Soaring on Ridgelift

Barriers to entry

Pitch a VC and one of the likely questions you get will be "so, what are your barriers to entry". A common answer is "deep intellectual property" as it represents the most attractive barrier – some knowledge, insight or invention that is a) hard to replicate and b) defensible with patents.

10 years ago this would have got you a long way – but not anymore.

10 years ago it was possible to identify a big problem, come up with a potentially valuable solution and raise money with a fair expectation that you would have one or two other competitors. Given a market of size, a small number of companies could coexist and fight for the lead – even then it was still winner takes all and becomes the most valuable.

The Internet/Web/Search engines have flattened information flow – it's now very unlikely that a meaningful problem remains hidden from sight for any significant time. Even a "stealth" mode company doesn't get much of a break – after all, while what they are doing remains hidden, the problems they are going after are in plain sight!

Start a company today and you have to face:

• Ideas get shared faster
• More people start thinking about visible problems
• Between excess capital looking for a home, lower implementation costs (Amazon AWS, Open Source, web development etc.), its way cheaper to start a company.

The end result is intense competition from the beginning.

So while you should still look for defensible intellectual property, today's environment places the highest premium on management execution:

• Do enough, no more (at least for this release!)
• Get it right, quickly – not necessarily the first time
• Build a firm foundation for growth
• Be able to add a steady stream of new features
• Delight your customers!
• Be better quality than anyone else (stability, ease of use, performance…)
• Scale gracefully

It's hard to claim management execution as a barrier to entry but if you have it, it provides a real advantage. Not only will it help you build momentum faster, your success will make your competitors spend more time looking at you at the expense of focusing on their own business.

Management execution isn't about being perfect in everything the company does – it about being better than anyone else on the stuff that matters. When you are looking for your advisors, selecting your investors or building out your team, look for people who have had exposure to companies that clearly demonstrated good execution.

Learn from these people – it will really help…

Vista = DOS?

Is Vista* a "Dead Operating System"? This question came to mind over the last couple of weeks as more and more entrepreneurs pull out Macs to give their pitches to me and everyone else is still running Windows XP.

The percentage of Macs has really spiked over the last 6 months – ok – anecdotal observation with no scientific method or basis to back up the claim – but the increase has been significant enough that as we waited for a entrepreneur to hook up to the projector (only to find that the projector didn't have a DVI cable) one of my friends remarked, "we need to get a couple of MAC adaptors and keep them in the conference room".

Ok, this is the Best West Coast and the sun is shining, everything is green (for a couple more weeks) and what happens in Palo Alto/Menlo Park isn't a proxy for what happens in New York or D.C – but the (re) adoption rate of Macs is remarkable.

With the ability to run XP (through Parallels), get the benefits of OS X (Mac and Unix under one cover) plus have all the great Apple industrial design, it's tempting…

If it wasn't for my investment in software for digital photography (much of which I'd have to purchase the MAC versions), I'd give some serious thought to switching...

So that brings me back to Vista…

There is no compelling reason or attractive feature in Vista to make me want to upgrade – moreover, the experiences of my friends with Vista has made me stick to XP for the foreseeable future. The lack of sizzle in Vista and the rising penetration of Macs caused the "dead operating system" thought to pop into my head.

With Apple now a serious Intel customer, Intel has become neutral in the OS wars – Linux, Mac, Windows – doesn't matter to Intel – they collect the dollars for the CPU every time.

Absent a new release of Windows that adds significant new (and useful) functionality, I'll stick with XP… or keep thinking about a switch to the Mac**.

*All trademarks are the property of their respective owners

**I'm sure I'll get a lot of email from my Mac friends who have been telling me to buy a Mac for the last 2 years!

Merger Mania

Mergers of equally sized companies seldom work – the integration challenges are large, you seldom get the promised (hoped for?) cost structure by eliminating duplicated functions, systems or staff, and it's a huge distraction to management.

I wrote about this a few weeks back in the context of the potential acquisition of Yahoo by Microsoft and was reminded of it again reading the NY Times this morning and its coverage of the Delta/Northwest merger.

In the past this particular challenge tended to occur most with public companies – one of the key words I looked for was "merger of equals" which tended to pre-sage a disaster in which the merged company became a shadow of its two former selves.

Lately I've seen a lot more mergers between private companies. With the IPO market effectively closed and many of the traditional acquirers focusing on their internal challenges because of the economic conditions, there are very few decent sized exits. There's a meme around Silicon Valley at the moment to look at private acquisitions as a way to get to scale faster or expand a market footprint.

In many ways this is a great strategy… as long as you go into it with your eyes open and with focus on the issues that can make the difference between success and failure of the merger/acquisition. Here are some issues to think about:

• Merger of equals is a real challenge and don't kid yourself, it's seldom two "equals" despite how the PR is spun. One company has to lead – with conviction and determination otherwise the result will be a shambles. You increase the probability of success when one of the companies is significantly larger than the other – makes for less indigestion!
• Appoint one individual from the beginning to plan and drive the merger process. This person has to have the power to get decisions made quickly. Give them as much power to make their own decisions (i.e. trust them!) and provide quick access for the bigger, far reaching decisions that need CEO or board review.
• Have a plan that results in ONE company – swallow the smaller one and integrate it quickly. Systems, people, products… everything.
• Make sure that every person affected by the merger knows their future quickly. Don't let people sit around wondering what is going to happen to them. Communicate this to the affected people upfront and preferably one-on-one.
• Streamline the board of directors upfront – this isn't about merging two boards into one – please don't do this, it will be a mess – but instead, figure out the structure of the new board and who will be a director of the combined company. Hint – although the ego of some of the directors will try and drive this, build a board that can help the CEO and management team the best.
• If the combined company isn't going to be profitable on the runway left with existing cash, get the investors to pony up enough capital to give the company the necessary runway.

Once you get part way into the merger, play Sheryl Crow's "No one said it would be easy" and give thought to the chorus…

"No one said it would be easy…
But no one said it'd be this hard."

PLAN, persevere and prevail!

It’s the simple things…

Sometimes it's the simple things in life that offer the most joy! Simple things like… sunny days, clear blue skies, skiing in pristine powder or something more mundane like listening to static free music from your iPhone.

One of the advantages of the iPhone is that you always have your music with you and the battery is usually always charged! I couldn't say that about my iPod – carrying around a second device (and forgetting to charge it) was a hassle. The iPhone provides an elegant solution to both issues.

Unfortunately, my car doesn't have either the support for an iPod via the integrated electronics nor an AUX input. This leaves two options… hack the car (even I draw the limit here…) or using an FM transmitting adaptor to play through the car stereo.

The second option was my historic approach to iPod and car integration – not the best of solutions given the crowded airwaves here in the Bay Area. Every frequency is in use somewhere and often the radio station overpowered the iPod FM transmitter. This solution was a bust when I got my iPhone as not only did the phone give an incompatibility warning, the interference from the GSM RF deck made music listening an unhappy experience.

When iPhone compatible FM transmitters appeared in the local Apple store I gave in and bought one – the interference was gone but the poor reception problem remained. I kept thinking about ways of improving the reception but never thought about the problem when I had a browser at my finger tips… until this last weekend.

A short browsing session later I had a very simple, inexpensive and elegant solution. There are several sites that reference this out on the 'net – here's one of them.

Get a 33 inch length of wire (any wire just as long as its insulated), fold about 2 inches of the wire back on itself in a U-shape about half an inch across… and tape with duct tape (or any other strong tape available) to the back of the control unit of the transmitter.

You are done.

No kidding, this creates a simple antenna that's one quarter wavelength long at 88.3 Mhz that gets inductively fed from the antenna in the unit. No invalidation of the unit warranty, nothing to break, nothing to build, fix, or curse.

Works like a charm and renders music listening static free even in the RF swamp of Silicon Valley.

 

Food for thought – a sobering thought

It was a little over a year ago when I wrote "First oil, next food?" wondering how long it would be before food suffered the pricing pressures we'd seen in oil.

Sadly I didn't have to wait very long as an article on CNN this evening describes rioting over food prices in several countries around the world – "Riots, instability spread as food prices skyrocket".

The last 6 months have seen incredible increases in the prices of commodities as investors poured money into futures. I suspect this speculation is more the cause for rising food prices than the demand for corn to make Ethanol but surely that's also an underlying cause.

As I re-read my original post, this paragraph stuck in my mind…

"But as any investor will tell you, if there isn't a return to be made in one sector, money will flow into a sector that offers the promise (hope?) of a better return."

We've seen the impact of huge capital inflows into specific sectors – the sub-debt mortgage fiasco, the (continued) growth of LBO funds and now the commodities market. The promise of a superior return attracts more and more capital which eventually kills the returns that attracted the investment in the first place.

I wonder where all the capital will go next? I shudder to think!

A long week’s travel…

Just back from a 10 day business trip that included Sydney, Australia. I lugged all my camera gear with me on the trip – glad I did as I was able to get this night shot of the Opera House from my hotel room. The browser rendering of this picture doesn't do it justice – it looks great full size!

Sydney is a beautiful city – sort of like San Francisco without the fog!

Metro-WiFi – free IS the only way

Today's NY Times has a front page article on the looming failure of metropolitan WiFi networks in cities like Philadelphia and San Francisco – "Hope for Wireless Cities are Fading". Faced with deployment challenges to get adequate coverage and competition from other broadband offerings, the service providers that "won" the contracts are withdrawing.

" But the excited momentum has sputtered to a standstill, tripped up by unrealistic ambitions and technological glitches. The conclusion that such ventures would not be profitable led to sudden withdrawals by service providers like EarthLink, the Internet company that had effectively cornered the market on the efforts by the larger cities."

The challenges of building these metro-area WiFi networks are not new – almost 2 years ago I wrote about the issues that cities like Taipei were having in getting an adequate number of users to pay for the network – in "Saturation Point?" I speculated that the challenges of getting enough users would cause projects to be postponed or cancelled. Sadly, it looks like those fears are being realized.

Hopefully these setbacks are temporary and don't foretell the end of metro-WiFi – these networks would be a great asset.

As I said in my original post, "the imperative is on the user hook" – what does it take to get enough paying user up and running on the network to help subsidize those who can't afford to pay? Perhaps the answer lies in getting the cities to sign up as anchor customers as this quote from the NYT suggests…

"In Minneapolis, the Internet service provider agreed to build the network as long as the city committed to becoming an "anchor tenant" by subscribing for a minimum number of city workers, like building inspectors, meter readers, police officers and firefighters."

In the meantime, I place my bets on the community efforts sponsored by companies like Meraki where the goal is to get the network deployed, not run it as a "for-profit" business. If it had been a requirement for the original "Internet" to be run "for-profit", I doubt we would be using it today – the plug would have been pulled a long time before critical mass was achieved to make it a profitable endeavor!

Some background on “Too Early”

I really appreciated the comments on my post "Being too early" that talked about the difficulty in raising money to get a company up and running. After reading the comments several times and reflecting on recent entrepreneur meetings, I thought it would be useful to give some background on the current VC world.

Like me, most of my VC friends think we are already full into a recession. Worse, there appears to be greater risk of a period of stagflation (recession AND inflation) than we have seen for many years. This casts a pall over a venture world that is already gloomy from dealing with an exit-constrained environment (more on this below) – there's not much optimism to go around, a key ingredient to pulling the trigger on a new investment.

Although there has been some reduction in the size of venture funds post-bubble, the funds are still large. Sitting on a pile of committed capital (and getting paid fees to invest it) doesn't endear a venture firm to its investors – after all the job is to INVEST the money!

[Side note – I suspect our neighbors in the LBO world are soon to experience this phenomena – tight credit, gloomy public markets in a slide (why buy now? It will be cheaper tomorrow), aren't conducive to putting billions of dollars to work either].

It's not easy to shrink the size of a fund once you've started investing it – fees are paid on committed capital, not the capital that has been drawn down. Shrink the fund size and the investors want the excess fees paid back… That puts a big dent in current income levels for a venture fund; if the VC has a lot of infrastructure it might be impossible to shrink the fund without shrinking the overhead – that can be a death spiral decision.

Even the VCs that raised smaller funds post-bubble suffer with the lack of exits in their portfolio. Lack of exits mean the portfolios are heavy with later stage companies – fine if they are cash flow positive but bad if they still need to raise additional capital to get to break even. One investment banker I met last week described the IPO market as the worst he had ever seen (in his case, that's about 30 years – can you say ugly?)

Here's a thumbnail of many VC firms facing this perfect storm of woes:

• Heavy board load per partner as there have been few exits…
• Fund returns hit as there have been few exits…
• Pessimism pervades…
• Still have to invest the latest fund

Faced with these dynamics, many VCs are looking for investments that:

• Don't need as much time from the partner
• Have been mostly "de-risked"
• Can put $10+M dollars to work at a slug (more is better)
• Have a 2-3 year time horizon to an exit

This last point isn't dysfunctional for a pessimistic investor – after all, the only thing you can say about the financial markets (IPOs and enthusiasm for M&A from buyers with money) out 2-3 years is… It will be different and probably not worse than now!!!!

The same dynamics explain the general lack of interest in making early stage investments whose characteristics are diametrically opposed to the current "good" investment. Early stage investments need:

• A lot of time, even with great teams
• Have all the risk you can think of… market, team, technology
• Don't need a ton of capital upfront
• Current statistics show the median time to exit is 6.5 years

If you want to raise a smaller amount of money for a brand new company, your best prospect is a smaller fund where the folks running it firmly believe that investing smaller amounts of capital, earlier and often represents the best strategy. Those funds are out there but you will have to work hard to get them as investors as they have little competition right now and can afford to be very picky.

While this post isn't going to help you raise money, hopefully it sheds some light on what's going on and why it's a challenge to raise first money. I really liked the closing quote that RAGZ gave on his first comment:

"Champions take chances. Pressure is a privilege."
- Sharapova winning speech, Australian Open 08

Time to take a chance!

 

Analog Dollars, Digital Pennies

It's hard to think of a form of media that isn't being fundamentally altered by the transition from analog to digital and the associated distribution changes (physical to bits, fixed schedule/place to anywhere/anytime).

TV advertising hung on for a long time but faces enormous pressure as:

• People spend less time watching TV
• DVR penetration continues to grow (fast forward me passed the commercials)
• TV content is available online (time and place shifting)

Today's NY Times has an interesting article covering the increasing consumption of TV content via the computer – "Serving Up Television Without the TV Set". There are a couple of quotes in the article that really strike home the disconnect that faces the TV industry:

In an address in January to television executives in Las Vegas, Jeff Zucker, the chief executive of NBC Universal, noted that NBC.com had measured more than half a billion video streams in just over a year.

"Our challenge with all these ventures is to effectively monetize them so that we do not end up trading analog dollars for digital pennies," Mr. Zucker said, calling it the No. 1 challenge for the industry.

Compare this against:

One piece of good news for the networks and advertisers is that viewers are more likely to remember ads on the Internet versions of TV shows, partly because the commercials are less numerous and more demographically aimed online, according to many studies."

The advertisers already realize that those "analog dollars" are really worth pennies and the TV industry is trying to hold on to its old business model as it struggles to find ways of converting "digital pennies" into dollars.

Efforts like Hulu may help but we see yet another example of a threatened industry struggling to prop up its old business model – much as King Canute tried to stem the rising tide.

Will the established players in the TV industry be successful in weathering this change? Parallels in other industries suggest not – the winners tend to be new entrants who wholly embrace the new realities – it's too soon to tell who those winners will be but it's fascinating watching yet-another-industry transition resulting from the impact of the PC, mobile and the Internet.

Normal service will resume shortly…

Back in the days when the BBC didn't have quite the same level of reliability in its TV broadcasts, it wasn't unusual to see the BBC test card displayed with a voice over saying in a very BBC voice…

"We apologize for this interruption. Normal service will resume shortly.

Of course, "shortly" was a misnomer for "we aren't telling you because we don't know!"

I thought about the old BBC test card over the weekend when one of my friends asked me why my frequency of blog posting had fallen off of late. So, just like the BBC, I thought some explanation was appropriate.

One of the advantages of being a venture advisor is that I can spend more focused time working with companies – not just a few hours a month but often a day or two each week. Of late I've been working very closely with a particular stealth mode company and spending a lot of time helping on business strategy and product development. This has included a lot of late night phone calls with the development team.

It's an opportunity to work with smart people and it's a lot of fun – unfortunately, writing articles for my blog has been the casualty.

Time to get back to blog writing!