VCinJerusalem

Making Things Easy (or at least easier...), or Pay Less Legal Costs

Long ago a business colleague told me that he operates according to the KISS principle. Now, he was a nice guy, reasonable good looking, but I was not interested in that kind of relationship. He quickly explained that KISS stands for Keep It Simple Stupid. Ahh...that king of kiss sounded great to me.

We have enough complexity in forming start-ups, given the challenging nature of a new business, the last thing we want is to add layers of complex corporate mechanisms. KISS sounded like a great principle, and one that I have tried to live by...in the face of law firms doing their duty and looking to make a living.

This week we at Jerusalem Capital were involved in a refinancing of one company, M&A transaction of another, and "regular" course of business in a few others. And there is my new Hanaton project (more on that some other time), non-profit board meetings, etc. Throughout all of that I struggle to keep people working according to KISS.

With that in mind was pleased to come across a posting (pointed out by Brad Feld )from Techstars giving actual copies of financing documents for a typical seed stage deal. The full posting and the docs themselves can be found here. If that link doesn't work for you, try http://www.techstars.org/2009/02/07/techstars-model-seed-funding-documents/.

In these challenging times, we need to do everything we can to strip away noise and focus on what's important. Thanks to Techstars, at least the financing part can be kept to KISS. 

What Are "VC Returns"??

So I am back to work (never stopped, but mentally taking me time to recalibrate to current realities), and will start to regularly post again. In the wake of the revelations that the various Emperors have been running around naked, I have been giving a lot of thought to the business I have been in the past few year, the formal VC industry. In some sense, a continuation of the entrepreneurial path I have been on professionally since 1994, as the pitch to a potential investor remains the same in terms of potential retu

A company I am advising, and looking at as a potential investment for us, got this feedback from a well known Israeli VC (one of the franchise operations of a well known American VC):

    Hi Jacob, apologies for the delay in getting back to you. This email seems to have gone to the             wrong folder.

    We are not going to pursue the XXXXX opportunity, though we thought it was extremely                     interesting. it was hard to justify VC returns on this type of investment so we passed. We do             think it is an interesting project with a nice potential.

Ok, so we all know the "wrong folder" trick, just an excuse as to why we don't respond to emails when we should, but look at what they wrote---and explain to me the difference between "nice potential" and "VC returns." When T-bills are paying out less than 1% return, seems to me anything more than that should be considered VC return. After all, with the risk of VC comes reward. What reward justifies the risk? And should shouldn't the level of risk be partof the equation?

I don't have any clear answers to these questions, but everyone involved in start-ups need to think these questions through, whether as entrepreneur seeking investment capital or VC looking to make profits.

For those claiming the VC model is broken, I say the world is broken. We all need to figure out how to fix it, and make a living at the same time...

 

Running on Empty...And Surviving On Air

Not much I can add on a formal VC level to the postings by my VC blogging colleagues Brad Feld and  Fred Wilson (definitely read what they have to say). Brad and Fred relate to the current financial crisis by focusing on what early stage start-ups need to do...which is mainly cut costs (and then cut them again) and survive this bleak period. Fred also points out the bit of positive analysis, that unlike 2000/2001 this is not "our" fault (i.e. not Internet entrepreneurs or their backers), but rather a global financial crisis that has its ripple effects across all sectors.

What I want to focus on is how to survive, and take the conversation one step further -- to ultimate entrepreneurial activity.

For me the "ultimate" is when entrepreneurs have no outside funding, when they literally have to work odd jobs, do whatever it takes to put food on the table, while at the same time moving their companies forward. The cleanest version of this would be a start-up that has only been funded to date by "sweat equity." (I will relate in a moment to other situations). When 2,3, or 4 friends come together to start a new venture, the goal should be to get as far as possible without taking outside money. That means keeping your day job[s], whatever it is, and creating something from nothing.

Oh, and besides sweat you might have to fork over some bucks...but not much. There is so much open source out there, free trial services, etc., that pizza money should suffice. And even if you weren't working on a start-up you would need to eat.

The problem in today's start-up culture (certainly in the US and Israel, the markets I know best) is that we have educated entrepreneurs that they need to "raise money." I believe if people are passionate about what they are doing, the goal should be to raise their energy level, and that of their co-founders. Money should be a luxury, a nice-to-have, not a must.

Now, this path is only for the truly driven. Not so good for people with families or other major life commitments. And should be for a specific period of time (anywhere from 6 months to 6 years, depending on your stamina and personal situation). "I don't have time" is the mantra of those who choose not to make time. Sometimes, for good reason-- because you already have children, family, community, that already have received your time pledge. In a time of financial crisis, you probably are not a good candidate for ultimate entrepreneurial activity. That is simply being self-aware.

Now lets look at what happens when you did take in outside money, and now are at a brick wall. You have used up the financing. You want to continue investing sweat equity (your time, which is priceless). Your investors, those who forked over hard cash for a piece of your dream (and did not take salaries) choose not to invest more cash. What happens now? How do you value your time, vis a vis past investors, and what should happen to the cap table? While 99% of the time this is not talked through at the time of investment (and we at Jerusalem Capital are just as guilty), I believe the ethics that should rule is as follows: When someone invests in you (be they formal VC, angel, or family), they are investing in you and your dream. The goal is not to pay you a salary for a few months or years. Salaries are for salaried workers, not for ultimate entrepreneurs. You want a salary, go get a job. Less risk, and sometimes less direct financial reward.

When I invest, it's because I believe in the people, and expect them to whatever is in their power to bring about success (and a return on my hard earned dollars invested in the dream). If there comes a time, when to put food on the table they need to take a day job, so be it, but the moment I come on board, I expect to be treated as a partner.

Now, in formal VC documents and investment agreements, we do speak to situations of next round investors, dilution by new investors, etc. That is the written law (and like most written laws, it is harsh, full of "wipe-outs," "reset rounds," and "death spirals." But then there is the oral law, the law of good faith and integrity. That law demands that everyone involved keep the dream alive, as long there is hope.

Now, if a partner loses all hope, and explicitly gives up, the status qou changes. The cap table should change. But hope should NOT be dependent on whether salaries are being pulled out every month. And hope is very difficult to measure. It's like weighing air. My best advice is to leave nothing unspoken -- talk through where the company is, where it wants to get to, and reach deep down to see who still has hope and can remain committed.

In times like this, hope and commitment are the most important ingredients to potential success. Obviously one cannot run forever on empty, and quite difficult to completely survive on air (most breathatarians don't survive that long).

May our world be blessed with a quick recovery and may none of us need to run on empty or survive on air for longer than absolutely necessary. 

 

Come On, Dustin, Enterprise Software Facebook Flavor? Puhleeese.

OK, so I have not been the greatest Facebook fan in the world (but did just check my Facebook account for first time in a week, discovered that a friend's dog died. That was a waste of time). But even I am surprised that Facebook co-founder Dustin Moscovitz is leaving to start a company that...now get this, will be leaving to start a rerun of Lotus Notes (remember that program? It actually ran the majority of Fortune 2000 systems for a period of time). Huh?

According to Valleywag Dustin sent out an email to colleagues at Facebook, in which he said:
    "I've seen us unblock ourselves time and again with new tools to increase transparency and passive     information flow and many times it was the fruit of my own labors. While working on improving         Facebook's tools, however, I came to a very difficult conclusion: doing this for all the companies of     the world was not the same project as doing it for one of them. This idea is one that needs an             organization that was built to do it, with every fiber of its DNA engineered in a way that producing     an extensible enterprise platform becomes little more than the logical consequence of an organism     executing its own nature." [emphasis added]

Wow. A bigger pile of [nonsense] would be difficult to find. Either Dustin is smoking some really good stuff, or five years of being poked finally got to him.

We all knew that keeping good people around would be almost impossible for Zuckerberg and friends would be difficult if the future at Facebook became cloudy, and cloudy it is. No business model, high overhead, and a stock market barely functioning. Moscovitz's stock is not vesting, its his, and I am sure he will have no problem raising big chunk of $$ from silicon valley VCs still starry eyed by Facebook fluff. He will be able to pay himself a nice salary, and dream about corporate organisms executing their own nature. Sounds like VC version of Adult content [read PORN] to me, but hey, if it sells...

Now nothing is impossible, and Dustin could very well have some incredible concepts for better corporate organization, although he probably should spend some time in real corporations that have real products (and things like revenues and profits) before thinking he has figured enterprise nirvana.

What does all this say to me? The consumer social network eco-system has run out of gas. When one of the stars starts talking about enterprise software, means VCs should head for the exit.

Fail, Fail, and Fail Again. But Always Believe You Can Succeed

Living as an early stage VC in Jerusalem, it's easy to get burnt out on so many different levels.  All of our companies need to raise more money (the difficult part),  close  business deals (the easy part),  and keep their teams incentivized, excited, and with a feeling of positive momentum. Not easy.  And all of this while living in Israel where the very existence and future of the state is questioned on a daily basis.

I saw the following video on Brad Feld's blog, reminded me how true visionaries are the ones who know how to deal with failure (but not "give up"):

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.

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.

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!