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 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

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

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

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 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

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

Real innovation relies on a myriad of macro and micro-economic benefits to succeed. The key to a lasting technology business is not just the introduction of snazzy new technology, but more importantly, how well macro-economic improvements address the needs of everyday consumers.

Below are three examples of a misrepresentation of the benefits of innovation that will strike early adopters.

1) Digital Photography
We all instinctively believe the innovation from analog to digital is fantastic, and for some (like me) it is. But when you look closely, the conversion from analog to digital suddenly requires everyday users to tether a camera to a computer, buy and learn about digital asset management systems and figure out which service to use to get images printed (not even a trip to Walmart erases the Do-It-Yourself paradigm). So, rather than a more streamlined process we’ve actually complicated the process, increased the initial cash outlay and forced users to learn, often complicated computing skills for novices.

Kodak’s biggest challenge is to convince users that their camera is not broken when it gives the cryptic message “Error: CF card is full” (check out EyeFi, for another technology “solution” to that). So, the reduction of expenses in printing that digital photography promised, has simply shifted to an upfront expense in computer technology and knowledge that has so far amassed less market penetration than traditional cameras. That, to many, is a step back, rather than forward.

2) Internet Television
Many broadcasters now provide internet based viewing to anyone with a web browser. But the protocols and video players of each of those providers (CNN, ABC, NBC etc.) is different. So, for years the FCC has regulated the creation of a standards compliant way of watching TV with any NTSC television (or PAL in Europe), suddenly, thanks to our border-less innovation we find ourselves with as many video players and playback encodings as there are content providers. While companies like Boxee attempt to provide a TV portal, the playback mechanisms are unique to each source, and thus delivering a confusing user experience. That, to many, is a step back, rather than forward.

3/ Mobile telephony
While GSM (the underling technology for most mobile phones) was designed and implemented in its early days to provide free-market access to mobile telephony network, companies like AT&T (that support GSM protocols), artificially restrict the use of other (competing) networks (such as T-Mobile) by locking the SIM cards that are pre-installed in the phone. As a consequence consumers are restricted to a proprietary brand and narrower network coverage while there is no technology reason to do so. That, to many, is a step back, rather than forward.

Ample other examples exist. The role of technology is to disappear, not to expose itself. Few companies (big and small) achieve that objective today.

As gambling-style exits and IPOs disappear it becomes more important for technology companies to keep both macro and micro-economics in check. More investors should screen companies for these more impact-ful innovations that focus on making technology less, rather than more prominent to consumers. That is where the real big bucks are.

Tags: Innovation, Internet, Investment, Macro-economics

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

I wrote about the death of mobile application investments a while back and the recently leaked e-mail (posted by Tech Crunch) from Tapulous shines more light on those unattractive economics for investors. Investing in the Long Tail of content (the games category) is not a good idea.

Now I want to preface that selling 100,000 copies of a game is a great accomplishment (good job Bart and thank you Apple), but the $1M or so this very popular game generated can hardly be called a venture funded business that is going to emerge with a billion dollar market cap anytime soon.

Here is what needs to be accomplished to generate a little over $1M:

• #1 most popular game for iPhone & iPod touch for 2008
• #3 most popular app overall for the US
• 5 million unique installs on Tap Tap Revenge! (that doesn’t double-count when a user upgrades TTR)
• 100,000 paying customers

So, if being the #1 most popular game on iPhone means you make $1M, I can’t see how:
1/ This initial success is going to continue with an avalanche of other attractive games entering the market
2/ The company is going to be able to produce a consistent stream of similar “winners”

And so here is another example if subprime investing, this time provided by a long tail of angels.

Tap Tap Tap.

Tags: Gaming, Investment, Long Tail, Apple, Mobile

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

Not for a second do I buy into the doom-and-gloom spread by early stage investors citing the state of the economy as the reason for cutbacks. While the economic situation is worrisome, much of it is generated by supposed financial and business experts that are not. To say the least.

Sounds familiar? We have a few of those in Silicon Valley too. When money is involved, some people just can’t help themselves (or rather the opposite).

Investors still have plenty of overhang to invest with and their portfolio companies are on a 5-7 year trajectory to exit, meaning the viability of their choices is determined by the value at the end, not the value in the middle or the trajectory. The macro-economic value of a startup should remain intact in an economic downturn. So, the behavior of your investor will tell you whether you “married” well.

Very few startups should be materially impacted by the state of the economy, because:

1/ Their early stage market penetration is immaterial to the overall addressable “market”, leaving enough room for growth in any economy.

2/ The majority of (consumer focused) startups generate income through indirect monetization such as click-thru advertising, which is somewhat resilient to economic aberrations (even though purchasing may not).

3/ In early stage development, monetization is secondary to land-grab, and smart operating plans have very conservative and immaterial income projections built-in.

So, the fact that investors strike fear in the minds of entrepreneurs is the same as a president of a country at war expressing similar fear; not productive. Sure you need to be cautious and count your chickens, but great investors see this as a fantastic opportunity to double-down on their investments and amplify the market differentiation rather than restrict it.

Access to capital is a serious barrier to entry that can keep competitors out. So, if you are being restricted by your investor at this point it means he’s just not that into you and is doing you more harm than good.

Tags: VC, Markets, Investment, Economy, Consumer, Subprime, Startup

By Georges van Hoegaerden

I recently watched an interview on Charlie Rose with Nassim Nicholas Taleb and decided his “Black Swan” theory accurately describes the fundamental problem in early-stage technology investing (and innovation in general).

To paraphrase Taleb; the cultural assumption is that all swans are white (and therefor black swans could not exist). So you think.

Taleb (a partner at an investment firm) believes that scientists, economists, historians, policymakers, businessmen, and financiers are victims of an illusion of pattern; they overestimate the value of rational explanations of past data, and underestimate the prevalence of unexplainable randomness in that data.

The proof that Silicon Valley suffers from the white swan syndrome lies amongst many in the foolish behavior of investors, the predetermined investment allocations based on the tagging with ambiguous acronyms (such as web2.0, SOA, Cloud computing, CRM etc.) and the mindless herding of primarily unsuccessful ideas (or copies of a few successes) at the many popular technology conferences.

I am inclined to take Taleb’s theory a bit further: I believe the majority of people are victims of an illusion of pattern, established by years of (often irrelevant) education infused with the technology Kool-Aid that confined their thinking to a predetermined direction and scope. It prevented entrepreneurs and investors from ever being able to identify true innovation until it had become part of their past. Hence the rampant number of false positives and false negatives.

Taleb further adds that black swans are actually the ones that change the industry, and that the so-called “unexplainable” events (that have no single precedent in time) redefine the future of the whole industry. And so, the search is on, not just for the investor with the right macro-economic views, morals and personality, but also the vision to spot innovation that has no precedent - the black swan.

The noise in our industry is still drowning out the music. We need to change the way we invest and improve our ability to spot black swans or otherwise we will lose the entrepreneurs that can build them. Our excuse today is not the economy but our own performance in producing truly disruptive value that can withstand the test of time. We need to put real entrepreneurs on a pedestal and throw the copycats to the curb, quickly.

Albert Einstein was right all along: imagination is more important than knowledge. That applies to investors too.

Tags: VC, Innovation, Macro-economics, Einstein, Subprime, Startup

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

For over 10 years I’ve built and managed growth for early stage innovation in Silicon Valley and more than ever do I believe that building real disruptive customer value is more important than trying to time an acquisition opportunity. You may too, unless of course you are a gambler and firmly believe that the $3 red-white-blue slot machines in Vegas consistently yield the greatest returns. I will not argue the outcome.

Acquisitions remain nothing more than a welcome diversion on your way to building the largest technology empire. And even now when IPOs have dried up any focus away from building your empire is damaging. Real disruptive innovation is resistant to economic aberrations and a consistent focus on customer value remains your only rescue.

I believe that IPOs for technology companies will return (and subsequently spur more pre-IPO acquisitions), albeit not with the same players. Real companies can only be built by real entrepreneurs, with real disruptive products supported by real investors. New participants (on both sides) with higher moral values will be the ones to restore trust in the technology industry and subsequently public stock markets that want a piece of it.

Today, the VCs are stuck with a product of their own aristocratic making. Commoditization of investment philosophies since the 1990s has generated technologies that can best be described as sexy-cool rather than disruptive and meaningful (with a few exceptions). It paved the way for get-rich-quick entrepreneurs that are skilled in feeding the dogs the dog-food, rather than support the real entrepreneurs that have a dissenting view of the world.

So, assuming you as an entrepreneur are for real, how would you recognize an investor that is not. Here are some of my anecdotal recommendations:

1/ Avoid an investor who blames his quick response on ADD
Attention Deficit Disorder is an illness, not a skill. Recommend the investor to consult a doctor.

2/ Avoid an investor who does not carry (or seriously considers) an iPhone
The iPhone is the biggest innovation in consumer electronics in my lifetime (so far) and if your potential investor does not understand its ramification to the technology ecosystem as a whole, it is unlikely he will get yours.

3/ Avoid an investor who cannot price your company ahead of you.
Any technology investor should be able to price the value of your disruption. Ask the investor for the valuation and if he is close to your target, you can share with him your cost model and where you are today on the trajectory. Cost model and stage (the risk) are a discount to the disruptive value, the ability to build the technology is merely a commodity. In Silicon Valley technology is not the risk, but market entry with sufficient disruption is. Walk away from investors that incorrectly evaluate the risk model.

4/ Avoid an investor whose partners you can’t stand
Investors in a fund make decisions collectively, they need partner consensus before they can invest - just like in politics (more on that later). A firm with a partner you don’t like should be taken off your VC prospect list, as you cannot risk the influence of the bad apple to your company’s future. Develop your personal blacklist (as we did) based on fundamental people principles.

5/ Avoid an investor who wears his education on his sleeve
Wearing a Super Bowl ring means you made it in the real world, wearing an Ivy League ring does not. I wholeheartedly agree with Craig Venter that later stage education (without operating experience) in general is a deterrent to creativity and innovation or the ability to spot and spawn it. The majority of Silicon Valley investors are remnants from a bull market, echoing beliefs that are founded on skewed business principles.

6/ Avoid an investor who asks really dumb questions and is proud of it.
I never thought dumb questions existed until I ran into one investor who proudly blogged about how other entrepreneurs simply walked away from him, making his life easier. We walked away from him too.

7/ Avoid an investor who thinks he knows your industry better.
Even in the unlikely scenario he does, you should still walk away. Investors that know industries better than the entrepreneur should have become one. So either the investor is better informed (which should send you back to the drawing board) or he thinks he does (which becomes a pain in board meetings). Investors see a lot of things that don’t work, rather than discover the opportunities that do.

The bottom line is that we recommend entrepreneurs not to squander their great ideas with the first investor that waves money in their face. Real disruption does not become extinct quickly and so you literally have years to find a great investor out of the 790 firms that exist in the United States.

Thankfully the get-rich-quick money schemes in technology are drying up, so make sure you, as the entrepreneur, also have the integrity to build real disruption that spawns real and lasting customer value for years to come.

I look forward to helping develop new investor 2.0 and entrepreneur 2.0 strategies with you.

Tags: IPhone, VC, Investment, Commodity, Entrepreneurs, Subprime, Startup

By Georges van Hoegaerden

As any economist will tell you, a dollar bill is not worth a dollar. And so the real value of that paper bill is defined by the trust we put in it. The trust that you will receive a certain (yet fluctuating; some days a dollar is worth more than others) amount of goods and services in exchange. Simple right?

So given that, trust is the most important denomination in determining the value of a product or a service. And trust builds from consistent delivery on stated promises, which - in turn - requires the unwavering commitment from people with integrity and honesty....do you feel the slide coming?

So:
1/ Why do many companies make promises they don’t keep?
I evaluate a lot of technology companies (about 60 this year alone, public and private) and most are simply lying about, or overstating (decibel marketing) the benefits of their proposition. Because the majority of potential customers and investors are ill-informed about the pros and cons of this specialized industry, technology companies can often get away with sneaky monetization strategies that take advantage of a lesser informed audience.

In Silicon Valley, “success” is often defined by how skilled you are in fooling customers and sucking up to aristocratic investors (to which few have access), rather than the authenticity of your proposition. A mediocre ecosystem is what still remains after the technology bust from 2001 in which self proclaimed “serial entrepreneurs” and investors have been able to dodge real value creation and sell out short.

Not the VC model is broken, but many of the participants are. That noise is severely eroding the trust in an inherently sound technology industry. We need to enforce more transparency and hold ourselves to higher standards to restore the integrity and trust.

2/ Why do we allow short-selling on public company stock?
First, the performance of public stock says nothing about the actual value or outlook of a company, in the same way the dollar offers no guarantee of what you get for it. Public stocks are already a lousy interpretation of the actual performance of a company, as it merely echos popular opinion (and not the company facts).

So, selling short is really a bet on performance of popular opinion and does nothing but undermine the trust in the longevity of a business and cannibalizes shareholder value. Quarterly earnings reports are an absolute joke as many companies move profits around, claim leadership in a market that is defined by themselves and reduce cost rather than improve their marketplace position in order to make quarterly earnings look good. They also force healthy companies to focus on often unpredictable economic aberrations rather than on their long term and macro-economic leadership position.

The ability to sell short creates unrest and undue fear in a system that requires the opposite. Can you imagine holding the president of the United States accountable on a quarterly basis? That would be bad for our country (in most cases).

We should implement a predetermined holding period for the sale of stock, the expiration determined by the company and regulated by the SEC (which can also prevent some nasty insider trader deals) to build back trust.

3/ Why are some allowed to resell securities?
Reselling securities (which was illegal a few years back) based on finagled credit scores are perhaps the double whammy in the erosion of trust in public companies. Company credit scores that are maintained (and marketed) by commercial companies create profit driven scores and unrealistic prices (up and down) for securities. We simply need to stop the resale of securities and regulate the process of maintaining credit scores (both business and personal) vigorously and immediately.

Regulations do not turn us into a socialistic society, but the reality is that no economy operates without rules to protect trust. Free-markets require a basic set of rules to prevent a few bad apples to create insurmountable fear for the rest of us.

For the technologists amongst us: eBay deploys no less than seven dedicated servers to detect suspicious transactions that could challenge the trust in its free-market model.

In the same way we deploy rigid traffic laws to drive a car, should we deploy rules of engagement to protect our economic serenity. As long as we don’t dictate the destination of our travels or where we place our individual economic bets, we should be just fine in our support of a blossoming capitalistic society.

Trust comes from transparency, integrity and authenticity that builds real value, not from taking advantage of the ill-informed. So, building a successful company does not start with a new product strategy but with a leader who has the drive to win that is larger than his greed. Building disruptive products that truly improve people’s lives will yield personal satisfaction and trust that will keep customers coming back for more.

Trust is the only currency that matters, so stop squandering it.

Tags: EBay, Economy, Eco-systems, Free-market, VC, Stock, Transparency, Securities, Capitalism, Macro-economics, Economy

By Georges van Hoegaerden

With that title I just pulled the pacifier out of the mouths of many marketers...and many of them will start crying.

But smart business people know better. Compartmentalization is very fundamental human behavior, in our personal life and business. In business the definition of “The Market” is the currency that aims to provide quick answers to everyday questions. The problem with market categorizations is that they are often incorrect, irrelevant, stale and frankly, the antagonist of innovation.

Here is why:

1/ People buy products, markets don’t.
No matter what the scenario, in the end people (not businesses) make purchasing decisions. And since people are unique, so are their complex reasons to buy. A unique mix of psychographics and demographics aided by free-market access to the Internet further emphasizes the power of “You” over the power of “The Market”.

2/ Markets are bad type-castings.
Customer surveys show that the compelling-reasons-to-buy rarely match up with the predetermined definition of “The Market”. And since many purchasing decisions rely on factors unrelated to the product (such as budgets, approvals, personal relationships, operational planning, risk mitigation etc.) a prospect qualification or disqualification within that market means absolutely nothing.

3/ Market definitions are bad currencies.
Since there are no rules for defining markets and everyone gets to dream up their own, the value of that market definition is meaningless. Imagine the value of the dollar if everyone gets to define how much it is worth and print theirs at home. Market segmentation and negotiations on market positions with analysts further deflate the significance and trust in traditional market definitions.

4/ Time changes everything (but markets).
Market definitions (in technology) change slowly yet products that attract new buyers change quickly. That means the definition of “The Market” (to which much decision-making is attached) is always far behind the adoption rate of new products and therefor far behind the identification of a new set of buyers. The minute “The Market” is defined, it has become irrelevant and ripe for disruption.

So, where does that leave marketing? Is marketing dead?

No, but it is time for technology marketers to grow up. The pacifier is being replaced by something else. Something more substantial and meaningful. Food becomes the new pacifier and customers will be feeding it to you.

1/ Listen before you speak.
Literally. Forget about what you as the marketer think of the product, early-adopter purchasing decisions are much more valuable in determining how the product is perceived and received. The credibility of new customers counts, more so than the ability of a marketer to spin a story. Spend time with your VP of Sales, in online forums, setup a Google Alert and figure out how to market customer perception.

2/ Manage the promise.
Crucial to the impact of marketing is the credibility of the company promise. Marketing, and specifically Product Marketing is vital in establishing that the promise is fulfilled to the satisfaction of the customer. A few bad words from customers on the internet can cost the company millions of dollars to repair, if it can recover from it at all. So, it is important that the promise to customers does not consist of blatant lies, leads to frustration or bleeds hundreds of support calls. Manage the critical success factors of your promise.

3/ Enable the dialog.
Orchestrate the interaction between customers and prospects and be sure to listen in. They will give you the marketing messages that truly resonate - on a silver platter.

4/ Manage the conversion rate.
Getting crowds to listen or visit the company website is rather simple, getting them to buy the product is more difficult. The company is only measured on the latter and since marketing is usually the scape goat and the first to be questioned when results are down, implementing a mechanism that detects, manages and reports on conversion rates yields invaluable metrics for improvement.

As long as there is macro-economic benefit to using your product, marketing is a very straightforward process. It requires a new class of people that are not afraid to throw the old-class of market definitions overboard and focus on the extrapolation of existing sales success, by simply listening for and consistently reverberating an honest and effective marketing message.

As Don Draper, the biggest ad man at the Sterling Cooper Advertising Agency of the TV series Mad Men explains; I don’t tell stories - I sell product.

Tags: Markets, Marketing, Performance, Promise, Analysts, Google, Psychographics, Demographics

By Georges van Hoegaerden

Apparently Digital Railroad, another storage provider of the digital photography market is in trouble. No surprise again, because the company never supported a free-market model for photographers and buyers. We blogged about that topic many times, and recently Dan Heller adds to that fundamental thinking (even though I remain in disagreement with the artificial classification of stock photography).

Since its founding, Digital Railroad primarily supported supply-side photographic capabilities, which if not seamlessly connected to the buy-side provides really nothing more than storage space and website make-up for photographers. A nice service, but similar services from Smugmug or Photobucket already exist to do just that. All these technologies fail to solve the most pressing issue for every commercial photographer: sell, sell, sell.

Photographers are not empowered by a storage service or nice looking web pages, they are empowered when they sell. Photography is an expensive job and if it does not yield $70,000 in yearly revenues (based on 2006 PDA numbers), you will not be able to make a living from it. We have yet to find a true marketplace that connects any seller with any buyer, using free-market principles that truly empowers photographers.

Free-markets are more than a fashion statement or a label you suddenly slap on the website. The implications of free-market principles (as listed in this blog) change a company, its execution and its funding strategy to the core. The devil is in the detail.

Digital Railroad’s and Photoshelter’s demise are examples of why investing in technology, without macro-economic impact - no longer works. The 150-year old photography marketplace, with the introduction of digital photography and the internet, has moved from a premium market model (with many walled gardens) to a free-market model.

Akin to Ratatouille (the movie), where a five-star chef, Anton Gusteau, declares that “Anyone Can Cook”, the photography market and its technology providers need to get used to the fact that in this new age, “rats” will take and purchase great photographs ($22B of them).

The irate response to my recent blog about Photoshelter from a Vice President of the American Society of Media Photographers reminded me of the angry cook in Ratatouille that hires Linguini, a clumsy youth hired as a garbage boy, who can still not accept that great taste in food is like the beauty of photography - in the eye of the buyer.

We should embrace all photography that move people to buy, regardless of who shot it and build a real marketplace to facilitate that exchange.

Tags: Photography, Consumer, Content, Marketplace, Startup

By Georges van Hoegaerden

I received a lot of feedback and questions on my previous blog posting named Building efficiencies in tough times and the embedded presentation posted there. The danger of attaching a presentation is, that as a reader you may miss the rational that built the words.

Because of that I want to explain my sometimes condensed thinking a little further.



It may have appeared that I only care about the product, but nothing is farther from the truth. The diagram on the left of the chart is what I see a lot in technology companies, early and late stage - across the board. The diagram on the right is what I tried to convey with the words in my presentation. Let me clarify:

Many companies develop incremental innovation (to leapfrog their competitors) without a diligent (re-)assessment of the opportunity to change the battle field. Not surprisingly. Real disruptive innovation requires a certain amount of vision, faith and a compass combined with larger commitments and investments, all seemingly based on untested values.

The path of least resistance therefor is to start with an incremental product and throw inordinate amounts of marketing & sales at it, in order to push it beyond its competitors into the marketplace. That is a highly inefficient model (in any economy). But it is a model to which many companies are forced to comply because of risk adverse management and the stale investment criteria deployed by many Venture Capitalists (VCs).

So, it is somewhat ironic that the VCs are now telling their startups to be more efficient, right after they were pushed through the VC wringer of startup-commoditization.

I believe the market for cheap (bootstrap-to-market) technology companies, that yield a large early exit is gone. That model only worked in a bull market of technology (from the 90s that has not dissipated) and the investors that still cling to that model will get punished for it. The new opportunities are for companies that build real macro-economic value.

The starting point of the next wave of innovation, in my view, is to feed a macro-economic need, as depicted in the diagram on the right. That macro-economic need is directly attached to the way we behave as humans (which is relatively predictable). It is our need to express ourselves, live the life we want and be in control (rather than technology controlling us). Think free-market principles, think social, think benefits, think fundamentals.

The fundamental shift in thinking that needs to occur in Silicon Valley, is to develop technology with a fresh mind, looking from the outside in, and serve a larger, less specialized, constituent.

Apple comes to mind as a company that often completely ignores the current state of the technology industry and connects better to basic human needs than any other technology company. But Apple can improve/be beat at the macro level, but I digress.

We simply need to support human behavior with technology.

With “free” distribution of information through the Internet, psychographics - not demographics - matter. Four-hundred year old free-market principles, The Long Tail, and marketplaces like eBay prove that the traditional rules of marketing do no longer apply. In my thirty years in technology I have never met anyone who truly understands markets. And market definitions have changed, they comprise no longer of buyers that fit an artificial model (I cringe when I hear people debate for hours how many users delineates the SMB segment), but because they subscribe to the pain or gain from which subsequently, marketers can extrapolate a larger pool. Bottom-up.

We do not all need to be economists to create the next successful technology company, the material is all around us. All it takes is a healthy interest in the actual behavior of human beings, compare their offline and online behavior and fill in the gaps. So, stop supporting companies that just build nifty technologies, but focus on companies that create larger macro-economic differentiation. More impact to everyday people.

No company will be more efficient by simply cutting cost (as suggested by the recent doom-and-gloom VC messages), it will just take longer to die. The real efficiency comes from a more disruptive value that attaches more people to better technology. On top of that, macro-economic value is very resistant to economic downturns.

Tags: Performance, Commodity, Consumer, Marketing, Markets, Marketplace, VC, Macro-economics, Psychographics, Apple, Distribution

By Georges van Hoegaerden

With the Venture Capital high society dropping doom and gloom economic messages onto the CEOs of their portfolio companies, I wanted to help out and at least do my part to deliver some more operational substance.

Great companies and their resilience is defined by the quality of their products.

Great products make up for an endless amount of sales and marketing deficiencies, but in most cases sales and marketing spend too much time making up for lost product opportunity and becomes an endless money drain. Product definition (from a buyer’s perspective) and quality are the most important drivers for consistent business success, as Larry Ellison and Steve Jobs (both product gurus) have proven time and time again.

But when money is plentiful, yet guarded by aggressive milestones we tend to throw products over the fence early and have sales, marketing and support compensate tirelessly for its in-market deficiencies. Both startups and established companies (trust me, I’ve seen a few) make those same fundamental mistakes. The results are slow sales traction, excessive marketing expenses and runaway support costs. Not things any company can afford these days.

This morning I put together a presentation (in pdf, named TVC_building_efficiencies) that identifies some of the deficiency symptoms, emphasizes the benefits of great products to the cost model, and pulls together new ways to build amazing new products. Thus creating a more resilient company, no matter what the economic conditions.

So, to directly affect company efficiency, keep a close eye on the definition and implementation of the product, its macro-economic impact and how it grows and where it bleeds. Or simply contact us if you need some help.

Update: more on building efficiencies.

Tags: Performance, Consumer, Disruption, Free-market, Growth, Marketing, Markets, Quality, Resilience, Software, VC, Macro-economics

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


Facebook, one of the fastest growing social network sites has really screwed up User Interface (UI) design with its new look. Take a look at the screen capture above. Now you tell me in 5 seconds the intuitive difference between clicking on: [Facebook] and [home], [home] and [profile], [profile] and [Georges van Hoegaerden], [settings] and [profile], and [settings] and [Georges van Hoegaerden].

But more importantly, Facebook has clearly not read my blog on removing the technology language to appeal to consumers, an issue that prevents many consumer technology companies from maximizing their growth potential. But who’s counting at Facebook these days?

Facebook is a technology company that exposes social networking capabilities in a very technological fashion. The examples are plenty: the workings of the UI described above, the categorization of data optimized to suit their internal data-models and the very complicated way to add applications to the platform, and we can keep going on. But for now, they’ll get away with it. Other consumer technology companies won’t be that lucky.

A great user interface can never be an objective by itself as that just presents a pretty face, try living with a person that only has that. The ultimate user experience (and this is where I politically depart from the previous analogy), is defined by an ecosystem of capabilities, cost and ease-of-use that creates the real and sustainable appeal.

BMW figured out early on that the Ultimate Driving Experience™ is what sells cars albeit their engine capabilities and timing was their initial core strengths. Today they sell the sum of all parts, The Ultimate Driving experience: great engine capabilities, spiffy performance, practical design and excellent comfort - a thrilling way to drive from A to B.

Facebook currently has a horrible “Ultimate Social Experience”: good (but no longer unique) social networking, so-so performance, impractical design and pretty bad comfort. Those are probably the reasons why 90% of my Facebook friends never use any Facebook features but simply create an account.

Many of Facebook’s recent poor decisions (including ad network issues etc) are evidence that user growth is outpacing their ability to grow up. And that could be catastrophic. Facebook is a great social networking platform with a lot of potential that many people rely on.

Facebook better watch out and prevent that too many people will start hating it. Those same users may use Facebooks own social networking capability to turn it off as fast as they initially turned it on.

Tags: BMW, FaceBook, Performance, Platform, Consumer, Startup

By Georges van Hoegaerden

Two days ago we got word about the demise of the Photoshelter collection marketplace. Not surprising because Photoshelter was not a marketplace. Technologists have a tendency to slap the marketplace label on anything they build, without understanding what it truly means.

Marketplace models, criteria, funding and execution are fundamentally different from premium market models. Photoshelter was really nothing more than a replica of Getty Images without Getty’s money to buy inorganic growth.

Here is how Photoshelter failed to meet marketplace rules:

Marketplace violation 1: Photoshelter artificially arbitrated supply, through a lengthy subjective signup process in which Photoshelter arbitrators determine whether you get to play.

Marketplace violation 2: Photoshelter artificially arbitrated demand, as it aimed to sell it to “the industry’s top buyers”, not to everyone.

Marketplace violation 3: Photoshelter gave preference to images they liked, rather than simply connecting any supply with any demand.

Marketplace violation 4: Photoshelter deployed a sales-force (from Getty and other photo agencies) that promoted a premium market model, like any sales-force driven by quotas would.

But CEO Allen Murabayashi makes a few damaging statements in his blog on why they failed and tries to blame that on the market as a whole:

“Licensing photography is fraught with clearance issues”
150 Years of photography exchange has resolved the fundamental issues of rights management quite effectively. Getty-Images, Corbis and others have gone through a well defined process in order to clear rights in their move from analog to digital exchange. Photoshelter has relied too much on a model that requires people intervention, while the majority of rights and enforcement can be embedded in and enforced by technology and made the responsibility of the asset owner. In the same way eBay sellers are responsible for the fulfillment of transactions. That enforcement guarded by a true meritocracy will quickly weed out bad behavior (that plagues any marketplace).

“Stock photography is a slow growing market dominated by a single player”
Nonsense, the term stock photography is an artificial classification (made up by its current participants) that bares no value. Today $22B of photography is exchanged of which less than 10% is transacted electronically. Growth through the premium market model of Photoshelter is limited because the photography market requires a free-market.

“Research Requests move too quickly for individuals to react in a timely fashion”
Perhaps they do in the “top buyer” segment, but certainly not in all. Since Photoshelter artificially limited the demand characteristics, any assessment of market traction and behavior should be taken with a grain of salt.

“Buyers desire more diversity, but convenience (aka subscription deals) triumphs this desire”
Absolutely, buyers deserve diversity, and buyers should be presented with the ultimate experience (subscriptions are not the answer). What has fundamentally changed in a 150 year old analog photography market is that demand does not come from a few buyers, but a highly fragmented buyer market that will want to use an image for any purpose (not just for your average advertising purposes).

“A crowd-source model for stock will likely never work”
Absolutely disagree. Photoshelter deployed a premium market model on a market that requires free-market principles. It failed for the same reason Getty Images fails to become a market-leader in the un-arbitrated exchange of digital photography (identified by roughly 30% market ownership). Getty Images grew by inorganic growth and acquiring other photo agencies with staff photographers that create the majority of images it sells (less than 7% come out of third party supply according to a statement by its CEO in 2006).

Photoshelter, as lovers of photography, seemed to have their hearts in the right place but not their execution. And they neglected to respond to our offer for help one year ago, when we saw their demise coming.

Tags: Photographers, Photography, Getty-Images, Growth, Free-market, Marketplace

By Georges van Hoegaerden

From time-to-time I hear from investors: what if Google decides to build it?

My replies are as follows:

1/ Google is the king of web-based advertising derived from search, and it does so extremely well and profitably. Yet Google is a pretty monolithic animal. While the company is capable of building virtually any technology outside of its core competency and brings a bright sparkle of innovation to Silicon Valley, it is consistently unsuccessful in turning that innovation into great Billion dollar businesses (which reminds me of Oracle, before Chuck Phillips came on board).

2/ Google is not a true marketplace, nor does it seem to understand free-market principles as witnessed by their actions. Google is a premium market for search-based advertising placements and it will continue to drive premium market DNA to the adoption of technology. Nothing wrong with that, unless they portray a more liberal character. So, you’ve got little to fear if a free-market platform is what you are building.

3/ Google does not understand any software category that doesn’t derive its revenue from advertising. While there may be a great future for software (as a service) that no consumer ever pays for directly, today that is not the reality. Desktop software, proprietary enterprise applications, software-as-a-paid-service are examples of what Google is highly inexperienced and generally unsuccessful with.

4/ It would be a great sign if Google decides to build a similar product or service, as it would produce a rhetorical blessing of the proposition and an impromptu acquisition play by its competitors. Isn’t that what you want as an investor.

Google’s relatively young age, massive growth and company DNA are probably the best reasons why it hasn’t succeeded financially in many areas it operates in. But I greatly admire their drive to invest a large part of the difference between their (Wall-street) valuation and real value in new technology development.

Beyond search, Google is in essence a giant research institute with the limited financial successes that come with that model. But Google lays important development groundwork that has and will continue to do us all good. They also provide valuable incubation of new technology ideas a commoditizing VC market rarely picks up on.

My startups have a different charter; turning great technologies into great businesses, now!

Tags: Google, Wall-Street, Innovation, Markets, Marketplace

By Georges van Hoegaerden

When Facebook decided to integrate new application capabilities that were first available as a third-party application from a marketplace participant, they broke the cardinal rule of marketplace meritocracy. When Getty Images’ staff-photographers allegedly took new pictures similar to previously top-selling pictures from participants they too broke a fundamental marketplace rule. When Amazon.com optimized sales results based on margins requirements they too broke many of the free-market rules as described in “Look, but don’t touch”.

By calling themselves platforms or marketplaces those companies misled their participants and engaged in what I would characterize as false advertising. Not only did the suppliers expect to be treated equally and become successful based on a true meritocracy, buyers expected to get an untainted view of that meritocracy to make informed purchasing decisions.

Technology platforms need to obey to a simple macro-economic marketplace definition:

A marketplace connects unrestricted supply with unrestricted demand through an un-arbitrated and transparent exchange.

Marketplaces thrive because they support free-market principles, and as a result they level the playing field for all participants. No longer are unfair advantages for participants defined by geographic location, subscriptions, volume or other artificial boundaries, but simply by the value and the price of their products.

Here is what platform vendors, to maintain free-market principles and thrive, should stick to:

1/ Don’t employ sales people that sell marketplace content. Sales people give preference to specific content which violates the integrity of the marketplace. Sell the effectiveness of the marketplace mechanism instead.

2/ Don’t market specific content, but market the effectiveness of the exchange. Unfair advantage is an attribute of a premium market not a free-market.

3/ Don’t arbitrate. Anyone should be able to participate, participation fees (that anone in the target group can afford) are okay.

4/ Don’t hide sales results. Transparency of the effectiveness of the marketplace is crucial to invite new entrants on the supply and buy side.

5/ Don’t participate in the marketplace yourself. Clearly seperate yourself from the participants, platform vendors should just build the platform, not the content.

Technology companies that are building platforms should check out our cardinal marketplace rules and investors should measure their platform companies on the compliance to those rules. Investing in a premium market business is fundamentally different from investing in a free-market platform business. Funding requirements and use-of-proceeds differ dramatically.

I’ll make the point again that investors should understand macro-economics impact before they invest.

Marketplaces are not for-free and still support capitalism, but the money will be made by platform owners from a transparent margin on the exchange (and sometimes carefully applied advertising opportunities). Diligent consumer marketplaces achieve winner-takes-all participation levels and massive exchange volumes and revenues. eBay and the Apple AppStore are great examples of more disciplined marketplaces.

Because of the virtually unlimited global reach of the Internet we have an incredible opportunity and obligation to present the world with free-market platforms that treat all participants fairly and with respect.

Let’s stop whining about the authenticity of our presidents, and instead, as the creators of the technology industry show the world how we turn authenticity, embedded in our technology, into a massively sustainable advantage.

Tags: Platform, Amazon, FaceBook, Getty-Images, Photography, Macro-economics, Meritocracy, Marketplace, Markets, Premium

By Georges van Hoegaerden

With the proliferation of the new iPhone, Mobile Applications as a viable VC investment category is dead.

Companies like Digital Chocolate (founded by software gaming pioneer Trip Hawkins) are now painfully aware of that. Recenty switching gears, it is debatable whether they can compete with the endless supply of a new free-market.

The future of many companies like Aeroprise, still basking in the glory of a proprietary Blackberry environment and tucked away in the enterprise mobile markets, will be severely threatened by standards-based technlogy running on any internet capable device, very soon.

The premium market of mobile applications protected by walled gardens has been changed to a free-market by Apple’s iPhone and the App Store. Macro-economics, discussed in this blog many times before, at work again.

Rather than single minded companies being able to protect their turf with a collection of proprietary applications (usually aimed at businesses), now individuals will start to create applications for other users. By the people, for the people. N/N :the airplane code for Steve Jobs’ Gulfstream. Get it already?

User-generated-content (one of those awkward Silicon Valley attempts of describing content that resides in a free marketplace) has a brand new companion, it is called: applications.

But these applications are no longer mobile applications, they are internet applications - that happen to run on a great mobile internet device. And they will run on many other internet devices, hard-wired or mobile. Think of them as the big brother of widgets, task oriented applications that remove the need to use a browser to benefit from the Internet. They target regular consumers, not internet savvy technologists and they self-configure, based on location and other user preferences.

So the investment model for mobile has changed dramatically and the recently announced $100M iFund (by top investment firm KPCB) and a similar one by BlackBerry - the vehicle of purportedly investing $1M per application vendor - makes no sense at all. Here is why:

1/ User-generated content does not provide a great foundation for large upside - let alone an acquisition or IPO that is priced to produce interesting VC returns.

2/ The value to the VC is in the “winner-takes-all” platform, not the content (albeit that produces great value and choice to the consumer). Apple, with the App Store platform for distributing applications using free-market principles (although still not perfect, check out our marketplace rules) will again walk away with the same benefits it reaped from the iTunes store, direct and halo.

3/ Application development is a very high cost business, especially in a highly competitive marketplace. The gaming industry wrapped in a slower transition from premium to free-market is finding that out too.

4/ Mobile used to be a proprietary, and protectable, path to the internet. No longer. The intelligence of the backend service, accessed through a mobile of hard-wired computing device is where the value is.

So, i suggest to rename the iFund in Software-As- A-Service fund, agnostic to access paradigm.

Nokia and Blackberry (RIM) will have to follow quickly. But they would need to start hiring people that understand macro-economics, not just technologists that create poor copies of Apple’s implementation.

All phones need to have a real operating system inside, and Roger McNamee’s investment in Palm may make sense in that way, but they better step it up quickly. Nokia is off playing with Symbian, Microsoft has its own concotion. All of them pretty much asleep at the macro-economic wheel.

Yet for individuals, on the supply and buy side, all this disruption leads to new opportunities that are derived from a meritocracy. Fantastic applications are being developed and used in massive numbers. The world is indeed flat after all.

Tags: Apple, Nokia, Blackberry, Free-market, Marketplace, Meritocracy, SaaS, Proprietary, Gaming, Funds, Wall-Street, ITunes, Mobile

Finally the market is talking, and I knew it would have more impact than my blog:


(from VentureBeat)

By Georges van Hoegaerden

Years back we suggested the diminishing value of micro-economic innovation (or technology silos) and a stubborn VC club that still operates under old fashioned principles (see “In Search of the Economist VC” written in 2005, “10 Investment lessons learned” and “Invest different” in 2008) as the main reason for this decline.

Alex Haislip on PEHub agrees:
“The VC industry is laboring under a set of outdated assumptions, a structure optimized for conditions no longer applicable and an unwillingness or inability to embrace the tectonic change it is undergoing. The hand wringing about various short term shocks (such as skittish investors) that sunk the second quarter’s IPOs misses any serious discussion of the long-term systemic shifts that many VCs have failed to act on.”

What needs to change is:

1/ VCs need to start investing in businesses rather than technologies
No one outside of Silicon Valley cares about Web2.0, Mashups, UPnP etc unless it proves to deliver a unique experience, deliver substantial competitive advantage or significant cost savings to customers. Indeed, back to fundamentals.

2/ VCs need to embrace different investment models
We need a long-and-short and high-and-low in technology investments, and everything in-between. With a business centric view of the world comes an investment model that is tailored to that business. Every unique company ecosystem has unique financial requirements. History has shown not all businesses benefit from low-ball investments; the majority of seed stage deals go for less than half the price of a regular house in Palo Alto. The superficial categorization of businesses in technology categories is turning new business opportunities into (forced) commodities.

3/ VCs need to change how they find deals
The problem starts at first encounter. The Ivy League kids fresh out of business school that are the first point of contact for most entrepreneurs are just not capable and experienced enough to spot disruptive technologies that have macro-economic impact. A first time pilot right out of school is not allowed to take the helm of a commercial airliner, neither should an MBA graduate be allowed to veto an investment. False negatives are rampant and deflating overall market value. We need unconventonal companies, not more conventional ones.

But the great thing about the demise of the current VC model is the need to create a new one that, in turn, spawns a new more exciting asset class.

Tags: Investment, Eco-systems, VC, Limited Partners

By Georges van Hoegaerden

Nothing is sweeter than success, real success, hard earned success. That is what my grandfather achieved when he helped create the company (van Melle) that still makes the Mentos candy today and, in the early 1900s turned it into a worldwide company and brand. Every day, I strive to live up to his achievements. Not just to make a buck, but to fundamentally challenge the establishment and contribute to improving the world we live in. Albeit my sweet spot is technology.

Building a business is all about people; entrepreneurs and investors working hard together towards achieving the common goal. Too many times do I see or hear from investors how entrepreneurs finagle their way into the money pot, with damaging consequences.

While I do not consider myself in the league of Donald Trump in terms of inspirational speaking, I do want to emphasize how important the evaluation of personal skills are to support a great company. I learned some valuable lessons from my grandfather early on - not by asking him many questions (I was too young to do so intelligently) - but by watching him operate. My grandfather did not have access to the funds we have at our disposal in Silicon Valley, but the rules of success have not changed.

1/ Have an opinion.
Unless you are ill informed, having an opinion and expressing it is vital. Vital to you personally - in achieving what you want, and vital to the company you work for - to provide the best quality of service. If you can't see the flaws around you (and in yourself from time to time), you won't be able to detect or imagine true innovation.

2/ Have guts.
The world is full of artificial rules to keep us all in check. Throw them out from time to time, just to see what happens. I run a stoplight litmus test with most entrepreneurs, to demonstrate how tucked-in we still are. And you'll be amazed.

3/ Have integrity.
The goal of creating a lasting personal brand should outweigh the short-term obsession of making money. "Nice" people don't make great impressions, what they stand for does. I bet you'll make more money sticking to your personal brand, then you ever will chasing dollars.

4/ Be transparent.
Transparency is the fair assessment of capabilities, good and bad, combined with the ability to expose them. The companies we create together inherit our good and bad, yet no one will suffer if they are exposed properly. Quite the opposite, transparency builds fairness and trust.

5/ Find your passion.
You will not see me go-green anytime soon, even though there is a lot of money to be made there. My passion is technology, specifically consumer technology and has been since I was twelve years old. I was lucky in that way, but it hasn't been easy, extricating myself from common beliefs. Explore your own true passion (not that of someone else), and don't rest until you've found it.

Many times is the path to success cut short, not by the market, but by the entrepreneurs themselves. As a CEO I have left companies where major shareholders lack or infringe on those fundamental principles, and I killed investments for similar reasons.

The real sweet taste of success is being true to yourself. So, next time you knock on your investors' doors, pay a little more attention to yourself - rather than the business plan.

(In memory of my hero and grandfather Simon de Smit, I miss him in more ways than one)

Tags: Investment, Integrity, Transparency

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

I just came back from a trip to Europe and let me tell you: Belgian chocolate, raw herring from Holland and ficelle from France - nothing is more authentic and delicious.

But few of these travel well or find a large deserving audience in the United States. Much like technology.

The state of the technology industry and the accompanying investment ecosystem in the US are quite a bit more developed than in Europe, 15 years at least.

In the US, roughly $30B per year is poured into early stage companies by some 300 investors in my backyard in Palo Alto, not including Private Equity deals. In contrast, only a handful European early stage VCs exist and the majority of all european investments are late stage investments done by Private Equity firms.

In Europe, early stage VC valuations hover around $1M, compared to $4-7M in the US. As a result desperate european entrepreneurs often default to Angels that show some flexibility, but those investors are often very inexperienced with the technology sector and early stage investing or the combination. They made their money somewhere else. Because of the young history of technology success in Europe, very few european investors (either VC or Angel) have actually had the personal experience of building an early stage technology company from scratch.

To sum it up, european investors (with a few exceptions) take large early equity stakes, provide limited relevant business insight and push those companies to early profitability (even at 250K euro investment levels). Selling a product or a service too hastily, before it is ready to enter a global marketplace delivers NO validation of the business, good or bad. But it is a sure way to slow down its innovation and differentiation.

So, underdeveloped access to quality early stage money makes life of entrepreneurs in Europe quite difficult.

But, let's assume you passed the bar on all the above and your company is on its way to the United States. No one can stop you in the pursuit of the great early exit opportunities only Silicon Valley can offer.

So here are some things to be aware of:

1/ A cherry, picked by an investor in Europe is not always a cherry in the US. Be sure you understand - or seek advice about the timing differences between continents that attract follow-on investors in the US. Some of that timing has to do with technology, but market timing is even more crucial.

2/ Plan ahead. Allocate a larger fundraising runway than you would in Europe. To US investors foreign companies are yet another risk they need to mitigate. By default you are less attractive than a US company.

3/ Modify your operating plan. Change it from a plan to profitability to a plan to market dominance (which could include profitability but can also have other primary denominations as drivers, such as owning a majority of eye-balls in the consumer space).

4/ Move your headquarters to the US. Without it you'll find very few US investors interested.

5/ Assuming you get this far, be open to a recap. US investors understand the equilibrium of shareholdings will provide the best business value, not exorbitant ownership of the initial investor achieved through a low initial valuation. But since the US valuation should increase significantly, the initial investors should not lose too much net value, if at all.

6/ Hire a local management team that understands how to perform in a petri-dish that is quite different from Europe.

My final recommendation is to be prepared before you come over and not put your head in the sand, I can give you a long (and still growing) list of foreign companies that were forced to move back.

For larger US VC firms there is a fantastic opportunity to scout for technologists in Europe and fold them into their US investment model before they've taken in too much local money. I see technologists in Europe building innovation that is at least as good as the in the US. Remember the most delicious chocolates from Belgium?

But, the worlds largest chocolate factory is Hershey's located in the US. The name of the game remains matching sufficient technological capability to a fast growing market, in the same way Hershey's reaches a much larger audience than Belgian chocolates - with a quality that is good enough for most. Market timing, not technology, is key.

Tags: Investment, European, Private Equity, VC, Angels, Marketplace, Markets, Silicon Valley, Palo Alto

By Georges van Hoegaerden

Since a platform is the technology foundation for a marketplace, platforms - to achieve extraordinary growth - need to instill the rules of marketplaces as we laid them out in our previous post.

But not all platforms are created equal and some self-proclaimed platform vendors do not adhere to marketplace principles. That could mean you as a provider think you subscribed to a meritocracy - with equal opportunity exposure - yet other participants (your competitors) get pay-to-play advantages. Potential buyers in that tainted market are actually shopping in a premium market, not the free-market they expect to be most economic and trustworthy.

Other synonyms of the same phenomenon abused in the technology industry include: ecosystems, exchanges, communities and networks which all serve identical needs in connecting disparate supply with disparate demand, something a premium market is unable to do.

Consumer companies understand the freedom of choice customers demand. Enterprise software and services vendors have long basked in the glory of premium markets and have a long way to go in order to truly build winner-takes-all free-markets, which in total size are often larger in size than the total size of premium markets in that category.

In the Enterprise space the majority of customers (roughly 80%) buying products or services deviate from its intended design and want to add on, integrate or correlate those off-the-shelve configurations with other ones. Enterprise customers often spend more money on customization than they spend on licensing fees for say, Oracle products. Hence the requirement for a true marketplace of additional enterprise components (check out Serena, great concept but marketplace execution and marketplace compliance - yet to be developed - will be the tell-tale of their real success). Salesforce.com's Appexchange seems to provide the best proximity to a free-market of applications we've seen, although we have yet to verify its integrity against the marketplace rules.

Developer programs from companies like Oracle (with OTN), Microsoft (MSDN) and others use surrogate models of marketplaces to mimic, but not truly deliver on its powerful benefits. Go visit their websites and you'll notice no mention of third party products. There literally is no marketplace, although Microsoft has a link to "a library", if you can find it.

Apple (with the iPhone Developer Network) is experimenting with its rules but apart from compliance to the free-pricing rule, its overall compliance to a free-market is minimal. And, today, they don't need to. Apple still has time to deploy some premium market tricks as long as Google with Android doesn't deliver on a real marketplace for developers early.

As a software provider you may need to run on and comply to a major vendor's technology, just don't assume a developer network, exchange or community will make you rich - not until the marketplace supports a true meritocracy. And for that, again, real marketplace principles need to be deployed.

Tags: Marketplace, Oracle, Microsoft, Apple, Google, Android, Enterprise, Networks, Eco-systems, Meritocracy

By Georges van Hoegaerden

If you've read my previous blog on marketplace rules, you would agree. Amazon.com is a Super Store which, by expanding the relationship with other premium suppliers mimics the appearance of a marketplace. And because Jeff Bezos associates Amazon.com with a marketplace frequently, I stand to correct him:

Marketplace rules.
Rule #1: Failed. Amazon limits the supplier participation to their premium strategy.
Rule #2: Failed. Limited suppliers means limited transactions are available
Rule #3: Failed. Amazon regulates the process of how a transaction takes place, conforming to Amazon pricing models
Rule #4: Failed. Once you book an order from a different supplier than Amazon, all bets are off with regards to transparency, shipping, returns etc
Rule #5: Failed. There is no way for new buyers to see who bought what at what price and equally for sellers who sold what.
Rule #6: Failed. User opinions are irrelevant if they are not borne out of a transaction.
Rule #7: Perhaps not relevant here.
Rule #8: Failed. Amazon is "competing" in the "marketplace" with its suppliers

Amazon will have a much harder time to sustain growth and meet Wall Street expectations, as a lot of growth through premium suppliers will become non-organic (or sell through revenues). Amazon has plenty of opportunity to migrate to a real marketplace without losing its footing, but it better hurry. In the meantime, Jeff, please call Amazon what it is: earth's premium selection.

Tags: Marketplace, Amazon, Bezos

By Georges van Hoegaerden

There is a lot of misconception about marketplaces and I wanted to summarize my response to benefit more entrepreneurs.

Real marketplaces are much more powerful than just a collection of stores. Amazon, for example is a Super Store not a marketplace today. EBay, FaceBook and YouTube represent more fundamental marketplace principles - and as a result - fascinating growth.

Marketplaces are a favorite topic these days, perhaps spawned by sky high valuations for social-media platforms such as FaceBook and Bebo. A social-media platform, you know, is nothing more than a marketplace in which personal attributes are traded (through the use of social applications).

Marketplaces are interesting because, if implemented successfully, provide massive user adoption and winner-takes-all leadership positions. Great traits for any investment portfolio. A marketplace is highly disruptive in a market where the premium opportunity, the Super Store model has been exhausted - or simply does not exist. Some markets, because of their highly fragmented nature, cannot be captured by high margin and proprietary access and a marketplace is the only way to leverage its total size.

I have written extensively about marketplace criteria in specific markets and its origination about 600 years back, so I won't cover that specifically here. But so many other markets are ripe for marketplace macro-economics delivered by technology. Virtually any market characterized by unique transactions between large amounts of sellers and buyers is a candidate for free-market principles. The life-cycle of proprietary markets is dramatically shortened by the Internet, a distribution medium that instantly removes artificial boundaries such as geographic location and limited access.

Here are 8 rules that make a marketplace succeed:

1/ Un-arbitrated participation
No seller or buyer should be banned from participating in the marketplace. A key fundamental of a marketplace is that it grows itself and that the quality of the buyer and seller is a reflection of the market, not controlled by the market. After-all, the purpose is to connect The Long Tail of supply with The Long Tail of demand.

2/ Un-arbitrated transactions
Apart from exchanges that are illegal by law, no transactions should be banned. People come to a marketplace to perform a unique transaction, one they could not act on in a premium market.

3/ Free pricing mechanisms
Pricing models and terms are defined either by the seller or buyer or by both. Not by the marketplace. Pricing models can include such transactions as sell, auction, reverse auction or subscription - or even a combination of those. Pricing, including free, is completely and independently determined by or between seller and buyer, predetermined or negotiated. The marketplace takes a simple transaction fee off of the transaction value.

4/ Predictable behavior
Marketplaces need to establish trust in order to survive and thrive. Pricing models and behavior of the marketplace need to be predictable and follow (not dictate) the goals of buyers and sellers. The marketplace should follow the needs of the market not the other way around.

5/ Transparency of transactions
Marketplaces rely on a vast new influx of sellers and buyers to grow to massive size. That means the marketplace must operate with a transparency that shows new buyers or sellers how to become successful as most of its users are greenfield participants.

6/ Meritocracy builds reputation
Trading favors and segmentation can be established but only based on mechanisms that are derived from real transactions, not plainly from user opinions. Opinions are useless if not supported by a proven reputation within the marketplace. Transactions based reputations provides long-lasting stickiness to the marketplace.

7/ Support for intermediaries
For existing markets moving from premium to a free-market, its existing intermediaries need to be able to continue to represent their sellers or buyers. A new technology marketplace should not want to disintermediate or alienate those agents.

8/ Non-compete
The marketplace cannot itself participate in the marketplace by providing its own transactions or even participate in - or act on behalf of - transactions between sellers and buyers. Apart from the fact that the business models don't jive, a marketplace cannot be trusted when it simultaneously participates and facilitates an impartial exchange.

So, a simple method to determine whether a marketplace has massive market potential is to hold it up against the rules provided here. These rules are macro-economic principles that dictate how markets behave and grow, the technology implementation must support those principles to have a chance of making it big. It's a free world after all.

Tags: Marketplace, Startup, Social Media, Long Tail, EBay, FaceBook, YouTube, Amazon, Transparency, Free-market

By Georges van Hoegaerden

Over the last 10 years I've also been closely involved with early stage technology funding (advising VC firms and Angels) and have invested personal time and money in early stage ventures. That has given me a unique perspective of the challenges between entrepreneurs and investors.

I've written about my Top 10 fundraising lessons for entrepreneurs, and dare to follow up with my Top 10 investment strategies that may be useful to investors and entrepreneurs, here:

1) Invest in the founders, but be wary if the company consists of technologists only. The ones that come in without an operating plan clearly do not understand what you as an investor are looking for. Get a real operator in early.

2) Invest in the business, don't invest in technology. The statistics prove it: ninety-nine out of a hundred of the most innovative technologies never turn into successful businesses. Especially investors (both VC and Angels) that made their money in the hay-days of technology have a tendency to underfund the business side, providing a weak foundation for any technology to succeed.

3) Don't invest in an early stage company with more than one product or service. Let the company become the King-of-One, rather than the King-of-None. Multiple products or services require more money to support successfully and dramatically dilutes the focus of the company. Multiple products or services also "invite" a larger group of competitors, making it hard for customers to perceive true differentiation and unknowingly, slows down adoption.

4) Don't invest in an early stage company with more than one business model. Keep it simple. Multiple revenue models sound good, but usually don't yield the projected outcome. The company should make all of its money in advertising or in subscriptions, not in both. Dilution of focus is costly and provides yet another reason for failure.

5) Don't invest in companies that rely heavily on partner support early on. This is the typical David and Goliath phenomenon. Partners sell once the company does in overwhelming numbers. The company should always have direct control of its own business model first, before they allow any partner to reduce its margins.

6) Invest money or time, don't do both. I very much relate to Carl Icahn in an interview with Dan Primack (on PEhub) with regards to CEOs responsibility to make the numbers work, and not to rely on investors to "add value". The CEO is in the driver seat, take him out if he doesn't produce.

7) Look for fundamental changes in customer experience. The Ultimate Driving Experience is what sets BMW apart, not just the timing in their engines. Customer experience is much more than a pretty user interface, it is an overall experience that spawns disruptive purchasing.

8) Watch how professional the team operates pre-funding as an indication of their interaction post-funding and with customers. Real professionals do everything with a purpose and I have mastered the art of detecting them. So well that I can tell from a visit to a trade-show floor whether a company is going places.

9) Don't categorize investment allocations based on past investments or trends. Every company is unique and requires an amount of money unique to their assets: people, timing, market and ecosystem. If you don't think you have a unique scenario, you probably don't have a valuable investment opportunity.

10) Invest with passion but don't fall in love with the company. Investing is the ultimate flirting game, but it is usually a bad idea to get really involved. Your asset value is the selection and performance of all the companies in your fund. Stick with what you do best.

From an investment perspective I see many "sub-optimizations" but not a lot of real great innovations these days. I do blame the current investment model for that sometimes. We, in Silicon Valley, have too many technology investors using the same rearview-mirror investment criteria. Although I have a lot of admiration for Apple, it is a bad sign when we need to leave real innovation in the hands of large companies like theirs.

The landscape for investors is about to change dramatically, no longer can they just continue to invest in proprietary technology silos at single digit valuations. They'll soon need to broaden their experience ("in search of the Economist VC") to understand the macro-economic impact of marketplaces, platforms and the impact of technology to other industries.

A wonderful long road for technology innovation and investing still lies ahead.

Tags: BMW, Experience, Disruption, Revenues, CEO, Timing, Markets, Investment, Startup, Apple

By Georges van Hoegaerden

I visited the entrepreneurs week at Stanford this week where many MBAs were walking around with new business ideas. Since we raised a fair amount of money ourselves in the last 10 years we've been focused on startups, I wanted to give some advice that may be helpful to any first time entrepreneur:

1) Define the end goal of the company in a newly defined market
The determination of pre-money valuation, even for the first round, should be based on the disruptiveness of the company when it grows up. The goal is to find the investor that understands the path to that goal, not an assessment of the current value of the company. The starting valuation then becomes a reverse calculation from that goal.

2) Don't set a valuation, but have one in mind
The valuation is usually suggested by the investor, but ofcourse, you don't have to take it. Ask your potential investor to value the company after you give them the pitch, the outcome of that tells you whether the investor really understands your unique proposition. If it is too low, it may be because the clarity of your pitch. If not: walk away.

3) Have an operating plan ready
An operating plan defines how you turn technology into a business, without it there is simply too much room for debate and depreciation. Show investors you know how to run the business. The more you do the easier it is to cement your use-of-proceeds.

4) Find an investor you truly like
Every entrepreneur deserves to be treated with respect. Waste no time talking to deep pockets with awful personalities, but don't be afraid to get some straight talk. Check TheFunded.com for war stories and ask around. Later, when business gets tough bad guys usually get a lot worse.

5) Define business disruptiveness
Building technology is one thing, but yielding a disruptive business value is even more relevant. The latter is defined by macro-economics, not just a more clever way to improve existing technology.

6) Take passion over domain expertise any-day
Find a lead investor that has passion for the business problem you are about to solve. An investor that claims to have domain expertise is usually the one that doesn't understand disruption within or across that domain.

7) Don't get squeezed
Investors like to put investments into past investment categories and make an assessment of how much it costs to build your business. Don't let them stray too much from what is in your operating plan, if you do you will get punished for it later, both on the execution side as well as in excessive dilution.

8) Know the investment allocation
Usually a little harder to do with angels but VCs should have a total investment amount allocated to the business. Ask them for the total allocation upfront, so you know when you need to go shopping somewhere else. Also, don't be afraid to ask who else needs to sign off on this deal within the VC firm, in most cases it is a very democratic process internally with a primary sponsor. After your first meeting you should get in front of a General Partner, talking terms.

9) Control your own eco-system
Investors like to wiggle around and determine how much money should go into R&D, Sales, Marketing, Business development, Support and G&A. Too much money in marketing is usually an indication the product or service lacks real viral adoption and that should be avoided. If the balance of this eco-system is not guarded heavily by the entrepreneurs the result is an excessive bleeding and further dilution in subsequent rounds.

10) Balance your board
A board without a balance of technical and business expertise can really bring a company down when the going gets tough. The technical board members will spend too much time validating deep technology progress without real affinity for the bottom-line. On the flip side a demand for too early revenues can have disastrous effects on product or service readiness and customer experience. Keep them both in check.

Be honest and transp