life, but at the end of the day his underlying message is that there's no substitute for life experience. This extends to all walks of professional life.

One of my colleagues is fond of saying, "you don't know what you don't know"...which isn't merely a pithy truism, it really holds water in a lot of circumstances. The older i get the more I realize how much I don't know; in fact, I would say for many of us, our actual depth of knowledge is inversely proportional to our own perception of it.

kawasaki vc vcat experience irregulars career advice investing startups woodrow