Rocky Top MBA

CMM February 19th, 2010

A really exciting technology area that’s starting to gain some major market validation is streaming video content. According to research from the TDG Group,  half of Netlfix customers with high speed internet are streaming the content on a television. Personally, my wife and I utilize Netflix streaming on our Roku and Playstation 3 all the time. The movie selection is a little weak, but the streaming content really carries its weight with television shows. We’ve watched entire series on Roku (as I type, we’re on episode 7 of season 4 Lost). We’ve talked about canceling cable, if it wasn’t for sporting events and HBO’s series (specifically Bored to Death, Empire Boardwalk , The Pacific, since Entourage has almost become unwatchable and HBO ended The Sopranos, Rome, Deadwood, John from Cincinnati every other show I loved). Now that HBO is introducing a streaming platform with HBOGO.com, we’re rethinking our cable subscription. Of course, HBOGO.com has to move to a subscription fee that doesn’t require a television contract, but surely they aren’t so dense as to goof that up.

I’m not sure where technology goes next with streaming content, but I think we have a convergence of traditional content and internet streaming in the not too distant future. Some how, entrepreneurs have to manage the dynamic environments of electronic devices (run for the hills, it’s the iPad) and streaming content. To top it off, we’ve got to build out the infrastructure to have the bandwidth to accomodate all of it. I’d expect a media mogul to attempt something like that, but the current generation is still trigger shy after Time Warner got slapped around with the AOL deal. Mind you, that parent owns HBO… so maybe we’re seeing some down road benefit of that catastrophe. Oh, and Google is also on the job (remember Google TiSP from 2007… yeah, it was a joke, but apparently they were thinking about connectivity to residential households).

If Netflix really wanted to put some pressure on the big media business, they should do a couple of things (in my not-so-humble opinion):

• Provide a rotating streaming big ticket picture on a weekly basis
• Provide the opportunity to stream weather and local media
• Provide streaming of live sporting events
• Build a library of musical performances

If we can keep technology and entrepreneurship on the tracks, we’ve got some real value-add developments coming. It takes a few years (late 90’s and early ’00’s) of stupid wasteful foolish risky ventures to help focus in on the viable opportunities. The show ponies are dieing off and the stallions are left behind. They may not get the attention of show ponies, but that’s because they’re stallions… they do –gasp– work. Our entrepreneurial communities aren’t dead, they’re focused on survival and committed to their concept. But enough of that, or I’ll start talking about the blasphemous and offensive fact that increasing government expenditure decreases small business growth and innovation.

• Technology , Venture Capital
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CMM February 17th, 2010

Next week I’m taking a very brief (30 hours, to be exact) trip to Washington, DC for the Southeast Venture Conference. I’ve attended this meeting the last two years and was impressed both times by the speakers and the presenting companies. I really appreciate that my fund allows me to represent us at this opportunity (although, I’d also love to attend the annual NVCA meeting San Fransisco… but that’s not gonna happen).

I thought I’d write a few words about how I’ve prepared. I’ve looked over all the presenting companies and developed a short list of companies in our profile and/or that look attractive. I’ve reached out to most of those companies through emails or phone calls to make initial introductions. The way the conference is organized, their isn’t a real bullpen area where you can easily locate the companies. Plus, with so many potential investors in one place, it can be challenging to get the attention of folks. Even VCs get lost in the crowd when the crowd is other VCs. Same thing, if not more so, for entrepreneurs. I also plan to drop emails and calls to certain colleagues that tend to attend this event. It gives me an opportunity to catch-up with those folks, gaining valuable insight on how active they are and what areas they’re looking at.

After looking over the list of presenters, I noticed a few trends: lots of web-based platforms (i.e. accounts receivable, entertainment management, etc), lots of companies touting “cloud computing,” and a noticeably less “clean tech” companies. Make out of it what you will, but those are my observations. Also, here’s a good article on cloud computing that I stumbled across at Venture Beat.

Here’s some quick-and-dirty advice for presenting at one of these opportunities:

• You only get 5 minutes, so focus on the material the audience cares about. Sorry engineers and technologists, that probably doesn’t include CAD sketches and technical analysis.
• If you’re raising money, investors want to know– how will you make me money and how much money will you make me? Period. End of discussions. Please, no CAD sketches or technical analysis.
• Do not read off the slides. In fact, use the slides for context and support, not as the foundation of the presentation. Your personality, passion, and speaking should be the foundation.
• Investing is relationship driven, whether institutional or individual, so don’t forget to introduce and give context for your leadership team. But remember, you aren’t the product, so don’t act like it.
• Want other advice than mine, then checkout this post from Guy Kawasaki… The guy is an authority on presentations. Don’t believe me, just watch the video below:

• Venture Capital
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CMM December 10th, 2009

Over the past few days, President Obama has turned up the rhetoric on small business growth. He’s held summits (we won’t mention the attendees and who wasn’t invited), he’s included a new laundry list of talking points, and issued a round of encouraging statements. This past Tuesday, December 8, the president even went so far as to suggest “a complete elimination of capital gains taxes on small business investment” for one year.

Unfortunately, members of his own party were not listening.  Or, maybe they were but they chose to disregard the president’s guidance. Yesterday, without a public hearing or committee vote, the Democratic controlled House of Representatives voted to raise the tax rate on carried interest paid to equity fund managers to 35% from 15%. This 133% increase was accomplished by reclassifying carried interest from a capital gain to ordinary income. That’s why today’s headlines should read “House of Representatives Loves High Unemployment, Punishes Job Creators.”

How Does Venture Capital Work?

While this bill applies to many investment groups—including broader private equity, real-estate partnerships, and oil-and-gas partnerships—my perspective is focused on the affect of small business growth resulting from venture capital investment. Venture capital is high risk portfolio style investing that utilizes equity and equity-like investment tools for the purposes of providing development and growth capital for start-up companies. Companies fitting this profile typically have a curve-jumping quality, focus on an underserved and growing market, and have all kinds of risk due to their infancy, sensitivity to the overall economy, and dynamic change factors. As a result, most venture investing is done with a portfolio approach and with a significant return-on-investment expectation.

Investment capital is typically raised from institutional partners such as endowments and pensions, with the occasional inclusion of a high net worth individual. These investment partners compensate a staff, led by fund managers, to manage the investment capital and the portfolio investment. This staff has two methods of compensation, through an annual management fee and with a carried interest bonus upon liquidation of the fund. The management fee goes to pay all expenses, including salaries of the fund, for the life of the fund—typically around 10 years. In my experience, staff members have lower salaries than they could find in other industries, with the majority of their compensation coming in the form of the carried interest bonus. For purposes of this conversation, these salaries are taxed as normal income.

Over ten years, the fund may invest in a handful of companies. Some of those companies may fail, some may break even, and a small number will make a significant return. At the end of the fund, the goal is to return all investment capital to the investment partners, plus the additional money made off the fund. A portion of this additional profit is set-aside as a carried interest bonus to the management team. Traditionally, this bonus has been taxed as a capital gain because of the nature of its source—the money comes from a successful investment and is not a guaranteed return. The money occurs after many years of tedious and patient management of investments.

Changing the tax structure on carried interest changes the economics of incentive for the people that work in venture capital. As financiers, we’re very sensitive to the idea that there is a cost to the capital we deploy. If we fail to meet that hurdle, our investors will look for other investment opportunities. Likewise, there is a cost to the time and resources we commit to managing that capital. If our compensation doesn’t justify the stress and commitment necessary, we’re likely look for alternatives. Ultimately, less potential carried interest return to the management team leads to increasing salary compensation, which results in less capital available for deployment. The other alternative is that we run the risk of venture capitalists seeking careers in other industries. While there are arguably too many funds active today, the mind set and culture of the venture capitalist is a rare animal. Run too many of them off, and you’ll find this to be an endangered species and industry.

Why Should I Care?

To put it bluntly, venture capital provides a unique and critical service to our economy—capital and guidance for start-up companies. According to U.S. Census Bureau data, companies less than 5 years old created nearly two-thirds of net new jobs in 2007. While not all of those companies were candidates for venture capital, a substantial number of them were rapidly growing businesses serving unique market needs. These companies often lack the assets or history to secure debt, making an equity investment like venture capital a lone source of financing. Without access to capital, those companies grow at much slower rates or even close down completely. Our small business economy isn’t a recent phenomenon; it’s been the staple of our economy for the past fifty years. The small business economy and innovation spurred companies like Microsoft, Apple, Oracle, and Amazon to name a few.

Tinkering with the economics of venture capital is playing a dangerous game.  While the short term intent may be to supplement incentives in other areas of the economy, the long-term effects may be regression of small business growth and capital deployment. Why punish a critical piece of the mechanism responsible for two-thirds of business growth?

• Venture Capital
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CMM August 10th, 2009

I know it’s a little stale (seeing as it’s now August 2009), but here is a little commentary from the folks at Kauffman on the activity of angel groups in 2008. In case you don’t want to read the whole thing (Kauffman folks are typically long-winded, although this is relatively brief) here are some key considerations:

On deals (micro-economic):

• 2008 average investment per deal was $276,918
• Average number of investments was 6.3
• Average number of new investments was 3.7
• The largest identified sweet spot, with over 40% support, was between $250,000 and $500,000

On the investing (macro-economic):

• More than 2/3rds of respondents think current economic conditions will extended until 2010
• Uncertainty of the economy, a desire to preserve capital for follow-on investment, and loss of wealth were identified as the primary reasons for closing less deals
• 2009 will bring more quantity and quality deals for angels
• The current environment is providing more attractive (author’s note: and realistic) valuations
• Nearly 3/5ths of respondents expect the liquidity time line to be greater than five years
• Respondents expect to increase their co-investment with other angel groups, early-stage VCs, and individual angels
• Angels are increasing management activity and follow-on investing

• Angel Investment , Venture Capital
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CMM July 2nd, 2009

The data for this analysis came from NVCA, who has a relationship with Thomson Reuters. You can find the NVCA press release here.

Basically, Q2 of 2009 showed some signs of life out of the IPO market with five offerings, four from into tech and one from non-high tech. While we’ll celebrate those as the first real high technology IPOs since Q1 2008, we can’t over do it. We’re still a long way from the IPO payday; for example, in 2007 there were 86 IPOs for the year. The IPO market imploded in January of 2008, which in hindsight was probably an early sign of the financial fiasco we’re still struggling with to this day. I still feel like lots of politicians were trying to talk us into a little recessionary dip with pre-election angst and finger pointing, but in retrospect I don’t think I paid enough attention to the stalling IPO market. But I digress…

The venture industry needs liquidity events. Right now, many funds have all capital tied up in portfolio companies that can’t exit even though they’ve reach profitability, or the fund is tied up pumping capital into companies unable to raise additional outside equity. Either way, funds are limited on their ability to engage in real value-add, early stage investing. In addition, some funds are taking huge cram-downs and dilution as portfolio companies go through recapitalization and down equity rounds (i.e. raising money at lower valuations than before). Now, I’m not waving a “poor pitiful VC” flag. I’m just saying we need a healthy, vibrant, and liquid venture industry to keep entrepreneurship going.

The thing about entrepreneurship and early-stage investing is that it’s an expertise lost to the general public and most public officials. Frankly, you don’t really hear major media reporting on innovation, new business creation, IPO registrations, and patent filings. It’s all too complicated for the average Joe or Mary, so real high-growth entrepreneurship seems reserved to those fringe elements of society. Lots of people want to claim some title in this arena (angel invstor, entrepreneur, etc), but few of them really have the somatch and even less ahve the know-how. In addition to the complexity and unknown of this space, the target is always moving as a result of disruption and hyper competition. In my experience, working in this industry requires a high level of commitment to learning and a deep humility/sensitivity to how much you need to learn and relearn each and every day.

In conclusion, we’ve seen some sign of life in the IPO market, but we’ve still got a lot of capital clogged up in venture-backed companies. Exits are approximately 60% of their high over the past five years, with IPOs still anemic.

Here are some graphs showing venture0-backed liquidity events in the US (sorry for the poor pic quality):

• Economy , Entrepreneurship , Venture Capital
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