VCinJerusalem

Facebook Fallout: Nobody Wins, Especially VCs and Start-Ups

You have heard me go on before about why I thought the valuation Microsoft gave Facebook for its "strategic investment" was way out of line (nice way of saying absolutely ridiculous). Below please find analysis by Daniel Primack (of PEHub fame), which I think is spot on, so simply reposting in...bottom line, Dan thinks that "Microsoft’s initial investment may be one of the worst venture capital deals of all time."

Not only do I agree, but want to add that in addition to being terrible deal for MSFT, also sent shock waves through the entrepreneurial ecosystem, even here in Israel, which made entrepreneurs (and some VCs and Angels) silly for several months. All of a sudden every idea for a new social network was deemed to be worth $5 million pre-money...which is one of the reasons Jerusalem Capital did make any new investments since September 2007.

We already see that people have come back to reality, a bit. Anyway, here's Dan:

                                                                

	Dan Primack | 1191 articles posted | contributor since 11/2006         read my column ...
Facebook’s Valuation Problem
Topics: VC Deals,  PE-Backed M&A,  PE Exits		This entry was posted on 05-09-2008

 

The WSJ recently reported that Microsoft is sniffing around Facebook, less than seven months after investing $240 million in the social network at a $15 billion valuation. It was largely discounted as the hopeful fumblings of Steve Ballmer, in his search for a rebound acquisition after being dumped by Yahoo. But it got me to thinking: Microsoft’s initial investment may be one of the worst venture capital deals of all time.

Longtime readers know that the current title-holder is Hummer Winblad, for its Napster investment in the midst of that company’s legal morass. And it will remain that way, as Microsoft’s Facebook deal presents neither the legal difficulties nor the likelihood of a total write-down. In fact, it’s probably been a good strategic deal for Microsoft, which doesn’t need to sweat the small stuff (i.e., cash). The only caveat to that last part is that Microsoft is now expected to overpay for all its other acquisitions, which has led to a trickle-down throughout the Web 2.0 market. For example, macro valuation inflation helped scuttle the Internet roll-up envisioned by Ross Levensohn and Jon Miller — as their targets upped their respective asking prices.

Anyway, back to my thesis. The reason this might be one of the worst VC deals is that all of its negatives fall on its supposed beneficiary: Facebook.

This isn’t a dilution argument, but rather one of public perception. Social networks partially work because of functionality, and partially because of bandwagon popularity. You don’t necessarily join and use Facebook because it works well, but perhaps because your friends have joined and use it. And, as has been proven with MySpace-Facebook-Beebo, that usage can be fickle and prone to migration.

Public perception is very important, and I think the Microsoft investment has set Facebook up for a giant egg pie in the face. For example, imagine the endgame is to go public. If so, there is no way a company with such low revenue could possibly get near a $15 billion valuation (this isn’t 1999, and Facebook isn’t Google circa 2004).

So let’s generously imagine it could get $5 billion. Know what the headline will be? How about: “Facebook Files for IPO.” Looks good, but check the subhead: “Social networking company worth just one-third of 2007 valuation.”

Ditto for an acquisition, as no company in its right mind would pay close to $15 billion for Facebook. Yes, that includes Microsoft.

What this means is that Facebook is going to lose heat upon liquidity, and a loss of heat can lead to a loss of cachet. Remember all the buzz when Facebook got the $15 billion? Now imagine it again, but with a negative spin (particularly outside the TechMeme bubble, where most of Facebook’s users actually live).

All of this is exacerbated by the fact that Facebook never really needed to take the Microsoft money (could have gotten it elsewhere), and certainly didn’t need to confirm the valuation in a press release.

The only out I see for Facebook is to take another big strategic investment at the $15 billion figure. It could provide liquidity for Facebook’s early VCs like Accel (whose LPs would really like some payoff) and other employees looking to turn their paper green. And, yes, that probably means Microsoft again. If not, that original investment will hurt Facebook far more than it will help it.

Note: Much of the above argument was first made (to my ears) by venture capitalist Stewart Alsop, at this year’s VC in the Rockies conference. It took my a while to come around, but I’m now there. Hope he doesn’t mind the pilfering.

On Yom Hazikoron, It Hits Home

I was standing at our local community center Yom Hazikaron (Memorial Day) ceremony last night when I looked around and noticed my friend Aharon Horwitz (for more on him and his projects see here ) there as well, along with many other friends and neighbors, a true local community recognition of a national event. When I got home, and checked my email, found reflections that Aharon had already written and sent out, and far more articulate and personal than anything I would say. So Aharon is my guest blogger for the day:

Dear friends,

On Yom Hazikaron I try to personally honor--and ask those I know to as well--two soldiers from my unit (Nachal 931, August '99 draft) who died in service:  Dani Cohen and Shani Turgeman.

Standing tonight at the Baka community memorial ceremony my thoughts were already on Dani when, to my surprise, a boy from Bnei Akiva read aloud to the community about him. Dani, so it turns out, was a counselor at the neighborhood chapter. I didn't expect that, didn't even realize that I was daily walking the neighborhood bereft of Dani, the same neighborhood he'd invited me home to for Shabbat in the year 2000 (how I wish I'd taken him up on that invitation). Dani's name joined tens of others, sons and daughters of the assembled bereaved who sat among the rest of us mourners. Seeing the families and accompanying friends and community members reminded me that a soldier in Israel is never alone, accompanied as he or she is by the hopes and dreams of a country, and by the love and firm faith of a family. So much is risked on every soldier we send out. So much is lost when they fall.

I, like each of you, honor those like Dani and Shani who sacrificed for their friends, fellow soldiers, and for all of Israel, and pray this Yom Hazikaron for the day when no more soldiers will be added to the lists of fallen. The mitzva of Yom Hazikaron must be to rededicate ourselves to personally striving for that future day. As Dani wrote in a letter of premonition to his parents, "the point of life is to be the part of the puzzle you were meant to be to the best of your ability....to give rise to future generations better than yourself either by influencing your children or those around you. I, it seems, am destined to be one of those who had to make his difference by impacting those around me." To me that is the undying call to us from these who have fallen in service: one's life is to be spent--as theirs was--in pursuit of a better future for those who come after. And in that sense, both Dani and Shani lived life to the fullest.

Dani died in the November 2002 battle near Ma'arat HaMachpelah in Hebron. Shani, serving in the reserves, was killed near Lebanon during the attack that lead to the kidnapping of Regev and Goldwasser. May their memories continue to inspire the living.

Thanks for remembering with me,

Aharon

If a "Tweet" Falls in the Forest....Does a VC hear?

If you have not yet heard of Twitter you are part of the blessed 99% of the population of the Western world that are not "early adapters." For professional reasons and general curiosity of the 1% (I consider myself to be a bemused observer of the early adapters) I signed up for Twitter back in January, although Twitter has been around as a public service since October 2006 (see here for more on history).

OK, so what is Twitter? Its is a messaging service limited to 140 characters...wait, all of you semi-Geeks ask, isn't that the same as SMS? Well, yes. And aren't there dozens of companies that allow you to message blast from/to mobile phones, PCs, etc.? Yes. So what is new about Twitter? Well, nothing and everything. Nothing technically new, that's for sure.

So what is/was new about Twitter? Well, they picked a funky name, that's always important (think Yahoo!, Google, Ebay...). And they specifically marketed their service to US semi-geeks (think self-important VCs and well-known bloggers). And timing was right, when [finally] the 1% crowd in the US felt comfortable messaging from their mobile devices. And of course after the first blogging wave, which already prepared us to be interested in complete nonsense(;-)).

One of the "features" that Twitter added (this feature exists in many blogging platforms) is to sign up to receive the tweets of a certain Twitter. Basically, to get their micro-blog feed. The 1% crowd loves this, all zapping messages to one other all day long.

As I said, I signed up, literally to just see what the sign-up process was like, see how it worked. Sent a few twits to test web/sms interfaces. haven't twitted in quite some time. But slowly slowly people have found me on Twitter and have signed up to "follow" me. So far only 18, but half of those people I don't even recognize their names! And there is nothing to follow.

To understand better how Twitter is being used by the 1% crowd, I popped over to Brad Feld's Twitter home page, and see that he has 1,383 people "followers" and that he is "following" 132 people. Very believable, and reasonable, given that Brad is one of the best living VCs, and prolific blogger. Persusing through his "tweets," I recommend he stick to blogging, and stop tweeting, but whatever makes you happy.

And then I looked at super-uber-blogger Robert Scoble's Twitter page, and see that he is sending tweets every few minutes (while awake, and sometimes while sleeping). He claims to be following 21,209, and to have 22,545 followers. Meaning every time he sends a tweet, goes out to 22,545 people. That's a lot of virtual ink. Does this make sense? Could he really be keeping up with 21,209 people? Doubt it, but maybe he has outsourced himself...

Bottom line: with all this tweeting, does Twitter make any money (you knew I was going to ask)????

Answer: a few weeks ago, on their Japanese version, started running some ads. Other than that, nada. no revenues.

The aptly named Peter Kafka wrote the other day on Twitter's current fundraising round, see here (asking the age old question, but this time for Twitter, How Much Is Twitter Worth?):

The bigger question: How do you put a value on Twitter, anyway? The company has only just started seeing a trickle of revenue, via advertising on its Japan version. But beyond that there's no money coming in, and it's not clear what the model will be.

While Twitter itself has great buzz, we hear the majority of the site's traffic comes from outside the site, via other apps like Twhirl, mobile access, etc. So traditional online advertising--a difficult prospect to begin with for a communications service (see the struggles of various IM, email platforms) may be even harder.

That said, based on Twitter's growth and brand dominance, $75 million post-money seems plausible. There must be a pony in there somewhere.

I am sorry, Mr. Kafka. A company that has no real technology, a usage base of uber-geeks, and no significant revenue should not be valued at $75 million. It's bad for the business of creating businesses.

SKYPE: Cheap.Com Just Isn't Interesting...Especially if Not an RFB

I learned the expression RFB (Real Frikkin Business) from my friend Jeff Pulver , in response to my describing a new start-up idea. As many of you know, I believe should pay for things, and I believe businesses should only continue to operate if they have a coherent business model.

Officially I am on vacation this week, due to the Jewish holiday of Pesach [Passover], but made the mistake of reading the free International Herald Tribune left in front of my hotel door this morning. In the business section was this headline: "Skype offers a flat rate calling plan." Bottom line of Skype's innovation, is that for certain groups of countries, pay one price and then "unlimited" calling (there is fine print which actually limits it to fair use). This "innovation" has been offered for at least 4-5 years by  probably over a dozen companies.

This is it...this is the big innovation we see from Skype ...how depressing. Cheap telephony is so 90s (believe me, I helped create it!). No wonder my old company, Delta Three , trades below its cash and was just delisted from NASDAQ--they too failed to bring out any new innovations since 2000.

As we head to the second half of Passover, may we be blessed to emerge cleansed of all this [over]leavened bread -- all these companies that fail to innovate and/or republish old stories. Its time to move on, to liberate IP telephony from "cheap,"and have VoIP become cool again.

VC as Motiviating Coach: GO FOR IT! Vyond a Finalist for Start-Up of the Year

One of the most important characteristics of a successful start-up CEO is the ability to inspire his team, much like the team captain in many sports. But who motivates the motivator? The coach. A successful coach can empower the CEO, inspiring her to be a better captain. A good coach  does not try to replace the team captain, but helps keep her spirits up, pushing her to reach deep down and lead the team as best she can--and sometimes to go beyond what she thinks possible, "winning against the odds."

In my short career as VC, I have found that  my best moments are when I inspire (OK, sometimes more like nudge....) my CEOs to be the best they can be, and more.

To jump into start-up life is not easy--and to be the CEO of an early stage start-up is probably the most stressful position in business life.  VCs, I believe, need to provide  a good  support system,  that sometimes reminds the CEO how much  she should believe in herself -- to  Go For It!

I experience this almost every day, but one pleasant example: TheMarker, Israel's leading business publication, together with Microsoft, are running the annual Most Promising Internet Start-Up (in Israel)competition. With the deadline approaching, I coached/nudged Adi Ashkenazy, CEO of our portfolio company Vyond to enter the competition. Adi, like all start-up CEOs, is juggling many things, under all kinds of pressure...and did not at all think Vyond would win...I coached him through it, reminded him just how cool our product is, and he got the application in. I am proud to say Vyond is one of the three finalists (chosen from hundreds of start-ups), with the overall winner to be chosen/announced at TheMarker annual conference on Sunday. I will be there, very proud of Vyond whether we come in first or not.

Are VCs To Blame For "Free?" And Is Free Model One Size Fits All?

Excellent posting by Hank Williams today on Silicon Alley Insider, which is one of my favorite sources. See full text of his original post below, and definitely check out the discussion that erupted within minutes on SAI...back and forth brings out the angst that many of us have been dealing with over the past few years.

With the success of Google, who weave billions of dollars of profit from millions of "keywords", convincing the world that a "click" has inherent value, there has been a run on the bank. Literally. Everything is now supposed to be supported by "advertising." But remember, as I have often said, in the end someone needs to buy something. That's how advertising works. Otherwise its a massive ponzi scheme.

Traditional media companies have always had (and will have) advertising as a dominant (and sometimes sole) source of revenues. But advertising was never 100% of the revenues, think of movies, video games, even most daily newspapers. There is a price. It is not free.

And now think of services that are not media companies -- there is no historical justification for free. Salesforce.com, a pioneer of using Web X.0, charges. And many gladly pay. Is Gmail free? For now. I doubt it will last, and if it does will mean a re-shuffling, but not complete revolution.

Advertising has its place, but I for one am tired of very smart entrepreneurs acting like deer in the headlights, who have been brainwashed by VCs with too much money that usage/users  are all that's important. We will be facing a capital crunch in the days, months, and years ahead -- those who have developed real revenue generating businesses will survive.

I agree with Hank, that VCs are killing many businesses, but there will be a revival of the dead. Make sure you are prepared!

Free" is Killing Us--Blame The VCs

             

Hank Williams             April 4, 2008 9:20 AM        
                          I believe it should be possible to start a small business and to have a small number of profitable customers, and to earn a living. From there, it should be possible to work hard, and to grow your business into something substantial. Until recently, this was the American way, and it applied to technology as much as to any other business. But no more.

In today’s “free” world, in most online business categories, it is inherently impossible to start a small self-sustaining business and to grow it. This is because in the digital world, advertising, the only real revenue stream, cannot support a small digital business. If businesses were based on the idea that people paid for services then small companies could succeed at a small scale and grow. But it is very hard to charge when your competition is free.

The economic problem with advertising businesses is that advertising businesses do not work without really significant scale. In the past, a good product or service could address a niche and succeed without being a home run. Today, a home run is required because if you do not reach a massive scale, advertisers are uninterested. And even if advertisers could be attracted, CPMs are so low that the revenue would be inconsequential. Small Internet businesses don’t work.

So how did we get here? In a word, VC.

Venture capital has totally distorted the market. VCs are investing billions of dollars in companies with instructions to get big fast and to worry about advertising revenue later. As a result the competition is for users and not for paying customers.

Unfortunately, to fix this, many more companies need to die.

With less “free” floating around, a more regular supply and demand dynamic can take hold, customers will have to pay for the things that are important to them and non-quantized growth dynamics can return. In the meantime, why should consumers pay for products and services that VCs and their pension fund investors are willing to give away for free?

The good news is at some point VCs will indeed realize how dumb all of this is and stop giving away everything of value on the Internet. This will all stop when the average VC can’t get any of his/her companies to scale because there is just too much VC sponsored free stuff out there. Then and only then will this crazy eyeballs business model redux finally be put to bed.

I cant wait.

SAI Contributor Hank Williams is a New York-based entrepreneur. He recently launched a new blog: Why Does Everything Suck? Exploring the tech marketplace from 10,000 feet.

    

   

When Everything Goes Wrong...VC, CEO, Board Be Prepared

Today I spent a few hours dealing with one of the "downs" in start-up life. Biggest deal portfolio company X was working on came to a screaming halt. Not important for this posting as to why the deal got pulled -- important is how the company deals with it. As we are still too close to this situation, will not speak to how CEO of company X and us, his board, are working through this issue (but trust us, we are, and will not only survive but thrive).

But do want to point out that CEOs and boards of early stage start-ups need to constantly be ready for "When Everything Goes Wrong." Because inevitably it will! If start-ups do not operate in that mode, i.e. always being ready for the worst case scenario, then they are not being responsible start-upists. VCs who want to play in "seed" stage start-ups either need to be really deep pocketed or really smart (that would be us ....;-)). Being really smart means planning for the worst, and working for the best.

Is that an almost impossible tension to live with on daily basis? Sure, but "buyer beware," "enter at your own risk" to start-up land. If you want to have a guaranteed salary and multi-year job security, well, then get tenure at the nearest university.  Yes, Big Company could theoretically provide that job security, but only in theory, because here today and Bear Sterns gone tomorrow...

Back to our main issue, planning for worst scenario, for when everything goes wrong.

Number one, what is your back-up plan? If you need to think about it under fire, you will not be able to think straight. So make sure when everything is going right that you have that plan, constantly updated, just in case.

Number Two, look at your cash. When things "go wrong," will make it obviously much more difficult to raise more money -- and you will need to survive in order to thrive. For most entrepreneurs, going without salary,or reduced salary for some period of time, is acceptable. For staff of start-up, usually more of a stretch. But a charismatic  CEO sometimes can stretch it...to a point. People do need to put food on the table.

Number Three, look at your cap table. Know it by heart at all times. You will need to be prepared for intense pressure on cap table both from bringing in new cash (if necessary) and providing incentives to staff.

And finally, just remember that just as things can go all wrong, they can all go all right -- and pray you have just gone through the worst!

As Determined As A Turtle: Start-Ups Need to Stick To It!

Yesterday, in one of my first mid-week bike rides of the almost-Spring season (officially Spring starts here after Pesach [Passover]) I was thinking to myself how good it was that  I was able to  jump out of the office and into nature, getting in a 1.5 hour ride between conference calls (I don't eat lunch, so have that "extra"  time in the middle of the day....). And of course, like my virtual friend Richard Dale of Venture Cyclist fame, thinking about how my biking weaves its way into thinking about start-up life.

Just as I was musing about how start-up entrepreneurs need to be absolutely dedicated to their cause/company, but still need to stay sane and get fresh air by enjoying nature, I came across this fellow:

Yes, it was a turtle crossing the road (and thank God not a well traveled road, friendly to bikers as well as turtles). That turtle was moving as fast as he could, determined to cross that road (because there is always something better on the other side). Did not matter to the turtle the risk involved, he was forging ahead. Now, truth be told, like any good start-up story, he also had some luck--my friend Robby Berman , who inspired me to ride with him in the middle of the workday, could not bear the thought that after us might come a car, and picked up the turtle and moved him beyond the yellow line...Because with all the dedication in the world, without some luck and helping hands you could end up as roadkill.

Moral of the story: even the turtle realized that he needed to take a chance, enjoy the first hints of Spring, and hope for some luck. May we all be turtles in our own way.

Defining a "User"...Skype Says They Have 276 Million of Them: Questioning Where We Are in VoIP

Just reviewed a recent presentation by Skype GM Jonathan Christensen at Ecomm2008 entitled "A Brief History of VoIP." The full presentation can be viewed here or below. Besides a nice ego boost, in that Jonathan cites Delta Three, which I co-founded and helped lead, as a "pioneer," I came away with a few highlights, and questions.

Number one highlight, is that Skype (and others) went from talking in 2003 about downloads (500K in 2003) to "users." Jonathan says that today there are 276 million users of Skype. Believable? I think not, but depends on how expansive your definition of user is...When I tried to use Skype tonight (more on that below) there were 12.4 million "on-line." Not using, obviously, just running Skype in the background. No usage statistics are ever given....would be fascinating to hear what those 276 million actually are doing.

Number two, is that Jonathan does not relate to quality issues, which in my mind are still A BIG DEAL. VoIP has had a bad reputation since the beginning as a low quality phone quality, when in reality we geeks know that true VoIP should be better quality than the PSTN. Why is it [still] not? Because unless you control the network[s] you run on, you have no quality of service. Tried to talk to one of our CEOs tonight on Skype (he in hotel room in LA, me in my house in Jerusalem where I have 5 MB line), and after few minutes of CB radio like static has to IM him asking for hotel room number, and I called him using my POTS phone.

Number Three, while Jonathan claims profitability for Skype, as far as I know the only revenue they have is from Skype Out, which is nothing more than a cheap calling card for the PSTN -- in other words, they generate no revenue from  actual pure IP communications. Could they at least put ads on the Skype app? Sure. But I guess being part of Ebay, there is no rush to bring in new revenue channels...

Finally, Jonathan talks about "mash ups of web based communications," but as far as I know, Skype "users" are restricted to calling, on net, other Skype "users." Not much of a mash up there. In fact, sounds very much like a closed garden, even worse than regular phone network. Where are the inter-op agreements for Skype users to talk to MSN/ICQ/AIM/GoogleTalk users?

I have a lot of respect for Skype team past and present, but think VoIP community is still taking baby steps from the "pioneering" days of Delta Three, ITXC, VocalTec, and others. It is time for new pioneers to really move us forward in leveraging the power of IP communications.

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Sewing and Running, or The Jerusalem Half Marathon and My Daughter's Skirt

My father always says, when you want something done give it to a busy person to do...I've lived long enough to agree with him. But that doesn't mean that busy=efficient. I still am struggling with time management, as I have mentioned before in these "pages." In addition, there is a ordering of priorities that needs to take place, to find the place that best suits you in the life/work balance.

With six kids, multiple civic commitments, and running a start-up venture fund, I know what busy is -- and I know what can happen when you lose control over true priorities.

Anyway, yesterday was the annual Jerusalem Marathon, which is really a half marathon (21.1 kilometers). I pledged I would train, I told myself to get to bed early the night before. I didn't train at all, in fact only ran twice in the past month. Work, new baby in the house, etc.

The night before the race, I said, ok, now I need to get to bed early. My 9 year old daughter comes to me at 10 PM and says, "Abba, you need to sew my skirt -- my dance recital is tomorrow and we need to wear THIS skirt." I thought, oy, a button fell off, who has time for that...but then she held up a large piece of cloth, a strip of elastic, and scissors. I have never made any article of clothing before, let alone a skirt. I took a deep breath, and having realized that my highest priority at that moment was my beautiful daughter, I sat down with her and a needle and thread. After half an hour, threaded the needle. 2 hours later, we had a passable skirt.

Time management is important, and I need to get better at it, but priorities need to be order. Nothing was more important than that skirt.

Oh, and how did I do in the [half] Marathon? My best time ever in Jerusalem, 1:56. I guess sewing helps running...;-).

Shabbat Shalom. Spend some time with your family.