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

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

The subprime investment tactics by Venture Capitalists has a damaging impact on the returns provided to Limited Partners (those who provide the funds to the Venture Capital firms, such as pension-funds, university endowments, insurance companies etc.) and on the technology asset class as a whole.

We predict that as a result - and within 2 years, when the gestation period of the post 911 VC funds has expired LPs will dramatically reduce the inflow of moneys in the technology asset class, disappointed by unfavorable returns. To no fault of great entrepreneurs in this great country.

Here is how subprime VC fools LPs:
1/ The LPs believe they are investing in a premium technology asset class but in reality they are investing in an artificially constricted commoditized asset class we call bootstrapped innovation.
2/ The LPs believe they are investing in a high-risk high-yield asset class yet the VCs operate using low-risk (almost investment banking style) tactics with inherently low yields.
3/ The LPs believe they are spreading the risk by investing in multiple VC firms, not realizing that the majority of them invest using the same rule-book and therefor identical risk patterns. The LPs unknowingly are investing deeper rather than wider.

So, just like when my daughter behaves badly (rarely) and I need to take control of the situation, so must the LPs take control and tighten the leash with VC firms that are behaving “badly”. The behavior of my daughter (or dog if you consider that your child) is my responsibility, the behavior of VCs is an LP responsibility.

Here is what every LP should do right now:
1/ Bring every invested VC firm in and re-assess whether the invested amounts, category and valuations per portfolio company match the initially stated investment thesis and more importantly, your current risk profile across all assets.
2/ Ensure the spread between the investment in technologies versus the application of technologies to markets aligns with renewed opportunities and your current risk profile. The impact of technology has dramatically changed (rather than reduced), and many VCs are still stuck in the past.
3/ Hire an operational partner that establishes continuous oversight into the VC investment allocations (get one here) based on the risk and identity associated with each participating fund. That oversight should prevent the fund from investing outside the pre-established criteria.

Now is the time to reassess the investment opportunities in our technology industry. We believe the opportunities are abound, just not with the current investment tactics.

As Cesar Milan, a.k.a. the dog whisperer teaches us: its not too late to rescue any dog - as long as we can change the behavior of its caretaker. Similarly, it is not to late to improve entrepreneurialism if we change the behavior of its investors.

Tags: Subprime, Private Equity, VC, Entrepreneurs, Limited Partners, Subprime, Fundraising

By Georges van Hoegaerden

Subprime VC, as described in a previous blog is easily recognizable, here are some of my metrics. Run for the hills when the investor...:

1/ ...seems more interested in how it is built rather than what the disruptive business proposition is.
Innovation becomes successful when it marries macro-economic value with micro-economic (technology) execution. Technology risk is the least of our worries in Silicon Valley, yet fundamental disruption is crucial and should take up the majority of the discussion.

2/ ...seems more worried about cost of development than cost of greenfield customer acquisition.
Capital efficiency is a buzz-word investors love to throw around. In most cases they want you to be as cheap as possible. But capital efficiency is relative to the cost and value of customer acquisition. Not all venture capital deals start with a seed round below $250K, more disruptive innovation usually costs more to build well (think iPod, iPhone, iTunes, eBay, etc).

3/ ...talks about valuations before you’ve explained the value of becoming the market leader.
A favorite trick of investors is to value the company based on its present accomplishments and many entrepreneurs fall for it. Their companies become undervalued and underpriced which leads to early loss of control to investors. And when investors run a company, statistically the chances of success have diminished significantly. Early stage companies should be priced based on the value of the idea and accomplishments along the trajectory of market leadership. Your glass should be seen as half-full not half-empty.

4/ ...seems more occupied with categorizing the investment than understanding its unique business value.
When investors start categorizing investments in technology categories and subsequently base their investment decisions on them, that means they clearly missed the fact that you business proposition could have value regardless. Again, technologies are not the business, application of technology to a market segment is.

5/ ...talks about capital efficiency without probing market inefficiency.
Again, capital efficiency is a relative term. When a large market is extremely inefficient it probably means that the absolute cost to enter is high (otherwise someone else would have entered it before you). So, the cost to enter the market is a function of its current inefficiency. Many investors are less versed in inefficiencies than you and therefor misjudge the price it takes to enter. As the entrepreneur you will be faced with the inequitable consequences if you decide to bow down and take the investors’ word for it.

6/ ...doesn’t question market entry risk, but focuses on cost.
Investment risk is what should be top of mind to investors, but many of them think they have the operational experience to challenge the assumptions of the entrepreneurs. In many scenarios market entry risk can be mitigated by developing a better product, but a better product costs more money to build. At any time would I rather spend a dollar on R&D to make the product better, than spend a dollar on marketing expenses to try and make a “cheap” product land better. So, the right amount of money (not cost) is imperative to disrupt a market.

7/ ...doesn’t ask about the runway to profitability, but the initial round to get in.
Most companies require multiple rounds of funding. Those rounds are not there for you as the entrepreneur, but for the investor to establish milestones to make him more comfortable. An investor that does not allocate sufficient runway, is effectively selling short on the promise of your company and will cost you months of fundraising efforts at every round.

8/ ...asks you which other investors you’ve spoken to.
Investors are lemmings, and so you should not disclose who you talk to until you have all their term-sheet on the table. Force them to make their assessment of your company independently. Usually each investor has a different risk analysis of your company and last thing you want to do is add up all the negatives before there is a buying signal on all sides. Herd the positives.

9/ ...asks you to talk with his associates first.
As discussed in this blog many times over, associates are graduates that should be used to perform due diligence, not to discover a black swan. Many investors will use associates as a way to offload the workload created by the noise inherent to our industry. The minute you get the associate, you have become noise.

10/ ...asks you more about your education than your work experience.
Building innovation that is truly unique requires an analytical mind and ignorance to anything else but bottom-line results. Education teaches you how to respond to prescribed scenarios, innovation requires the opposite; an ability to respond adequately to a myriad of circumstances that have never presented itself to you, in that composition before. Any investor that focuses on your (or his) business school accomplishments has a warped view of what innovation really is.

Never forget that a great entrepreneurial idea sponsored by the wrong investor yields nothing but failure. Keep searching for the right partner and don’t bow down to subprime investment tactics.

Tags: VC, EBay, IPhone, Growth, Capitalism, Subprime, Startup

By Georges van Hoegaerden

It continues to amaze me how VCs point to the economic downturn as a reason for sluggish investing. We all know that at this point they should do exactly the opposite (and a few good ones do).

Information Technology is here to stay as we clearly have not reached the saturation point of its practical implementation, even though short-term M&A and IPO windows have pretty much closed - for now.

But I am especially dismayed by the fact that VCs seem to completely ignore responsibility for the fact that their investments strategies can’t seem to weather the storm and how they continue to hide behind the economic downturn to avoid the disclosure of their bad choices. Reminds you of anyone?

I don’t believe the VC model is broken, in the same way I don’t believe mortgage lending is broken. We will continue to buy new houses - and technologies. Both represent sizable investment returns for years to come. But the risk profile associated with lending money for a home has been miscalculated and I contend the majority of VCs are fundamentally miscalculating the risk of early-stage investing. Birds of a feather.

Here are some of the similarities:

1/ The sheer number of lenders entering the mortgage arena forced an artificial expansion into the low-end. In the technology industry about 790 US investors force a similar artificial expansion down into the low-end. Most entrepreneurs are forced to comply to the “capital efficiency” rule-book or, as I call it, subprime VC.

2/ The majority of people working at the mortgage bank cannot accurately assess the risk profile, neither can the majority of people working at a VC firm. The associate in a VC firm (or worse the General Partner), fresh out of school is simply not able to detect disruption. Schools are, by design, setup to teach students about white-swans, not the black swan that usually spawns real innovation.

3/ The lenders took advantage of uneducated buyers, without sufficiently reminding them that buying a house yields a debt, not an asset. Similarly, entrepreneurs are often made to believe they are successful when they land a round of funding, mistaking that for an asset (instead of a liability) and subsequently not paying enough attention to the acquisition of its real assets; new paying customers.

4/ The majority of home-buyers should not have qualified. Similarly, most technology ideas should not. Innovation is only meaningful when it monetizes ideas. So investing based on technology classifications is the wrong qualification of innovation.

As the included chart attempts to depict, the investment strategies in the 1990s and even the exuberance in 2000 produced better variance and returns than the atrophy created by the current VC rule-book. Now, too many investors herd (syndicate) around the same investment strategy, diminishing its returns and making it increasingly less attractive for smart entrepreneurs who refuse to submit themselves to subprime investment rules.

An artificial VC rule-book, subprime valuations, lower founder salaries, fewer M&A and zero IPO makes for a very unattractive entrepreneurial playground. If we don’t throw the VC rule-book out of the window, we should expect nothing more than sub-prime M&A and subprime IPOs, even when the economy recovers.

The concern is that we are creating fewer companies that someday have the financial wherewithal to acquire its smaller innovative brethren and like the lending market, are stuck with “innovation” that no-one wants to buy. I wrote about that starting more than 3 years back (here, here, here). We need VCs with the ability to spot disruptive business opportunities rather than perpetuate technology gimmickery.

Perhaps we can put the National Venture Capital Association (NVCA) to work on something better than mindless self congratulating statistics of the past and misleading videos of the actual workings of venture capital today. It could instead create more transparency of its members, to stave off tougher selection and regulation from the Limited Partners (pension funds etc.) that are otherwise unavoidable.

We, as collective contributors to the technology ecosystem - not the elusive economy - are responsible for the performance of our industry and our ability to produce real value that can weather any storm, and that means we need to get out of subprime VC quickly.

Tags: VC, Investment, NVCA, Integrity, Innovation, Risk, Limited Partners, Startup, Subprime

By Georges van Hoegaerden

Silicon Valley is not dissimilar from the politics in Washington DC in the sense that its existence today is regulated by aristocratic people (investors) who are not up for re-election for another 7-10 years and have created an ecosystem that spawns more false positives and false negatives than any politician could ever get away with.

So, it is not without a smile on my face (as I have been preaching and practicing for years) that I quote Barack Obama’s innovative approach to politics that we in Silicon Valley could learn from:

Strong personalities and strong opinions
Obama looks for strong personalities and strong opinions, while the venture business is often afraid to hire people who challenge its popular opinion. Many technology companies over the years have been invaded by managers who akin to the gold-rush are looking for the gold that is no longer easy to find. We need to change too and cultivate managers that have real experience, strong vision and strong abilities to rally a team around achievable results. Let’s get rid of managers that just like politicians prefer to feed their sex drive (my first boss in the US spent his days watching porn-videos as we prepared feverishly for a major launch) and their 401K with the least resistance possible.

Think anew and act anew
Obama is shaking things up. We should too. The really new ideas in technology are few and far between. We need to build and feel responsible for an ecosystem of new financiers that fund technology ideas that do not fit the mold, rather than continue to create clubs that mindlessly perpetuate businesses that copy few successes or popular acronyms.

Extreme transparency
Obama teaches us how the disclosure of governmental documents is the floor and not the ceiling. Compared to that metric, early-stage performance disclosure is probably more than 6 feet under, or in the cellar. We have no transparency in the venture business to discover who has integrity, and who is poisoning the technology ecosystem. We need to deliver transparency in order to improve the trust in technology companies that keeps private and public investor interested.

High integrity and moral
Obama, when moving back to Chicago, took a job doing what he believed in, not what made him the most money. We need to stimulate people in Silicon Valley with a passionate desire to fundamentally improve technology adoption, rather than continue to feed people who hone their skills just to get rich.

Use it or lose it
Obama evaluates and then commits quickly. And then, when the money is forked over, you are expected to make things happen. That’s how real savvy businessmen run their companies, quite different from the puppet role many startup CEOs play to appease their boards, the source of perpetual mediocrity. We need to grow a culture of buy-in and commit, risk and reward that holds people accountable for the results.

Either we regulate the early-stage technology ecosystem ourselves or the market will do it for us - with much less grace. Already, it is predicted that 25% of the VCs will go out of business soon, freeing up LP overhang for a new crop or reallocation to a new segment. Other countries (such as China) are not sitting still, the performance of our technology ecosystem will now be challenged on a global basis.

The only way not to lose grip globally is to hold the values, that made our country vote for Obama high, and aggressively reward integrity, passion and sincerity over greed. Real capitalism rewards the good and punishes the bad. And the American dream flourishes again.

Tags: Innovation, Eco-systems, Economy, Limited Partners, CEO, VC, Startup

By Georges van Hoegaerden

Jupiter-Images finally sold to Getty-Images after a similar attempt in February of 2007. With estimated revenues of around $79M (when last tracked) and con-jointed debt of $95M with other Jupiter Media properties, Jupiter-Images sold to Getty-Images for only $96M in cash. Sounds like a fire-sale to me.

Imaging super stores make no economic sense, as described in this blog before.

1/ Images are like art. Taking preferences of buyer and seller into account, they preferably sell only once (or as few times as possible). No buyer wants that image to appear in similar publications and so every transaction is unique. Super-stores, however, are modeled to provide one-to-many sales transactions and are therefor NOT suited to support the image exchange marketplace.

2/ Except when images are produced on a commissioned photography basis (for example by Getty-Images staff photographers), the image super store actually does not own the image, it merely has a right to operate as a reseller. Nothing would stop a photographer from trading his images somewhere else, dramatically deflating the value of the super-store.

Fact remains that $22B of images are exchanged every year, most of it (90%) not through online transactions or the sum of all super-stores. This represents a big opportunity not many Venture Capitalists understand, as it is a market-play rather than a pure technology-play. But established companies may be able to build an iTunes of images to feed their ecosystem of products.

In the meantime, Getty-Images (now private again) keeps on puffing itself up like a puffer-fish. The question is: how long will it be able to hold its breath.

Tags: Photography, Getty-Images, VC, ITunes, Jupiter-images, Revenues, Private Equity

By Georges van Hoegaerden

I understand the need for a greener environment (and enjoyed the fantastic video presentation from Google CEO Eric Schmidt at Corporate EcoForum), creating more renewable energy and perhaps making us less dependent on foreign countries.

That promise sounds good, albeit I think it will just redefine what we as countries fight about. Today it is oil, tomorrow it is probably about green technology and resources. In the near future, green technology will also find its core competencies and attractive pricing in countries other than just ours. Yet if we don’t learn how to resolve our differences and respect each others cultures, the subject of our debates is irrelevant. New leadership is key, so go out and vote.

But the part I don’t get is why many investors, like Kleiner Perkins, “flee” from information technology at the shimmer of rising oil prices, financial instability and tax incentives and dive head first into a completely new, and may I add completely different line of business. A line of business that often has more similarities to farming (with all of its intrinsic risk factors) than effortlessly moving bits through thin air.

The reason why information technology remains an interesting investment category to me is:
1/ The innovation of information technology is cheap, a few smart people in a room behind a computer and voila, a new star is born.
2/ The distribution of technology is cheap and immediate, there are virtually no borders (except to China perhaps).
3/ The monetization of technology is well understood, and is either direct or indirect but almost always single source.
4/ The enormous left-over possibilities of information technology that has yet to percolate many other industries.

Contrast that with green technology where I see:
1/ The massive costs associated with early foundational development.
2/ The costly implementation and distribution that requires safety, governmental, social approval processes (literally lasting years).
3/ In most cases the requirement of multi-source monetization, involving grants and many regulatory constructs (requiring a longer sales cycle).
4/ A limited time-to-market benefit for early adopters and therefor lack of urgency to buy. The adoption of green technology is generally believed to lengthen the time-to-market, aiming to produce a return on investment spread out over many years.

Again, I do see an enormous need for green technology to save our planet and a justification for investments supporting it. I am just not confident that the current Venture Capital model (born out of the technology era, and driven by information technologists) will lend itself to that segment. I am very curious to see what vintages will produce viable returns for the Limited Partners in the green-tech funds.

I hope I am wrong, as carefully applied Venture Capital has the potential to change industries, countries and the people in them.

In the meantime I’ll stick to my core competency, creating and managing growth of innovative information technology companies.

Tags: Green Tech, Innovation, Investment, Distribution, VC, Limited Partners

By Georges van Hoegaerden

As an entrepreneur, getting to know your Venture Capitalist is important, especially because their life is not as cushy as you may think.

Just imagine the onslaught of business plans they get, and how much time it takes to find that rewarding investment. Eliminating the false positives and false negatives takes time, lots of it. We personally reviewed about 40 companies over the last 7 months, yielding 3 companies that have huge potential for our investors but they need work. Hard, fun work. But life of the VC doesn't end there. Knowing the goals of your VC (in terms of fund composition and exit requirements) will make you better understand why a VC firm behaves the way it does. Its fund needs to end up in the top quartile, with or without you.

Operating on both sides of the isle and getting to know the investors I work with better, I attended the AAMA-AAAIM session in San Francisco called "Fund Management As A Business" (presentation in pdf used with permission from AAMA), moderated by the skilled and jovial Robert Grady, Managing Director of The Carlyle Group with a fantastic group of fund managers (Hamilton Lane, SFERS) and a surprisingly honest VC (Altos Ventures). I wish everyone in the investment community was as transparent as this group so we can remove some of the stigma around VC.

Here are three reasons why VCs don't have it that easy:

1/ Many more VCs need to compete aggressively on a relative steady amount of fundable deals, hovering around 4,000 equity investments in venture backed companies per year. The number of VC firms has grown from 399 in 1990 with $31B under management, to 798 firms in 2006 driving $236B into the US venture marketplace.

2/ Joe Schoendorf (Partner at Accel Partners and board-member of World Economic Forum) confirms that less than 5% of the VCs deliver the goods that sustains technology as an investible asset class. That means 95% of the investors are probably stressed out. So don't take a lack of response or a no from a VC too personal. VCs deal with complicated and sometimes long drawn investment strategies (it took Altos Ventures 3 years to land their last fund). Investment allocations may be another reason why you don't always get a quick response for your technology venture.

3/ VCs are working hard. The exits of about 400 M&A plus IPO transactions per year account for less than 10% of total venture investments made. And in order to get a successful exit, VCs review more than 20 times (and that's a conservative assessment) the amount of business plans before they invest in one. So, south of 0.5% is where their - and your - statistical probability of producing a successful exit lies.

The same criteria that apply to the return of the collective technology investments made by a VC with a fund, applies to their Limited Partners (LPs) trying to find great collective VC returns for their Investors (Pension Funds, Insurance Companies, Endowments/Foundations etc). The VC is sandwiched smack in the middle between the entrepreneur and LPs breathing down their neck. Their only "luxury" is time: 5 years of investing and 5 years of harvesting.

As an entrepreneur you can't worry too much about the statistics, if you did you wouldn't be an entrepreneur. But that the amount of deals is slightly on the rise again, perhaps indirectly spurred by massive influx from sovereign funds, means access to money - to live out your dream is improving slightly.

But be prepared to talk to more VCs and saddle up for an extensive roadshow. Fact remains: the cost of doing business to entrepreneurs and investors has increased dramatically.

Tags: Investment, Innovation, VC, Funds, Limited Partners, CalPERS

By Georges van Hoegaerden

Getty-Images pulled it off as we indicated would happen, and sold itself to private equity group Hellman & Friedman LLC in San Francisco (and the "network of the private equity group" which apparently includes the Getty empire) for a little over 2x revenues, assuming also an additional $300M in debt. Someone clearly felt that was an accurate price for its organic growth business: "Wall Street was paying more attention to the stagnating core business than to its emerging segments."

Indeed, non-organic growth is hardly ever a sustainable endeavor, lacks core competency and focus and often hides many skeletons in the closet. Now the fun part of discovering its real value starts, although the company does not forecast a lot of changes according to this interview with Jonathan Klein, Getty-Images' CEO and PDN. We could suggest a few fundamental changes along the lines of my blogs and then some.

But anyway you cut it, this will turn out to be good for photographers and the market. New competitors will spring up and VCs will now perhaps see the value in supporting imaging marketplaces. So for that, we need to congratulate Getty-Images.

Tags: Getty-Images, Investment Banks, Revenues, Wall-Street, Debt, Organic growth

By Georges van Hoegaerden

While there may be some value left in Getty-Images, remodeling an "old-house" in this case appears to be much more expensive than building a new one. We just completed a formal business plan to build a real photography marketplace for less than $5M first round (est. $13M total, less than 1 fiscal quarter of Getty's capital expenditures, to shed light on Getty's inefficient business model).

The "body" of the Total Addressable Market is $22B / year, ignoring the size of the Long Tail of photography Getty-Images has no penetration in, we will. So, a $13M investment would yield $600M in annual revenues based on 30% market-share (even if we were to cover "the body" only). A darn good business, and best of all, it will help great new photographers get "free" and transparent access to buyers. So good karma too. The walled gardens of the imaging marketplace will be torn down. Call or e-mail me if you want to play.

Tags: Getty-Images, Free-market, Funds, Photography, Long Tail, Marketplace, Markets, Revenues

By Georges van Hoegaerden

Getty-Images appears to be having trouble getting sold for $1.5B according to an article in The New York Times today. Perhaps the 40+ investment banks on Wall street and an equal amount of large private companies that visited our website really took our Puffer Fish analogy to heart.

So what could be done with Getty-Images? The problem with finding an acquisition partner is Getty-Images' hybrid business model. For a technology acquirer the services business with staff photographers is a burden they will not want to swallow. On the flip side, very few other services companies than perhaps the Associated Press can find solace in the photographer factory that is an integral part of Getty-Images.

1/ Buy company at a decent value
2/ Separate content producer business from content distribution
3/ Privatize each
4/ Sell content production business
5/ Revamp content distribution

ad 1/ To establish a fair price I am eager to see the operating plan metrics separating content production from content distribution in order to find out to what extend both lines of businesses have suffered from being under one roof (there may be some opportunity hidden in there)

ad 2/ Content production is a business model that, in today's world, needs to be separated from distribution. With the internet in place as the conduit for distribution, very few company can still afford to compete with the content produced by a "free-market". There is some remaining value left in the production of "premium" content for a "premium" audience, in the same way the Associated Press is able to provide this service to a confederation or co-op of newspapers.

ad 3/ Build companies that focus on what they do best, one produces content - one distributes it. Not within a single company or P&L or board. Each with its own growth trajectory.

ad 4/ Just like in the "premium" production of news articles (where bloggers compete), the news media will require a "premium" production of editorial photographs that has some trust associated with it. Perhaps a deal can be struck with AP - or a new version of AP can be created with identical goals. Getty-Images already has established a large installed base of agencies who can lease resources on a subscription basis.

ad 5/ Long term, content distribution is where the money is. The Long Tail of photography is massive, much larger in total image exchange than any Super-Store will ever be. Thanks to the Internet. But to build an effective free-market, a core of premium supply is needed to create its initial pull, Getty-Images certainly has that. To make this new company a winner though, it needs to truly support free-market principles, something very few companies can pull off.

We'd be happy to assist in the assessment of the Getty-Images acquisition value along the lines of the aforementioned strategy and even more in the post-acquisition execution. Our passion for photography, the ever increasing reach of the internet, and the value produced by all photographers around the world creates a fantastic new opportunity.

Tags: Getty-Images, Wall-Street, Investment Banks, Associated Press, puffer fish, Hybrid, Business Model, Content, Premium, Bloggers, Free-market, Super-Store, Long Tail

By Georges van Hoegaerden

So, if you've read my blogs on the imaging market here .... why would you plunk down $1.5B to acquire an Image Super Store like Getty-Images (alias Getty).

Consider this:
1/ Non-agency images are always owned by photographers not by Getty
2/ Getty's assets can vaporize quickly, photographers can switch their assets to a better marketplace instantly
3/ The vast majority of images in the world are not transacted through Getty
4/ Getty qualifies premium photographers not premium images
5/ Getty needs to cannibalize its business model in order to meet the Long Tail market requirements
6/ Getty is diluting focus to higher margin media like film and music, fat chance
7/ Getty has the expensive overhead of an agency, with declining image ASPs
8/ Hundreds of new and competing sites indicate Getty's non-supremacy

There is value in Getty-Images, as an agency or as an image store, but I would not put two diametrically opposing business models on the same P&L. Neither one is worth $1.5B. The imaging Puffer Fish is about to deflate.

Tags: Getty-Images, Super-Store, ASP, Agency, Images, Photographers, Media, Margin

By Georges van Hoegaerden

The Puffer Fish of the imaging market, as described in my previous blog have large volumes of fleeting image assets. Yes, dear Wall-street analyst, they may have been experiencing double-digit growth temporarily but we believe that originates from non-organic growth and growth attributable to the incorporation of that non-organic supply into the global brand, in Getty-Images' case for example. If you keep buying stock photography companies you delight existing buyers with an ever increasing supply, but the novelty of that supply wears off real fast. In the end that apparent growth comes at a high cost. So witnessed by the most recent disappointing earnings reports.



Jupiter-images is literally pursueing an image super-store strategy, a copy of Getty-Images' strategy. They too have been buying stock companies. Stock companies strike deals with photographers to create a good looking selection. Yet most images have a value that is completely photographer agnostic. The value is in the photograph, not the photographer. So, a super-store of images by definition contains a small amount of sellable images.

But the real interesting fact about the imaging industry (and many related to it) is that all images have fleeting value, especially after they have been sold for the first time. Photography is the ultimate Long Tail market, with a very, very long tail and a tiny body. A great reason why any player with a "premium" imaging strategy is relegated to selling to very small and concentrated set of buyers.

Not unlike the music industry where we are used to buying music collections on CDs, a large part of the stock photography market still sells collections of photographs to artificially increase the number of images sold and the average sales price (ASP) per image. As a result, investors may think the ASP is somewhat stable and predictable and the value of the super-store may not be as grim as it seems. But Super-stores will never contain enough image variations to meet Long Tail demand. As a result, commissioned photography is still going strong.

Most photographers that produce sellable images still sell their images offline and commissioned. The ones that do sell online, literally use a total of hundreds of photo-sites today to tap into a Long Tail demand. All these factors are hardly evidence that Getty Images is indeed meeting the needs of the photography market.

On a side note: MacNN reported this week that Adobe has halted its stock photo library, perhaps it is getting ready to buy Getty-Images? I think they are smarter than that.

Tags: Getty-Images, Wall-Street, Non-organic, Stock, Earnings, Long Tail, Premium, Images, ASP, Adobe, Stock, Super-Store

By Georges van Hoegaerden

I have recieved a lot of inquiries from Wall-street personalities and companies due to the gracious blog posting in PE Week Wire on the imaging marketplace, so I wanted to dive deeper to clarify beyond just the financials.

1/ Getty-Images does not clearly distinguish between total addressable market and "market", probably to puff itself up as the owner of the imaging marketplace. More than 50% of (traceable corporate) images produced (by about 17,000 commercial Photography companies in the US) are generated by suppliers making less than $5M in revenues and have less than 10 employees. Very few of those (less than 1%) use Getty-Images as their distribution channel. In fact the majority of images sold in the world are traded offline, yes, offline (Getty-Images started its online presence in 2000, after going public on NASDAQ in July of 1996 and re-listing on NYSE in 1998). In addition, the peer-to-peer exchange of digital images, we estimate, is at least twice the size of the traceable exchange. It is quite irrelevant if Getty-Images is performing better than its peers, but Getty-Images by no means owns more than 10% of the addressable market. The risk for Getty is that a new kid on the block will be more successful in emptying out the market with a new business model, rather than outperform the existing players.

2/ Getty-Images is not a marketplace, it is a Super-Store in the economic sense of those definitions. A large part of the images in their store are produced by their own photographers (organic and non-organic) and sold to their existing, primarily agency customers. But the real definition of a "free-market" marketplace is that customer own their product which they sell, un-arbitrated and completely transparent, to buyers. Getty-Images charges exorbitant commissions (known to be in the range of 60%), which can't hardly be considered a marketplace transaction fee. It is suggested on the internet that Getty-Images plays unfair, even include changing photographs and forcing the original photographers to hand Getty-Images an additional 100% of the delta. True or not, that is not the kind of trust that makes anyone believe that Getty-Images will become a true marketplace.

3/ The photo acronyms are meaningless. Stock photography does not exist. It is an artificial definition, used mostly to identify a low priced photograph. But a "stock" photograph can be sold rights-managed, royalty free or exclusive and in the new world of publishing even be published as editorial. And therefor, being the leader in stock photography means absolutely NOTHING. Did you know an exclusive photograph is really not exclusive (it is only exclusive to a certain usage), that a buyer has no guarantee that the photo does not show up somewhere else. So, the only measure of success is how many photographs the company has sold and how many times over.

4/ Getty-Images has very restrictive policies to let users participate in their Super-Store, another sign it does not meet a true marketplace definition. WIth dSLR sales growing last year at 60% rate and 9B images produced on those cameras (18B cumulative dSLR images since 2003), Getty-Images is clearly not successful in monetizing the exchange of those images (even if you argue the majority of images have no re-sale value). The number of professional photographers is estimated to be around 36,000 according to PPA and D&B numbers. We believe Getty-Images falls short on counting the majority of those as their suppliers. We believe the unincorporated semi-pros that produce at least one sellable image to be much, much larger (cumulative roughly around 9M dSLR have been sold since 2003).

So, regardless from which angle you slice the business, Getty-Images by no means, has amassed critical penetration in the Total Addressable Market of image exchange. But if you artificially constrict the size of the market by calling it stock, rights-managed, royalty free, editorial or creative, perhaps you can swing it. Undoubtedly someone will buy into it.

Tags: Getty-Images, Corbis, Jupiter-images, PE Week, Wall-Street, PE Week, Images, Revenues, Stock, Super-Store, Cameras

By Georges van Hoegaerden

A Puffer Fish is a fish that blows itself up to dramatically change its appearance and size: not unlike Getty-Images (GYI), Corbis and Jupiter-Images (JUPM) in the imaging market. All three have hybrid business models that disguise the money they really make in the exchange of digital photography. But we know better, we've analyzed empirical data and studied their reports carefully.

That does not mean these "Three Bandits" are failures: Getty-Images is very successful as a photography agency (doing about $805M in revenues per year), Corbis is a very rich catalog of historic photographs stashed away in a bunker in Pennsylvania, slowly being digitized at a cost of about $25 per photograph (revenues around $250M). Jupiter-Images is the division of JupiterMedia, formerly a magazine publishing and events company, now morphing into a content acquisition company.

But they are not a successes either. Organic growth of these companies is well below the growth of the image exchange market and their combined market share is less than 10% of the image exchange addressable market. So, while the $1.5B asking price for Getty-Images doesn't sound outrageous (less than 2x revenues), what you're buying is an outsourced photography agency. Getty-Images is in essence a people factory with ever eroding profit margins.

Twenty years ago Getty-Images started with a $20M investment from grandpa Getty and has continued to purchased a wide array of photo agencies (hence the Puffer Fish) and large libraries of photographs that over time become stale rather than increase in value. The average sales price of those, primarily editorial, photographs is declining steadily (more so than creative photography), leaving the company with a large family of complacent celebrity photographers and mainstream content only the a select few publishing agencies are interested in.

With publishers (of all kind) looking for original content, the imaging Super Store approach (as described here) from the Three Bandits is fundamentally flawed. But the reason why we don't believe in the longevity of their business models (and their asking price) is that they ignore and suppress the massive influx of new digital photographers that create phenomenal high quality and original content most publishers would be dying to get their hands on.

So anyone buying these companies will soon find out how small Puffer Fish really are.

Tags: Getty-Images, Corbis, Jupiter-images, Photography, puffer fish, Photographers, Margin, Editorial, Super-Store

By Georges van Hoegaerden

Two weeks ago Digital Railroad (a private digital photo aggregator, funded by Venrock and Morgenthaler) announced it was restructuring, cutting half of its employees and repositioning the company into a photo marketplace. Today Getty Images (GYI) is said to be looking for a buyer at around $1.5B, after its stock price is unable to recover for more than two years. And Corbis, well -- Corbis is being kept afloat by Bill Gates. Swallowing stock photography companies as fast as it can is Jupiter Images' attempt to boost its potential acquisition price, a strategy that didn't work so well for Getty Images. So, why are these companies not growing organically while the dSLR market that produces those images is growing 60% YTY and GMV of the image market is north of $22B.

Here is my take: the imaging markets consists of demi-cartels that produce "premium" supply that does not meet the requirements of an ever growing and changing market of buyers. No longer is the size of the buyer's market dictated by agencies nor is the new seller's market defined by the old definition of pro-photographers. As a result sell side content does not find enough buyers and the only way to make money is to make sellers believe that if their work is good enough, it will sell.....nice promise. Out of desperation most photographers post their images on multiple websites to get maximum visibility, a true testament of an inefficient market.

Getty Images is really a hybrid business, it has about 3,000 photographers on staff and does editorial projects for its main customers and in armored trucks if it needs to, providing news worthy photography on location. The side-business of Getty is the stock photography business which yields ever declining average sales prices for royalty free and rights managed photography. So, in essence, Getty Images was trying to become a "record" company with its own supply while on the side playing the independent party with a transparent image store; i.e. the "free-market" supply is competing with Getty's core business model. Over the years, many photographers have complained of unfair practices that gives better treatment to Getty's images than to the supply from individual photographers.

The Digital Photography market is in the same state as the music industry (albeit condensed in time) , premium supply doesn't turn out to be premium, demand has changed and the "record" companies in this space have no other option but to erode their premier status business model. I was right three years ago, let that be noted.

As for Digital Railroad, I doubt that they'll develop the macro-economic strategies that determine the success of any real "free-market" marketplace at this point. It would take a sizable investment in technology to turn a super-store into a "free-market". Adobe is rumored to be working on an image marketplace, but here too, the devil is in the details.

We don't need another Amazon.com of the photography business but a real free-market in which YOU the photographer and buyer make decisions on what transactions you want to engage in.

Tags: Digital Railroad, Getty-Images, Corbis, Startup, Jupiter-images, Premium, Photography, Amazon, Adobe, Stock

By Georges van Hoegaerden

With homeland security as a hot topic these days, LaserCard in Mountain View (NASDAQ: LCRD, formerly known as Drexler Technologies) quietly continues to ship millions of unique memory cards as the foundation for "Green" cards and National ID cards to US, Italian, and Canadian governments and others. In addition to its incredible resistance against wear and tear (we punched holes in it and it still read successfully) and unique security features, the LaserCard stores an impressive 2.8M of personal and biometric data. Fingerprints, retina scans, voice encoding or whatever becomes the prevalent set of biometric verifiers, can be combined with visual authentication to ensure the holder of the card is indeed the one presenting himself. All these attributes can be stored on the card and read offline without the need for centralized databases. So why is homeland security not using this card to it's fullest potential? Why does it waste time on privacy debates with regards to centralized storage? Why, four years after 911 are we still not able to verify a persons real identity?

Tags: LaserCard, Security, Homeland Security, Biometrics, IDentity

By Georges van Hoegaerden

Getty Images, the self proclaimed market leader in the $7B stock photography market, recently posted an impressive $622M in 2004 revenues. Our in-depth analysis of the market actually shows a 2004 decline in Royalty Free and Rights Managed images sold compared to 2003 and Getty making it up by increasing ASPs significantly and a small increase in editorial sales. Royalty free images were sold at an ASP of $210 compared to $150, Rights Managed images moved up to $585 from $560 in 2003. While the company boasts an impressive 70M images on file, our analysis shows Getty Images sold no more than 1.5M images in 2003, a 3.5% market share of 43M images sold each year in the stock imagery market. Hardly a gorilla, want to know what are they are really selling?
Our opinion: Agency & distribution model are in conflict, restricting organic growth.

Tags: Getty-Images, Photography, Stock, Revenues, Images, Distribution, Markets