By Georges van Hoegaerden

The Prelude to 2010: The State of Venture Capital is now available for public viewing here.

Tags: Limited Partners, VC

By Georges van Hoegaerden

And socialism without merit is a lie too, a hollow lie. So do not even try to juxtapose capitalism and socialism here, not the point. Neither is the "rich" man's black-or-white argument that the mere thought of criticizing capitalism defaults into sudden socialism.

Putting our economies in a box is the last thing we should be doing, it separates us further in an increasingly global marketplace that requires the opposite. The real issue here is how to revive our economy, knowing we have powerful capitalistic assets and an unending innovative drive in our back pocket.

We need to be ready to challenge the status quo, let go (yet not discard) of the past and endure the rigor of change if we want to prevent the bottom from falling out from under our economy or face worse in ten years from now. Hope is not a strategy, change is. So, hang in there with me to redefine economic change.

The Lies We Tell Ourselves

We cannot change our economy for the better if we keep lying. And as a former leader of this country has proven, reiterating lies do not make them come true. The biggest lie is that we claim that we are more free than any other country in the world. As a polyglot immigrant I can refute that argument flat out, that is if we use the same definition of "free".

Freedom is the foundation of free-markets that ensures that every willing-and-able participant can become an integral building block of our economy. While there will never be total freedom, the lies we tell ourselves prevent even rudimentary freedom from taking hold.

Our Freedom Is a Lie

Freedom is not your compliance to your boss's expectation to dress-up to go to work every day, nor your inability to challenge his leadership for fear of losing your job, health insurance, pension contribution and other financial perks.

Freedom is also not a financial system eleven times the size of production that turns running a company into a Las Vegas gamble, demanding a focus on investors that precedes and overshadows the needs of customers. Freedom is also not an aging stock exchange (copied around the world) that promotes the financial agenda of short sellers and forces companies to adopt a short term agenda, rather than to build long term sustainability (or however the company prefers to be measured).

Freedom is not the inability to really say or write what you want, for fear of retribution from a bulging legal system that makes it so easy to file bogus claims, such as defamation of character. Freedom is also not our cunning ability to segregate the rich from the poor, the native americans (in today's indian reservations) from the rest, or blacks from whites (I should know, I am part of an interracial family).

I can go on for a while, but I think you are getting my point. We are lying.

The Freedom To Abuse Freedom

Just because all 400 million of us live in the same country, does not mean we enjoy the same freedom. Many of us are disenfranchised by freedom; the freedom to abuse freedom and to create whatever walled gardens are needed to keep others out. And that is the freedom I am so against.

Our Government's Delicate Role

We cannot really blame Apple that it signed an exclusive arrangement for the iPhone on AT&T's network to yield focus and produce higher margins, but it is the Federal Communications Commissions' (FCC) fault, asleep at the wheel that allowed device-to-network locking before the iPhone was even conceived (device locking was contrary to what the GSM standard was designed to do; I was free to use and roam my european GSM phone on any european network more than 20 years ago).

We cannot blame public companies to drive a short term strategy, as the Security and Exchange Commission (SEC) has implicitly dictated that a string of positive quarterly earnings reports are the predominant way to measure company performance and respectively its CEO. And we should not be surprised that a temporal decline in revenues is then quickly followed by staff reductions to make those quarterly numbers still look good on paper. Are quarterly earnings really an accurate reflection of company performance for a company that has been in business for twenty years or more?

We also cannot really blame Venture Capitalists (VCs) for taking advantage of the blind faith (and now delayed response) from Limited Partners if the SEC continues to treat participants and investments in private companies as under-the-table transactions, hiding important transparency from marketplace participants.

Cure the Disease, Not the Symptoms

But the delicate role of our government is not to regulate the symptoms but to prevent the disease. It is impossible for government to keep tabs on the impurities of symptoms in all marketplaces, but rather it should aggressively work towards enforcing the definition of free-market principles to each domain that poses what it deems a direct or indirect systemic risk to our economy (I can think of about ten depending on granularity, possibly all boiling down to a single driver: our financial systems).

I do not want our government to tell banks how to describe their interest rates to customers, but I do want our government to require banks to file and freeze (for a certain period) their lending terms in a central database, so its customers can query a single website to get the rates from the bank that meet their needs.

The role of government is to establish the marketplace principles, not to establish what is merit. The marketplace participants will sort the latter out quickly.

Relevant Transparency Builds Merit

Transparency is becoming a buzz-word and similar to the buzz-word "experience" means nothing without the preceding adjective relevant. What is relevant is that all participants have immediate access to the transparency of marketplace transactions (between supply and demand) in order for that marketplace to be driven by merit. And that means that the performance of marketplace participants is measured solely by the nature of their unique offering in the marketplace, not a complex myriad of stifling walled gardens and derivatives.

The beauty of relevant transparency is that all marketplace participants become watchdogs. That the signals of impropriety are detected instantaneously by many rather than by a few who choose to pay attention. That must be the reason why the Romans preferred a flock of geese over a single dog to protect their property.

Economic Growth is Defined by the Merit of Marketplace Transactions

No longer will merit be built by the posturing and decibel marketing of the supply side of a marketplace, that without transparency can make virtually any claims it wants. Merit will also not be built by the endless expression of desires from the demand side. What creates economic growth is the merit of the completed transactions between unrestricted supply and unrestricted demand.

So, to come full circle on our financial systems; our stock exchange needs to evolve into a free-market. Where the supply of stock will reflect the strategy by-and-of the company (not by the bourse), and the purchasing of stock is based on investors buying into that strategy. Venture Capital needs to change from a closed market to a free-market in which the transparency allows Limited Partners and entrepreneurs to find VCs who have the merit to pick, build and monetize truly groundbreaking innovation.

Free Ourselves and The Rest Will Follow

Relevant transparency builds free-market principles that leads to merit, in every economic circumstance.

Relevant transparency of our education system will improve the much needed individual merit of teachers and the individual opportunities for children. Relevant transparency of our financial system will improve the merit of investors and the innovative companies they spawn.

Relevant transparency of our economy will improve the opportunity for all people with merit. And all people do have merit. Many people, stifled by the constriction of artificial marketplaces have simply not discovered it yet. Opening up our marketplaces to become more free will allow each participant to discover and hone their own merit and produce better customer value.

The world will be a much better place when every person can participate and validate their own intrinsic merit in a thriving marketplace. So, let's stop lying and demonstrate to the world what real freedom looks like.

Tags: Meritocracy, Entrepreneurs, Free-market, Marketplace, Transparency, Innovation, Government, Wall-Street, Apple, IPhone, Limited Partners, VC, AT&T, Securities

By Georges van Hoegaerden

I saw an article a few days ago from an enthusiastic young General Partner (GP) declaring that "Venture is Back" and it reminded me how frighteningly naive some people in the venture business are.

A naiveté that gives entrepreneurs (and Limited Partners) false hope. And we do not need more false promises in the venture business.

Believe me, I want nothing more than to leave this horrible decennium of venture behind and start a new one afresh, but I cannot get excited about the mere sound of a spinning engine that gets the car rocking back and forth. Frankly, the car is still stuck in the sand with spring breakers drinking the kool-aid and cheering it on.

Spinning the wrong wheels

I too see the statistics on the venture pace going up and down and depending on whose reporting of an in-transparent venture business you believe, you can pick your pill of the day.

But how fast Venture Capitalists spin their wheels is irrelevant to the performance of the venture business. And even how many deals are done and how many exits are produced is irrelevant. Short of any transparency in the venture business those metrics are poor derivatives to report on its ups and downs.

What matters is fund returns

But what really matters to Limited Partners is how much money goes into the VC fund and how much comes out at vintage (after the 7-10 year life-cycle of the fund). Only a fund return that outscores any other asset class a Limited Partner (LP) invests in, can count on receiving continued commitments that add to the growth of the venture sector. And the venture sector is far from growing.

Why venture remains broken

There are much more fundamental reasons as to why in the years between 9/11 and the economic crisis of 2009 venture funds have not shown dramatically better performance while the wind was blowing in the sails of VC who had their LP commitments lined up (see how we counter the hope-and-pray philosophy).

Here is my top 3:

- Flawed deployment of risk

The majority of VCs today rely solely on what I call "technology grazing" as the method to extract greater business value. While that not only reduces potential upside it also deploys a flawed risk profile to the creation of early stage companies.

Venture Capital has died and resurfaced as micro-PE (Private Equity) that deploys an inappropriate risk model to innovations that are supposed to set the world on fire. To the many VC funds larger than $100M, chasing companies that have access to less than $1B in monolithic revenue opportunity and less than a $300M exit opportunity is simply a waste of time.

But the GPs have done so in droves anyway, because God forbid if they would have to give money back to LPs unable to find truly disruptive innovation and forego some of their management fees.

- Too many cooks who can't cook

The vast majority of VCs in the venture business today have never themselves crossed the chasm that would allow them to find the outliers and arbitrate innovation accurately. While GPs in Private Equity may get away with rudimentary skills to accelerate growth, the venture sector relies on specialist GP skills to turn early ideas into highly relevant innovations.

And even then, outliers are usually detected by outliers themselves, not by people who merely followed an educational trajectory cum laude. From a dissection of their bios on their websites you will find the evidence that most General Partners have no merit in judging how and when an early stage company should make the transition from an early adopter to a mass market and with what kind of an investment.

Experienced entrepreneurs are like discerning food lovers, they have a choice and stay away from bad restaurants.

- Endless diversification without accountability

Excessive multi-level diversification does not work and leads to more fog than clarity of purpose. Everyone and everything becomes a derivative, with no line-of-sight to accountability.

First the LPs diversify their risk by deploying a mere 10-15% to alternative assets (which includes venture, relying on other assets to produce the majority of LP returns), then they diversify to commitments in a multitude of venture firms, who then diversify into multiple funds, that then diversify to multiple GPs, who then diversify in multiple startups, who then diversify investments in multiple rounds, and then syndicate with multiple VC peers.

Hence my reference to a venture soup. And the asset holders, LPs and entrepreneurs are not liking the way it tastes.

The real fix

The underperformance in venture is similar to the car driving in the sand with the wrong tires and without locking differentials. The size of the engine (VC fund) does not matter, nor does it matter how fast you sped away on other roads. Only the way you apply the power to the current surface does. And so what matters is to what risk the moneys of a VC fund are applied.

So, unless the VC funds are setup and mandated to chase different risk, I do not expect to see any positive sustainable change in venture performance.

Yes, macro-economic confidence will increase investment pace and even improve the pace of mergers and acquisitions, but as long as we keep filling the pipe with sub-prime investments, we will not see more than sub-prime returns. We simply keep producing insufficient innovative disruption to significantly outpace other prime LP asset classes.

Over the next couple of months our government should instill free-market principles to the financial industry that through transparency can expose the real merit of investors in the venture business. But before that each individual LP can make immediate changes to their VC commitments now, to stave off the lingering curse of subprime VC.

The good news is that the future of the venture business is solely in the hands of the LPs, who by virtue of more discretionary VC selection are able to enthuse the outliers of innovation who, because they have more options, are currently patiently lying in wait.

Tags: Limited Partners, VC, Transparency, Disruption, Assets, Diversification

By Georges van Hoegaerden

Even though Venture Capital has produced no more than 10% IRR for the last 10 years and has lost the confidence of the public markets (lack of IPOs) and public companies (lack of M&A, except for a few "garage" sales), many entrepreneurs keep chasing the mighty dollar from VCs who will not let entrepreneurs challenge their merit, at all or ever.

Even the top VC brands appear not what they look like on the outside.

Tags: Entrepreneurs, Innovation, NVCA, VC

By Georges van Hoegaerden

I covered the systemic risk of Venture Capital (VC) many times (see in my previous article "Less is more") and emphasized how the passion to create disruptive innovation is the driving force of our great nation, an asset the rest of the world looks up to and I aim to protect with everything I have.

I came to this country some 15 years ago to pursue my entrepreneurial endeavors and despite my successes have seen the effects of a debilitating venture business restrict the dreams and bright future of others.

Even some of my entrepreneurial work could have yielded better financial returns, were it not for the subprime nature of some VCs (and their entourage) of whom, in an in-transparent business (read "How to fix VC once and for all"), it is often impossible to establish their real merit (and character) ahead of time.

The Venture Dilemma

Limited Partners (Pension funds, Endowments, Family trusts etc.) who supply their money to VC in capital-calls are faced with the harsh reality that venture (the venture capital sector) has produced less than 10% IRR for the last ten years and are now asked again to buy into the rhetoric from General Partners (GPs) at the VC firm that none of this was their fault, and renew 10-year multimillion and sometimes billion dollar commitments. The question for the Limited Partner (LP) arises; should I stay or should I go?

Many Prime VC Firms have Turned Subprime Too

Top quartile performance (a meaningless definition in its own right) by one VC fund is unlikely to rescue the plethora of under-performers nor yield much higher than 10% IRR in total LP sector returns. And even the performance of classic top-tier VC funds leaves a lot to be desired.

Mayfield Fund appears to have no regret admitting “classic bubble” mistakes and “bringing in big company management”, non-market risk mistakes that do not belong to a seasoned investor. Sequoia Capital issued a dramatic cutback message at first dawn of the economic crisis to its portfolio companies, in essence communicating that their companies are not disruptive enough to withstand economic aberrations. From public reporting by a public pension fund, Draper Fischer Jurvetson does not appear to be knocking it out of the ball-park either. Rumor has it that another top-tier firm, Benchmark Capital is the only firm in Silicon Valley to produce more than a 1x return on all of its funds. This is totally unacceptable performance and behavior of venture firms we collectively tend to think of as top quartile. Are they?

Many of the top-tier funds that flourished in strong winds and made even turkeys fly, have diluted their teams with general partners who simply lack the relevant operational experience (read "Why VCs really need relevant operating experience, now") needed to prevent them too from sliding into the overwhelmingly subprime venture ecosystem.

The Threat to Innovation

Clearly LPs have alternative options of deploying money into other asset classes (liquid or illiquid) and not buying into the feeble VC (and their lobbying organization) arguments will by default yield to a significant reduction of funding for innovation if not cause the industry to spiral further down to inappropriately applied risk and deal commoditization (we refer to as subprime VC).

At least ten years of subprime VC continues to attract subprime entrepreneurs which in turn creates more subprime performance and turns venture capital into micro private equity (PE). The erosion of the venture sector is well on its way and LP assets meant to be deployed to high-risk/high-yield innovation have instead slid down to high-risk/low-yield scale. LPs who meant to invest in venture, have instead invested in micro-PE.

Technology is Not the Risk

Fragmentation and further diversification at the VC level is not the answer to an ailing venture business. While it is exciting for the unknowing entrepreneur to see new angels attempt to fulfill the role VCs are not; such as Jason Calacanis, Adeo Ressi from The Funded, and other new angel groups, the early stage technology trials (as I prefer to call them) continue to deploy the wrong risk and continue to pull the venture business further into the swamp of subprime innovation. As I described before (also read my reference to Vinod Khosla's model of investing), technology development is not the investment risk of the venture business.

Smart LPs Look for a New Breed of GPs

Those LPs who do not want to flee the venture sector and realize that technology still has a bright future ahead better not make the same mistakes twice. The dating service of innovation (VC) may not be working correctly, but the real asset holders in the marketplace of innovation (see my article on the innovation marketplace) are eager and aplenty to monetize a new world of change.

New VC fund requirements need to be established to reintroduce risk-taking Venture Capital to the technology sector which subsequently attracts entrepreneurs that have the capacity and drive to change the world.

LPs need to:

• Establish new GP qualification criteria. Money without merit is not likely to yield outlier results.
• Re-evaluate Private Placement Memorandums to focus on market risk rather than technology risk
• Drive defragmentation and accountability of the investment thesis
• Implement merit based GP remuneration, including downside

Financial marketplace imperfections aside, the miserable performance of the venture sector has nothing to do with the economy and has everything to do with the risk we as early stage investors deploy to attract truly groundbraking innovation.

I have been called taking cheap shots at VC when they are down - by one VC titan I reached out to. But for some reason I do not feel bad demanding excellence from people driving their Maseratis and Porsches from the mostly public money that feeds them. It is not personal, but we owe it to our economy to return merit-to-money.

Limited Partners are in full control of their own destiny in venture, by virtue of how they commit. And now is the time to commit to venture with more discretion and expertise and hit the VC reset button.

Tags: Limited Partners, VC, Assets, Transparency, Subprime, Marketplace, Meritocracy

By Georges van Hoegaerden

For the first time I listened in on a live interview by members of Congress with members of the Private Equity and Venture Capital community recently. I was surprised and-then-not that Congress, who closed its eyes and ears to the malaise of our financial systems for so long, is now also buying into the arguments from the participants of that malfunctioning marketplace that there is no systemic risk in Private Equity's Venture sub-sector. Duh!

Massive systemic risk, financial and spiritual

Congress and the majority of VCs are (again) so wrong. Do we really need more evidence to justify change?

1. Less than 10% IRR produced by VC for the last 10 years makes many Limited Partners wonder why they should put their money in Venture Capital, and rightfully so. The result of some of the LP's withdrawal results in a lack of support for the sector, even if miraculously VC would get its act together. The cultural advantage we have to produce an endless stream of innovation is (and has been, some argue) suppressed by an underperforming financial system that sits on top and squeezes the air out of it. Our competitive advantage as a nation is at stake.
2. $2.9 trillion in spin-out revenues (as reported by Polaris Ventures in its public address to Congress) produced by VC over the last thirty years is about to significantly deflate as a result of lack of exits over the last ten years. The Venture business has produced very few real companies in the last 10 years or so, resulting in a massive erosion of spin-out revenues.
3. Roughly $297B in yearly venture commitments is hoping on "external factors" to recover, ignoring that sub-prime (or micro-PE) VC tactics are preventing the intake of truly disruptive innovation that would have had the potential to create significant returns. And that while early stage innovation is very resistant to economic aberrations and in many cases thrives because of it.
4. We agree with some of the titans in the VC business (Mike Moritz, Vinod Khosla, etc.) that Venture Capital has been broken for 20-years, meaning we are steadily amassing a deficit of 40 years of investing in the wrong innovation, further deflating our competitive advantage as an innovative economy.
5. The participants in the venture business (see "How to fix VC once and for all") with real assets, the Limited Partner (money) and the disruptive entrepreneur (idea) are unhappy with the artificial arbitration of Venture Capital, yielding a departure and declining entry of both. So, despite great spin-stories and self congratulatory statistics from VC lobbying organizations (such as the NVCA) we are witnessing the net outcome of a severe decline in venture job creation and value.
6. It is dangerous for Congress to rate our systemic risk low because of the sheer size of our financial system, proudly described by one member of Congress to be larger than that of China, India and Europe combined. I surmise that is because our financial system is bloated with derivatives, currently eleven times the size of production. We have become a nation of gamblers in derivatives rather than direct investors in the creation of disruptive innovation. The size of our in-transparent and mostly derivative financial system is an unstable and unsustainable foundation to our economy.

If I had the resources of The White House at my disposal I could come up with a much larger laundry list of negative spinout from the underperforming venture business for those who still need it.

Does Congress matter?

Clearly Congress does not understand the venture business, as it interviewed in that recent session only the derivatives of the venture business, the VCs who hold no assets. If congress had read my blog "How to fix VC once and for all" as some of its peers in Washington have, it would have invited the real asset holders, Limited Partners (money) and Entrepreneurs (innovation) to verify the actual effectiveness (see "Why do we keep listening to VC as the barometer of innovation?") of the matchmaking service we call venture capital.

Congress has again allowed protectionists to write their own report cards, just like it allowed the auto companies to make false new promises. Maybe we should just not expect real leadership from Congress.

Healthcare reform has been on the books for a long, long time until a new and smarter president (Barack Obama) decided to pull it through the bureaucratic system and deploy free-market principles that expose merit and long-term save us all a ton of money. The (often hidden and recurring) cost of an ineffective artificially arbitrated market is much higher than the cost of transforming it into a free-market once and for all. But there is a cost nonetheless, the cost of change.

I count on the President

It is the same leadership that finally allows us to transform the healthcare system to a free-market and expose the merit of its participants that is needed to expose the merit of the venture business and our financial system as a whole. Our dependency on a bloated financial system, riddled with derivatives and artificial arbitration is what blurs the creation of real value.

I do not believe Venture Capitalists are bad people. But the venture business has simply adopted a financial system, with all its impurities, that overarched it and allowed it to get away with unverifiable merit for too long.

Less regulation is more

As we can learn from Cesar Milan (The Dog Whisperer on National Geographic) that the behavior of a dog is the responsibility of its owner, so is the behavior of our financial system the responsibility of our government. Just like any dog can be rescued, so do I believe our financial system can be. That is, if we have a pack leader.

Our government needs to institute free-market principles (a few simple filing regulations maintained in a central database) as described in my blog "How to fix VC once and for all" so we can ensure that transparency exposes merit. The merit of which VC (by General Partner denomination) is truly the expert in spawning and monetizing disruptive innovation he claims to be and at what expense. The transparency of the investments to all marketplace participants (including Limited Partners and Entrepreneurs), will quickly and continuously separate the weed from the chaff. And like free-markets are known to do, they create unique marriages between the outliers of innovation and the outliers of investors.

When the free-market of innovation is in place, and only then, should we evaluate getting rid of costly regulatory compliance such as Sarbanes-Oxley, FAS and others that were created to curtail the bad behavior of the old artificially arbitrated market. With the erection of free-markets, less regulation can then indeed be more.

A free country is built on free-markets

Capitalism without verifiable merit simply means we are fooling each other, and the bottom is falling out of our economy because of it. I believe we can rejuvenate and re-authenticate capitalism by deploying free-market principles in our financial system, starting with the venture business. In a free-market those who have merit will become the capitalists, who will then be able to discover and support others with merit. The engine of innovation is revving up again.

I am at your service, Mister President.

Tags: GDP, NVCA, Congress, Limited Partners, VC, Innovation, Government, Marketplace, Meritocracy

By Georges van Hoegaerden

I keep getting questions from Limited Partners (LPs) and Journalists all over the world as to why and what relevant operating experience is needed to become a successful early stage investor or Venture Capitalists (VCs).

The easy answer is: well, if you are building a house you better know something about architecture, design and construction.

But the reason for the return of those questions is probably because I covered this topic before (see: "Why VCs need relevant operating experience") and left the door open to less operationally savvy investors in a new world of investing. After all in a new free-market of innovation (see: "How to fix VC once and for all") the merit of the investor, whatever that merit is composed of, defines the reputation of an effective marketplace participant.

If only we had arrived at that glorious point already.

Since we do not have a free-market of innovation today and Limited Partners are asking me for new fund selection criteria now, I give them the following reason as to why technology Venture Capital's General Partners need relevant operational experience:

1) Venture investing requires different skills than Private Equity

Investing in early stage companies requires a solid understanding of how to turn a vision into a thriving business. As Geoffrey Moore pointed out in his book Crossing the Chasm, successful innovation requires from entrepreneurs an understanding of how to cross the chasm and I demand from VC an understanding of when and how to help entrepreneurs make them do so.

VC should make the appropriate assessments alongside the entrepreneur and support the transitions with appropriate funding levels in which selling to early adopters and visionaries turns into selling to much larger demographic on the other side.



That means Venture Capitalists who claim value-add in their Private Placement Memorandum (PPM: the business-plan from VC to LP), better demonstrate that they know how to cross that chasm and better yet, can prove to Limited Partners that they themselves have done so successfully. Not at a time when turkeys could fly, but when the wind was blowing in the wrong direction.

VCs with only impressive corporate backgrounds very often fail to be aware and understand what it takes to cross the chasm. It is easier to have earned stripes on the right side of the chasm, than it is to have earned them from the left-to-right.

Private Equity investors spend their time on the right, successful Venture investing requires an understanding and experience from the left-to-right of the chasm.

2) Ecosystem performance defines company success

In a perfect world a startup would build a perfect product with support from the perfect investor that relies on the enthusiasm from satisfied users and their word-to-mouth to become successful.

The reality is that tip-toe funding combined with downside investment strategies the success of a company is dependent on many more attributes than merely product development, especially in subprime VC.

Limited funding forces companies to push out product early (many times too early) and relies on "decibel" marketing, business development, and customer support to compensate for product deficiencies in-market.

A great CEO is the ultimate orchestrator of the unique ecosystem of his company, one that requires continuous tuning to run like a well-oiled money-making machine. A Venture investor who drills deep into the performance of a company and make judgements on ecosystem parameters, should have knowledge of and experience in each of those ecosystem parameters and better, have been a CEO at an early stage companies having made such an ecosystem work against-all-odds.

Separate relevant from irrelevant experience

Thanks to the Internet, anyone can do the following exercise: go to a VC website and look at the relevant experience of the General Partners and hold them against the two criteria described above. The outcome will not surprise their performance.

A product manager at the GAP, a financial analyst in Hong Kong, a VP of Marketing in a large hardware company, a CEO at an IT consulting company, a large-cap consultant at Bain - all combined with impressive ivy league education makes for nice resumes in a PPM, but delivers no relevant credentials to lead the early stage innovation that our country depends on.

My advice

Limited Partners should stop doing business with people who have never crossed the chasm and never operated as the CEO of an early stage companies having successfully managed its ecosystem. And entrepreneurs should thoroughly review the relevant operating experience of its prospective board member, before they take their money.

If we do not pay attention to these things, the technology sector is poised to become the next auto-industry: a business we invented but lose in the end. The time for change is now, if we want the technology sector to be in a better position in five years from now.

Tags: PPM, Limited Partners, VC, Entrepreneurs, Eco-systems

By Georges van Hoegaerden

It baffles me how the representatives in Congress keep listening to, and some media stay enthralled with the self-serving circumstantial excuses of Venture Capitalists (VCs) that also still manages to keep some Limited Partners (LPs, their bosses) tuned in. I predicted five years ago, with my declaration of sub-prime VC that Venture Capital was at the brink of disaster, so what is the hot news now?

VCs continue to demonstrate their lack of foresight as they only now, when the statistics of their performance are rolling in, seem able to "predict" their demise with remarkable accuracy. And that while foresight should be one of the most important traits of early stage investors. They still do not understand that an underperforming artificial market leads to one of two outcomes: cannibalization or replacement.

The VC benchmark

News to me is that one of Silicon Valley's most renowned VC funds; Benchmark Capital is rumored to be the first and only VC firm scrambling to produce at least a 1x return on all of its funds. Is such best-of-the-worst really a crowning achievement to be proud of and listened to? Such top-quartile performance is not going to save the reputation of venture sector (even if it does Benchmark's), which relies on the deployment high risk to promise high rewards.

Let me juxtapose why VC should have performed much better than any other time in history:

• Technology has moved from hardware, to software, to software services with immediate market recognition and impact, allowing for simple business models and reduced risk with regard to customer adoption.
• The Internet with its ever increasing penetration provides a boundless addressable market for technology that a successful proposition can tap into at almost no additional expense.
• Until this year (thankfully LPs are now waking up) there have been truckloads of support from Limited Partners to the Venture sector, allowing VCs to pick their preferred fund size and implement their ideal diversification strategy.
• We produce more highly skilled local students and have access to a much larger petri-dish of (global) entrepreneurs than every before, that should account for a much larger supply of disruptive ideas and development resources.
• The penetration of applications to vertical markets (healthcare, oil and gas, real estate, etc.) remains pretty much untapped, leaving low hanging fruit investment opportunities unserved.
• The deployment of macro-economic principles with the application of technology to drive more efficient marketplaces remains untapped, leaving winner-takes-all investment opportunities unserved.

So no, I do not buy into the excuses from the current VCs who point to irrelevant market indices or anything else they can hang their hat on to justify why they should be allowed to deploy a fundamentally flawed risk profile for another 10 years.

The Venture business should continue to outperform other asset classes by a long shot, by virtue of

• its long-term commitments from LPs, and
• its never ending (long-tail) supply of entrepreneurs, and
• its resistance to economic aberrations (as monetization of disruptive monetization happens typically at the end of the funding runway)

And VCs who do not, should be ashamed of themselves and be pushed out of the business. LPs should no longer accept anything but bottom-line results, regardless of the state of the economy. Playing with someone else's money requires merit, just as much merit as we demand from entrepreneurs to help their companies grow. It is time we hold VC to higher standards and make them accountable.

Free this marketplace

VCs spin their rhetoric and mask that for too long they have deployed not Venture Capital but micro-PE (Private Equity) to innovation, a fundamentally flawed risk/reward investment thesis applied to the early stage sector. And they continue to do so under the cover of darkness (to the marketplace participants).

No improvement in the economy, except for the implementation of free-market principles (see "How to fix VC once and for all") will change the outcome of the Venture Capital sector.

Congress and government should worry less about the symptoms of its considerable systemic risk and stop applying useless post-mortem regulatory checks to the Security and Exchange Commission (SEC), but instead deploy macro-economic principles so the "disease" will not continue to percolate and the marketplace of innovation will self-regulate based on transparency and merit.

It is time to demand from VC not relative, but absolute performance. And stop listening to those who are going to be cannibalized or replaced. All the ingredients for an efficient marketplace for innovation are here, and with newly established free-market principles at its foundation we can finally let the real cooks emerge.

Tags: Macro-economics, VC, Private Equity, Congress, Marketplace, Innovation, Limited Partners

By Georges van Hoegaerden

The currently running TV show The Shark Tank on ABC produced by Mark Burnett is an amuzing, dare I say reality show in which five investors confront entrepreneurs with direct investment decisions into fledgling startup companies.

What the investors on the Shark Tank have in common with Silicon Valley is that their seed funding rounds range from $50,000 to $1M, yet often in more than pure technology plays.

While the title of the show sounds harsh, and some of its investors are, its actual workings is much better and more sincere than that of Silicon Valley:

Investors with relevant operating experience

Kevin O'Leary, Barbara Corcoran, Robert Herjavec, Daymond John and least impressive Kevin Harrington have earned their stripes in running very successful businesses with exits to boot. They demonstrate their knowledge and experience in making impromptu investment decisions and their ability to deliver their value-add to entrepreneur. So unlike Silicon Valley.

Transparency of decision making

Not only is the investment decision occurring almost immediately (or declined at the same pace), the reasoning of such decisions is happening right in front of the entrepreneur. The entrepreneur is able to respond, interject and argue a refusal to invest if he believes the arguments are invalid, and worth rebutting. Transparancy of decision making allows for a better alignment between entrepreneur and investor. So unlike Silicon Valley.

Open competition between investors

Once the interest in a startup has been established, the key investors Kevin, Barbara and Robert publicly fight over the deal like lions devouring a kill. Kevin cannot help but expose his unruly personality and because of it never gets his way, which reminds me of many Sand Hill Road investors. Robert is the more level headed investor who keeps his cool and his smarts at every turn, and Barbara perhaps the shrewdest of them all, waits silently until the boys have finished argueing and often walks away with the grand prize. All while the entrepreneur enjoys a steady increase in valuations and moneys invested. So unlike Silicon Valley.

There are many aspects of the show that are compelling and an interesting watch for entrepreneurs. The Shark Tank demonstrates why Silicon Valley needs the transparancy, that leads to a meritocracy that leads to the discovery of truly disruptive innovation (as described in "How to fix VC once and for all"). The show also points out how badly Venture Capital treats entrepreneurs and how it has stooped below the tactics of the Sharks in Nature's pyramid of investing.

Bottom feeding comes to mind.

Tags: Meritocracy, VC, Entrepreneurs, Silicon Valley, Transparency

By Georges van Hoegaerden

I have had several discussions and e-mail conversations with entrepreneurs, journalists and venture capitalists (VC) about the free-market principles described in my blog "How to fix VC once and for all". In that blog I propose to apply free-market principles to the marketplace of innovation, in connecting the assets of the Limited Partner (LPs): money, with the assets of the entrepreneur: ideas.

What struck me most is how few people are familiar with those macro-economic principles that beyond consumer benefits have a significant impact on how an entrepreneur goes to market and how VCs fund them.

VC feedback

Especially eerie, short and dismissive was the interaction with one of the most well-known VC czars of Silicon Valley, who publicly proclaims to be a proponent of free-markets (that is exactly why I contacted him) yet does not seem to understand their basic premise. He brushed off my marketplace-for-innovation plan as just more creeping Socialism.

I am of course the fool, for telling the old-boys club to now support a meritocracy, and dump the walled gardens that made it fat-and-happy in the first place.

I knew that switching to free-markets will unleash the protectionist stance in many VCs. But what worries me more is that the opinions and decisions made by this General Partner (GP) impact startups whose successes are predicated on a firm understanding of macro-economics. His responses mean that this GP would simply brush off platform investments that embody free-market principles (eBay and the Apple AppStore for example) as socialistic movements. History proves that is not a good idea.

And that dear reader, is what the rest of the world (and the majority of Silicon Valley) looks up to. We blindly copy methodologies that no longer work in the hopes that 20-years of underperforming past behavior is not indicative of future behavior. It is all someone else's fault.

Start praying.

Debunking free-market myths

But where there is smoke there is fire (aptly considering the many other fires in California) and it is important for the marketplace participants, LPs (money) and entrepreneurs (ideas) who bring real assets to the table, to get a good understanding of free-market benefits. So, let me debunk some free-market myths:

Myth #1: free-markets are socialistic movements

A free-market is a self-regulatory instrument that ensures that a true meritocracy prevails, destroying artificial walled gardens such as geography, demography, old-boy status, first-mover advantage etc. A free-market ensures that the quality of the authentic value-add by each participant is evaluated based on its independent merit. A free-market therefor is the ultimate in capitalism, those who build earnest value will prevail.

Myth #2: free-markets require a lot of governance

More and different regulation than none, for sure. But the regulation will not come from government but from the marketplace participants (see my blog "Why innovation needs regulation"). When transparancy to all participants (a requirement of free-markets) is implemented, all participants benefit from the exposure and individual merit becomes the governor.

Myth #3: free-market transparency is unwanted

Transparency promotes competition, and competition based on merit is good for LPs, VCs and entrepreneurs. Merit yields better value to the detection of outlyers who lay at the foundation of disruptive innovation. LPs will benefit because in the formation of new funds, they can proactively bid to get in on a VC fund they previously only had access to when approached. New LPs can enter the fray and compete at an equal level. Small LPs can bid alongside large LPs. Entrepreneurs gain precious time in dealing with VC that have proven merit, and achieve more attractive valuations and secure better runway support - reducing the infant death syndrome as a result of investor lock-ins. VCs who are comfortable that money is not the only value they offer should feel confident their role is secured by the merit of their value-add.

But even if you are not convinced that the current VC performance is a systemic risk, a move to a free-market mechanism that (if nothing else) offers the transparency to all participants, is the fastest way to prove the other side of the argument wrong.

My hope is that we, in the venture business, establish these free-market principles voluntarily and without intervention from the government. But the feedback to my query as witnessed by the protectionist answers from VCs does not hold a lot of promise.

With a systemic risk of $2.9 trillion of innovation-spin-out revenues quickly deflating, we face a similar overruling by the government as healthcare, where rather than a voluntary free-market, a free-market with arbitrage from the government will be forced upon us.

Take your pick.

Tags: Meritocracy, Marketplace, Silicon Valley, Innovation, VC, Entrepreneurs, Limited Partners

By Georges van Hoegaerden

The venture business needs an overhaul, and below is my low-burden / high-impact plan for change.

Problem

Venture Capital (VC) is a systemic risk to our innovative culture, to $200B in direct asset allocations and to $2.9 trillion in spawned revenues (since 1970, per IHS Global Insight report). Yet VC has produced less than 10% IRR for the last ten years promoting a fear/flight response by Limited Partners (LPs), on the verge of pulling their money out of the sector and investing it elsewhere.

Top technology and investment experts, like Larry Ellison, Vinod Khosla, Greg Lamond and many other illuminaries now subscribe to the mediocrity of the current state of venture, with Mike Moritz (GP Sequioa) stating venture has been underperforming for 20 years. I agree.

Direct and circumstantial evidence suggests that the venture business needs a major overhaul, to ensure that the assets of the Limited Partners (money) are effectively lined up with the unwavering assets of the entrepreneur (innovation). Just because the intermediary "dating" service (VC) is broken does not mean we should lead to conclude supply (LP) and demand (entrepreneur) side participants are.

LPs are still looking to deploy high-risk/high-yield commitments and entrepreneurs are still coming up with highly disruptive ideas. The economic marketplace where those transactions occur is simply structurally ineffective.

Opportunity

Technology venture should be producing premium returns because of:

• Its infancy, 5/6 of the worlds population is not connected via broadband, exposing a massive greenfield of new unexplored market opportunities.
• Relatively (compared to other sectors) low cost of production, software applications and services require no physical manufacturing.
• Low cost of distribution, the internet distribution is effective and low cost (as long as the product is good enough).
• Immediacy of customer fulfillment, the impact of internet applications is instant.
• Independent ownership of the complete value-chain from idea-to-customer means the risk to success is highly predictable.

I cannot think of a better asset class or sector where the development of an idea can lead so quickly to immediate and widespread customer impact. Unlike biotech or greentech, the attributes of technology venture are such that they will produce returns compatible with the 5-10 year lifecycle of those funds. That is if the market intermediary makes the right choices, guided by relevant experience.

Solution

We can all argue until we are blue in the face as to what is a great venture investment strategy, and I certainly have my opinions. But none of that matters. What matters is to create success for those that put assets to work, financial success to the LP and entrepreneurial success to the inventor. What matters is merit not rethoric.

Venture investing needs to move from an artificially restricted market to a free-market in which the transparency of, and to all participants identifies and perpetuates the ever changing meritocracy of innovation.

That means all participants need to adopt free-market principles so that the merit of their work, not an artificially privileged status distinquishes them from others. Such is the necessary, sustainable and thriving foundation for innovation and capitalism.

No one will be able to hide, and the marketplace as a whole will automatically give preference to those participants and their transactions that build real success. Only capitalism based on merit is sustainable long-term.



Above is a simplified chart that depicts the venture marketplace. For those unfamiliar: LPs invest in VC funds who, by virtue of a lead GP invests in the startup of an entrepreneur. LPs set aside a predetermined commitment to the VC fund and GPs make capital calls when required by their investments into startups. GPs allocate a certain runway for startups and at funding time stage their investment in investment rounds to mitigate risk. At M&A or IPO cash is returned to the VC in exchange for the equity position and VC returns a part of those funds (minus management fees and other reserves) back to the LPs.

Transparency leads to meritocracy

To enable a meritocracy the marketplace needs to enforce full transparency to all of its participants. At the transaction level by GP, not by VC firm. More important than to feed the Security and Exchange Commission (SEC), the marketplace itself (not a government agency) will then govern its own success:

1. LPs need to disclose their commitments, how much is drawn, when, running returns and include the fund maturation date
2. GPs need to disclose which companies they invest in, how much and at what valuation
3. Entrepreneurs need to disclose what exit returns they produce

I realize that type of transparency will get VCs all riled up, they recently testified to congress as such. As protectionists of their current walled-gardens they fear that such disclosure would challenge their competitive stance. Exactly, and that is what we want.

Because today the cartel VCs have formed around their collective wisdom, outdated execution and dismal returns prevent really smart entrepreneurs from participating in venture transactions to begin with. If VCs believe so firmly in the proprietary value-add of their services to the investment process, why would they be afraid to disclose everything but their secret sauce. Investment dollars into a company can be derived from other sources, but is very cumbersome if not impossible to retrofit to the exact origination and source in the marketplace model.

LPs would have less of a problem disclosing such information and many, like pension funds, already do. But they will need to firm up that reporting to the standards of the marketplace, not an incomplete disclosure that does not match up with that of its peers.

Not public is not private

Economically and to minimize abuse, all companies should be transparent to some extent, including private companies at least to meet the above described marketplace requirements.

Not all transparency is created equal, in a marketplace the transparency needs to be provided to all participants; LPs, VCs and entrepreneurs in the same fashion. Not just in case of suspected abuse and post-mortem to the SEC, since that kind of transparency does little to promote marketplace merit.

In the same way banks are supposed to report certain transactions above $5,000 should we disclose the investments in private companies above a certain threshold. In other places outside the U.S. (such as Europe) private companies already need to abide to certain disclosures, paving the way for meritocracy.

Entrepreneurs are often proud to disclose how much money their idea generated were it not for acquirers, who afraid of competition often press for non-disclosure. Yet those numbers will now come out of the new marketplace, and competition as a vital ingredient for exits is re-established as well.

Once we have the fundamental transparency of the marketplace in place, the following benefits will surface almost immediately (especially when we apply this transparency retroactively):

• We will know which VC actually has money to deploy, and entrepreneurs will not be wasting precious cycles
• We will know which VC actually has a reputation of building successful companies
• We will know which GP actually has earned the reputation to sit on a board
• We will know which GP actually has the foresight and credentials to invest in upside rather than downside
• We will know the merit of GP vision, specialties and domain experience
• The meritocracy of investments will support the long-tail of ideas rather than regurgitate its commodization

The merit of all participants will be disclosed, by virtue of their investment in success.

Low burden change, immediate impact

The goal of this plan is to serve the risk/reward needs of LPs and connect that with highly disruptive innovation from great entrepreneurs. No drastic changes need to be made to the current investment model. No drastic change in the investment pace needs to take place until the meritocracy demonstrates otherwise.

Transparency to all participants will act as the dynamic referee in an ever changing venture business. Compared to the past, merit will now closely follow and support the change of innovation, rather than remain stale and outdated. And the meritocracy of the marketplace will also determine whether or not the venture business is too large, too small, or just right. But it would be highly inaccurate and irresponsible to make those decisions based on the workings of the venture business today.

How you can help

I am already working with individual LPs to familiarize them with the specific rollout of this plan, and I invite others to participate (contact us here). I also extend a hand to VCs, some of whom have responded, to become be part of the solution. I would like nothing more for us, as participants to the venture business to solve our own problems, without the need for government intervention.

The venture business is too important to our economy (for the reasons mentioned above) and we owe it to the entrepreneurs (across the world) to build a financial system that supports the merits of their intellectual brainpower.

Join me in this effort and feel free to spread the word, syndicate this blog (with proper attribution and link-back) and retweet. Let's make positive change happen.

Tags: Meritocracy, Macro-economics, Government, Marketplace, VC, Limited Partners, Entrepreneurs, Transparency

By Georges van Hoegaerden

One of the most important traits of a great person, great CEO and great investor is the unrelenting pursuit of the truth and a firm ignorance for anything else. The truth in a world that is full of smoke and mirrors, stemming from an unconnected era in which the creation of heaps of walled gardens would go unnoticed to unsuspecting participants.

Even though we don't like to admit it, we as grownups still play the telephone game frequently, in which a chain of derivatives regularly degrades the truth.

But those days are slowly coming to an end, as the internet with the free-market principles it aims to deploy, and social networking as its unforgiving arbitor is steadily eroding misplaced authenticity and trust (see Trust is the currency of success).

Most people reading this blog will think of derivatives as a financial instrument first, but our world is chockfull of others that invade our lives from every corner. The dictionary definition holds a clue:

• adjective : imitative of the work of another person, and usually disapproved of for that reason
• noun: something that is based on another source, an arrangement or instrument (such as a future, option, or warrant) whose value derives from and is dependent on the value of an underlying asset

Sound decision-making comes from a clear understanding of the difference between fact and derivative. Below are examples of everyday derivatives and the impact they have on their surroundings. Some may be shocking, but I promise will yield incredible new focus and progress if simply ignored.

Markets

Markets don't exist, we covered a whole blog about it. Read it please. Customers do not buy products because they associate or belong to a derivative descriptor of a market. They buy because the marketplace (a mechanism to buy) offers the best opportunity to serve their (often complex) individual needs. So, go ahead and thrown away your industry and market segmentation or market-share leapfrog strategies. They are worthless.

Venture Capitalists

In the investment equation between the assets of a Limited Partner (money) and the assets of the entrepreneur (idea), venture capital is merely a dating service (with no assets to speak of) that establishes the transaction of the marketplace, a financing round. While Venture Capital (VC) behaves as if it is the originator of assets and the creator of value, LPs are actually the ones that deploy the commitments to the creation of value by the entrepreneur. Contrary to their testimony to congress, VCs did not create millions of jobs, LPs did by deploying their monetary assets. While VCs force entrepreneurs to buy into their (steadily commoditizing) investment wisdom, more than 90% of those wisdoms do not pan out. An entrepreneur is better off to ignore VC advice altogether and pursue the creation of real value to its customers. Fundraising is a lot easier that way.

Psychologists

Many people seek solace in the interaction with a psychologist to solve relationship problems or otherwise. While an outside perspective may be liberating at times, a sustainable solution based on a derivative opinion is highly unlikely. Spend more time with the people you have relationship problems with, than your psychologist. Because the stories you tell him are themselves derivatives.

TV Journalists

CNN today is a prime example of a network that has gone from reporting the news (expensive) to regurgitating the news with hordes of consultants (inexpensive), delivering derivatives of the news rather than the news itself. CNN has moved from a real new source to a commodity entertainment channel, eroding and consistently being beaten at its home turf. Ignore the regurgitation by derivatives and you'll save precious time of your day.

The Stock Market

The stock market is an exchange but not a marketplace in the free-market definition of it. As if the performance, long and short, of a company can be derived from something as simple as price-to-earnings ratios. Public CEOs know how to dance the dance, market to those numbers and become short term focused to meet Wall Street expectations. Yet long term and macro-economic differentiation that requires investments (expense) is arguably more important than meeting the quarterly drill of meaningless earnings reports. The performance of stock is a derivative of the short-sellers view of the performance of the company, and by definition inaccurate. And so are the investment decisions derived from them.

Money

The dollar is not worth the paper it is written on. It merely communicates the value of trust attached to that piece of paper. And even though that money can buy you great things, it matters whether it is acquired from a foundation of trust. Cash is not king, trust is. Easy money has a way of punishing its acquirers in un-expecting and fleeting ways, hard earned money amplifies itself consistently. So, money is a derivative of trust, and someone with a lot should not automatically be confused with authenticity and trustworthiness. Earn money the hard way and you'll be rewarded for life. Money can be a derivative of trust, but with financial derivatives eleven times the size of production should not be confused with trust itself.

There are many more derivatives I can talk about. But the purpose of this blog is to make you think. Hopefully the next time you spend time with someone, you will ask yourself the following question: is that person claiming to be the authority of derivatives or the authority of truth. The answer will define your success.

Tags: Commodity, Free-market, StockMarket, CEO, VC, Limited Partners, CNN

By Georges van Hoegaerden

I could not help but chuckle (again) when Oracle's 30-year-running CEO, Larry Ellison (full disclosure) fiercely yelled out the words from the title of this blog, referring to the artificial arbitration of innovation applied by Venture Capitalists (VCs) we talk about in this blog so often.

Sand Hill Road, for those unfamiliar is the street in Menlo Park, California where the majority of Silicon Valley VC enjoy some of the most expensive office rent in the country and invite their often starving entrepreneurs to "beg" for money. The area is considered the birthplace of Venture Capital.

Larry goes on to say that Venture Capitalists think that innovation is like coming up with a new technology buzzword, expressing his specific dismay with the term cloud computing (watch the Churchill Club interview on YouTube, skip to 47:53 min if you don't like boating).

The reason why I bring that up is four-fold:

1. Entrepreneurs are subject to this artificial arbitration (that is applied with the seasonality and commonality of fashion) as the primary method to get their high growth company funded. Entrepreneurs think that "wisdom" leads to success, yet deplorable VC returns prove otherwise.
2. Limited Partners (LPs) seem to respond commensurate with their limited allocation in venture (usually less than 15% of total allocation) and their natural inclination is to rest with the excuses (we debunked) from VCs, who never fail to reiterate that cyclical behavior of the financial markets and the economy are to blame for the deplorable returns in venture.
3. VCs are downplaying the systemic risk of this artificial arbitration (applied by the venture investor cartel) to our government, stating that $200B of venture investments pose less systemic risk than other asset classes, while completely ignoring that their behavior kills the meritocracy and innovative culture our country was founded upon.
4. Other VCs in the country (and around the world) copy the tactics of Silicon Valley investors, with similar results awaiting them.

But feel free not take my word for it. Agreeing with Larry Ellison, Mike Moritz, one of Silicon Valley's most lauded VCs was recently heard saying the Venture Capital business has been broken for twenty years. So do similarly successful venture peers Vinod Khosla and Greg Lamond, who believe - like we do - that when the risk is sucked out of investing, one should not expect great returns.

Still not listening? Stanford, Yale, Harvard and Princeton universities all appear to be suffering from significant losses to their endowment as a result of investments in "alternative" assets, which includes venture capital. To combat, according to PE Hub, Stanford has just raised a $1 billion in a bond offering last April in case of a “true emergency".

By the way: with those Ivy League universities having bred the most renowned economists and professors in entrepreneurship does anyone question whether their expertise is worth the tuition? Are the experts really what they claim?

How much exactly of that depressing news can be contributed to the performance of Venture Capital is not clear to me today (Hedge funds and Private Equity are the most common other assets) yet reports from both CalPERS and CalSTRS pension funds suggest a lackluster contribution of VC across the venture spectrum.

Deaf? Many of my peers in executive positions at Apple, Cisco, Oracle, HP, eBay refuse to enter the venture fray in which the equilibrium of entrepreneur and investor is completely out of whack. The cyclical nature of the downward sub-prime spiral continues to rear its ugly head. The only entrepreneurs that submit to sub-prime investments today are as sub-prime as their investors, incapable of building great fund performance.

The alarm bells are ringing. Limited Partners need to wake up, simply because of the loud reverberation of a vast preponderance of circumstantial evidence. It is time for LPs to listen, not to popular opinion from the people who got them in this financial debacle in the first place, but to people who offer ideas that simply serve entrepreneurs better. The time for change is now.

Passively waiting for consensus on data driven views is guaranteed to lead us to what Larry referred to as an L-shape recovery in the venture business.

Tags: Oracle, VC, Silicon Valley, Innovation, Limited Partners, Subprime

By Georges van Hoegaerden

I decided to do a little deep dive after I reviewed the CalPERS alternative assets performance posted by PEHub's Dan Primack, to help entrepreneurs get a better understanding of who they may be talking to when raising their next round of funding. While in the relationship between entrepreneur and VC the utmost transparency of the entrepreneur is demanded, VCs often bask in the glory of darkness.



For those who do not know, CalPERS is one of the largest state pension funds in the United States with a large alternative asset allocation (north of $53B over the last twenty years), the majority of it dedicated to venture investing, both directly into VC funds and indirectly through fund-of-funds.

Why half transparent is in-transparent

The CalPERS performance report may comply to the government's mandate for transparency, but still lacks the full transparency needed to understand whether or not CalPERS is making real money in the venture sector.

Here is why the numbers cannot be used to represent CalPERS performance:

• Size of commitments may be larger due to exclusion of terminated relationships (no reason specified)
• Actual yield may be inaccurate due to lack of standardized VC performance metrics
• Actual yield may be inaccurate due to J-Curve and varying fund vintages
• Actual yield may be inaccurate due to difference between commitments, cash-in and cash deployed
• Actual yield may be inaccurate due to varying definition and timing of remaining value per fund
• Actual yield may be inaccurate due to the exclusion of terminated commitments

What we can surmize is that the total size of commitments to the alternative assets as of March 31st, 2009 is at least the size depicted in the chart, and the yield percentage in my chart is a simple calculation based on the actual amount of cash put into the VC fund (unbiased by the remainder of commitments from CalPERS to the fund). Only the most "meaningful" returns, the returns from pre-2005 vintages have been included in this analysis.

So, while we cannot discern from the report how CalPERS is managing the alternative assets, we can get an overview of how CalPERS evaluates the performance of the commitments it has on the books.

Individual VC performance(*)

The simplest way to evaluate any financial performance is to calculate the difference of money-in versus money-out. We then calculate a yield as the difference between money-out and money-in as a percentage of money-in.

A positive yield means the fund is on track to return all of the money it has drawn, plus that percentage above zero. A negative yield means the fund is losing that percentage of the money drawn (yet depending on vintage it may still have enough capital commitment or return value left to recover from those losses).

The point I am making here is simple, just like VCs want entrepreneurs to explain their ups and downs in their career, it make sense that based on the reporting provided by CalPERS, entrepreneurs start asking questions about the ups and downs of VC as well. Bad money is rampant in the venture business and knowing who sits across the table is pertinent to the chances of success for an entrepreneur.

Furthermore, funds that remain under 10 or even 20% at the end of their vintage are subject to increased scrutinity by Limited Partners (LPs) as they do not outperform the other asset classes LPs can deploy money to. LPs do not need to take risk that is out of sync with the rewards or worse, they do not need to deploy money at all in certain cases. Apart from performance, entrepreneurs should also be aware of the fund vintage a VC General Partner is investing out of, to ensure an exit is not solely driven by the unilateral urge to produce desperate VC returns.

Entrepreneur, consider yourself informed:
































(*) Performance numbers listed here are subject to change, depending on fund type, vintage and many other cash-flow reporting factors.

Tags: Performance, VC

By Georges van Hoegaerden

Everytime I see the quarterly reports from Fenwick & West on Silicon Valley valuations I cringe. Not because the report is wrong, but because I know how entrepreneurs and Venture Capitalists (VC) use the valuation medians (that have gone down again) in the report to establish their starting, or worse their ending negotiation positions. And they are both so wrong.

First off, valuations are never to be discussed by entrepreneurs before an alignment of the grand vision with the VC is established. Whether or not the VC is the right partner has everything to do with a shared vision of the upside potential of the company, at the outset excluding the potential of the newfound company's ability to execute on that promise.

No precedent

In many ways VCs discussing their allegiance to Silicon Valley medians is a testament of what a cookie-cutter business early-stage venture investing has become. Great investments (in truly disruptive innovations) have no precedents and neither do their valuations. Compliance to median valuations is an early detection of a sub-prime investor juggling with an equally sub-prime and subordinate entrepreneur.

Don't step up

Years of sub-prime investing (that has yielded equally sub-prime Limited Partner returns), by inexperienced technology investors have dumbed down the investment thesis to incremental rather than disruptive innovations. That is perhaps the biggest problem venture-investing faces today. The "step-up" approach to investing yields insufficient exit values and allows technology prospects (and acquirers) in less attractive economic circumstances (personal, local or global) to wait until the dust settles and delay their buying decisions for the next step of that incremental development.

As Ray Lane, former COO of Oracle and now partner at VC fund KPCB in remarkable honesty once declared: "[Oracle] customers would have been better of skipping client/server altogether" describing posthumously the problem of "step-up" innovations best.

Step-up innovations are highly unlikely to generate the $300M+ exits needed to build a decent VC fund return and leaves the VC after the "honeymoon" with a majority stake in the company, unwilling to wait for further miracles and because of the urge to produce cumulative vintage-fund-returns for LPs, to sell out at any price. Many subprime VCs hope that the sum of all tiny subprime returns still yields something of value, rather than chase the best outcome for each portfolio company independently. With a lack of exits (of their own making) those same VCs now use cumulative portfolio company revenue reporting to demonstrate to LPs that they are building value, and deserve another chance when "exit-markets" miracularly recover. Cumulative portfolio revenues is a poor man's defense of venture capital.

Think big, or go home

So, the first step to setting a great valuation for an entrepreneur is to ensure the idea is truly disruptive. Disruptive not from a relative perspective (compared to existing competitors) but an absolute perspective. Absolute disruption does not care about competitors, because there are none.

Absolute innovation relies on a greenfield of 5/6th of the worlds population that is not (efficiently) served with technology products today, but should. Low hanging fruit is the application of technology where a need is already defined, just not with the implementation of technology. Many ideas come to mind and marketplaces are fundamental, and I would love to hear about your ideas.

The unfortunate aspect of today's early-stage venture investment climate is that investors who recognize disruptive innovation are hard to find, not in the least because few fund structures are designed to chase them.

Glass half-empty valuations

Many venture investors (I should know, I lived in Palo Alto amongst them for 15 years) cannot detect innovation until they spot it in their rearview mirrors. Replicas or step-ups of a handful of sector investment success still creates an ocean of delayed me-too investments with mediocre exits, steadily decreasing the confidence in venture investing as a high yield asset sector for Limited Partners.

Smaller funds, lower valuations and risk averse investments have led to VCs and their syndicates huddling together in what I would classify as an informal investor cartel. An investment cartel that uses (the inappropriate) technology segmentation as an artificial standard for the lowest valution they can get away with. Hence the reason why entrepreneurs should not expect or shop around for higher valuations; you will be snitched on.

I refer to those investments as downside valuations, since they are based on the average choices and (lackluster) performance of past investments by all investors, not the unique marriage between the individual investor and entrepreneur. It is also a downside valuation because it is based on the lowest cost-to-entry, rather than geared towards the highest chance of success.

Downside valuations are easy to spot. Regardless of the problem the entrepreneur aims to solve, his company value is improperly correlated to the underlying technology architecture or technology categorization.

Glass half-full valuations

Truly disruptive innovation however, is priceless. If as an investor I believe an entrepreneurial idea can feasibly claim access to a monolithic $1B+ revenue opportunity, the difference between putting $10M, $20M or $50M in the runway and therefor the valuation is somewhat irrelevant (assuming the fund is big enough). The confidence required from both entrepreneur and VC comes from the words of Albert Einstein: "Imagination is more important than knowledge." Imagination, just like in Einstein's case, ofcourse guided by experience.

So when, and only when, the grand vision of the entrepreneur fits the imagination of the investor should further discussion take place around upside valuations. In our book not many of today's VC investments would fit the profile of disruptive innovation and so upside valuation calculations would not apply. Upside valuations differ in granularity and exact makeup for every investment opportunity but goes roughly like this:

Upside valuation = 30% of total-addressable-market divided by investment risk to get there.

Total-addressable-market is a subject I can write a book about. Most technology companies are embroiled in a short term rat-race (to feed quarterly earnings hunger to Wallstreet) and spend very little time on the wide open greenfield opportunities that take a little longer to plan. Lets take computer security software as an example.

Symantec and McAfee attempt to leapfrog each other in this space, with Symantec for now taking the top spot (primarily due to a plethora of acquisitions) from a revenue perspective. Yet by our latest estimate more than 40 spam and virus vendors exists, and on top of that, the majority of computer users do not use any security software at all. So the pursuit of delivering a truly effective product in a highly inefficient market makes a ton of sense, even though most investors would qualify the security market as saturated. Clearly it is not.

There are many examples of ineffectively served segments, many which current investors are unable to attract, by virtue of their structure, lack of relevant experience and operating credentials. The definition of investment risk in the aformentioned equation is multi faceted. Investment risk consists of the following broad stroke categories, in no particular order:

• Inroads
• Patents
• Management team
• Runway required
• Business roadmap
• Business model
• Dependencies
• Timing
• Flex power
• Customer experience
• Product evolution

Without going into detail about each category (beyond the scope of this blog), the report card on those issues determines the amount of discount applied to the total-addressable-market. It simply discounts the probability of reaching market leadership (losely defined as 30% ownership), by the proprietary risk assessment of the investor.

Counter to the glass-half-empty valuations, the glass-half-full valuation method does not challenge the absolute value of the idea, it merely discounts the value with the work that needs to be done to build a real business out of it. In many cases, again assuming the idea is truly innovative, even an aggressively applied discount does not lead to a majority stake in the portfolio company, as it shouldn't.

In a modern world a great marriage means you do not own your wife, just like in a great investment you do not own the business. Neither of them work very well when exorbitant pressure is applied.

Upside valuations are applied to take calculated risk, the risk that makes Venture Capital as an asset class segment so different yet so much more rewarding than traditional Private Equity. Disruptive innovation is priceless and nowadays may consist of many other attributes that just a piece of code. Yet to achieve upside valuations entrepreneurs need to prove that the value of their idea is not the technology itself but the application of technology to a marketplace.

Ask, never give a valuation first

When an investor likes an entrepreneurial proposition they will invariably ask for a valuation, unless the pitch did not strike a chord. Under no circumstances should an entrepreneur mention a valuation first, as this is the entrepreneur's most powerful instrument to verify the authentic alignment with the assets, skills and imagination of the investor. Money talks.

Asking the investor for a valuation is like asking a customer to buy, crucial to the closing process. If the investor's valuation is out of sync (most commonly negatively) with the realistic, yet unspoken expectation from the entrepreneur it is time to walk away. The alignment on valuation speaks volumes about the entrepreneur's future and the equilibrium of entrepreneur and investor on a deal moving forward. It means that just like in marriage both parties are in it for the right reasons.

So, an investor who does not want to talk about the value of the upside is an investor from which you should expect nothing but a downside valuation, similar to the many others in his portfolio. Entrepreneurs should avoid getting stung by sub-prime VC at any cost (including shelving the idea for better times), because money from the wrong investor is a dead-end street anyway.

Valuations are fantastic instruments to gauge (from the beginning) if the entrepreneur and investor are meant for each other. The outcome should be like the innovation; priceless or else both parties are just wasting their time.

Tags: Security, Valuation, Innovation, VC, Markets, Entrepreneurs, Limited Partners, Oracle

By Georges van Hoegaerden

I was delighted to hear Barack Obama yesterday describe a marketplace mechanism as the platform for improving the meritocracy of healthcare, something I have talked about with regards to economies, venture investing and technology products for the last two years. I can only muse that the recent vists from Axelrod and Clinton to our blog delivered some inspiration for the change we need to undergo as a country. Perhaps one of my readers was right, I should be running things in Washington. But enough about me.

Our greatest assets

We should be proud to live in a country that has repeatedly earned its stripes as a staunch democratic and a fierce capitalistic nation at the same time. Each individually breaking new ground in creating building blocks for a more effective economy. We are blessed that way. Not all countries in the world have both assets represented in a single economy and their imbalance makes them more vulnerable.

More vulnerable than we are, for we can quickly swing either way and tap into those resources to correct a temporal imbalance that threatens our economy. With the rest of the world watching over our shoulder, learning from our resolve.

Artificial segregation is our biggest problem

Just like how we are still extremely racially divided (I should know) do we remain politically divided. We act as if we live under seperate roofs on a single property, sharing a bathroom through which we regularly flush the disdain for each other, in subtle and not so subtle ways. Whites against blacks, democrats against republicans, opponents of regulations against proponents of regulation, proponents of gun control versus opponents of gun control, etc. Idian reservations with autonomous rulings are a stark reminder of how we allow segregation to perpetuate.

We often take a hard stance by associating ourselves prematurely to an (artificial) association, without re-evaluting our actual stance based on the acute problem that is being presented. I could categorize myself in any of the aforementioned groups depending on the economic problem at hand and may want to change my mind at any time based on timing and perhaps my deeper understanding of the issue. The timing and situation would define my choices, not a party line.

We are all right

Monolithic democratic societies and monolithic capitalistic societies simply don't work, history has proven that out. Pure democracies (I should know given my country of birth) are known for their endless debates where everyone has a voice that eventually yields nothing but burgeoning baggage of complacency. Pure capitalistic societies are driven by classic neanderthal behavior, where the biggest stick gets rid of everything in its way and drives the majority of less fortunate and lucky to dispair.

For years have we benefitted from the surplus of democratic and capitalistic assets while ignoring the deficiencies in both. Now, the state of our economy forces us to illuminate and evaluate all the pluses and minuses.

Meritocracy = democracy + capitalism

We need our economy to be an organic reflection of the current opinions and capacity of our people, not a delayed distortion field of vintage parties, segments or groups. We need to combine the value of our democratic and capitalistic assets and get rid of the deficits of both.

Mathematically put: opinions plus actions minus complacency minus abandonement equals a meritocracy. And a meritocracy is the product of free-market principles (extensively described in my previous blogs). Free in terms of equal access to all participants, supply and demand.

Just like in the Venture business, politicians better prove that they accurately represent the meritocracy of opinions from the people (all people, not just the ones that vote). If not, replacement and removal of politicians will soon be upon them soon. They better stop bickering about party lines and start worrying about why the majority of people in the US still don't vote (36.8% voter turnout).

Perhaps technology can help shape up politicians by building a ballot marketplace in which for certain decisions, the house of representatives, senate and president can directly tap into the opinions from the people they represent.

Our financial system is not a meritocracy

Barack explained why healthcare is not a meritocracy yet needs to be, and if you read my marketplace blogs you would not be surprised to find that our stock-markets are not meritocracies either. Stock-markets, the way they work today, violate fundamental supply and demand rules associated with free-markets. The foundation of our financial system (copied around the world) is based on the same artificial arbitration as healthcare, posing a systemic risk to our economy.

Testament of the misalignment in our financial system is its size; an exorbitant 11-times the size of the businesses it represents (2008 Wikipedia). That means that the size, performance and characteristics of our financial system is far removed from the size, performance and characteristics of the underlying businesses. It also means we have become a nation built on gamblers rather than on value creators, and that too poses a high risk to our economy.

So, to remove the systemic risk of our economy we need to remove most derivatives (similar to parties and associations in politics) and create a marketplace (which is macro-economically not the same as an exchange) in which the meritocracy of ideas meets with as few financial derivatives as possible. That will re-ignite the innovative culture our country was founded upon, as it tears down the artificial arbitration that prevented a meritocracy of ideas from taking shape in the first place.

We need a transparent, trustworthy and flatter economy if we want to protect its vibrant future.

Tags: Meritocracy, Macro-economics, Government, Marketplace, Capitalism, Democracy

By Georges van Hoegaerden

I read Bill Gurley's article on "What is really happening to the Venture Capital Industry" and submited my reply. While his article provides a decent explanation of the mechanics of Venture Capital (VC) today, especially for entrepreneurs who want to get to know the workings of VC better, it (again) offers no clues as to how it should work. Those of us working in the venture sector know how LP allocations work, the important question is (just like with innovation): what should a brighter future look like. And Bill's article falls very short on that.

VC is not an industry

Far from merely an excusable slip of the pen, the self serving pronouncement in the title of Bill's article is indicative of how many Venture Capitalists see themselves; as the center of the universe of innovation. A balsy statement for VCs to make considering that they hold no assets (I'll explain). Some of them go even further by correlating their, should I repeat dismal performance to the capacity of disruptive innovation and even the lack of great entrepreneurs.

It is true that VC should be the most effective way to get early stage innovation out of the gate. The reality is that in many cases VC is not, and has not proven to deliver the promised value. Some describe the VC sector as broken, others blame it on mechanics, or a too large VC pool, or mega funds, or a sudden lack of exits, or the economy, or anything else they can hang their hat on - with the media having a field day delving into the pros and cons of every argument.

And with money to distribute, the articles from VCs - who created the problem in the first place - gain most of the popular momentum. At this point do we really believe their analysis is credible? But that is why you are now reading this blog too, so lets continue...

Innovation is a marketplace (continued)

Venture Capital is the arbitrator in the marketplace of innovation connecting the assets of Limited Partners (money) with the assets of entrepreneurs (ideas), both collectively referred to as marketplace participants (supply and demand). Simplified, the VC makes choices and investments (and yes, regulates) on behalf of the LP in return for equity in the assets of entrepreneurs (ideas and execution), of which at exit VC gets a commision (the carry and then some).

For any marketplace to thrive, the needs of supply and demand participants have to be satisfied. Only then will each participant come back for more (and tell their friends).

LPs expect the venture sector to outpace their other (often less risky) asset allocations and entrepreneurs want to change the world and get rich while doing it (in that order). LPs have not seen more than 10% IRR over the last 10 years from VCs (there are other measurements of VC failures) and smart entrepreneurs shelve their ideas because of unfavorable funding conditions and fundamental misalignment between VC and entrepreneurs (also read my blog Idiot CEOs).

The self-regulatory nature of marketplaces has started; new LPs and entrepreneurs refuse to enter and many currently active LPs and entrepreneurs will take their losses and leave. If the rules of engagement do not change, money hungry entrepreneurs who continue to submit to sub-prime VC will stay, supported by non-discretionary LPs who have the patience to wait for miracles. Unchanged, the future of disruptive innovation is bleak.

Long live the VC

But although the marketplace (in its current incarnation) may and should die, its participants never will. There will always be a need to deploy high-risk/ high-yield assets and there will always be entrepreneurs that can produce disruptive innovation. All it takes is a new marketplace in which the meritocracy of ideas from entrepreneurs is matched with discretionary support from LPs.

The matchmaker in that marketplace better be a VC who understands that simply serving one participant, while depressing the needs of the other will inevitably lead to removal of the arbitrator status in the marketplace. Only a VC with vision who understands free-market principles, and satifies LPs and entrepreneurs simultaneously can generate the meritocracy of ideas that are priceless.

VC is here to stay, but the overinflated personalities with no authentic value-add will be kicked to the curb. For LPs and entrepreneurs it will take some time to recognize which VC is on his way out and which one is on his way in. 7-10 Year VC fund vintages with lack of transparency will do that to you.

But if you read my blogs carefully (or ask my advice) you will learn to spot them from a mile away.

Tags: VC, Limited Partners, Entrepreneurs, Marketplace, Meritocracy, Free-market

By Georges van Hoegaerden

A ban on advertisement of healthcare drugs on national television in The Netherlands. Free public phone calls in Singapore, just a one-time 10 cent connection charge. Mandatory health inspections in restaurants in North Carolina, with regularly updated door-posted scorings. Those are great examples of how government regulations provides better quality of life to its citizens.

But in the United States we generally balk at any form of government regulation as if it is poised to erode the freedom we set out to create. It makes for good press to publicly support a free world and anarchy rather than the opposite. Being a freedom fighter is good karma.

Regulation is not an option, but a requirement

But regardless of government involvement our world is riddled with self imposed regulations. We stop when pedestrians cross the road (regardless of whether they should), and show more respect to elderly than we are often given. We raise kids as best as we know how, and send them to the best schools we can afford. Most of us are decent people who respectfully comply to our individual interpretation of the definition of decency; a set of self-imposed regulations.

Regulations, self-imposed or governed, are the foundation of free-market principles (see our extensive coverage on free-market principles in our blog entry Marketplace Rules). And free-markets only function well when they stimulate or enforce behavior that builds transparency and trust, pulling in new participants and thereby allowing the marketplace to grow itself.

Everything in life is a marketplace (in the macro-economic sense of the word). And we have the option to growth those marketplaces based on a meritocracy, or create excessive walled gardens that, when the impact on our economy becomes too big, risks the enforcement of regulations by our government.

Innovation is a marketplace

In large part early-stage innovation in The United States is fueled by the investment dollars from Limited Partners (LPs), allocating their money to invest in the ideas of the entrepreneurs, using Venture Capitalist (VC) as their conduit and decision maker. In the marketplace of innovation the LP and the entrepreneur represent supply and demand with the VC acting as the arbitrator of the marketplace.

The preponderance of evidence makes for a lousy marketplace in which the VC acts as the Emperor with no clothes:

• Less than 10% IRR of the venture sector in the last ten years
• Few truly disruptive innovations are born
• The number of entrepreneurs are declining (according to Kauffman, see attached chart)
• The number of LPs and investment dollars are declining

The VC as the systemic risk to innovation

It is ironic that so many VCs who are vehemently against government regulation (and put their efforts at attempting to stave it off) actually are themselves the ones that aggressively use arbitration to regulate (with their peers) the restrictions that are put upon the entrepreneurs. They collectively set standards on deal intake, technology focus, valuations, syndications, geographical proximity etc., and allow for very little deviation that is inherent to a marketplace meritocracy.

Simply put, VCs are the ones that violate many of the free-marketplace rules (stay tuned for a detailed deep-dive) and prevent the innovation marketplace from prospering, thereby inhibiting the creation of disruptive innovation.

Why we need new regulations

Frankly, we messed up and we should be ashamed of ourselves.

Innovation is a crucial ingredient to our economy, as explained in my previous blog entry The Systemic Risk of Venture Capital. We need to remain at the forefront of innovation for our immediate benefit and how we set an example for (not arbitrate) the rest of the world. Innovation has a big impact on GDP growth and spirit.

We, marketplace participants and government should do our part in fixing the innovation marketplace that is so sorely broken. Our government should force VCs to exhibit transparency (one aspect of marketplace rules). LPs should do a better job of hiring VCs with relevant early-stage operating experience to create more trust. The integrity of the new marketplace we create together will improve the integrity and quality of entrepreneurs it attracts.

We are responsible

The point I am making is that every marketplace requires pretty much the same amount of rules and regulations to instill transparency and trust, no matter where you apply that marketplace. The owners of the marketplace, by virtue of their performance, get to decide how much of those regulations they can deploy themselves. Bad performance with big economic stakes is punished by government intervention.

So, rather than to discourage and blame the government, we as marketplace participants should instead re-install the support for free-market principles in innovation that promotes the meritocracy, spirit and entrepreneurial capacity that this country was founded upon.

Stop blaming someone else and join me in this effort for the sake of our global competitiveness.

Tags: Innovation, Macro-economics, Marketplace, Meritocracy, VC, Limited Partners, Entrepreneurs

By Georges van Hoegaerden

In the words of Danish poet and author Hans Christian Andersen, Silicon Valley has become the emperor who wears no clothes. Many Venture Capitalists (VCs) like the emperor will hold their head high and continue their procession for the sake of protecting their management fees.

And even though more than 77% of funds will finagle themselves into the top quartile performance bracket (according to a recent study) and persuade LPs to hang on, the simple fact remains that very little disruptive innovation is born. And without disruptive innovation (and the risks that such innovation incurs) it is just a matter of time before the Limited Partners (LPs) recognize that the emperor's procession is coming to an end.

It continues to amaze me how certain people and organizations (specifically the NVCA, desperately hanging on to the past) continue to protect the failed "dating service" between the assets of the LPs and the assets of the entrepreneurs, and continue to blame external circumstances on the miserable performance (less than 10% IRR) from the last ten years.

A recent conversation with a Mercury News technology journalist confirms again how many VCs still blame their underperformance on anything else but themselves (see how we debunk their excuses). Another reason why the crop of current VCs could never be or align with entrepreneurs, real entrepreneurs would never stop until they get it right. If VCs are so entrepreneurial, why don't they innovate themselves out of this malaise?

How did we get here?

In the early days of VC, originating from Bill Draper's first innovative financing, the sector produced more than 40% IRR. New LPs, attracted by those generous returns, flocked to the sector and deployed massive amounts of money to VC, without properly validating the GPs relevant entrepreneurial credentials. And with VCs improperly calculating risk, the wrong companies are funded - in large numbers. With almost none of them able to fool private or public markets, regardless of the state of our economy. That's where we are today.

Innovation is not the problem

But just because the current VC "dating service" is broken that does not mean the LPs or the entrepreneurs should lose faith in the monetization of disruptive innovation. Both should simply seek to establish a more effective dating service, one that focuses and supports upside, rather than worry about downside risk.

Entrepreneurs should refuse to work with investors that improperly assess business risk, money from the wrong investor is a dead-end street anyway. But most influential will be the immediate action from LPs who should close their underperforming commitments (instead of flee), reset their fund requirements and require more relevant operating credentials from General Partners (Venture Capital requires more relevant early-stage credentials and vision than other Private Equity sectors).

New opportunities abound

With the foundation of technology established (chipsets and the internet) the next wave of innovation comes from platforms and applications (macroeconomic marketplaces), all of which can be developed anywhere. Combine that with the dysfunction of Silicon Valley VCs and you have the perfect storm of starting new entrepreneurial endeavors in other geographies.

Innovation should not and will not just come from Silicon Valley, but it will only thrive in the hands of investors who understand that the cost of disruptive innovation is priceless. So, simply starting technology innovation elsewhere is useless if it is not matched with an investor who has the experience and foresight to see what others don't: a unique innovation he wants to put his all behind.

The procession continues

The sheer size of LP commitments outstanding to the VCs will keep the emperors procession going for a while, and the VCs refusal to criticize themselves is a sign that it is incapable of recovery and self regulation. We need new VCs, with a new mindset and a different DNA to get there.

While there were more important reasons for me to move (with my family) to the East coast, I certainly do not regret not being there when the naked emperor continues his procession through Sand Hill Road. My focus will remain on helping LPs understand how to invest in Venture Capital and how to regenerate the impressive returns the sector is still capable of producing -- or show it to them myself.

We are after all at the beginning, not at the end of technology innovation.

Tags: Innovation, Disruption, NVCA, Limited Partners, VC, Silicon Valley, Private Equity, Marketplace

By Georges van Hoegaerden

[The article has been supplemented by a more recent "Why VCs really need relevant operational experience, now"]

I frequently get asked by individual Venture Capitalists (VCs) whether I really think General Partners (GPs) need operating experience to be more effective (as if my blog is not clear about that). And just recently HP's Venture Group seems to agree with me.

That topic was also recently challenged by Daniel Primack from Reuters' PEHub (I know he likes a good debate) who decided to make a statistical point that there is no correlation between fund success and GP operating experience.

Yet my short answer is: "yes, but it depends".

What my answer does not depend on is Daniel's statistical analysis of the Forbes Midas List and loosely matching credentials to his sample. With more than 90% of VC not making a real profit (above the asset class expectation of it), the 10% Midas sample can hardly be called statistically representative. And even if it would, a highly inefficient market (created by the ineffective "dating service" VCs currently provide) does not statistically represent the workings of the efficient market we wish for. And the majority of the Midas List GPs have their "success" firmly rooted in a timeframe when "turkeys could fly". Should I go on?

But most importantly, statistics are derivatives - not drivers - of market behavior, in the same way liabilities and assets are opposites (read "Rich Dad, Poor Dad"). It is unwise to apply a derivative (statistic) as a driver for market decisions. All experienced entrepreneurs know that.

So, my answer depends on whether you reference the actual or supposed workings of VC.

In today's VC

In today's venture capital ecosystem it is very important for every GP to have relevant operating experience, with the emphasis on relevant. Relevant experience as that of an early-stage CEO in tough times, still producing success.

Many GPs can only flaunt past experience from behind the confines of a large brand name conglomerate, rather than the experience of an early-stage CEO, investing his own money, defining a unique company ecosystem, living on borrowed time, raising a few rounds and selling the company. The VCs with that level of operating experience are hard to find and so are their successes.

Why is VC operating experience important:
1/ Many venture funded companies today are built with what I coin as the sub-prime VC model. Amongst many things it means founders need to prove a lot of technological capabilities (see my Khosla reference) before they see an investment dime, and when so, usually receive too little money to hire an experienced CEO. As a result, the board (of investors) runs the startup and thus their relevant operating experience becomes pivotal to the success of the startup.

2/ Relevant operating experience matters, not just any operating experience. Successful startups rely on a clear definition of a unique ecosystem (with divisional expenditures and conversion rates). The last thing an entrepreneur needs is a group of investors who can barely deviate from their business school thesis to meet reality and a world that is in flux.

3/ GPs need to be entrepreneurial to recognize and weigh one. The success of a technology startup is not just dependent on how cool the technology is but requires an operational assessment to figure out whether the business model is sustainable, and whether the application of that technology to a demographic makes economic sense. Operating experience is crucial to validate the combined value of operations and innovation.

I can name probably a hundred other reasons, but that would extend beyond the artificial limit of this blog and your patience.

In new VC

In a new VC structure I would argue for a more balanced makeup of economic managers and operational managers. But that structure can only work when all GPs share responsibility for every deal, rather than today's norm of every GP managing his own subset of companies within the portfolio. Many more things need to change in order for VCs to accurately calculate startup risk, snippets of which I've covered elsewhere in this blog and will cover extensively in my upcoming LP seminar "The Inconvenient Truth of Venture Capital".

Alignment with the entrepreneurs

So, until we change the fundamental workings of VC are we bound to hire GPs with relevant operating experience, those that combine that operating experience with the ability to accurately calculate upside risk and align with the entrepreneur.

But a VC firm without relevant operating experience is a risky investment (for LPs) and a bad strategic partner for the entrepreneur. The great difference between Private Equity and its sub-class Venture Capital is that the latter can create massive returns, albeit with GPs that are capable of recognizing a diamond-in-the-rough and performing a little bit of heavy lifting when needed or desired; by applying experience and influence.

That, as an operator, makes Venture Capital so much fun for me.

Tags: Eco-systems, Subprime, PE Week, Innovation, Experience, VC, Business Model, Limited Partners, Entrepreneurs

By Georges van Hoegaerden

The biggest complaint I hear and agree with is that Venture Capitalists (VCs) just don't get it and in the words of a VP at Apple, VCs simply don't line up with the needs of entrepreneurs.

Real innovation has no precedent and leaves many VCs, with their platitudes and an army of analytics in the dark in coming up with a reliable reason to invest. I personally had a VC become teary-eyed about the prospect of having to convince the rest of his team about an investment I presented, and I subsequently got it funded elsewhere.

With monetary assets being equal, it takes a visionary or a black swan (whichever classification floats your boat) to separate the good investor from the bad. Great investors have a strong belief that finds solace in an internal compass that is fine-tuned by years of risk-taking. Risk-taking in entrepreneurship or personal life, whichever one shaped that core competency. We have many VCs with strong beliefs, but few of those beliefs are founded on relevant experience.

So, entrepreneurs (and LPs) take note of what is the most important ingredient to look for in the bios of General Partners (GPs). With few exceptions, a GP (General Partner) that has never been a CEO at a startup, responsible for developing and executing its unique ecosystem, is not a great candidate to become a VC. Neither is the GP who has never challenged him/herself personally.

Venture Capital is government

But not only are those investors hard to find, the physical makeup and workings of the current VC construct is diametrically contradicting the decision-making for groundbreaking innovation. As long as the meritocracy at the VC level of the investment pyramid that started Venture Capital is not restored, the artificial arbitration of the current aristocratic model will continue to erode high yield returns.

Here is how VC acts like government:

1/ You (still) need to be in Silicon Valley

Just like you need to be in DC to make an impact on politics, do you need to be within 20 minutes of Sand Hill Road in Menlo Park to be on the radar of investors.

2/ You need an intro to the VC

In DC you need lobbyists to get anywhere, in Silicon Valley you need to find similar lobbyists that can introduce you to the investor you want to talk to. Most GPs simply refuse to talk with entrepreneurs they have not met before. Entrepreneurs who contact VCs directly will find themselves debating the vision with an academic white swan, dramatically improving their chance to get rejected.

3/ Investment decisions require internal consensus

Politics is based on consensus. Likewise, if the entrepreneur is lucky to convince one GP of their proposition, the next monday morning meeting at the VC firm is spent on getting other GPs to agree (except if the first GP is of John Doerr stature). In essence it means a unique invention is shoved through a democratic (government) filter to be validated with chances of a majority vote rapidly approaching zero.

4/ Deal syndication requires external consensus

Many VCs don't have the balls (excusé les mots) to make independent contributions to companies and look for syndication to mitigate the risk. Just like in DC where politicians look for peers to join their charter, before they stick their necks out.

5/ Lack of accountability

VCs can hide behind the size of the portfolio to select one or two successes to brag about. Just like politicians that hide behind a party and associate themselves with many initiatives and get credit for the few that worked. Quite opposite to the devotion of an entrepreneur.

6/ Lack of transparency

To understand politics you need a graduate degree in the subject matter, to understand VC you need to be (or have been) one. Just because the type of businesses VC invests in are private, that doesn't mean VC needs to be.

7/ Far removed from its constituents

Not only physically but spiritually many politicians are far removed from their constituents when they enter into office. So are the VCs who prefer to congregate more with each other than with entrepreneurs to develop unique support for disruptive innovation. VCs are oblivious to the many "false negatives" (as described in my previous blog) they don't even get to see, just as many politicians forget that many americans don't vote at all.

8/ Fewer real innovations are born here

DC (at least before Barack) is not the place to get anything done, and Silicon Valley choking on a vast supply of sub-prime VC is not the place to get anything really disruptive done. The real world is the market, not the current VC interpretation of it.

9/ Long incubation periods

Just like in politics, once the GP secures a fund with the LP the performance of the fund is in limbo for 5-10 years. That is a more secure job than the presidency of the United States. Many GPs stack funds or jump ship before it is about to go under, picking up new management fees under a different fund and LP structure. Another 5-10 years of GP safety lies ahead.

10/ External circumstances

Just like in politics, VCs blame their underperformance on anything else but their own decision making. The state of the economy is their welcome excuse, even though startup economics are quite resilient to macro economic aberrations.

So, the point of this blog is to emphasize that in order to get VC to create high yield returns we not only need to take a close look at the GPs that take the risk but change the mechanics of VC from a "government" based system to a meritocracy at the VC level of the investment pyramid. That is the message I will develop further (and more constructively, I've hammered on VC enough) in helping individual LPs develop new relationships with VC firms.

Tags: VC, Limited Partners, Risk, Funds, CEO, Entrepreneurs, Subprime

By Georges van Hoegaerden

The debate is heating up about the impending regulations from the government applied to Private Equity (PE) and its sub-class Venture Capital (VC), fought by the National Venture Capital Association (NVCA) and reluctantly supported by the Private Equity Council (PEC). The latter stating that private equity does not represent a systemic risk. Perhaps not, if the council excludes VC from its membership, but VC as Private Equity poses a systemic risk as the gatekeeper to innovation.

Why the government is forced to step in

The government has decided to step in and we, as participants in the ecosystem should present our government with the facts (good and bad) so it can make informed decisions going forward. If we give the government self-serving information, rather than the facts, we will get punished by regulations that miss their intended target. So, now is the time to separate greed from honesty and shape the regulations that will be bestowed upon us.

The most rational explanation as to why the government is tightening our private equity belts came from Bob Grady, Managing Partner at The Carlyle Group (who worked for the government for a while) at the recent IBF conference. He suspects that the government simply wants to reduce the size of the financial services industry as a percentage of GDP (Gross Domestic Product).

Not unreasonable, considering the collapse of our financial system and the discovery of an endless supply of imploding derivatives (and vice-versa). Simply put, the equilibrium between people who create products and those that capitalize on them is out of whack. We need more innovation with fewer derivatives attached to them.

VC is a systemic risk

The creation and growth of the Internet (and all the components around it) could not have existed without the faith and dollars from Limited Partners (LP), deploying their assets through VC firms. Kudos to people like IBF life-time award winner Bill Draper who started Venture Capital by literally knocking on the door of an interesting company, buying his first shares for $20,000. But the last nine years have been dismal for VC performance, almost 900 U.S. VCs producing less than 10% IRR, tarnishing the technology ecosystem and prompting LPs to look around to reallocate money to a different asset class.

Why VC needs to work

While venture-backed companies represent around 0.02% of GDP prior to exit, post exit they represent about 18% of GDP (according to the NVCA) and 9% of jobs in America. So, the decision-making process by a VC of what company to invest in is vital to building a healthy economic conversion rate. And I predict information technology will claim a larger stake of GDP as it continues to mature from its infancy. So while VC is a small percentage of the total Private Equity pie invested, it has proven its ability to produce a healthy stimulus to the economy.

What has changed

We can look at the statistics from the NVCA and debunk those statistics with reality, but common sense tells us that most of us would be hard pressed to name ten ground-breaking technology innovations in the last ten years. So, if 900 VCs produce this few real innovations, the billowing smoke is sufficient indication of a fire. On top of that companies like Apple show us how to invest in categories (like music) VCs had unsuccessfully invested in for the last 10 years, challenging VC fundamentals to its core.

Proper assessment of investment risk

The problem with VC is that it is inherently risky (more than other forms of Private Equity) and with the wrong people running VC firms, the asset - risk - that produces great returns is being sucked out of the investment equation.

Smaller funds, feverish syndications, easy exits are all instruments that create more rather than less derivatives to the creation of disruptive value. VCs now sell to LPs a similarly ill-fated pattern of risk as sub-prime lenders sold to their investors. Hence our frequent use of the sub-prime VC classification throughout this blog.

As a result of a lack of meaningful segmentation and guard rails by many me-too VC funds, LPs have actually invested deep rather than wide in information technology (as the included chart points out). For the last nine years that has created a massive number of false positives and false negatives and a continued downward spiral that attracts only entrepreneurs that comply with this risk-deflated investment mold, rather than attract entrepreneurs with truly disruptive ideas (that hold their value in any economy). So, for the last 9 years LPs have invested deep in a risk-averse technology sector while they expected their 10-15% venture share of total allocations to be applied to the inverse.

Moving forward

Many LPs are ready to cut all but their top quartile VC funds from their portfolio by flushing them through (i.e. letting them run their course without re-upping new commitments). That means over the next 5 years we are going to see many VC firms disappear, some replaced with new VC firms with more relevant entrepreneurial pedigree and investment models that are as unique as the strategies of the entrepreneurs.

New regulations by the government and tougher practices by LPs will make our industry more transparent and aim to create a platform in which the old aristocratic VC model will be replaced by a model that supports a meritocracy at every level of the investment pyramid. That is a fantastic development for entrepreneurs and VCs who are attracted by - and deserve - the merit.

Big stakes, big returns, fewer players, better innovation

LPs expect bigger returns (before larger commitments) from their allocation in venture and the only way to get it is to deploy risk. VC is designed to be the intermediary between the LP and the entrepreneur to mitigate that risk for LPs. Yet because of the aforementioned commoditization of VC investment strategies the VC model has failed to produce.

With LPs retrenching (to perhaps another asset class), the VC firm that wants to survive better articulate a clearly differentiated investment strategy with new GPs that can recognize and attract more disruptive (and sustainable) innovation, knows how to commit and helps make its portfolio companies work.

A new day

To create better returns for LPs, VCs need to rethink how to pick better companies with more disruptive (and sustainable) innovation and invest in upside rather than downside. The smart entrepreneurs are out there (we talk to them), waiting patiently for the right investment climate to light up their flame. Remember, great innovation can afford to be patient.

Venture Capital as the derivative in the investment pyramid between the assets of the LPs (money) and the assets of the entrepreneur (innovation) needs to provide a better service to both parties (or else it will be tossed out as a "dating service").

Until we fix VC, will it remain a systemic risk to our asset class, economy and frankly our reputation as the most innovative country in the world.

Tags: Limited Partners, VC, Apple, Subprime, Innovation, Funds, NVCA, GDP, Commodity, Investment, Integrity

By Georges van Hoegaerden

Last week's 20th anniversary of IBF Venture Capital Investing Conference (congrats to Alex Scott and Christina Riboldi) in San Francisco was a unique opportunity for me to witness the atmosphere between 487 Limited Partners and General Partners (also referred to as Money Managers by LPs).

My first ringing of the closing bell on Nasdaq followed by a packed premier event of the Asian American Association of Investment Managers (AAAIM) at The Harvard Club in New York, with keynotes from Julian Robertson, CEO of Tiger Management and David Rubenstein, founder of The Carlyle Group gave me some great insights into the world - and thinking - of LPs.

It is clear from these sessions that LPs (and Fund-of-funds) are misled and confused about how to improve the performance of Venture Capital (VC). The VC sector of the Private Equity asset-class has been plagued with dismal performance of less than 10% IRR (Internal Rate of Return) for the last 9-years, leading some LPs to question and reduce allocation (US: 10-15% of total assets per firm, Europe: ~4%) in a sector that deserves quite the opposite.

The emerging opportunity in technology VC

The technology sector which is my passion for the last 30-years is at the beginning, not the end of its emergence. Perhaps the top-level indicator of the innovative runway we have ahead of us is the following: more than 5/6 of the world's population does not yet use a computer connected to high-speed/broadband internet today. And all should and will, given the right technology. That's where technology innovation comes in; not just in connecting people to the internet but in deploying innovation that uses the internet as a distribution mechanism. The way we use the internet today is rudimentary, and many new technology stacks will emerge to improve its impact on everyday citizens.

Given the early days in the life-cycle of the technology sector relative to any other sector or asset-class is; low-cost to produce, low-cost to distribute and because of the internet has immediate customer impact with independently short sales-cycles. That means with relatively little money in, a massive impact can be produced, virtually instantly. A great investment allocation opportunity for LPs still lies ahead.

Why the VC sector is not producing

In the words of Cesar Millan, the popular dog whisperer on National Geographic, who states that the behavior of the dog is the responsibility of its owner, so should LPs demand control of the behavior of the VCs. Like dogs, VCs exhibit primal behavior that can make them great money-managers, but only when they are controlled. An issue even The Carlyle Group recognizes by including a code-of-conduct in its recently published annual report. LPs should let go of the leash after VC performance becomes apparent, not before.

-- Risk deflation
VCs sell well upwards to the LP at fundraising time, but they seem to have forgotten that they need to serve the entrepreneurs just as well. In the investment pyramid between the dollars from the LP and the ideas of the entrepreneur, the VC is simply the derivative that should serve both. Today it does neither. The money-tree report further hides the ugly reality under-the-hood as the funding stages have disrupted the equilibrium between entrepreneurs and VCs and steadily turned VC into loan-sharking.

-- Lack of relevant experience
Most VCs in Silicon Valley simply have no relevant operating experience that allows them to service the needs of entrepreneurs adequately (see sub-prime VC). And that in turn creates a massive amount of false negatives and false positives to which no liquidity mechanism (from the NVCA or Tim Draper) will suffice. Beginning in the early 2000s, the VCs have simply consistently invested in entrepreneurs that submit to sub-prime innovation and terms.

-- Lack of vision
No surprise that, according to a conversation with a chinese private equity investor at the AAAIM conference, recently 12 highly successful chinese immigrant entrepreneurs left the U.S. disappointed to go back to China because the VCs did not allow them to take the helm at their own companies. They will in China. Smart entrepreneurs simply won't submit to sub-prime VC, leaving the VC (and therefor indirectly the LP) alone in their spiraling sub-prime demise.

To echo Jessica Reed Saouaf, Managing Partner of Hall Capital Partners (with $17.5B in assets under management) who describes at IBF that the VC business today is too institutionalized with too few visionaries to create promising returns. LPs need to do a better job in sourcing, segmenting, controlling and demanding transparency so the behavior of VCs remains an extension of the LPs investment brand and integrity.

The myths LPs are being told

But the incumbent VCs are not taking this criticism without a fight, a fight to hold on to their cushy management fees and plush existence. From the focus of their rebuttal (by way of pump-and-dump liquidity plans, annex funds etc) you can gleam their true nature, they worry more about protecting their downside than improving their upside.

A welcome exception to the majority of followers of the auto company's plan to fixing VC are the younger VCs like Jason Green (Emergence Partners) and Paul Holland (Foundation Capital) who on the IBF panel proclaim that, unlike the NVCA they do not lie awake at night about the impending increase in capital gains tax on their carry. Instead, just like great entrepreneurs, they worry first about delivering value and returns, trusting that personal wealth will naturally follow.

Here are the most frequent myths I hear VCs attempt to imprint on the LPs that I want to debunk here quickly to prevent a further slide down the sub-prime spiral:

-- It's the economy; new fund - stack fund - annex fund
Nonsense: even the most successful startups do not achieve revenues or market-share above 10% of their total-addressable-market (TAM) during their private funding cycle. That means that 90% of the total-addressable-market is still not served effectively. With a few exceptions it is hard to imagine that a 10% decrease in market will have any affect on the success of the startup. I would argue that in a down-market the opportunities for new technologies improve considering the fact that an early adopter can more effectively compete with 90% of its competitors. So, conversion rates of companies with macro-economic differentiation should improve and so will their market-share and revenues and consequently the opportunities for great exits.

-- We are in a down-cycle, we will bounce back; new fund - stack fund - annex fund
Nonsense: the barrel of a downward spiral is cyclical too, be sure to recognize the difference. Sub-prime investments have no exits and will not yield valuable fund returns, no matter what the liquidity structure is. VC portfolio choices that cannot withstand the test of time simply have no fundamental differentiation and independent future. And a GP that cannot distinguish between prime and sub-prime will never be successful.

-- Companies are cheaper to build; new fund - less money
Nonsense: I have heard LPs echo the term "Capital Efficiency", and it is a trap. Not just for the entrepreneur but for everyone in the technology ecosystem. Unlike in the past, no product can withstand the scrutiny and the power of social networks unless it is really well built, offers fundamental and disruptive value and delivers authenticity and trust. Only then will users adopt it. And since distribution is virtually immediate, more competitors will spring up to provide the noise that makes life harder. So products are actually more expensive to build and requires a different ecosystem makeup and funding trajectory for the company. VCs that look for smaller funds demonstrate further misalignment with reality and therefor exits.

-- There are not enough great ideas; new fund - less money
Nonsense: but sub-prime VC behavior and terms turns off great entrepreneurs. Only idiot CEOs and unsuspecting entrepreneurs submit to terms that hands control and destiny to underperforming VCs. Other forms of artificial arbitration such as geographic distance of 20 minutes moves the VC even further from the meritocracy it should be looking to embrace. The institution on Sand Hill Road is severely limited by its lack of peripheral vision of technology and the world.

-- New (government) regulation is strangling exits; new fund elsewhere
Nonsense: the bar has been raised for technology companies as it should. No longer can public markets be fooled by valuations that have no value. Real value jumps the hurdles of regulations with ease (as witnessed by OpenTable and Rosetta Stone). The current startup inventory, that was subject to sub-prime investment tactics to begin with, may not be able to get to the finish line. Such is the punishment for lack of independent differentiation and value.

-- The grass is greener in green; new fund - hot market
Nonsense: I have witnessed the rush to these "hot-pockets" before but hot-on-supply does not equate to hot-on-demand. Or as Julian Robertson says; "there is a difference between having a bakery and baking bread". Contrary to technology, greentech is expensive to produce, expensive to distribute, relies on long sales cycles and arbitration (subsidies, politics etc. ) that is beyond the control of the startup (and much more complicated in its regulative risk than, for example, healthcare). A dependency on government is very dangerous in meeting the time-to-money milestones for early stage companies and fund returns. I believe in the value of green-tech and energy-tech to create a greener planet, but I don't believe the current VC funding models with former technology GPs looking for greener pastures can support its early financial success within the current funding vintages. It is ironic to see VCs use the capital-efficiency slogan under the same roof as their capital intensive strategies for energy-tech.

-- The grass is greener global; new fund - new fund elsewhere
Not yet: as we move up the technology stack and specifically the investments in software, the origination becomes less relevant, I will yield to that (although I see still see an entrepreneurial quality difference), but startup investments should reside where the execution is, regardless of origination. While other geographies score well on low-cost manufacturing (and programming), real disruptive ideas and the majority of early adopter markets (driven by the frantic pace of unbridled capitalism) still reside in the U.S. So VC funds should be equipped to handle international deal sourcing (and be the first investor in) and only become truly international once the remote exits prove to justify an independent local operation. For that to happen, creation, execution and exit values need to yield appropriate dynamics. Remote execution and exit values remain sporadic today, but that may change as those markets develop and emerge as prominent technology visionaries and consumers.

How to fix VC

Optimizing VC is probably easier than most LPs think, since the issues plaguing VC have to do with regaining fundamental leadership of the investment ecosystem. Simply put, LPs need to become "VC whisperers" (to use the Cesar Millan analogy), those that can control the performance of VC so the leash can be loosened. The good news is that none of the deficiencies in VC are rooted in the complicated micro-economics of technology, contrary to what some GPs may want you to believe. But it is important that LPs hear more than the repetitive sugar-coating from underperforming VCs and keep a close eye on entrepreneurs who actually represent the monetizable assets.

-- No more "duh" PPMs
No more Private Placement Memorandums (PPM) that look remarkably like a wish-list without substance. Yes, I've seen the memorandums produced from brand-name VCs that get replicated by many other VCs in the valley. No right-minded VC would accept a business plan from an entrepreneur that looks like that, neither should an LP. The quality of the PPM is a direct indication of the quality of the VC fund and should help LPs clearly segment the risk associated with technology investments. LPs have invested deep rather than wide in the technology sector, hence the birth of many false positives.

-- Assess the GP's unique vision
Many of the PPMs talk about rearview mirror analyses, but the only advantage one investor has over any other is his forward looking views on the industry, or vision. So LPs need to assess the risk associated with that vision, much of which again is related to macro-economic impact rather than technology waves. GPs should be able to demonstrate that their unbridled vision in the past came true.

-- Assess the GP's relevant operating experience
To become a valuable partner to the entrepreneur the GP needs to be able to prove relevant operating experience related to the investment thesis and specifically to the segmentation. Information technology is a broad sector and experience in consumer technology differs from the application of technology to healthcare. Being able to help entrepreneurs develop a large vision with tangible baby-steps is a skill that GPs need to master to improve the size of disruption and returns. That experience needs to map directly to the investment thesis in the PPM.

-- Assess the GP's track-record for deal sourcing
Getting your hands on real disruption requires a proactive approach to finding the "diamond-in-the-rough". Many early stage entrepreneurs, hurt by sub-prime VC tactics, need help thinking bigger. The size of the disruption, rather than the cost of entry is crucial. Finding deals that can be turned in game changers is fundamental to the success of great returns.

-- Hire an expert
All this deep-diving may be too much for an LP who has nearly 90% of its assets allocated to other asset-classes, so the smart thing to do is to hire an expert that speaks the language of the entrepreneur and ensures that the needs of LPs and entrepreneurs are effectively met through an intermediate VC vehicle.

Conclusion

Crucial to the success of the technology sector is to do the opposite of what most VC funds are currently setup or guided to do. To follow Warren Buffet's advice: when everybody is investing using sub-prime tactics then now is the time to do just the opposite. Venture Capital is a sector that can produce great returns when it takes great risks, not when it becomes risk averse, and fragments and commoditizes investment dollars. Deflating the risk through sub-prime investment tactics has killed the want to innovate, and may lead to an accelerated intellectual exodus that will hurt our economy as a whole.

Apart from fixing what is broken I think the time is right to fundamentally restructure early stage innovation and make its financial support just as innovative as the inventions themselves. Facebook sets a good example of how it taunts with the institutionalized investment "rules of Silicon Valley".

LPs who cannot see the massive opportunity in technology should simply exit from Venture Capital. But continuing to support sub-prime VC funds is a sure way to continue down the spiral of suboptimal returns we have been stuck with for the last ten years and damage the innovative ecosystem our economy depends on.

So dear LP, go big or go home. And when you plan to go big I will make myself available to put words into action. I cannot wait to turn this page.

Tags: VC, Green Tech, Growth, Investment, Limited Partners, LP, PPM, NVCA

By Georges van Hoegaerden

The National Venture Capital Association (NVCA) has released its recovery plan (4-pillar plan) to fix Venture Capital that is eerily similar to that of the auto companies. It focuses on the prolongation of (their) life rather than on the quality of its product; the ability to spawn meaningful innovation.

Now I am sure Dixon Doll, from his perch atop a $1.6B Venture firm, means well but his purview is severely limited by his role as chairman as one of the most closely held investment clubs in the nation. Its members, ninety-something percent of the U.S. VCs are simply not incented to present all options for improvement, and certainly not one that would include self-cannibalization.

Nothing in this plan covers the stimulus and meritocracy required to spawn and monetize disruptive innovation. The plan mentions entrepreneurs, as the real value creator in this equation - in passing - only once (slide 11) amongst its thirty slides. The plan seems to forget that the entrepreneur is the real value creator, not the VC.

The plan, like the plan of the auto companies boasts of past accomplishments (count on two hands; poor result coming from 800 VCs, but we all know that) and how it puts a lot of people to work (it better when $28B of LP money is dispersed; what else would you spend it on), yet it offers no clues as to the fundamental resurrection of IPOs and meaningful M&A. Could it be that VCs simply picked the wrong companies to invest in? Could it be that the driver, not the car caused the accident?

Faster and easier liquidity paths, using the suggested liquidity platform, does not make up for ill-defined risk assessment applied by many VCs. I predict, such a platform will then be used by VCs who are stuck with many false positives as the pump-and-dump platform to hide their bad choices. The proposed structure of the NVCA reminds me of an intermediary company/fund that tried very hard to sell me equity in some of Kleiner Perkins (KPCB) later stage companies. I happened to know a little more about those companies and their products and gracefully declined.

We don't need more complexity in the Venture Capital business. We need to flatten, segment and remove derivatives in the same way we are about to remove derivative structures from the banking world. We need Venture Capitalists that can quickly be held accountable for their actions and implement transparency that offers LPs the instruments to do so. After all, the VC is merely a derivative in the process of innovation.

Fixing VC will be remarkably easy when you consider the needs of entrepreneurs and I plan to present my entrepreneur focused plan to the LPs soon. A further descent down the sub-prime spiral (in which all participants are entangled) makes it hard for some to see the forest through the trees and find a solution. But the current situation is bad for Silicon Valley, for our leadership position in an increasingly global technology landscape and detrimental to our economy as a whole. That is why I care. I care about the meritocracy we talk about so often but so poorly deliver on, with capitalism as the excuse.

I don't want to see other countries walk away with an optimized model of our technology innovation, like we seem to lose many other innovations, just because they understand that (at least local) meritocracies require some form of regulation, transparency and other aspects of free-market principles. Capitalism, just like football, requires rules in order to flourish.

The NVCA plan is a bad plan because it does nothing to fix the false negatives and false positives VC produce today, one that is currently shutting out meaningful innovation. And it demonstrates how it continues to treat entrepreneurs with remarkable ignorance.

Tags: VC, Limited Partners, Innovation, Entrepreneurs, Free-market, Investment

By Georges van Hoegaerden

That's how one of the many CEOs that contact me recently described his colleagues who submit to Venture Capital (VC).

This alternatively funded CEO describes other CEO’s that seek VC funding as idiots – with a 1 in a 1000 shot at a lousy valuation (52% Round A, 25% Round B and 15% Round C). He continues that many of the serial entrepreneurs trumpeted by VC’s have no money themselves despite “successful” previous exits.

He is not alone about the ineffectiveness of Venture Capital, I frequently hear from other successful entrepreneurs about it. And the situation may get worse before it gets better. The economy is offering VCs even more excuses to turn the screws, and control of companies is gained in more ways than a simple equity stake.

I believe technology investing today is largely a sub-prime asset class as described in a plethora of sub-prime articles in this blog, and find many entrepreneurs discouraged by both the process as well as the outcome of fundraising, even when that yielded a round.

Because of the ineffectiveness of VC and the rampant false positives and false negatives I refuse to believe VCs (and the NVCA collectively), who suggest that the sum of Venture Capital equals the sum of technology innovation. We see great entrepreneurs actively pursuing more creative investment vehicles (high-net-worth individuals, private equity firms, investment bankers, sovereign funds...anyone with money), and rightfully so.

In the meantime, oblivious to recognizing their own flaws, VCs are further descending down the sub-prime spiral by restricting investments to compliant entrepreneurs, evidence that they remain clueless about the fundamental risk management of high yield returns.

Smart CEOs should simply refuse to work with many technology investors for the following reasons:

- Exorbitant loss of upside
Great entrepreneurs are known for their passion to pursue their dreams at virtually any cost, and sub-prime VCs smell their blood and desperation. Those companies become owned by VCs quickly and because of the investors' lack of relevant operating experience yields a further deflation of the valuation of the company. We've seen many companies with end-game founder stock way below 5%, which is unlikely to become life-changing. So, why would you take the scrutiny of the CEO job with that outcome in mind?

- Indirect loss of control
Voting rights as well as other fine print in the termsheet severely impact your ability as a CEO to disrupt a market. While in the beginning the founders may still own the majority of the shares, the dependance on further runway support gives VCs the ammo to press their preferred operational trajectory and leaves operational decisions at the mercy of its first investors.

- Restrictive expenditures
The powers of the CEO are further restricted by clauses on expenditures in either the articles of incorporation, termsheets, voting rights or other legal documents. We've seen restrictions requiring board approval for expenditures as little as $5,000. That means a CEO can't make pressing decisions until a next board meeting or when there is an ability to call an impromptu session. These restrictions are further evidence that a CEO does not have the trust of the board.

- Insufficient ecosystem control
Investors typify investments in technology waves (witnessed by their mindless herding at technology focused events) and blindly allocate certain expenditure expectations to R&D, marketing, business development and sales divisions. But the ecosystem of every company, regardless of segment, is unique to that company. CEOs who let VCs determine or validate the ecosystem expenditures will spend the subsequent board meetings explaining why they deviated from that, a waste of precious time.

- Deal with undeserved authority
Many VCs do not have the credentials and relevant operating experience to lead an experienced CEO. Yet it behooves the CEO to listen to the idiosyncrasies of the VC in order for them to endorse a CEO's leadership. Nothing is worse for a company's future than having to wait for the investor to validate every step along the way.

- Micro-economically sandwiched
Technology founders and VCs are often focused on building technology, very few investors pay close attention to the macro-economic differentiation (and valuation), leaving intelligent CEO left to drive a more sustainable big picture strategy with limited board and back-end support.

- Forced syndicates
Investors with early stakes can essentially force the company to engage with other VCs in subsequent rounds that favor the initial investor, rather than the entrepreneur. Many VCs huddle together in like-minded "vulture" strategies in the hopes of maximizing their often ill-performing portfolio.

- Damaging to reputation
The valley is so small and ignoring the advice from an investor can have detrimental effect on a CEO's future career. The "you will never work in this town again" syndrome is not unique to Hollywood, it is alive and well in Silicon Valley. The word spreads quickly when you challenge VCs and don't accept their terms, a reason why they tell you not to shop valuations around - it will actually hurt you.

- Sticky lawyers
We've inherited bad ones in companies we ran and found some good ones. But in many cases lawyers in Silicon Valley pretend they actually created the companies, simply because they filed their incorporation paperwork or attended board meetings. They mingle with the money sources and make the introduction to VCs that secure their billing runway. They end up getting cosy with the major shareholders and tilting the balance even further away from the CEO who signs their checks. Another entity to keep in check as a CEO.

- Low salary
Opportunity rather than salary is top of mind to entrepreneurs, but that changes quickly when they struggle to support their families and pay mortgages. $175K is not a salary that leaves much on the table, especially not when you live in the expensive area around Sandhill Road. And VCs are challenging those salaries even more while they are raking in astronomical fees associated with their large funds and sitting pretty for the next ten years. The risk/reward equation between VC and entrepreneur is completely out of whack.

- Poor severances
Board-run companies leave CEOs in a vulnerable state once its collective wisdom does not pan out. The blame for that failure is usually generously applied to the CEO, while the decision making power was not. An early stage CEO should consider himself lucky if the company can still honor its pre-negotiated severance obligation.

Pimps and Hoes

The current venture climate reminds me of the fascinating HBO documentary Pimps Up, Hoes Down in which the undeserved authority of Pimps is applied to the Hoes who do all the (dirty) work.

No self respecting CEO should accept the constriction deployed by sub-prime Venture Capital as described above. The outcome of the current entrepreneurial restrictions is not only highly predictable but has thankfully reached the balance sheets of fund-managers and Limited Partners, who fund the VCs and are starting to question the role of the VC as the intermediary.

The downturn in the economy masks the unrelated impending implosion of Venture Capital. No VC should use the economy as the excuse for the restrictions above and as a CEO you should read its deployment for what it is; a diminished faith in you and the company.

So, unless you can reach a great VC independently or with help from others quickly, my suggestion is to wait with testing your CEO skills until Venture Capital, not the economy recovers. If you can.

In the meantime I'll do my best to help fund-managers revive Venture Capital. It is about time the fund-managers hear the entrepreneur's point of view. That has become my new mission.

Tags: NVCA, CEO, VC, Valuation, Limited Partners, Economy, Subprime, Macro-economics

By Georges van Hoegaerden

What does that title have to do with technology innovation and investing? A lot apparently to my brain.

VC spin doctors
The recent flurry of articles by individual Venture Capitalists (with catchy titles such as "VC rightsizing") along with the help from their association (the National Venture Capital Association, NVCA) spin a wonderful story as to how external circumstances have closed IPO windows and reduced M&A valuations. "Helped" by an ailing economy, Sarbanes-Oxly, and other new regulations VCs blame their inability to spot real innovation on anything else but their own choices. Good luck trying to convince the police officer that your car was really to blame for the accident, and the VC malaise we are in.

Didn't your football coach teach you in school that you can't blame the referee for your loss, even if the referee made the wrong call? He would tell you to man up and just play better so there is no room for error. Isn't that what VCs expect from their entrepreneurs when they go to market?

And that is what I am now telling VCs.

No more excuses
I don't believe for a moment that Google, Facebook, Twitter, Rosetta Stone and OpenTable have or will consider their ability to go public on just the pressure of regulations or the process of going public. Those companies have a macro-economic value that is resistant to - perhaps - cumbersome rules. And companies that can't jump the regulatory hurdle should frankly not be allowed to play in the big league of public markets and offered an opportunity to stain the reputation of technology innovation.

A major issue that great new venture funded companies face now is their ability to overcome the erosion of trust (as the currency of success) caused by its many sub-prime predecessors. For the last 10 years sub-prime VCs have collected sub-prime innovations which, without prior resistance propelled meaningless valuations into unsuspecting public markets. The likelihood of the current VCs (gathered at the NVCA) regaining that trust is as likely as a cheating husband regaining the trust of his wife -- it will take more than blaming everyone and everything else.

What matters is the entrepreneur
Moreover, the efforts of the NVCA described in their recent presentation emphasize the wrong point. The conservation of relentless entrepreneurs, not the VCs, is the real issue at hand. A VC, at best is a derivative, not the creator of disruptive innovation. For too long have inexperienced VCs been allowed to attract and perpetuate false positives and false negatives that have now clogged up the entrepreneurial ecosystem. And the only way to attract better entrepreneurs is to attract VCs with a vision as impressive as their personal entrepreneurial experience.

So, yes, I am in total agreement with Barack Obama's stance on imposing regulations to curtail the erosion of trust in the public markets. The importance of a vibrant technology ecosystem is crucial to our economy (that part of the NVCA pitch I agree with), and fund and endowment managers need to do a better job of sourcing, segmenting and keeping their VCs on a tight leash.

All free-markets require rules
No regulation that embraces the spirit of innovation can be more damaging than a continuation of the current sub-prime VC model greased up with efforts to exit out even easier and faster. Thankfully, fund managers have woken up and realize that moneys are best distributed to people who add value rather than simply extract money.

Instead of greasing the skids for VCs we need to find capable risk managers who measure up to capable drivers, likely to avoid accidents altogether. So stop examining the vehicles, but rather take a close look at who is in the driver seat.

Tags: NVCA, Google, FaceBook, Twitter, Valuation, VC, Funds

By Georges van Hoegaerden

Last week I was invited to attend (thank you Brenda Chia, president AAAIM) the panel discussion "Market Changeup: Fund Management as a Business", with Priya Mathur (Board director of CalPERS, California Public Employees' Retirement System; one of the biggest investor in LPs and VC funds), David Fann (President & Chief Executive Officer, PCG Asset Management), Jan Le Chang (Vice President, Centinela Capital Partners), Phil Phleger (Morgan Lewis) and Bob Grady (Managing Director, Carlyle Ventures).

Compared to last year (written up here) the opinion of the people at the top of the innovation food chain was remarkably introspective:

Venture Capital is broken in some fundamental way.

So much so that PCG predicts a revolution and a complete redesign of the Venture Capital model, with CalPERS nodding in agreement. CalPERS has gone from a yearly review of their asset allocation to quarterly and is currently debating new hybrid asset allocation models. That means less dependency on VC, and more on other vehicles. At the same time it is looking to reduce its relationships to only the top quartile VCs and getting out of the mid and bottom tier ones altogether. Annex funds, created to fill the void of fleeing late stage investors, are not found to be interesting as the majority of the funds currently in the pipeline will not produce positive returns anyway.

The sentiment from the fund managers was that they are literally "fed up with the rock star parties from VCs that don't produce returns". A conclusion clearly not received by all funds as we hear (from a trusted source) that general partners at a downtown Palo Alto walking-dead VC firm are still fetching $1M yearly salaries each, this year.

Everything is going to change.

VC is not dead, but everything is under review. Fund managers are now for the first time talking to each other to fundamentally change the outcome of the game, regardless of the state of the economy. They all admitted that none of the widely used mathematical risk models prevented the precarious situation that now forces even CalPERS to pay close attention to its balance sheet and carefully manage available investment cash.

Limited Partners are looking for full transparency of the VC funds, going as far as wanting to see their balance sheets and who is holding their securities. Under the magnifying glass are VC management fees (no more 25%), splits, as well as exorbitant fees gained through stacked funds. Co-investment with endowment funds are debated as they are too over-allocated in the equity vehicle to provide sustainability. We may see more monolithic investments in VC as a result.

All fund managers think clean-tech and health-tech are interesting asset classes, but think the fleeing from technology is somewhat worrisome, they have become weary to over-allocate anywhere. Globally, no economy has proven to show any disparate advantage, the asian and china plays fell equally as hard as the US and elsewhere.

Moving forward, but not so fast.

New VC funds will need to come up with a better story. The creators of the new VC funds will likely be experienced operators (just like at the start of technology evolution), removing the pure money managers who failed to add substantial value. They are expected to, as a team, have demonstrated an ability to warehouse deals before, deliver a unique value proposition to the investment climate and provide substantial value to the disruptive proposition of their portfolio companies.

CalPERS is eagerly looking to invest in emerging money managers who in due time (2-3 years expectancy to close a new fund) can expect their renewed support. So far, in the first quarter of 2009, 3 new funds have been invested in (compared to 47 all of last year) and no significant uptick is expected until this summer.

Clearly fund managers are licking their wounds, in a holding pattern for some positive news on the economy and perhaps some much needed regulation with regard to transparency. Rest assured, no fund manager seems to debate the value of venture capital as an investment vehicle, it is here to stay.

Help is on the way.

The great outcome for entrepreneurs is that fund managers (as we predicted) from now on will pay close attention to the type, behavior and performance of VCs that allows entrepreneurs to build new companies more effectively.

Good times are coming.

Tags: VC, Funds, Fundraising, CalPERS

By Georges van Hoegaerden

More than 10 years ago I read an article in the San Jose Mercury News in which many complained that Venture Capital (VC) funded companies rarely produce viable and sustainable businesses. To no real surprise we find ten years later that the public markets have no appetite for technology companies and the majority of its VC firms are under water, soon to drown.

With angel investments (left to support the idea-stage of company formation) severely depressed by economic downturn, new VC funds (from an ex-Googler, Marc Adreessen, Manu Kumar etc.) spring up to fund the early stages of technology innovation with $250K injections and fill the gap.

Capital Efficiency is the popular buzzword some of these new investors claim as the new investment category (after outsourcing has failed to live up to similar promises). Sounds promising doesn't it?

It is not. "Capital Efficiency" is a trap.

1/ Companies are not significantly cheaper to build these days
The macro-economics of bringing products to market have not changed at all, mainly because customer behavior has not fundamentally changed.

While new marketing and distribution channels such as social networking promise to provide more effective ways to reach targeted customers, the high noise-level in those channels erases the temporal benefits gained from its early adopter stage. What remains as an advantage is "merely" the quality of the technology proposition in the eye of the beholder, regardless of how that proposition reached its prospective buyer.

So, rather than spending lots of money on old-school decibel marketing, technology companies now need to spend more money on building products that have fundamental macro-economic differentiation and a customer experience that delivers real (disruptive) value. As a result, and I know from experience, it is actually more expensive to build a successful technology company today, because no company can make the false promises it could get away with in the past. Social networking kills false promises really quickly.

2/ Tippy-toe loans yield investor lock-in
A $250K loan (convertible note, usually with restrictions) is an investment that provides no ability to hire professional management that has the experience and ability to turn technology into a macro-economic game-changer early on - or better yet - manage an effective company ecosystem through its life-cycle.

Now the unsuspecting technology entrepreneurs, proud of their newly acquired capital infusion, are dependent on the investor and his pool of syndicates (necessary to provide sufficient runway) to determine when and how that critical conversion (from technology to a business) occurs.

That determination is not the expertise of an investor but worse, has moved the control of a company's business strategy from the entrepreneur to the investor. Relinquishing that kind of control is counter to the fiduciary responsibility in developing a company's independent and most valuable future.

3/ Investors should not run companies
The majority of Silicon Valley investors have never personally ran a company, or if they did, grew up in strong winds that made even turkeys fly. Great investors invest in companies, not in technologies. They are known for their ability to spot the combination of a unique idea, the right timing and an experienced management team to allow that company to operate on its own accord.

In the end, few investors have the time or experience to manage anything beyond milestones established through board control. As a famous investor once said: "I am a better investor than an operator, otherwise I would have become one - you can make more money that way."

Building technology proves nothing

Don't get me wrong, I am excited that new investors with a better pedigree enter the investment fray. I just wished that instead of creating small fragmented funds, they had formed a larger early-stage investment fund with like-minded peers through which they could deliver on the original promise of Venture Capital, and that is: generate big returns from taking big risks.

An investment strategy that keeps entrepreneurs on a leash with micro-investments looks an awful lot like loan-sharking to me. To those who take it, don't be surprised if the bite is deep and quality of life will be severely diminished.

Consider yourself warned.

Tags: VC, Experience, Investment, Funds, Fundraising

By Georges van Hoegaerden

As I was about to write about one of the many deceptions in the technology industry, such as the creation and herding behind hollow acronyms like CRM (Customer Relationship Management), SalesForce.com appears to have beaten me to a much more holistic implementation of that definition.

Many times in this blog have I written about the notion that companies are actually selling a customer experience, rather than a product. Needless to repeat here that most are not.

But Salesforce.com CEO Marc Benioff, (in full disclosure, was one of the Oracle executives who wrote an e-mail to Larry Ellison inviting me to come work at Oracle headquarters some 14 years ago) perhaps realized (or read here) his short-sighted attachment to CRM by which he implied that sales would actually create a lasting relationship with a customer after the deal is closed. We know better from our Oracle days.

But great entrepreneurs out-innovate themselves and Salesforce.com recently stitched together a comprehensive proposition (on their beta website) designed to pay close attention to whether in essence, a sales promise - in actuality - is met in a satisfactory manner.

Now, I have not reviewed SalesForce.com's specific technology proposition, but merely their entry in the market is a big deal and here is why:

1. This SaaS (software-as-a-service) strategy will enable the meritocracy of customer satisfaction and create better value for consumers, directly or indirectly.
2. Not all companies rely on a sales force, but all companies rely on managing the experience related to their brand.
3. Companies with new products should probe their conversion rates through this new service, before turning on the marketing floodgates. Marketing a product that has unacceptable user satisfaction, spurred by the negative power of social networking, has the potential to damage its reputation forever.
4. High conversion rates from trial-to-buy (especially in this economy) are key to lowering the cost-of-sale and dramatically improves operational efficiency.
5. Many companies rely on happy return customers to grow at a sustainable rate. Companies that don't keep their customers happy will not be able to sustain the cumulative growth its investors and shareholders are banking on.
6. The satisfactory customer experience is the real market differentiator of any product or service in a competitive industry, products with great service win over products with bad service anytime.
7. The investment in call-center equipment finally makes sense now. Companies now have access to a killer application (and platform) that runs on the telephone hardware that moves support from an afterthought to an integral part of the brand experience.

I advise any company, and especially cash conscious startups, to verify SalesForce's new proposition in this space and gain immediate clarity of their product-promise early on. I bet that the way developers look at a product will dramatically differ from how consumers perceive it. Now is the time to cost-effectively validate product assumptions and use marketing and sales to extrapolate the successful validation of your promise.

I get excited by the surprising discovery of a technology proposition that can actually make this world a better place.

BTW: I have no relationship with SalesForce.com that prompts me to write this. As most of you know, I only write what I truly believe in.

Tags: SalesForce.com, Oracle, Experience, Consumer, Startup, Marketing

By Georges van Hoegaerden

I owe HP (Hewlett-Packard) a debt of gratitude; in the mid 70s (when I was 14 years old) the HP-41C, the worlds first alphanumeric programmable calculator is what sparked my interest in technology. From a beautiful but too quiet medieval village in Holland (Woudrichem) I wrote applications for it that won awards (and was paid in new accessories) and found a mental connection with some of the developers who wrote about their role (and hobbies) in a monthly newspaper distributed to all owners (think of it as a Facebook group before Facebook).

The members of the development team wrote passionately about their incredible innovations explaining why they designed the HP-41 the way they did, its extensibility, its use in space etc. I read that magazine and all other publications related to it from cover to cover. In my eyes, HP was synonymous with great design, groundbreaking innovation and flawless execution of marketplace models.

A lot has changed since then, not surprising since HP chose to move from a technology specialist to a technology generalist to keep Wall-street happy. With a big hammer it stuffs the market with massive marketing vigor and manages to stay just ahead of its competitors, for now. But HP has lost its vision, agility and enthusiasm to innovate and fundamentally change the computing landscape.

1/ Longevity by association doesn't work
HP never grew up to own a part of the evolving technology stack from hardware, to software to services (or better yet, the consumer experience) and still today is making little more than me-too gestures with large manufacturers to suggest they own a unique proposition in the application and services technology segments. HP has become a master of associating itself to many things it does not own or add value to (just like the behavior of the many parasites in our industry).

To give some examples: HP rode the gold rush of the PC evolution (driven by Microsoft) and then had to buy Compaq to win the battle in a market that is still 40% owned by no-brand suppliers. HP rode (and lost) the database war by buying a stake in Informix (rather than buying it) even though it sold more servers with Oracle as the primary database (HP's stance propelled Oracle bed-fellow Sun then). HP partnered with Apple to deliver an iPod with no value add, only to kill the program one year later. HP acquired Snapfish in the consumer photography space and never made any attempt to improve its convoluted photography strategy. Examples abound.

So, the key for HP is to own identify and own certain technology ecosystems (from beginning to end) and redirect its massive R&D budgets to build proprietary technologies that attach customers to HP and HP only.

2/ Lacks product vision and execution
Mark Hurd is a great operational CEO with a proven ability to optimize an engine so it consumes as little gas as possible, but sustainability comes from engineering new engines only HP can produce that run faster and better. Mark can continue to hold as many fire-side chats as he desires but that vision is unlikely to come from employees that have been with the company for more than twenty years. Innovation from within is likely to produce nothing more than the same.

With all of HPs fragmented and discombobulated assets in many segments such as document management, printing, imaging it should have developed by now a cohesive customer facing experience that ties these products together like Apple does with music. The company needs a CTO with business experience and an aptitude to fundamentally tap into continuously changing consumer behavior and be open to outside counsel rather than adhere to a stifling "process for investigating outside ventures to allow equal access to these firms and inventors."

3/ Treat people differently
For more than 10 years I've heard stories about how people took advantage of a one-sided aspect of "The HP Way", the ability to stay with the company for many years and move from one division to another to escape being confronted with the outcome of their own decision making. Some people left HP only to make three times the money as an independent consultant working for the exact same group. But "The HP Way" also describes a high level of achievement and contribution that because of todays large and hierarchical org-chart (with many dotted lines) is hard to measure and manage. HP needs to reorganize just once, not based on product - but simply based on ecosystems that align with customer experiences.

Many of HP executives have disclosed to me that the company does not have the engineering talent to build its own product strategy and that probably isn't helped by rampant stories of how HP (a profitable company that should not have a need to layoff employees) is now allegedly laying off people that have worked at the company for 20-years, challenging their severance payments and disallowing them to ever work for HP again. Can you imagine how fast that news spreads to Silicon Valley developers? Not too smart HP. No surprise that it can only attract the talent that favors a paycheck over a challenge.

Start with a compelling vision
But amazing things happen when you drive a company with strong leadership, vision and execution. As a CEO I have experienced that the original assessment of employees fundamentally change when they are confronted with visionary leadership. They wake up and become energized, feel part of a common cause. So, the way to optimize a business is not to simply layoff people but to deliver a compelling vision to which people can either subscribe or not. The employees that don't will walk themselves to the door, especially when you turn up the volume.

So, turning HP around is actually very easy. It requires the innovative mind that "believes nothing it hears but anything it sees". It requires a visionary who cares about nothing but customer adoption, and an ability to model a company towards its purchasing power. Everything else is simply irrelevant.

I know HP despises it when I reference Apple (only to whisper their name in a restaurant), but the company simply has a much better DNA than HP. It is not too late for HP to change but it should start by reading "How to compete with Apple" in order to assess whether it wants to make the real sacrifices that are inherent to innovation (rather than resort to business process optimization).

Call me for a fireside chat, Mark. I would enjoy repaying my debt of gratitude.

Tags: HP, Microsoft, CEO, Innovation, Integrity, Oracle, Apple

By Georges van Hoegaerden

I am fervent proponent of transparency in the Venture Capital business which before TheFunded (a website that rates Venture Capitalist firms) did not exist. And I admit that I peruse the site on occasion to see how well my network of VCs stacks up against the interpretations of individual entrepreneurs.

But apart from the publicity prank they pulled for April Fools Day, I am as much against any system (subprime investing) that treats entrepreneurs unfairly as I am against a system that treats VCs unfairly. The latter, in my view, is what TheFunded represents, and here is why:

1/ Lack of transparency
The premium market model that describes the VC community accurately (supply-side) is inversed at TheFunded, and only the demand-side of the fundraising equation has an opportunity to vent their opinion. That can never yield to an objective view of venture behavior and economics, in a similar way just the opinions of VCs cannot.

2/ Lack of trust
Who are these entrepreneurs, are they disgruntled copycats of investment waves that have just passed them by? I don't know, but I do not recommend blindly trusting the opinions from people we don't know. I would not recommend eating at Zagat rated restaurants for the same reason. Simply put: if the trust of the source cannot be established, the trust of the opinion cannot be established.

3/ Statistically irrelevant
Something in the order of less than 1% of the business plans get funded, and therefor is the representation on TheFunded really relevant? It is human nature to emphasize the dismay rather than the success of a fundraising experience (which may only prove to be really successful years later at exit time).

TheFunded should be a marketplace as outlined in our marketplace rules and definitions, and representing the VC and entrepreneur side with equal opportunity. And since it does not, the contents of the site are highly questionable and provides additional distraction, both in terms of false positives and false negatives, to an already in-transparent fundraising process.

Tags: VC, Marketplace, Fundraising, Startup

By Georges van Hoegaerden

We write frequently about sub-prime investors who delay and suppress the risk associated with technology investments, which in-turn only attract entrepreneurs that are willing to submit themselves to those sub-prime tactics.

Today sub-prime investments occur primarily because of underfunding, but the opposite - overfunding - happened in the bubble days. Here are two real world examples of how both types of investments deflate returns for entrepreneurs (and indirectly all parties involved):

OuterBay Technologies raised too much money.

The company was acquired by HP for triple digits in 2006, but the deal was not as good for the entrepreneurs as it appeared to be for the investors, as we predicted back then.

In the words of its then CTO; OuterBay Technologies would not have existed without the strategic vision, direction and execution of The Venture Company. We tell our story here for the first time:

During christmas in 1999 I ran, through a friend, into four developers from OuterBay Technologies with a horrible business plan. I gave them the bad news but to my pleasant surprise, they responded with open ears. I incubated the management team, refocused the company on a single product and led the company to launch and initial market traction. We secured many early stage customers at around $160K a pop to which no self-respecting investor could say no. Even though many analysts still did, we un-wavingly continued to brake new ground.

Success has many fathers, and I smirked after reading this "fathers" proclamation of his role.

Because of the early success we created as a team and swayed by the ample amount of money available to startups in the late 90s, early 2000s, OuterBay Technologies raised an $11M series A in 2001. About $6M too much in my humble opinion. As a board member I approved the deal (I did not want to hold the founders' dream hostage), but not before warning them of the consequences of such a large round (at double digit pre-money), selling my founder shares (at a discount) back to the company and relinquishing my board seat.

The net of this story is that with more than $48M in, and such a large series A the company was quickly being "run" by the investors who put in a CEO we would not have picked, and expected revenue run rates way above the organic growth of the enterprise space that this invention relied on. As a result and after almost 6 years of hard work, the entrepreneurs did not walk away with the life-changing money they deserved. They should have continued to listen to my advice and they would have walked away with more.

No company should be majority owned by non-founding investors, it is simply not the investors expertise to run companies, directly or indirectly. So, do not raise the money that relinquishes control to investors.

SoftKinetic raised too little money.

SoftKinetic, a company that developed 3D gestural recognition software, contacted us in 2006 (from Belgium) to build a US business and raise money in the Valley. Within 6 months I validated the proposition against the laboratory developments at Sony, Microsoft, HP and others and assessed its technological leadership - before Nintendo launched the Wii.

I invited 20 well known VCs one-by-one over to downtown Palo Alto, demonstrated Quake driven by marker-less full-body movement, still leaving the majority of investors clueless about how the "input device" in the gaming industry fundamentally changes the adoption to the platform. Nintendo sure proved them wrong only a few months later.

I lined up two angels (including many other friends who wanted to participate in any financial way possible) ready to wire a double digit pre-money $2.5M pre-revenue round, only to kill the deal because of growing conflicts with one of the original board members (who has since been removed).

I moved on and the company emerged one year later with a new CEO and a licensing strategy that, in our view, is the wrong business model for the company. As the new CEO explained it, "at this point we are not able to raise more money to deploy a different strategy."

The real solution to the success of SoftKinetic may have faded, but I believe the company could have deployed a premium game station PC platform strategy (not unlike Voodoo, with one of the independent PC OEMs and part of the 40% of the fragmentation in that market) and deployed a growing number of existing 3D enabled games on that platform initially. Since the majority of new games are deployed on PCs first to test their viability, the premium gaming experience by SoftKinetic could have provided a much better immersive experience than the Wii - immediately - and as 3D cameras further commoditize, the software that drives the experience would amplify the core competency of SoftKinetic and be deployed at very low cost, with hundreds of game titles.

But the latter strategy requires big thinkers at both the company (the board) and the investor side. Years of complacent investing by VCs (thank God for Angels) who can't see the forest through the trees sucks the gusto out of disruptive business strategies.

Now, the company is forced to tip-toe into the market and adopt a licensing strategy similar to GestureTek and shuttered Reactrix and yield to suboptimal traction that can be expected from niche game-play and home entertainment interaction. That is a pity for the entrepreneurs and me (as I am still a shareholder of the company).

So, raising too little money is forcing many companies to phase-in disruption, and presents many new obstacles at a higher overall cost to gain significant market-share, and at the immediate expense of its founders.

Get help

The point I am making with these two examples is that entrepreneurs who model their business after the direction of the investors are almost certain to lose out, spiritually and financially, on the level of disruption they aimed to ignite. These examples are representative of an alarming Silicon Valley trend, one we wish we did not need to counter. But we care too much about groundbreaking innovation to let it slide.

It is for reasons like these that entrepreneurs partner with experienced venture catalysts (like us) who raise the disruptive bar on both sides, put the investor's feet to the fire and raise the right amount of money at the right terms and with the real passion to support disruptive innovation.

Both parties, the entrepreneur and the investor will benefit from our game-changing attitude.

Entrepreneurs will retain more equity and investors are exposed to deals that actually have the potential to single-handedly impact fund performance.

Tags: VC, Gaming, Enterprise, Nintendo, Outerbay Technologies, Startup, SoftKinetic, Fundraising

By Georges van Hoegaerden

As regular readers of my blog you are aware of my criticism towards the current operators of the Venture Capital (VC) microcosm.

I often liken todays Venture Capital business to the sub-prime lending business where too many people without the skills to assess risk accurately, put the whole technology ecosystem at risk.

My comments can be perceived as negative, yanking the chain of 700+ U.S. venture capitalists of which many use sub-prime tactics. Or they can be perceived as positive, with the majority of those investors looking the other way now is a great time to start a new investment vehicle (more on that later) that returns to Limited Partners (LPs) the allocation in the technology asset class they were promised.

A new group I see springing up are the people who use the negative interpretation to chastise the US as a whole, extrapolating that the US is "losing ground internationally on multiple technological fronts". That is where, with my international experience (an expat ready to naturalize) in tow, I need to put a full-stop to the criticism against this country.

Here is why:

1/ Not only does the U.S. represent a great breading ground for investing in innovation but more importantly, the US represents a societal curiosity to adopt and purchase those unproven innovations like no other country in the world. Technology investments will collagulate where the early buyers are.

2/ The U.S. has the uncanning ability to bounce back because in essence, every citizen is an entrepreneur (forced perhaps by the lack of safety nets). It may not be easy to bounce back but adaptability is part of this country's DNA - not so elsewhere.

3/ Investors in the U.S. have a short term memory, they need to put their money "to work". Technology remains a very interesting asset class because of its early potential, low cost, quick impact and large scale. So, with new risk assessment criteria for VC funds in place, new investments will flow again quickly. BTW: those investors (LPs) are not just american, the amount of sovereign funds investing in U.S. technology is significant and growing (not in the least because of bullet 1).

The United States will remain at the forefront of technology innovation if it acts on critical opinions that lead to improved self-regulation. We, collectively need to turn the current technology "investment club" into a free-market that embraces the curiosity and meritocracy that this country was founded upon.

The VC business will re-invent itself, either by people like me who aim to expose and correct its current flaws or (a few years later) by the Limited Partners who invested in VC firms with suboptimal returns. Either way, no innovation exists without induction of significant pain or gain.

Have no doubt that like many other innovations globally, the reinvention of the VC business will start right here in the U.S. and produce a whole new batch of disruptive and exciting innovations.

Tags: VC, Innovation, Funds, Free-market, Risk, Subprime, Startup, Limited Partners

By Georges van Hoegaerden

Apple is fundamentally different from any other company in Silicon Valley, but certainly not perfect. Its photography strategy is flawed (in the same way its competitor's are) and its iTunes Store needs to adopt true meritocracy if it does not want to alienate the record labels (movie subscriptions anyone?), its wireless Networked Storage strategy needs work as well as Apple TV and the MobileMe service. But in many ways Apple is ahead of the pack but not immune to the inherent risks.

Here is how technology companies, such as HP, Dell, Nokia, Symantec, Cisco need to change in order to compete:

1/ Innovate from the top, then continuously out-innovate themselves
Innovation is about taking a look from the outside-in with a fresh perspective and the purity of a new-born. The way to innovate is using my mantra of "believe nothing you hear, believe anything you see" (SM), meaning, the only thing that matters is how many people that you want using your product, are using your product. Analysts are useless in this assessment, as they simply use artificial market definitions to tell companies what they want to hear. Once you define real innovation, the next step is to continuously out-innovate yourself, ensuring that the pace of innovation is untouchable by others, and thus sustainable.

2/ Build irresistible products
Many of the aforementioned companies are in the technology commodities business. I wouldn't want to be in the business of building a car where the rest of the auto business is forced to use the same engine. There is only so much a pretty exterior can do to hide the ugliness of aging underperformance. As the dependency on operating systems shifts from the desktop to the web, now is the time for these vendors to escape commoditization and build their unique web-operating-experience.

3/ Develop a unique experience and maintain it
Too many technology companies in the Valley are "stocking stuffers", they stoically stuff a "market" (see markets don't exist) as defined by analysts and predecessors with incremental point products to eek out a larger percentage market-share than their competition. They "trade" market-share numbers as if they are the currency, that is - until "market" definitions change. But products don't sell, the experience does. People buy an iPhone, iPod because of the ecosystem behind it. Additionally with the lifecycle of many technology products being so short - around 3 years - renewals by recurring customers are vital to sustain growth. A one off product that made a promise and told many lies is devastating to the renewal rate and even the return to the brand. So, the emphasis should be on the experience -say music or photography - and innovate from the top around those.

4/ Change the culture: incent continuos innovation, punish stability
Corporate culture is fundamental to creating sustained innovation and for many large companies that means the CEO needs to exhibit that exemplary behavior. (it is somewhat humorous to see how VPs often mimic even the dress code of their CEOs). CEOs whos core competency is operational efficiency (HP, Cisco, Dell) need a right-hand man with executive privileges to cut through the bureaucracy and fundamentally realign the company along new macro and micro economic differentiation. Divisions need to be realigned to match customer experiences (not product groups) and be reduced into a one-level hierarchy. That ensures there is no place for employees to hide.

5/ Invest in innovation
Innovation as defined by bullet 1 is sustainable, spending money on stuffing markets is not. But the advantage large companies have over external innovation sponsored by Venture Capitalists is that they can think big, they are in a unique position to redefine customer experiences that ties seemingly disparate products into a cohesive offering that is much larger than the sum of all parts. Unlike startups, large companies are uniquely positioned to focus on the value of disruption rather than be restrained by the cost of entry. Large companies can build solid platforms upon which an ecosystem of independent software vendors can thrive.

Most of Apple's competitors are now simply chasing the iPhone strategy or music strategy, as they've chased market leaders for so many years. But that will never work. Every company has its own core competencies and its challenge is to become the innovator in the category they can make theirs.

Tough choices lie ahead for the technology titans. Those that change will survive.

Tags: HP, Dell, Nokia, Symantec, Cisco, Apple, Markets, Apple TV, Eco-systems, VC, IPhone

By Georges van Hoegaerden

Pierre Lamond, a Silicon Valley legend who has been a Sequoia partner at the Menlo Park, Calif.-based Venture Capital (VC) firm since 1981 has decided to join Khosla Ventures, primarily to do what Venture Capital was designed to do, take risks again.

Having hit on subprime VC for a few years now, his reasoning resonated with me and I looked back at Vinod Khosla's "New old-fashioned" model for Venture Capital, he describes in his 2002 presentation as "Funding to Milestones", as depicted below:



Now compare the above chart with the one right below, the VC model practiced by the majority of current Venture Capitalists today, which I refer to as subprime VC:



What quickly becomes apparent from the latter chart (derived from actual pitches between entrepreneurs and VC) is that supported by the excuse of lower development costs related to web2.0 technologies, the investors have pushed down the majority of the risk onto the entrepreneur.

We all know by know that Web2.0 is not a business and still requires the definition of a disruptive business that does not fundamentally yield lower operating cost, but much more disturbing is how investors have reduced their risk and delayed their active participation with a company that, in the end, actually produces lower exits (investors are now satisfied with a 2x rather than 10x return) and no IPOs. We explained in our previous blog how that strategy cannot save Venture Capital funds.

While statistically we can time-shift the sub-prime chart to the left and assume nothing has changed by holding up the Moneytree reports, anyone who has walked around in Silicon Valley as long as I have, knows what is really going on under the hood.

Unlike people like Vinod Khosla who can assess technology risk before it is build, the majority of investors can't envision an opportunity until they spot it in their rearview mirror. Today, investors demonstrate by their actions (or lack thereof) what is fundamentally flawed in Venture Capital; the lack of people that can accurately assess risk. In 5-years our economy will be in better shape than it has been, leaner and meaner. Technology opportunities are and will be abound, as it is in the early stages of penetration. This is indeed a time for aggressive investing, rather than a time for crawl-back we see some VCs do.

The sub-prime VC problem will remain when the economy recovers, if it is not aggressively perforated by people with real early-stage operating experience who understand that risk is the lifeline of Venture Capital - and join the investment fray.

Stop blaming the economy and take a risk, everyday. Only then will you get better at it.

(I will explain the sub-prime chart in more detail later)

Tags: Subprime, VC, Valuation, Risk, Startup

By Georges van Hoegaerden

About one year ago I attended a great session with Limited Partners (LPs) to VC firms, the Carlyle Group's Bob Grady and fund managers from Hamilton Lane and SFERS in San Francisco.

At the time I was impressed with the rationale behind a deliberate slowdown in new VC fund investments, yet every fund manager assured that the technology asset class remained an interesting one that LPs cannot afford not to participate in. The group as a whole emphasized that the new VC funds being deployed must prove substantial differentiation in its investment strategy, not unlike an entrepreneur needs to prove a similar aggressive differentiation to win market share.

With that in mind you may just be as amused as I am to see the "duh" investment strategy explained in this private placement memorandum (PPM) from a triple digit fund in early 2000:

• Market capitalization at IPO of $1 billion or more
• Rapid growth and very large potential market size
• Leveraged customer acquisition strategies: the business is able to take advantage of established customer bases, “network” economics, or powerful “viral” strategies to acquire customers at modest up-front cost
• Scalable business models
• Robust economic models: significant margin generation with potential for self-funding in year 3 or before.
• Significant competitive advantages based on such factors as proprietary technology, establishment of industry standards, customer investment in applications and/or user interfaces, or winner-take-all economics (i.e., the market is a natural monopoly)
• The opportunity to create leverage vis-à-vis suppliers and customers by virtue of efficiency advantage, neutrality, scope of business, and hard-to-replicate investments

I have seen quite a few other PPMs since and the resemblance is remarkable. No surprise that VCs have had the flexibility to latch-on to every new technology acronym, using whatever allocation per company they desire and invest in virtually any technology company that comes their way. And so they did.

They all did. In pretty much the same way, as lemmings are known to do. So now, we are over-invested in the same deal constructs (deep, see the investment atrophy described here), and under-invested in the full scope of technology innovation. As a result, large technology companies (such as Apple) are eating early-stage disruptive innovation for lunch, leaving the little deals for the bottom-feeder (sub-prime) VCs that count themselves blessed investing in "capital efficient" deals with little disruptive value, let alone IPO prospects.

No longer can fund investments be made using a single yard-stick.

LPs need to take better control of the segmentation in the technology asset class especially since maturing technology evolution will have its feet in every market segment, including crossovers to other asset classes.

VC funds need to be pushed apart to yield less overlap and provide complementary investment strategies rather than an 80% overlap. That, with the requirement to start new VC funds with GPs that actually have had early-stage CEO operating success, allows VCs to better align with the needs of the entrepreneur and fundamentally improve the chances for high-yield returns.

Tags: Limited Partners, VC, Subprime, CEO, PPM

By Georges van Hoegaerden

Sub-prime Venture Capital is akin to the sub-prime lending market and we predict the bottom will soon fall out of sub-prime VC too, spurred by the fear of economic pressure and the depressing returns of expiring post 911 venture funds.

Just like working for Carnival Cruise looks glamorous but is not the way to explore the world, unsuspecting young entrepreneurs who fall for sub-prime investors will soon find out that building those technologies has all the glamour but few of the rewards associated with innovation. Regardless, many chasing the mighty dollar will fall for it.

Here is how entrepreneurs can recognize a sting from subprime VC:
Step 1: We like the idea, but before we invest please finish the product some more, then come back
Step 2: 6 Months later, you finished the product. Great, now prove it works by getting 100,000 daily users, then come back
Step 3: Fantastic, now we'll take 60% of your company for $1M

Ouch, that hurts.

Here is why sub-prime tactics hurt our innovative ecosystem, just like sub-prime lendings have a negative effect on the housing market as a whole.

ad 1/ Technology development is the investment risk we understand quite well, timely applicability to a market is the real issue. So, proving that the entrepreneur can build a product can easily be derived from the entrepreneur's vision, knowledge and credentials in that space, juiced up with some kitchen-sink prototyping. On top of that a 6-month self-funded development timeframe with 2-3 developers can hardly yield a sustainable competitive advantage anyway, so R&D development proves nothing.

ad 2/ In many cases it is impossible to land 100,000 users before you have a critical mass of product capabilities. That critical mass comes from an R&D investment that generates substantial differentiation, and rarely from tip-toeing into the marketplace. Marketplaces, for example, only grow when a critical mass of both supply and demand are lured in and participate, which often requires a bolstering of technology to support all constituents, rather than minimizing it. Already, too many technology products enter the market unfinished as a result of underfunding and yield false negatives.

ad 3/ Control and valuation of the company are a direct indication of the future success of an early-stage company. The vast majority of technology success stories are derived from retained majority control by its founders and CEO (Facebook, Google, Twitter, eBay etc). Investors are terrible operators (no surprise given their background and experience) and should not want to own a majority stake in their companies, simply out of self-preservation.

Additionally, the danger of these tactics deployed by sub-prime investors (many of the large venture funds deploy fashionable sub-prime tactics too) is that it marginalizes technology innovation and provides a very unstable breeding ground for the fund performance as well:

a/ Venture Capital is meant to stimulate the high-risk / high-yield asset class as defined by its Limited Partners, the sub-prime strategy described here (anecdotally) serves nothing more than low-risk / low-yield segment of the technology asset class.

b/ No fund larger than $100 Million can support the management attention needed to spur these tiny injections along. As a result sub-prime investors just constricted what they thought of interesting innovation with too little time and too little money to provide critical market entry.

c/ Very few low cost entry deals yield the disruption that prices out favorably to makes any dent in the return of the fund as a whole. Venture funds need few big returns to keep LPs coming back for more.

The only early-stage investors who may be able to turn sub-prime deals into prime are the investors who:
- have proven to be successful operators themselves
- support the vision before the product is there
- have great syndicates to support the full runway of a disruptive market entry going forward.

Investors that can turn sub-prime into prime can be counted on one, maybe two hands. People like Marc Andreessen with his new AZ (Andreessen-Horowitz) fund come to mind. But entrepreneurs who are not stung by these visionary investors may just as well hop on that cruise ship and enjoy life some more.

The economics of big technology plays have not suddenly changed, the cost of developing technology may have declined slightly but simultaneously competition has increased exponentially. So, we prefer to focus on plays that are high-risk and high-yield simply because only they create the disruptive innovation that can keep VC firms in business.

The challenge for early-stage entrepreneurs remains the same, to create unbridled and disruptive innovation that finds only one investor that believes in it. If many more do, believe me, the technology is just not disruptive enough. So, be ready for some controversy.

Finding the right investor, amongst 700+ firms in the U.S. requires that entrepreneurs understand and can read the dating game. If they don't, we'll be happy to help. But get to us before you've been stung 217 times.

Tags: Subprime, VC, Innovation, FaceBook, Google, Twitter, Startup, Investment Banks, EBay, Revenues, Valuation, Disruption, LP, Funds

By Georges van Hoegaerden

Retail store decorations reminded me that easter is approaching and that set off the memory of an easter egg chart (on the right) I received from an early stage entrepreneur who had been trying to raise money over the past 12 months. In many ways the chart indicates how the Venture Capital (VC) world is filled with the wrong operators (not a lack of money), incapable of assessing risk; I will clarify later.

The enclosed chart includes the names of every investor (VC and Angels) the entrepreneur has spoken to face-to-face (in dark green), conversed through e-mail (in light green) and is scheduled to connect with (in orange).

Needless to say the 217 investors (whom I will not disclose yet, to protect the entrepreneur) that bothered to meet face-to-face include pretty much anyone who means anything in the VC business.

Helped by a tiny amount of seed money and introductions from a well known and respected investor, most investors responded enthusiastically (according to the entrepreneur), yet virtually none have bothered to provide the valuable feedback (or responded back with a decent no) that could lead to a line-of-sight of a term-sheet.

So, we conclude from this painstaking process the entrepreneur went through the following:

- Fundraising takes time, a lot of time
Even with the introduction from a well known VC, carve out one year of your life to raise virtually nothing (a million or so). Most entrepreneurs chase a dream that is chiseled from years of experience dealing with inefficiencies, only to discover that at fundraising time they don't understand (and don't want to understand) the VC microcosm that holds "innovations" hostage. We recommend entrepreneurs to start socializing the idea with VCs the minute they start writing code, to establish a clear target list of investors that can and should do the deal 9 months to a year later. One year ago I would have recommended the entrepreneur to sell his house and raise money that way, easier and better retention of control in the company.

- Investors don't treat entrepreneurs with the respect they deserve
Not responding to the entrepreneur (even when they share valuable connections together) as the majority of the investors on the enclosed chart did is the lowest form of disrespect imaginable. I have written about obnoxious VCs in this blog many times before (reinventing VC, subprime VC, LPs fooled, curse of subprime VC, investors to avoid) and would tell you that those over-inflated personalities contribute that I have no interest to belong to the current VC club (I have been asked). Clearly not everyone was raised by a grandfather (and co-founder of the Mentos candy) who taught us early on that you can be hard-nosed, respectful and successful all at the same time.

- The current crop of early-stage investors are numb
As you notice from the linkages in the chart (hard to see at 6% of original size), many investors have provided referrals to others. But referrals only happen when investors believe "there is something there" (one of their favorite phrases) and pass it along to another investor who may better understand the proposition. In an effective investor ecosystem and regardless of their belief in the proposition, the chart would never grow to be as large as it is. When investors don't like the proposition they will not pass it on, and when they do they will keep it to themselves and work out a deal. So, the sheer size of this chart communicates really well how clueless our current VC microcosm is.

- The current crop of early-stage investors simply don't understand the technology business
The fact that this entrepreneur is thrown around like a rag-doll by some of the biggest "experts" in the VC business says it all. The investor's indecisiveness is an indication of their lack of knowledge and vision that has earned them such a prominent role in the innovation of our industry. But, the best investors weigh risk, they do not need to deliver vision. Experienced entrepreneurs do not need investors to hold their hands in understanding the technology business and just need their investors to get out of the way.

- The current crop of early-stage investors are cowards
There is nothing, I repeat, nothing wrong with a VC saying no, whatever the investor's rational. But this chart shows how none of them can decide on their own - either way. These investor cannot stand to lose a deal they may miss out on (and not saying no will keep that door open), and don't have the guts to take the risk if they thought otherwise. It takes a strong character to be a VC, not an insecure and arrogant one.

- The current crop of early-stage investors are lemmings in rudeness
We knew that they were lemmings already, but now we know they will not only decide to jump off the cliff together but also share incredible rudeness. A sad state of being. No entrepreneur should sign any of these people on to their boards, because if they were not rude to them yet, that behavior will undoubtedly pop up when they least expect it.

- Entrepreneurs need a professional agent
Talking to this many investors and not yielding any takers is creating the smell of a dead fish in the venture community. While great successes like Skype required talks with reportedly about 40 investors and I did 20 on one of mine, the entrepreneur should have forced an early feedback loop with some investors before proceeding to talk to any more. The entrepreneur should pick an advisor or agent that does not allow this to go on for so long. It is sad that we are beginning to look an awful lot like Hollywood to become effective.

Now, notice that I have not discussed the specific proposition of the entrepreneur here and we may actually side with the VCs unable to extract razor-sharp focus from this entrepreneur's broad tale (but we will have the courtesy to tell him that directly). But the validity of the proposition is beside the point made here. Entrepreneurs, while they eat away their family's life savings and make considerable personal sacrifices, deserve the straight talk to help them plan their resources.

It is even more appalling that without any serious feedback the only response from a few VCs is to come back later, build the base technology first (which the entrepreneur has done) and get a critical number of customers. As if at that time the entrepreneur is in need of any fair-weather friends. The true character of the sub-prime VC is shining through again, but I am surprised it includes so many investors I thought better of. No wonder people like Umair Haque become even more enraged, describing VCs asleep at the wheel of creative destruction.

I would suggest the LPs (Limited Partners) to pull back from 80% of their current VC commitment (that are not producing returns anyway) and re-allocate the majority of that money to the creation of new VC firms that target more fundamental diversification in the technology asset class. I hereby offer my services to the LPs that want to take a hard look at that. And I would love to see the remainder of the current "prime VCs" be forced to re-invent themselves by this new influx in the same way entrepreneurs are all the time.

The only way to grow technology innovation is to force the VC business out of its current sub-prime mode and challenge the behavior of the crypt-keepers by making them highly accountable for their performance.

In the words of Ron Conway (a prominent angel investor) who recently stated "it is time for a new crop of entrepreneurs", we surmise "it is time for a new crop of investors" that attracts better innovation.

Tags: Fundraising, Disruption, Entrepreneurs, Subprime, Innovation, Investment, Digital Asset Management, Transparency, VC, Startup

By Georges van Hoegaerden

As the creator of my own personal photography and blog website for over ten years that publishes new photographs on a weekly basis, I have experimented with many tools, none of which serve my purpose with ease.

Opportunity
Roughly 50 million semipro camera users (including dSLR and semipro hybrids, growing at a rapid pace) are just like me and cherish no less than 25 Billion photographs per year that they seek to publish and share. A nice big opportunity of which Fotonauts (now fotopedia) aims to capture a piece.

Complicated independent workflows
As one of those semipro users I keep my photographs in my file-system (where no vendor can lock my thousands of photographs in), use LightZone to edit, Rapidweaver for web authoring with embedded HTML photo libraries created by JetPhoto Studio. That whole process takes quite a few steps and is not for the faint at heart. Rapidweaver is not great at managing lots of photographs and JetPhoto lacks the web authoring capabilities to become more than a companion to a photographic workflow. That seems to be indicative of many of the technology solutions in the digital photography arena, that is littered with hundreds of fragmented software and services tools in which none provide full support for the complete photography workflow.

Smooth operator
Fotonauts is an improvement in terms of its ability to create an instant (while you work) and good looking web site with some powerful social media capabilities that promise to increase traffic to your photographs. It blends offline and online capabilities (in which it cleverly avoids recreating the strategically flawed asset management repositories of both Apple, Adobe and others) and live-to-the-web authoring with superb smoothness, even in this beta version.

Web pages created by fotonauts can incorporate photographs from offline repositories such as the file-system and proprietary iPhoto, Aperture and Lightroom photo databases, and fotonauts can also tap directly into online photo libraries at Yahoo! FlickR, Facebook and Google's Picasa. The technology promise is sound, as can be expected from former Apple developers.

More fragmentation
But Fotonauts does not erase the complicated digital photography puzzle that aims to reduce complexity for the semipros or professionals, nor does it seem to target amateurs that care less about optimizing traffic through viral capabilities. For semipros it does not contain any white-labeing options nor a way to make images available for sale. The uniform layout applied to all albums is slick but off-putting to photographers who want to create their own brand and separate themselves from the pack.

The fragmented state of the current photography technology reminds me of the state of MP3 music before Apple introduced a better player (mobile and desktop), a store and the availability of premium content all wrapped in a single compelling user experience. In photography that is an opportunity too large and too complicated for VCs to understand and can only be captured by an established company with the vision and the financial wherewithal to wrap its arms around the complete photography experience. It is time for the photography puzzle to become whole.

Until then, Fotonauts is a smooth and beautiful new piece.

Tags: LightZone, Aperture, Lightroom, Adobe, Apple, Rapidweaver, JetPhoto, Photography, Flickr, Picasa, FaceBook

By Georges van Hoegaerden

Every week I receive a new offer to convert my analog AT&T telephone service to Comcast's Voice-over-IP at a very affordable price of around $30 per month, combining Television, Internet and Phone (hence triple play) from a single provider. And I have been very close to switching over. But nothing makes it more clear to say no to them after having spent another frustrating hour at 5am in the morning on the phone trying to restore my repeatedly disconnected internet connection.

I do not usually use my own circumstances to highlight a vendor but this example emphasizes a much bigger issue: how destructive the experience can be to the acceptance of a product or service. Vendors need to learn that what sells is the experience, not the product or service.

Case in point. From the old days of Palo Alto's Cable CoOp (and MediaCity), the original provider of broadband some 10 years ago and final acquisition had landed my Television and Broadband service under one roof with Comcast. Fed up with receiving two separate bills for about 5 years I called in to Comcast to merge the two accounts into one. Four endless calls (one each month) and cumulative no less than ten hours later, I decided to throw in the towel and visit the Comcast store, one week before the inauguration. There, a helpful gal quickly assessed the situation, merged the two accounts and gave me a new cable-modem to serve my needs. Proud of my newfound face-to-face experience I returned home, installed the new modem and went on with life...so I thought.

Returning home from the inauguration in Washington DC a week later, expecting to relive the event we had witnessed in-person, I could not be more disappointed to find my Comcast DVR empty. A call in to Comcast led to the quick discovery and admission that they had disconnected ALL my cable activities by installing a physical terminator on the side of our house. Eager to reconnect and four hours later, with the help of a knowledgeable service technician my service was restored. Since then, consistently every month around billing time my service is being disconnected, requiring me to put in another 2 hour call to Comcast to repeat the saga and reconnect the service.

That gives new meaning to their Comcastic slogan, doesn't it. Needless to say I am not going to entrust Comcast with my phone service, or any other service.

But this case is symptomatic for many other consumer technology experiences we encounter.

We confirm again that:

• In this automated world face-to-face interaction still trumps phone support
• Customer relationship management does not come from an automated system (nor does it come from sales)
• Support is crucial to selling more services (or losing them) and should have profit and loss responsibility

But to Comcast specifically it proves it has no business in penetrating our life with consumer products of any kind. Let alone your most sacred connection to the outside world, your telephone. We named the Comcast DVR the most horrid consumer device ever built and combined with their incapable support provides for an unacceptable user-experience.

Just like AT&T in mobile telephony we expect (and demand) a consumer vendor like Apple to reduce Comcast to its core competency, providing nothing more than a reliable network connection.

I have high hopes for that new Apple TV coming our way soon, that with the help of the government mandate for cable-cards that is already in place, will make the choice for best-of-breed back-end provider very easy. I'll be the first one to take a hard look at the network provider.

Tags: Consumer, Experience, Comcast, CrM, Apple

By Georges van Hoegaerden

I am responding to an article written by Dan Primack at Reuters PEHub (where some of my articles are syndicated), pondering the question as to how to radically reinvent Venture Capital. To start offering a solution, we should look at the original promise of Venture Capital (VC).

Let’s not forget: Venture Capital exists by virtue of great entrepreneurs building highly monetizable innovations.

With that in mind it may sound weird that many VCs are obnoxious, pompous, rude and anything but transparent to entrepreneurs (even after they invest).

But it is really not such a big surprise. Subprime VC attracts subprime entrepreneurs ready to cash in on the hype and hence an overwhelming amount of pitch noise drowns out the music, leaving investors numb and unable to separate the two. And now, most of those VCs are debating whether a new VC firm structure or deal mechanics can fundamentally change the outcome of the game. It will not.

Since the beginning of 2000 VC performance is under water and that hurts. But just like un-inspirational politicians who can’t get legitimate voters to vote for them, un-inspirational VCs waiving an outdated rule-book around cannot attract great entrepreneurs. But don’t for a moment think the american entrepreneurial spirit is dead. It is not.

My top 3 (but I could easily list more) ways of how VC should change:

1/ Invest in macro-economics
Rather than invest in mindless technology classifications, certain macro-economic behaviors engrained in society for hundreds of years can be harvested with technology. Think premium “market” and free-market models, each has great potential depending on which product or service is being sold. The cyclical behavior of adoption can prohibit the success of either, no matter how good the technology. Studying the model and the reason for its receptiveness will be the first clue towards a fundable business.

2/ Invest in inefficient supply and demand
Regardless of technology, many technology segments that we discard off-hand as too difficult have not even reached maturity or dominance by a single player (achieving over 30% “market” share). Even the well publicized Personal Computer segment consists of over 40% fragmented ownership, let alone an untapped market of roughly 5B people on this planet that don’t use a computer today. But fragmentation is the ultimate indicator of under-served potential, it simply means the current capability is ineffective, opening new opportunities for a new solution (iPhone computer anyone?). So, get your facts straight.

3/ Invest in the application of technology
Many new lines of businesses can benefit from the infusion of technology innovation. If the application of technology yields dramatic bottom-line impact, and provides a sustainable roadmap, then how it is build (with what flavor of technology) at the moment of entry merely indicates the cost to improve the upward trajectory further. So, stop investing in technology, but invest in application of technology.

Those three points alone require a completely different assessment of the risk factors associated with innovation than the one I see Silicon Valley VCs apply today. Most investors have become risk adverse and invest based on cost rather than opportunity.

So, to reinvent venture capital we need to reinvent the people behind it. The mechanics and size of government is irrelevant if it does not affect the behavior of politicians that inspires people to vote. Similarly, the effectiveness of VC will not improve by changing fund size, deal staging, etc. (or escaping to a green-tech “bull” market, for that matter) unless the investors change their behavior that inspires the right people to innovate.

We need to bottom up VC. Investors need to become truly complimentary to great entrepreneurs and practice similar ethics, transparency, and perseverance traits to become valuable contributors to the innovative process that allows them to reap the rewards. Teams that can consistently yield a path to trustworthy IPOs will be charmed into even more lucrative acquisitions along the way.

It is a “buyer’s market” only for those investors who buy mediocre innovation. And mediocre innovation will not produce great fund returns. So, in the end, innovation remains a “seller’s market” - or no market at all.

Let’s not sit back and wait to find out which one it is going to be, as the writing is already on the wall. The time for VC to change and attract different innovation and entrepreneurs is now.

Tags: Subprime, Markets, IPhone, VC, Funds, Green Tech, Investment, Innovation, Limited Partners

By Georges van Hoegaerden

I am not going to add to the craze about Steve Jobs (Apple CEO) health rumors on the internet, and I seriously hope he recovers quickly and in excellent health.

Anyone trying to sue Apple or its board for inconsistent information, should back-off and be glad they are not faced with a similar diagnosis. One of my friends (much younger than Steve) was recently diagnosed with the same type of (a rare) cancer and is apparently being treated by the same doctor at Stanford. Having heard his stories first hand, I side with Steve that he cannot project with accuracy what is going to happen as 1/ what causes cancer is still fairly misunderstood (follow the cancer series on Charlie Rose and you’ll understand) 2/ his rare type of cancer (with about 8 known derivatives) is even less understood. So, give the man some space.

Steve has proven to be the best guy to ever run Apple, but that doesn’t mean the company can’t improve. Here is what I would do, given the chance:

1/ Making the current OS work “as promised”.
Snow leopard is on its way and without knowing any of the details the OS needs some fundamental improvements in Expose and Spaces that are simply not working correctly, those (and many other) flaws have been in OS X for quite a while and since it affects the user experience, that is simply not acceptable within Apple standards. It is clear, in many other areas, that the rapid pace of innovation in other areas has taken its toll on the focus on the OS. In addition, the OS needs an Applications Store similar to the iPhone App Store.

2/ Consumer OS, major OS overhaul.
It is time for Apple to define a new trajectory for the OS. The current O