Paul Graham Sees the Light

Paul Graham has written another epic post.  Titled “Why There Aren’t More Google’s?” he examines Corporate M&A, the lack of boldness in VC’s and the growing gap between founder’s capital and traditional venture capital.

Having spent a decent portion of my career in Corporate M&A and now committed to financing in the seed stage market, I echo most, but not all, of Paul’s comments.

He states that corporate acquirers underestimate high potential startups.  This is undoubetdly true in some cases.  But, strategics are willing to pay more than any other third party and many entrepeneurs want to remain in control, so it’s unclear if there is a market clearing price anyway.  Besides, for every Facebook and Google, there are many, many more high profile acquisitions which failed to live up to expectations.  Skype, anyone?

Many will argue that strategics don’t realize value because they mismanage integration post acquisition.  This is true in too many cases but many corporates purposely leave the startup alone and they still fail to perform to expectation.  The reality is that it is very, very hard to change the world (or dominate an industry) and perhaps even harder to this while under a corporate umbrella.  While high profile startups invariably have amazing potential, things happen.  Incumbents react, new competitors emerge, and often the market just isn’t as big or disruptive as previously assumed.  In this case, a fantastic company emerges, but it is rarely on par with Microsoft, Qualcomm, or Google.  Strategic acquirers know this but startups always want to realize “full value”.

I was surprised Paul didn’t discuss pace of change as one of the causes for a dearth of blockbuster startups.  It takes time to destroy one industry and build another.  The Circle of Economic Life.  While it’s certainly a faster cycle than in previous decades / generations, it’s helpful to remember that consumers need stability, standards and consistency.  Perhaps there aren’t more Googles because the world isn’t ready for another Google, just yet.

One market that is ready for reinvention, however is the seed stage market.  Paul is dead on when he says that VCs aren’t organized to pursue investments in early, early stage companies.  VC’s won’t pursue these deals because they want to mitigate as much risk as possible.  They want proof.  They want data.  They want market validation.  Not unreasonable requests, actually.  Who wouldn’t want this?  The problem is that by the time these proof points are established many capital efficient companies will be close to cash flow break even and they don’t want significant investment capital.  Just ask the domain industry.  These entrepreneurs got zero VC love but many built successful businesses.  Now, these company only do financings for acquisition and liquidity purposes.

The seed stage market is poised for a revolution.  There is just too much of a gap between capital demand and capital supply.  Plus, it’s incredibly inefficient.  Entrepreneurs generally loathe “herding cats” or rounding up angel investors, as they call it.  Angels usually work anonymously or in groups to avoid overwhelming requests from entrepreneurs and the demands of private equity investing.

Perhaps, it’s just my reflection but I see an increase in professionals in the seed stage market.  There will be an influx of capital into this market, both individual and eventually institutional, because capital seeks returns.  And there are great returns to be had in the seed stage market now.  I hope Paul focuses his pen on this for the next essay.

New Hulu – Now Open For All

Jason Kilar, CEO of Hulu.com spoke at Madrona’s annual meeting earlier today and he was kind enough to give us a sneak peak.  Of course, for thousands of technorati, who already have been beta users, the launch scheduled for today is not news.  Hulu is focused exclusively on discovery, navigation, and consumption of premium content, so YouTubers need not apply.

Initially skeptical of hulu’s plans to be primarily a destination site, I think Jason and team have done a nice job of embracing web openness.  They’re living by Fred Wilson’s rules of digital media.

It’s Chunkable – users control entry and exit points on embeds.

It’s Unlocked – No DRM (as far as I could tell) but there is geo blocking for US only. No doubt, rights related.

It’s Portable – users can embed hulu content in their own sites. No word if an API exists but it should appear at some point.  All hosted by hulu.

It’s Monetized – hulu is inserting 1 ad (instead of 4) into commercial breaks and also trying out some sponsorships and overlay graphics.

Secondly, they’ve embraced Flash with H.264 so the content looks fantastic.    It’s scalable, it’s DVD or better quality, and will scale to large monitors.  This is the first service, I’d even consider connecting to my flat screen.

The content is compelling as well.  Both current and no longer available shows are catalogued.  I’m sure money quotes from famous scenes will be appearing all over the web quite soon.

I’m sure there were (and will be) challenges keeping certain factions of the corporate parents happy as they have different and often competing agendas than Hulu.  But Jason,  George  Kliavkoff and Co.  have done a good job of getting the “internal” rights to launch a native digital service.

It’ll be interesting to see what CBS, Viacom and ABC do.  Quincy, any hints?



The Other Jeff Schrock

MVP announced that I joined as a venture partner last week.  It got some press which resulted in a number of calls and emails from long lost friends, which is always nice.  The last time “my” name was in the press, however, it wasn’t so nice.

 Two years ago, a man named Jeff Schrock, age 38, was severely injured and his five children were killed in a head-on collision near Spokane, the city in which I grew up.  Because of our shared and somewhat unique name, similar age and common geography, a number of people who knew me thought this horrific tragedy was mine.  They reached out to my parents, my siblings and even to me.  This sad confusion happened one other time as well.

 This creates a odd emotion (which I’m sure the more eloquent have memorialized as a word) I can only describe as a combination of sympathy and reflection.  I’m not related to and I didn’t know these other Jeff Schrocks but I feel badly about their and their family’s loss.  Maybe, this has happened to others you know as well?

I’m glad to share a touching update in the story of the Other Jeff Schrock.  He was survived by with his wife Carolyn, who was not in the vehicle at the time of the crash, and their unborn child (she is now 2) who are members of the Mennonite religion.  In an all too uncommon act of forgiveness, they are supporting the man who drove the vehicle which crashed into their family.  He is accused of vehicular homicide and they are sitting with him during his trial.  Evidently, they also supported him while he recovered from his injuries.  I find this incredibly brave.  I don’t think everyone can bring themselves to this level of reconciliation but I think the world would be a better place if more people tried.  I’m in awe of the Other Schrocks today.

My Heavenly Calling -The Angel Market

Following my disbanded quest to join the VC ranks, I kept searching for a way to successfully apply risk capital to worthy technology projects. If VC’s are suffering from too much money chasing too few deals, there are only two options: Less Money or More Deals (or both).

Because of the ways VC’s are structured they can’t really go after small cap and mid market opportunities. There are some exceptions but generally if a VC can’t see a realistic opportunity for a business to achieve a $100 million dollar exit, they won’t invest. My partner Rob and Marc Andreeson have both done a deep dive on the economics behind this but suffice it to say that Less Money is not an option many VC partners voluntarily pursue.

Which leaves us with More Deals. As a former M&A exec, I know most technology companies are acquired for less than $50 million. I also know that many scalable, digital businesses can get to profitability on less than $5 million in capital. Given reasonable timeframes (3-7 years), this formula should lead to above market returns. So why isn’t this small cap / mid market opportunity pursued more aggressively?

The Funding gap. Similar to the chasm found in mainstream technology adoption, there is a gap in the startup financing cycle. Robert Wiltbank of Willamette University, one of the preeminent early stage finance researchers, has told me that only 2% of VC deals are in the early (pre $3M raise) stage. It’s been my experience that most entrepreneurs can scrape together a few hundred thousand and defer compensation for a few quarters. Some are even willing to mortgage their house or may have access to deeper pools of risk capital. While this is often enough for the passionate entrepreneur to get things started, it is almost always insufficient capital. This leaves the undercapitalized company with a promising but not sufficiently compelling story for traditional venture capital.

Angels have historically helped fill this gap. But there are issues in this market. First, as companies have become more capital efficient, it’s not clear that investment dollars from angels are growing commensurate with the demand. Secondly, there are administrative challenges with the angel market as well. As an entrepreneur and later as an angel, I’ve seen these issues from both sides of the table. For most entrepreneurs, it takes a tremendous amount of time, effort, patience and the right connections to discover, pitch, and then close angel investors. To say it is a full time job (time not spent building the business) is an understatement. From an angel’s perspective, things can be equally challenging. Capital efficiency has increased the quantity but not necessarily the quality of startups. The volume of companies seeking capital is overwhelming, causing most to remain anonymous, thus exacerbating the entrepreneurs discovery challenge. In addition to deal sourcing and review, it’s also time consuming to negotiate, execute, diligence and most importantly manage an investment. Given that most angels are not full time investors and no one is paying them for their time, it’s easy to understand the challenges from their perspective as well. As my friend Bill Heston recently quipped, “We’re all ignoring our financial adviser’s advice.”

Despite this, I’m convinced there are unnecessary inefficiencies in the angel market. I’m also convinced that resolving (or reducing) these inefficiencies will be beneficial to angels, to entrepreneurs, to VC’s and to a local community. So, I’m happy to have joined forces with Rob Monster in trying to advance the angel market. Our goal is to profitably match risk capital with promising seed stage ventures in a partner (VC and angel) and founder friendly manner. Our approach is to combine the professional management and active involvement of a venture capital firm with the financial flexibility of an angel capitalist. This hybrid approach is somewhate novel and we hope well received in what we believe to be an underserved but promising market.

Draft Day Disappointment

Throughout my career, I’ve had a variety of relationships with venture capitalists. As an entrepreneur, I’ve asked them for money and worked along side of them after their investment. As a Limited Partner (LP) investor, I’ve been a (minor and unreliable) source of capital for them. And as a corporate executive, I’ve been a co-investor in and buyer of their portfolio companies.

But, I’ve never been a general partner. So when a few opportunities arose to become a GP at a couple of premier funds, I jumped at the chance to learn more. I’ve always thought of this as my ideal career path and considered a GP gig at top quartile fund to be a dream job. I literally felt like a ball player about to be drafted into the big leagues.

After all, the VC life can be sweet. No pressure to hit quarterly numbers or get product shipped. Pretty flexible schedule. Continual exposure to brilliant business minds, engaging ideas, and passionate entrepreneurs. And a compensation package which generally invokes industry wide jealousy.

What I learned, however, is that not everything is perfect in Oz. Many VC’s confided they spend most of their time with troubled portfolio companies. The next large block of time is with prospective portfolio companies they ultimately won’t fund. And those fantastic companies lighting the world on fire which will return your fund and make your career? Well, they often don’t need much more than your checkbook and your attendance at board meetings. And while all the websites depict a collegial collaboration amongst equal partners, the reality is that many VC’s are siloed practitioners, sometimes with vastly different compensation arrangements.

There is also much talk about how the VC model is broken. Capital efficiency has created structural challenges for many firms. Demand for capital (esp. per company) has gone down while the supply of capital (esp. per partner) has gone up. As a result of this structural dislocation, there have been a number of reactions. Some firms have become private equity or cross-over funds. Some firms have disbanded. Some firms have raised smaller funds. Some firms are just in denial. And for some firms, a very select few firms, it probably won’t matter – they are just that good.

So the VC life isn’t necessarily as it appears. It sure seems like there is still too much money chasing too few deals. My guess is that the GP winnowing will continue. Ultimately, I decided it wasn’t right for me. I didn’t get the draft day phone call (no tears, please) and decided to seek my adventures in capitalism elsewhere.