Redeye VC

Help me rename "Lifestyle Business"

While venture capitalists pass on companies for many reasons, one of the most common reasons is that they don't think the opportunity is "big enough". 

What does this mean?  It means that even if the company executes as planned, the VC doesn't think the exit will be large enough to generate the VC-sized returns.  This determination is based on the venture capitalist's "fund math" and their expected returns model.  It means that VC doesn't think he will make a big enough return by investing here.

What doesn't this mean?  This doesn't mean that the business is not going to succeed.  It doesn't mean that the entrepreneur will fail.  It just means that the VC doesn't think that the return profile of an investment in the business is a fit for a venture capital investment.

Like all VC's, I pass on many companies that I think will be successful and teams that I really like.  I do so because I think that the economic returns won't move my needle.  (And as one smallest venture funds around, my needle is smaller than most other funds.  And yes, I say this because I am self confident enough to handle the "small needle" jokes). 

However when I do pass for this reason, I try to make sure that I communicate the reason for my decision.  Specifically, I state that while I think the entrepreneur will make money here -- I just don't think I will generate the risk-adjusted returns I need. 

I think the industry places too much of a premium on raising venture capital -- and it has become the default operating assumption for every entrepreneur.  Entrepreneurs can create great businesses -- and have great outcomes -- without raising meaningful outside capital.  Just ask James Hong at HotOrNot, Eric Marcoullier at MyBlogLog, and David Clouse of VRBO.

Part of the problem, I think, is that the technology startup ecosystem seems to be structured so that the goal of every entrepreneur is to raise venture financing.  There is a pretty strong gravitational force that pulls entrepreneurs towards raising VC dollars -- and it's often hard for an entrepreneur to overcome the inertia.

However, I also think that a big part of the problem is that there is no good word/phrase to describe these type of companies.  The only phrase I've heard used is "lifestyle business" -- but I think that is inaccurate and pretty demeaning.  It falsely implies that these entrepreneurs aren't working as hard as those of VC-backed companies.  It falsely implies that these entrepreneurs are choosing a better lifestyle than they would have if they were operating a VC-backed company.  And, as 37signals has written, it condescendingly implies that "A lifestyle business is for the hacks and amateurs while a real business is for the big guns and grown-ups."

I think we need a new word.  Something that isn't demeaning.  Something that doesn't imply laziness or lack of effort. 

And maybe the best way to generate that word is by crowdsourcing it.  Fred Wilson posted a similar challenge in 2006 and it sparked the word "freemium".  And Brad Feld just posted a naming challenge yesterday. 

So here's my challenge -- help me find a new name for "lifestyle business".  Post your suggestions in the comments.  I've also created a public challenge for this on ChallengePost.  Thanks!

San Francisco Office Hours

I had a blast at our Philadelphia Office Hours.  My partners and I met with over 50 entrepreneurs at our biggest Office Hours yet.  My favorite was being pitched by an entrepreneur who arrived directly from Penn's graduation, still in his cap and gown.

Well, we are hitting the road with Office Hours again.  This time in San Francisco.  Please join us for Office Hours in San Francisco on June 11th from Noon - 2PM PST.  This event will mark two firsts for us.

• For the first time, the entire First Round Capital team will participate. 
• And it will also be the first time that we hold Office Hours in, well, our office. 

As with all of our Office Hours events, this is your opportunity to meet with the First Round Capital team and start a conversation about your start-up, your ideas, or yourself.  While the meetings are brief, we've found they are a good way to start a dialog and build a relationship.  We hope to see you at our office...

If you can make it or would like more information, please sign up at http://officehours.firstround.com/

Calling all Philadelphia Entrepreneurs

Over the last several months, First Round Capital has held our "Office Hours" events in San Francisco, New York City, Austin and Vancouver.  Well, now it's time to bring it home!  I'm super excited to announce our first Office Hours event here in Philadelphia.  Please join us on Monday, May 18th from 3-5pm at World Cafe Live.

One of the greatest opportunities in college was Office Hours. Every professor held them and suddenly became accessible. It was a few minutes where you could walk-in, sit down, ask questions, develop a relationship and catch a professor in an informal environment. We think the same opportunity for dialogue should exist for entrepreneurs and venture capitalists.  At Office Hours, we'd love to meet with entrepreneurs, people thinking about becoming entrepreneurs or folks who would like to join a start-up.  No agenda needed.  No presentations or preparation required.  Just an opportunity to discuss entrepreneurship and startups.

We've met with 50-60 entrepreneurs at every other city -- let's make Philadelphia our biggest event yet!

If you can make it, please sign up at http://officehours.firstround.com/

True Entrepreneurs

Last week the Wall Street Journal ran a story highlighting several entrepreneurs who are forgoing salary in order to keep their business alive.  I’ve often believed that the true measure of an entrepreneur’s character comes not during the boom times, but how they react in times of adversity and challenge.  Personally, I think I grew more as an entrepreneur during the years when Infonautics struggled (and the stock price languished) than I did during the Half.com rocketship.  You learn a lot about yourself and the people around you when you’re in the foxhole and things aren’t looking good. 

That’s why I’m so proud to have worked with Doug Camplejohn, Ofer Doitel, Roger Matus and Sean True.  These entrepreneurs founded two First Round Capital companies - Mi5 Networks and Inboxer.  These entrepreneurs experienced -- and overcame -- real adversity during their startup journey.  These entrepreneurs went without salary at times, even investing personal capital to help their company meet payroll.  These entrepreneurs all passionately believed in what they were building. 

And last month their belief paid off, as these entrepreneurs succesfully led their companies to acquisitions.  Doug and Ofer led Mi5 Networks to a sale to Symantec – a wonderful outcome for their team, their investors and their customers.   And Roger and Sean led Inboxer to a sale to Safecore – allowing Inboxer’s employees, investors and customers to benefit from a much stronger platform.

I’m honored to have worked with all four of  these men .  They are true entrepreneurs.  And I can only hope to have the opportunity to get back into the foxhole with them in their future ventures. 

Board Transparency -- and the Implicit Web

I just read Fred Wilson's post about communicating bad news to investors.  I completely agree that it is important for CEO's to avoid surprising their board and to communicate bad news just as fast as you share the good news.  However, one of the big changes I've seen in the last several years has been the incrased use of SaaS tools to manage reporting -- and how that subtlely changes the dynamic of board meetings.

For example, through Google Analytics, I have access to real-time dashboards of almost all my portfolio companies.  So, when I walk into a Modcloth board meeting, I already have seen their traffic and revenue for the month.  Several of my portfolio companies that focus on direct sales have created accounts on Salesforce.com for board members with a customized Board dashboard to provide a 30,000 foot view of the pipeline.

The power of the Implict Web is that data that previously had been in hard-to-access silos is now easily accessible and shareable.  This can change the way information is used and shared within organizations.  I've written about this before, and said:

By providing [a board with] open access to information sources there are a number of benefits:

• It eliminates surprises. By providing a continual stream of information, the board should never be surprised.

• It makes board meetings much more productive.  Rather than spend a lot of time presenting the raw data, the CEO can now provide interpretation and analysis of data -- they can put the numbers in context.

• It allows board members to make more meaningful suggestions.  Different board members have different skills. Some are strong at enterprise sales -- and by tracking a sales pipeline over time they might be able to identify areas for improvement in the sales cycle.  I personally am stronger at online consumer marketing -- and feel that by having access to website traffic reporting I can ask better questions and make better recommendations. 

Sharing data with a board does not mean that you are sharing control. Rather, I believe that an informed and knowledgeable board will be less intrusive (and more hands-off) than a board that is in the dark. (That said, a CEO should clearly set expectations that they are not looking to get the "why are Tuesday's sales 2% lower than Monday's sales" phone call. )

Too many CEO's try to hide their bad news and setbacks -- they stick it in the fifth paragraph of a six paragraph email.  I get extremely uncomfortable with that approach. It forces the investor into the role of detective -- constantly on the look out for hidden clues.

Shrink a Market 2.0

Image via Wikipedia

It was almost three years ago that I first blogged about the benefits of "shrinking a market".    Ironically, the example I used in that blog post was how Encarta shrunk the encyclopedia market (and basically killed Britannica and World Book).  Well, we've now seen the encyclopedia market shrink again.  Today Microsoft announced that they will be closing Encarta -- an apparent victim of Wikipedia. 

The power of the Internet to remove friction, eliminate inefficiency, and drive innovation never ceases to amaze me!

Related articles by Zemanta

• The Category of Traditional Encyclopedias Has Changed. Forever. (themoderatevoice.com)
• Microsoft Closes Book on Encarta (xconomy.com)
• Goodbye MSN Encarta. Was Wikipedia too Much? (taragana.com)

Yogi Berra wisdom for startups

My first company was called Infonautics.  I co-founded it in 1991 when I was an undergraduate at Penn.  This was back in the dark ages of online services -- when people used 1200 or 2400 baud modems.  Our initial product (called Homework Helper) was one of the first consumer "search engines" -- we created an online library of over 2,000 magazines, books and newspapers focused on kids -- and made it available online (via services like Prodigy).  We spent four years negotiating the rights to high quality content. Not surprisingly, publishers didn't even have digital versions.  We ended up sending a lot of stuff overseas to be scanned/keyed in.

And then the web browser was invented and consumers started going online in droves.  While we decided to leverage the Internet for distribution, we did not include web content in our index. 

The first time I saw WebCrawler, in 1994, I remember thinking, "Wow - indexing the web instead of licensing data directly...neat idea!  Too bad we didn't think of that.  We really missed that boat."

Then, we saw Yahoo.  And while we contemplated adding "web content" to our proprietary database, we concluded that it was too late -- and that the search game was "won" by Yahoo and WebCrawler.  And we would differentiate ourselves based on the quality of our proprietary content.

Then came Excite, Infoseek and Lycos  -- now it was really too late for us to move towards web search.  These guys were well funded and had all the momentum.  For sure they were going to own the space.

Then came Altavista and Magellan.  I thought Altavista had search nailed.  Game over for sure.

Then came Dogpile, Inktomi, HotBot. 

Then Ask Jeeves launched with the ability to actually give you an answer to your question.

Then Goto.com (later Overture) launched with a really novel business model.

Then, finally, in 1998 (seven years after Infonautics was founded), came Google.  Boy, they must have been nuts to go up against such a strong array of well-funded competitors?

The two lessons I learned from this experience can be best summarized by Yogi Berra quotes:

If you come to a fork in the road, take it.
Infonautics was in the right place in the right time -- but made some wrong decisions.  (Or, as Yogi said "We made too many wrong mistakes").  We were so locked into our initial strategy and vision that we were unwilling to "pivot" in response to changes in the market.  We had all of the necessary ingredients (funding, search technology, data center, hardware, engineering team, and consumer interface) but were unwilling to change the recipe.  Some of the most successful companies have been "pivots".  PayPal started out as a service to beam money through Palm Pilots, while YouTube was originally a video dating site. The truth is that early stage ventures are all about experimentation and iteration. As soon as it's written, every business plan is wrong. Good entrepreneurs recognize this, and tend to build agile teams that can quickly respond to early market information in order to identify a real business model and minimize risk.

It ain't over till it's over. 
Boy, do I wish Yogi could have been on the Board of Directors of Infonautics.  We made a huge mistake by calling "game over" too early - we had already conceded the game during the first inning.  (In fact, some could say that we called "game over" while they were still singing the National Anthem).  When you are in the middle of the game, you don't have the benefit of being able to look at the scoreboard to tell you what inning it is in - but I've learned that successful entrepreneurs typically resist the natural tendency to assume it's later than it really is.  And while Infonautics was successful enough to go public in April of 1996, the company struggled until it's ultimate demise.

An interesting thought:  Is the "search game" over today?  Or are we simply in the seventh inning of the ballgame watching what appears to be a blowout by Google?  Ten years from now, will someone be blogging about how silly we were to surrender the search game to Google by saying "game over" in search?   Perhaps, in the words of Yogi Berra, "Nobody goes there anymore. It's too crowded."

Nantucket Conference

I'm looking forward to attending my first Nantucket Conference in late April.  The agenda and attendees look very strong. Several topics are very relevant to the current environment. Bob Metcalfe will be giving his favorite talk on selling and I will be on a panel discussing the "Changing VC industry" with Brad Feld, Jo Tango, Paul Ciriello that is moderated by Dan Primack. 

As of Friday there were only 10 slots open. Act fast.

Nothing to Lose (or Risk Tolerance is a Competitive Weapon)

I've been thinking a lot about the market/economy lately, and what the economic downturn means for startups.  And I've come to the conclusion that while the economic crisis does present serious challenges to startups, it it might also offer a real opportunity to attack large entrenched players. 

Back in 2000, after I sold Half.com to eBay, I remained with eBay for a few years.  And while I was there I was a witness to their battle with (and ultimate defeat by/acquisition of) PayPal.  There are many reasons why PayPal won -- but I think it really came down to the differences in "risk tolerance" between a startup and a large public company.  Let me give two examples:

1.  PayPal had a different risk tolerance level for legal risk.
Around the time that PayPal launched, eBay launched its own payment product called Billpoint.  Paypal's product was widely seen as the better product -- it was easier to use, had less "friction" for sellers, and was well designed.  Billpoint was clunky and forced the seller (and buyer) to go through several additional steps.  The conventional wisdom was that PayPal had a better product team and that eBay was clueless.

From what I saw inside eBay, that wasn't really the story.  I believe that eBay understood everything that was needed to build a great payments product.  They were just unable to do so given the risks involved.  Specifically, I believe that PayPal had a better product than Billpoint because they were willing/able to take risks that Billpoint/eBay was not.  For example, when PayPal first launched, it was pretty clear that their product violated the operating rules for Visa, Mastercard and American Express -- and violated banking regulations is more than 40 different states. 

PayPal's bet was that they could ultimate resolve these issues after their product had won in the marketplace.  (And that if they didn't win in the marketplace, the legal risks didn't matter).  And they were right.   In late 2000, MasterCard threatened to terminate PayPal's ability to accept MasterCard cards for payment -- and PayPal ultimately worked the issue out.   In 2001, Visa said that PayPal was violating their operating rules -- and PayPal ultimately worked the issue out.  Over a dozen states investigated PayPal and several including Louisiana and New York concluded that PayPal was offering "illegal banking".  Ultimately, PayPal was able to work the issues out (and ended up applying for money services business licenses in more than 25 states).

It was clear to me (from inside eBay), that the Billpoint team knew exactly what they needed to do in order to offer a comparable product to PayPal.  They just were unwilling to accept the risks of doing so.  As a large public company, eBay could not afford to violate the laws of 40 states.  As a small private company, PayPal was willing to take the risk.

2.  PayPal had a different risk tolerance level for financial risk.
PayPal was one of the earliest success stories for online viral marketing.  Every time a user sent money to someone, the recipient had to become a PayPal user in order to access their money.  And to add fuel to the fire, PayPal launched a "refer-a-friend" bounty program, where they gave users $5 everytime they invited a new user -- and gave the new user $5 when they deposited money into their account.  PayPal was willing to invest millions of dollars to acquire new customers.  According to their financial filings with the SEC, PayPal spent over $15M in marketing fees in 2000 and lost over $169 Million that year. 

eBay, on the other hand,  was profitable in 2000 -- with Net Income of $48M.  Given the pressures that Wall Street analysts put on the company, there was just no way that eBay could invest anywhere near as much in the payments space as PayPal.  If eBay decided to spend half as much as PayPal did, eBay would have shifted from a $48M profit to a $37M loss -- a move which would have reduced eBay's market capitalization by billions.

Ironically, eBay was sitting on an enormous amount of cash at the time (over $1B) -- especially when compared to PayPal's $61 million cash reserve.  However, the realities of the public markets prevented eBay from spending/investing their cash to remain competitive with PayPal.  The fact that eBay was a publicly traded company forced them into a diferent risk profile when it came to financial investment.

In both of these cases, PayPal was able to pursue a strategy with a different risk profile because they had nothing to lose (except their venture capital investment dollars) and eBay (with their $20 Billion market capitalization) had everything to lose. 

So, as I look at the markets today, I think I see a similar situation developing.  There are a large number of public companies that have a lot to lose (and are forced to play defense to protect their sagging stock prices).  As they cut their spending (and lay people off), these companies are slashing investment in new projects and new products.  And that makes them vulnerable to scrappy startups with a different risk profile.  Granted, I don't think you're going to be able to burn through $150M (or even $15M) today to "go big" -- but I believe there are other ways to take an aggressive risk posture (as PayPal did with their willingness to accept legal "ambiguities").

Maybe the fact that startups don't have much to lose is a good thing - especially if you're competing with someone who has a lot to lose.

First Round Capital Office Hours in New York City and SXSW

Although the economy is hurting and the markets are in the dumps, we're still investing in new companies and are always eager to meet great new entrepreneurs and startups.  After holding successful office hours in Palo Alto and Vancouver, the First Round Capital team is excited to bring our "Office Hours" to New York City and SXSW (in Texas). 

As with all of our office hours meet-ups, this is your chance to meet with the First Round Capital team and chat about anything from starting a new business to joining an existing start-up, in an informal environment.  We’ll be available for a bunch of informal ~10 minute chats. No agenda. We’ll provide the napkins to write on and some drinks while you wait.

In New York, come meet myself, Chris Fralic, Howard Morgan and Phin Barnes in Manhattan on Friday, March 13th at Live Bait Restaurant and Bar from 2-4pm.  Details and signup form can be found here.

At SXSW, come meet Rob Hayes, Kent Goldman and Christine Herron on Monday March 16th at Rio Grande Mexican Restaurant in Austin from 11 am- 1pm.  Details and sigunup form can be found here.