Startable – Healy Jones’ & Prasad Thammineni’s Blog

And this is before the Nexus One!

I’ve really had my head down at Pixily recently and am behind in keeping my New England SaaS company list up-to-date. If you know of any NE based SaaS companies not on this list, please leave a comment or ping me on Twitter or over email: healy (at) startabledotcom. As long as the company has launched their product and is HQ’d in the New England area I’d love to have them on the list. Thanks!

Great interview with Don Dodge, tech luminary who recently joined Google from Microsoft. Don was technology ambassador for Microsoft and is now in a similar position at Google. Don has a very unique view into both companies strategies, technologies and cultures. Some of the best quotes:

One of Google’s biggest challenges: “Another challenge is to earn a reputation for communicating clearly with developers and partners, providing them the support they need, and being as clear as possible about our product road map. ”

On how Google is prioritizing its efforts vs Microsoft: “All the exciting new applications are running in the browser, with application code in the cloud and the cell phone as the platform… Microsoft has product offerings in each of these areas, but they weren’t the high-priority programs… At Google, Chrome (browser), Google App Engine and Google Apps (cloud), and Android (mobile) are top priorities…”

On the state of MSFT: “I think Microsoft today is a lot like IBM was in 1985.”

On the cloud: “It all comes down to your application needs, workloads and design architecture. Amazon, Google and Microsoft are all solid choices.”

It’s a great interview; check it out.

There has been a lot of talk recently about the amount of value venture capital brings to the US economy. As usual, this includes a lot of griping by entrepreneurs who were unable to raise venture funding and who thus rip on venture capitalists. Occasionally, there is an academic report that attempts to shine a little light on the subject. Many times these professors do not really understand VC, having never helped start a company nor invested money in startups. But on those rare times when a person who really understand finance and startups publishes a robust study it is really worth paying attention.

That is why a recent TechCrunch article, “What Have VCs Really Done for Innovation,” posted by Vivek Wadhwa, has got me thinking. Vivek is a professor (at Harvard, and I think Duke) who has also helped grow software companies and worked for CSFB. Not only his is his background the right one to study entrepreneurship and venture funding, but his post was thoughtful and much more measured than the typical VC-bashing.

Vivek is responding to the NVCA’s recent PR campaign. In this campaign, the NVCA highlights venture capital’s contributions to the US economy and how a lot of innovation in the US has been done at/by venture funded companies. Here are some of Vivek’s key points, as picked by me:

1. The NVCA claims that 81% of tech jobs and 21% of GDP is produced by venture-backed companies; Vivek responds by asking: “would those jobs never have been created if the VCs had never appeared on the scene? How can the NVCA prove causality?”
2. He highlights some research he is about to publish on how, after interviewing over 500 successful entrepreneurs, only 10% raised VC in their first venture and only 25% raised VC for their second. In other words, not that high of a percentage of successful companies bother/need to raise venture funding.
3. “The fact is that VC’s follow innovation, they don’t lead. They go where they smell blood.”
4. VC investments don’t really out-perform other investment asset classes (he specifically discusses research vs. the Russell 2000 index).
5. “What’s behind the NVCA’s voodoo economics? Even though they vehemently deny it, VCs are looking for bailout money and tax-breaks.”

These are some pretty negative opinions – from someone who has a right to be making them. I agree with some of his points, but not all. At the risk of sounding too much like a VC industry defender (remember I used to be one!) here are my responses/takes on his points:

5. Starting from the last point, I think Vivek is half right. The venture industry is fighting a real battle to avoid having their carry taxed as capital gains. However, other than a change in government policy towards cleantech I don’t think VCs are looking for bailout $. What I really think VCs are looking for from the government is to try to avoid being lumped in with “evil” private equity and hedge funds and thus become regulated as “risks to the US economy.” See my post on how private equity regulation might impact venture capital firms. In fact, this point is really a core reason why the NVCA has started making so much noise recently. Regulation could have a negative impact on venture investments, at least for smaller firms that can’t afford the time and effort to comply/prove to the government that their investments aren’t about to cause a global financial meltdown.

4. He’s probably right.

3. Again, he has a real point. But I disagree that all VC funds ignore innovation. First of all, what defines innovation? Would Google have been innovation? It’s not like they were the first search engine. In fact, the search space was already a sexy place to invest when they got funded. But, as a user of their search, analytics and ad words products I’m pretty happy this non-innovative company received money from their venture capitalists. Secondly, what makes venture capital so important for the US economy is not just the creation of innovation, but the commercialization of innovation. Universities are great at fostering innovation, but it is usually companies that take that innovation and create jobs and technologies that can be used. But, I do agree that there is a lot of me-too investing in the venture capital world. Too many of the same ideas do get funded – sometimes I actually wonder if this actually hurts innovation by creating too much undifferentiated competition in nascent markets. But that is probably something for another post.

2. I also agree with this. The ratio sounds about right. I’m willing to bet that many of those unfunded companies would have been less successful if they had raised venture capital. Venture funding is not right for most companies, even “successful” ones. Entrepreneurs too often think that their business needs venture funding to be successful – but as I like to say “don’t raise venture capital.” But I don’t think this is an indictment of the venture industry; it is more a generic point that most companies do not require VC to get where they are going.

1. I can’t really speak to the validity of the NVCA’s numbers in terms of what % of the US economy is based on venture funded businesses. However, I can say that venture funding does help companies get bigger faster. I know I just made fun of it, but would Facebook be as large as it is without venture funding?

Vivek has some very good points, and he presents them with data – which makes them even more powerful. I understand his negative reaction to the NVCA’s PR campaign – it is a little over the top. However, I think venture capital is important to this country’s technology leadership. While I don’t think the US needs MORE venture funding, I do think that a healthy early-stage financing environment is necessary to foster continued innovation here. I hope that as we come out of this downturn and seek to change the financial landscape that early-stage investors are not caught in a regulatory net designed to keep hedge funds from doing silly things with highly-leveraged derivatives or other exotic instruments.

So, Facebook announced yesterday at TechCrunch50 that they were finally cashflow positive. This is pretty big news. It means they’ve created a real business, one that is, in theory, self-sustaining. They’ve reached the holy threshold where venture capitalists stop biting their nails and thinking “man should I have sold this earlier…” Now the management team can seriously start getting wined and dined by investment bankers hungry for “the IPO of the year.”

But, after we congratulate the team for a job well done (nice job people) we probably ought to think about what this means for social media as a business. Here is a company that now has 300 million users – and has just now become cash flow positive. What is that, like 5% of the Earth’s population? What number of companies ever founded reach that high of a global penetration? That’s a pretty amazing number. And they needed that many users to become cashflow positive?

I believe that Facebook has raised over $700 million in venture capital. Impressive. I doubt that more than a handful of companies, ever, have raised that much private capital. I don’t know how much of that has been used in the quest to become cashflow positive, but I assume it is a decent amount. Although, to be fair, a meaning amount of that capital might have gone to providing liquidity to the management team.

So what does this say about social media as a business model? The requirement to get sooo large and burn sooo much capital calls into question the basic business model of a social media company. The pure online company with revenue only coming from advertising just doesn’t seem to make sense if you have to get that big to become a self-sustaining company.

Just to be clear – I am not questioning Facebook. I am pretty much amazed at what they have created and am excited to see what is next for the company, both as a venture-junkie and a FB user. But I just wonder if these stats are the death nail in the advertising-based online business model. Who else could possibly reach cashflow positive with a pure advertising model if you need that many users and that much capital?

Two quick items today:

1) Mass High Tech just announced their “2009 All-Stars of New England Innovation” Congratulations to Dharmesh Shah of Hubspot and David Beisel of Venrock for making the list! Also, congrats to Scott Kirsner, the founder of the New England Innovation Month and one of New England’s major technology journalists, and Gail Goodman, who doesn’t know me but whom I’ve seen speak at an entrepreneurship forum and who I greatly admire. Also, congrats to all the other innovators on the list, who I don’t know at all but who sound like they are doing some really forward-thinking things here in NE.

2) Growthology has a sobering post on the White House’s proposal to lump venture capital firms in with PE funds and hedge funds for new proposed financial regulation. VCs over a certain size would be required to report “information on the funds they manage that is sufficient to assess whether any fund poses a threat to financial stability.”

I guess I understand what is going on here. It is probably too hard to distinguish between some hedge funds and VCs. Except for the fact that VCs use almost no complex derivatives and very modest leverage. Now, I’ll admit that there are sometimes some pretty serious repercussions when a VC funded company fails, like if a major corporation relys on a VC portfolio company for important ERP software and it one day goes under, or if Kozmo.com goes out of business and you can no longer have DVDs and Starburst hand couriered to your house at 3:30 in the morning (yeah, that was a tough one to see go bye-bye.) But a “threat to financial stability?” That seems a little far fetched.

If you believe that VCs a) create high paying jobs by funding companies and b) foster home-grown innovation by taking risks with pre-development technologies, then you should probably be against this sort of regulation as it will slow mid and small-sized VCs ability to make investments. I left the following comment at the bottom of the Growthology post:

The main cost of complying with these types of regulation is the time involved for the managing partner(s). While larger funds can afford to hire non-deal COO/CFO partners, financial administration at smaller funds falls onto the active deal partners. Since the limiting factor at most VCs is the investing professionals’ time, anything that keeps them from investing or working with portfolio companies could be a real burden. Having been a junior VC at a larger firm & having helped with the silly exercise of annual portfolio valuations for the auditors, I can tell you that these sorts of low-value added administration are major time sucks – and did I mention that they don’t really add much value?

I am a little late to the party, but earlier this week Dharmesh Shah posted on the “10 Things MBA Schools Won’t Teach You” if you are doing the startup thing. It was a great post and I agree with his points. I know I’m a bit new to the actually being an entrepreneur (ok, ok, pretending to be an entrepreneur), but I’ve thought about his ideas and came up with a few of my own. Keep in mind I can really only speak to my experience at Wharton; different MBA programs are probably pretty different and may teach these particular issues.

Sales – When I was a venture guy hanging around BOD’s, and now that I am trying to help Pixily with customer acquisition, it is quite clear to me that my MBA program lacked real “sales” education – yet this seems to be pretty much the most important part of taking a company from $0 revenue and product to $100 million and profitable. Selling is fricking hard. I thought selling money at Summit Partners was hard. Selling a product that has never been invented before from a company no one has ever heard of is really hard. You’d think that an MBA program would at least have some sort of a course on how large companies sell their product and:

Compensation structures – particularly for sales. There was certainly a class in one of our core courses around managing and incentivizing people, and I have to admit “Managing People at Work” taught by Peter Cappelli was one of my best courses (I actually dragged my wife to it a couple of times because it was so good.) However, compensation probably deserves its own course. Perhaps if I had been a management major I would have noticed the existence of a course on this topic… My experience as a VC was that a TON of time is spent setting up the correct compensation and incentive structure for the team and it doesn’t feel any less important from within an entrepreneurial venture.

Other major issues, not related directly to the course work, were:

Winner take all attitude – Too much emphasis on “being right” and not enough on admitting mistakes. Read the rest of this entry »

Venture capital firms with the most desirable addresses in the venture business – Sand Hill Road, Winter Street and the Big Apple – out perform VCs not located in venture capital centers. I’ve recently read a study produced by four researchers on venture capital as a local business that suggests that VCs located in the three US venture capital centers make better investments than VC firms based in non-venture capital hubs. (see my comments in italics at the bottom of this post for some discussion around the study’s methods.)

The study also suggests that venture capital funds actually seem to be more successful when they make investments outside of their home territory, despite the fact that VCs are notorious for preferring to invest close to home. The authors believe that because VCs are more hesitant to commit to an investment outside of their home turf then they raise the bar on these investments, thus becoming more successful when they make them. Additionally, it is possible that they face lower competition for deals in non-core venture markets. I can buy both of these arguments and would not be surprised if venture firms did better when investing in non-local startups.

The authors also reach another conclusion that I probably don’t agree with. They postulate that the superior returns delivered by VCs in SF, Boston and NYC are totally driven by their non-local investments out sided performance, “the out performance of venture capital firms based in the venture capital centers can be attributed to their out sized performance in investments made outside of the venture capital firms‟ office locations.” That is pretty hard to swallow. I’m pretty sure that many of the best venture capital investors make a ton of their returns from successful investments in their home regions. Local investments such as Sequoia investing in Google or CRV’s investments in EqualLogic probably drive more of their “success” than the sum of their other, non-local, investments.

One other interesting point drawn by the researchers is that the presence of a local co-investor does not raise the likelihood of success when a VC based in one of the venture centers invests in a non-venture hub startup. Many times, when a VC makes an investment in an area not close to home, they try to syndicate with a local venture firm. The theory is that this local firm can better help manage the investment, recruit talent local to the startup, coach management, etc. If I am reading the study correctly, these local firms don’t help the venture center VC. I guess this means that VCs based in one of the 3 hubs are just better investors than shops located in other areas?

So how does the reality of the venture capital real estate market impact the entrepreneur looking for funding?

But enough about venture capitalists. The more important fact to be drawn from this study is that it is easier for a startup to get funding if it is located in on of the three venture hubs. 49% of all VC investments were made in one of these three areas. If you are not based in a technology center and a venture firm appears to be interested, but asks, “where do you see putting the company’s headquarters,” or even more blatantly, “will you move the company to San Francisco after it receives funding,” you may seriously wish to consider indicating that you are open to moving the company. I understand that there may be reasons why this doesn’t make sense for your particular startup, but it will be much easier for you to get funded if you move.

Secondly, it appears from the study that VCs based in one of the 3 core venture regions are better investors than their less-optimally located brethren. This would suggest that startups not located in SF, Boston or NYC would be more likely to be successful if they take money from a VC located in one of these areas. This does fit in with some of what I observed during my time as a VC. We would often get referrals from funds not-located in one of those 3 markets looking for a syndicate partner for a particular investment. Many, many times these companies turned out to be “me-too” investments. By this I mean business plans that had already been beaten to death by Boston area VCs, but somehow still seemed like a good idea in a non-technology center. This is probably because the investors and entrepreneurs in those non-hub locations didn’t have the same level of access to deal flow as we did and so they didn’t realize that their idea’s time had come and gone. If investors in a hub area are saying that they’ve already seen your idea a dozen times then you should do a little more research into your startup’s competitive landscape.

A few things about the study:

This is a US focused study.

Success is defined as IPOs. This is a bit too narrow, but given the databases the researchers were using I understood why they did it. I don’t have enough data to decide if this makes the study meaningless. The vast majority of successful exits that I have seen have been exits through acquisition, not IPOs. However, I’ve only been an investor during a time when IPOs were not easy (since 2002, basically) so my viewpoint may be unfairly biases. The study looked back to 1975, I believe, so their view is much longer term than mine. They also can’t analyze differences in the level of success of an IPO – so Google’s IPO is as successful as an IPO for a company that later goes under. This is probably also a too great of a simplification, but I don’t know how they could do it differently given the databases they used. They also have tried to run the analyses again including the “merged of acquired” status in VentureXpert, but I do not believe that this part of the analysis is valid – in VentureXpert a failed company can be “acquired” by a larger player for peanuts. This happens often enough that I don’t think the M&A outcome in VentureXpert is a good measure of “success.”

Increasing the number of venture capital firms in a given CSA increases the number of new venture-backed companies. However, the SF Bay Area is 5x more productive in creating new venture-backed companies per venture firm than anywhere else. Also, regions with higher levels of “successful” investments spawn greater numbers of new venture-backed companies. This makes a lot of sense, given that entrepreneurs leave public companies and start businesses with their capital and knowledge, and that IPOs are inspirational to other entrepreneurs (and VCs) in a particular town.

When Scott Kirsner, the Boston Globe Tech Columnist and New England’s Champion of Startups and Entrepreneurs sent me an email sharing details on his upcoming event, What’s Next in Tech, I started wondering what that would be. I came up with few predictions and asked some of the people I respect to validate my predictions. So here are my predictions for what we can expect in the coming years:

Mainstreaming of On-demand Small Business Services

Since late 1990s, large companies have benefited immensely with the SaaS-ification of services. Salesforce.com, NetSuite and many others have built large businesses providing enterprise business services over the web. Enterprises loved them as they did not have to make upfront capital investments and benefited from all the free upgrades, maintenance and more. These services are exhaustive in their capabilities and therefore complex to use requiring a lot of training.

Since 2004, and the launch of BaseCamp by 37Signals.com, small businesses started to get a taste for on-demand services. The success of 37signals.com and FreshBooks.com has shown that small businesses are looking for simple to use business applications that help them become productive, efficient and mobile.

I predict that more and more small business related services will migrate online and will be offered as an on-demand service. Some of the applications you will see include expense management, document management, bookkeeping, tax preparation, and virtual assistant services. Moreover, these services along with those already in the market will move beyond early adopter phase and become mainstream.

Read the rest of this entry »