Texas Venture Capitalist

Instead of studying for an Economics Midterm I spent a good chunk of this weekend playing with Windows Live, Microsoft’s attempt to combine a set of disparate internet services into a coherent web experience. Although I had individually seen these applications operate independently before, it wasn’t until I read Ray Ozzie’s memo on internet services that I realized that there was some coherence behind this chaos. This isn’t Microsoft’s only attempt to consolidate a hodge-podge of web services. Office Live is another, somewhat redundant, attempt to create a coherent web experience, with an emphasis on services for the (small) enterprise.

This isn’t a particularly new space. Google has been building and acquiring its own stacks of services to provide a fuller experience. (Even Apple has a stake in this game). A few things immediately strike me about the rival plays:

Rich Client Experience versus Collaboration: Based off of their areas of expertise, Google and Microsoft are advocating different paradigms. Microsoft uses the functionality of their ubiquitous software as a launching point, with web services meant to enhance the experience. The Office Live homepage feels like a light content management page (SharePoint Lite if you will) where the focus is on the documents themselves, created and edited based on local applications. The Google site I use with classmates is much more focused on providing a fuller collaboration environment (through light weight subpages, calendars, comments, etc) where the static documents are more of an afterthought. During their joint interview at last year’s All things D Conference, both Bill Gates and Steve Jobs talked about how they fundamentally believed that the richer client experience is a better approach to harnessing the web. I don’t know where I stand in the discussion, but the contrast is striking. Google apps give me the 80% of functionality I need to share something quick with a colleague, but doesn’t compare to the professional grade content I can create with Office or PageMaker. At first view the Google slate seems more appropriate for internal discussion, with the Office Live experience geared towards producing external deliverables. It’s also worth mentioning that these aren’t necessarily mutually exclusive strengths, making the next round of betas all the more exciting.

Hosted Email: Both slates also have hosted email solutions; Gmail and Windows Live Mail. Without getting into a long winded discussion of the merits of the two rival services, it’s worth mentioning that the same paradigm difference is here as well. The Live client (which requires a client-side install) provides a host of options (folders, offline persistence, etc) that Gmail just doesn’t offer. Once again its about providing a client heavy feature rich service powered by the web instead of living permanently on it.

The Victims: In my last blog post I mentioned the $3 billion content management market. Although neither of these solutions provide the depth of functionality (multi-level approvals for example) of a Documentum or FileNet, it’s worth noting that this rivalry has made check-in check-out functionality coupled with version control free. The market for a simple ECM solution solution no longer really exists.

The Real Shift: Last year Office made Microsoft $10 billion worth of profit (Windows made $11 billion), but with more people openly thinking about the Google alternative because of its ability to foster collaboration, Microsoft has found itself defensively competing on Google’s turf to protect their golden goose. I am very excited to see what come out next.

While talking to a friend I was asked who the major players in enterprise software are. I couldn’t really find any decent web pages to answer that question, so here is my weak attempt to put together a list. Suggestions on improving this list are welcome!

·         System Integrators ($53B)

o   Accenture ($6.3B)o   IBM ($6B)o   Fujitsuo   Lockheed Martino   CSCo   Hitachio   SAICo   SAPo   Capgeminio   Northrop Grumman

·         ERP systems ($5.5B)

o   SAP (41%)o   Oracle (11%)o   Microsoft Dynamics (NA)

·         SOA applications ($1B)

o   IBM (53%)o   Microsoft (8%)

·         Application Servers ($4.5B)

o   Microsoft .NET (<20%)o   Java (>72%)

§  IBM Websphere (43%)§  SAP Netweaver§  Oracle BEA Weblogic§  Sun Java Application Server§  Open Source

·         Red Hat JBoss·         Apache Geronimo

·         Databases ($18.6B)

o   Oracle ($8.2B 44%)o   IBM DB2 ($4B 21%)o   Microsoft SQL ($3.4B 18%)

·         Integration

o   Data Integration (EAI/EDI)

§  IBM Websphere MQ§  Microsoft Biz Talk§  Informatica§  Tibco§  Sun JES MQ (SeeBeyond)§  Oracle Fusion Middleware (BEA)

o   Reporting/BI ($5.7B)

§  Microsoft (31%)§  Oracle Hyperion (21%)§  SAP Business Objects (13%)§  IBM Cognos (13%)

·         Infrastructure  

o   VOIP ($9.6B)

§  Avaya§  Cisco§  Siemens§  Nortel§  Alcatel/Lucent

o   Routers/Switches ($2.5B)

§  Cisco (44%)§  Juniper (18%)§  Lucent/Alcatel§  Nortel (15%)

o   Network Service Providers

§  Telco NSP

·         AT&T, MCI, Sprint, Level 3, BT,  NTT, SingTel

§  Non-Telco NSP

·         IBM, EDS, CSC, Vanco, Atos Origin

·         Personal Productivity Software

o   Operating Systems

§  Microsoft Windows (>90%)

o   Desktop Applications

§  Microsoft Office (>90%)§  Sun Star Office (<19% SMB)

·         Collaborative Software

o   Email

§  Microsoft Outlook/Exchange (62%)§  IBM Lotus Notes (26%)

o   Content Management ($2.9B)

§  EMC Centera/Documentum (13.1%)§  IBM Filenet (24.9%)§  Open Text/Hummingbird (20.2%)§  Microsoft Sharepoint (1.6%)§  Oracle Stellent (4.1%)

Forrester put out a report today highlighting the potential of Web 2.0 technologies in the enterprise. I have been excited about this potential since meeting Drew Larsen, whose product SAVO does just that in the Sales space. I have always been a bit skeptical about Forrester because of their dismal track record at predicting trends (Anyone remember their prediction that Tivo would be in 55% of homes within 6 years of launch‽), so with that grain of salt I read through Sarah Perez’s and Kara Swisher’s coverage of the report.

I really appreciate the following excerpt: “Web 2.0 tools will be defined by (its) subsumption into other enterprise collaboration software over the next five years; it will eventually disappear into the fabric of the enterprise, despite the major impacts the technology will have on how businesses market their products and optimize their workforces.”

I couldn’t agree more. Having spent the past 8 years either working with CIOs or within the enterprise I can honestly say that no company will come out and say something along the lines of “I really need some Web 2.0 in here. Where is my checkbook?” they are more likely to unwittingly stumble into Web 2.0 technology based on improvements to their end to end processes.

A brief history lesson: 

For me Web 1.0 was the internet allowing professionals to get their content out there. Web 2.0 is focused on allowing the general population to create and syndicate content, with Web 3.0 focused on how to cope with all of this information.

Enterprise 1.0, was focused on getting data out of filing cabinets and spreadsheets and into monolithic functional-module based systems (like SAP R/3). Enterprise 2.0 is taking a more end to end focused approach with hosted applications focusing on specific end to end processes (aka SOA). Enterprise 2.0 will create a series of challenges for CIOs as they attempt to cope with several different systems built on varying standards delivered through server-centric Java and .NET infrastructures. As these SOA tools continue to mature, several distinct trends will continue to gather steam.

Software as a Service (SaaS) will only get bigger. Salesforce.com was the tip of a very big iceberg as more and more companies realize that although they need configuration, they don’t need customization. For this trend to truly take off however, a real answer to the data hold-up problem will have to take hold. Until then, internally hosted SOA apps will be king. Tools making that administration easier, like Phurnace or cheaper like VMWare will only get bigger.

Cross Application Reporting Tools will become simple but more important. Drew talks about how the number of customizations and configurations drastically dropped when SAVO embraced the new Enterprise 2.0 paradigm. The proliferation of SOA apps like Performix and Salesforce will make cross application reporting essential, but the reductions in customization will make the integration jobs easier. Tools like Microsoft’s BizTalk, & Informatica on the data integration side and IBM’s Cognos & Oracle’s Hyperion on the Reporting side will have to adapt to the new commoditized world, creating opportunities for upstarts.

The Forrester Report really starts to irk me when they attempt to track expected spend for wikis and blogs within the enterprise. I just don’t see companies spending real money on enterprise versions of tools they can get for free on the web. I don’t doubt that other enterprise tools will branch into those capabilities (Like how Lotus Notes branched into instant messaging with Lotus SameTime, can we say SharePoint Blogs?), but I don’t see this happening with standalone applications. 

My take anyway…

I had the pleasure of grabbing coffee with Eric Olson yesterday in Evanston. Eric recently joined the team at DFJ Portage specializing in consumer web plays after a successful run at Feedburner. Eric is also the cofounder of Tech cocktail, a meetup for technology enthusiasts, bloggers and anyone else in traditionally underserved technology markets (think places like TEXAS). Eric’s hard work at Tech cocktail recently got him a prestigious CityLIGHTS award. Just being around Eric makes me want to try to get something like this off the ground in Texas, probably in cooperation with the folks at Startup Houston, Texas Entrepreneurship Association, and others. If you are interested in helping, let me know. When I get down to Texas in June (I know, I always talk about what I am going to do when I get back) I’ll think through if this makes more sense in Houston or Austin (or both!).

Needless to say Eric’s blog just made it onto my iGoogle page. For my Chicago Friends, I will see y’all at the Tech Cocktail Conference on May 29^th!

I have experimenting for the past few weeks with the OpenID platform. I love the concept in theory, one secure set of credentials to use on the web to avoid having 50 different log ins and passwords. OpenID avoids the typical holdup problems associated with these efforts by not centrally administering the credentials, but rather represents a group of standards that are then implemented by several providers. The other captive alternative to this involves signing up for a one-stop shop for web needs. Google, Yahoo, and Microsoft are all vying for that title today.  Facebook’s open API is another interesting twist on this space. Non-internet based password managers, like the Firefox password manager also solve this problem in a machine specific way.

A few weeks ago I signed up with Claim ID, and began attempting to use my credentials to work on a few websites. The first place I tried was at wordpress, an Open ID supporter, and the source of the template for my blog. After a few hours of frustration, I gave up and tried using my OpenID at a variety of other locations.

Long story short, I have yet to successfully use my OpenID in the real world. It either hangs up, claims the account doesn’t exist, or is not supported by the web-applications I like to use. I am sure this is all due to user error. But if I can’t figure this out, how is the target audience of people unable to keep up with their user names and passwords supposed to?

Sorry for the delay in posting. My MS keyboard’s “m” key stopped working, making it very difficult for me to write anything from home while my laptop was in dock mode. I performed minor surgery on it this evening and fixed the issue.

Last week I had the pleasure of chairing the Web 2.0 panel at the Kellogg Private Equity Conference. Our panelists included Dan Hosler from Sterling Partners, Matt Moog from viewpoints.com, Drew Larsen from SAVO group, and Mark Koulogeorge from MK Capital.  The panel was moderated by Rob Cox from BreakingViews. The panel did a great job of talking about a variety of incredibly interesting topics. My favorite take aways were:

·         Content providers monetizing with ad revenue have a perverse incentive to keep their content less interesting when they are paid per click. Captivating content like facebook has incredibly low click rates.

·         Even destination websites like the New York Times’ About.com have close to 80% of their clicks come from search engines. Content businesses are “an algorithm change away from going out of business”

·         Web 2.0 technologies are finding homes inside of traditional enterprise software packages as they look for more efficient ways to carry out processes. SAVO group is a great example.

After the panel, Dan Hosler, Kapil Chaudhary from I2A fund, and myself had a great conversation about the myths surrounding company valuation. Although all three of us are VCs (and therefore have a self interest in seeing lower valuations), we all sincerely believe that high early valuations hurt companies in the long run. Allow me to explain.

Very few companies can get away with one funding round. Companies often need at least two or three capital injections before they can become capital self sufficient. In that context an overly high valuation hurts a company’s chances at getting the crucial second or third round of capital. That’s because you generally want to see a valuation step up with each round, well if the first round was valued too high for round one, you will have a hard time finding another funder to come in for round two and still be able to give them a decent amount of equity. (”Your high Series A Valuation just priced me out of Series B!”)

The common answer entrepreneurs give for why they want a higher valuation is because they want to protect their equity in the firm. They reason that a higher valuation allows them to keep a greater piece of the firm, so that when there is an exit they get to cash out a lot more. In reality this explanation doesn’t really hold. Without follow –on equity injections there will be no exit because the firm will run out of money.

Some VCs can give excessive valuations to entrepreneurs by coupling the valuation with participating preferred liquidation preference stock. This stock basically guarantees the VC a certain rate of return before the entrepreneur sees a dime out of an exit, essentially defeating the purpose of the higher valuation in the first place. In cases like this it’s just a better idea to stop playing the numbers games and go with the lower valuation.

In the beginning we used media like TV and radio to broadcast content. You still see a lot of legacy media on the internet:

The Professionals Talk: The first website I ever visited on the internet was CNN I remember thinking how cool it was to get the news whenever I wanted. Podcasts are the audio way to distribute this kind of content. Sites like hulu are the video way to distribute it.

Over the past few years social media, the framework people use to communicate with other people, has been advancing blindingly fast.

Talking to each other: When I started high school, internet email had just crossed the tipping point. Towards the end of high school instant messaging became all the rage. In undergrad ICQ gave us a more dynamic communications experience with video, audio, and text messaging capabilities mixed with file sharing, status messages and a host of other features.

Talking to the world: While all of these tools gave us the ability to communicate with other specific people, personal web pages (remember geocities?) followed by blogs gave us the ability to broadly communicate to an outside audience. YouTube, as great as it is, is just another example of a technology that lets people broadcast their content to others. Twitter also falls in this category.

The World is Talking: Wiki technology gave us the ability to allow a group of people who don’t know each other the ability to create content together.

Coping with all of the talking: Just as fast as we have been learning how to create content, we have also been trying to cope with the exponential increase of it. Search engines like Google help us find content. When I became one of the first users of Friendster I remember viewing the application as a way to organize all of my friends blogs and email information. MySpace built on that model, and facebook is taking it even further. RSS feeds, and Sharethis combined with personal portals help us digest the content. Just as fast as we think we have this under control syndicators like feedburner, twitterfeed, and podcast ready help us distribute our content much more efficiently and add to the pile.

Generationally Speaking….
What makes this evolution of social media so interesting to me is the generational component to it. Advances in helping the professionals talk are being embraced by older Americans. A mere 17% of hulu users are between 18 and 34, while 47% are 55 and older. Meanwhile advances in talking to the world, and letting the world talk are being embraced by a substantially younger crowd, with 18-24 year olds dominating facebook, 54% of bloggers under 30, and 20-somethings dominating wikipedia. Different generations are viewing communication on the internet in very different ways.
Politically Speaking….
Barack Obama’s use of the internet has been universally lauded by the mainstream press, and for good reason. He has masterfully used the newer generation of media to get his message out, and then carried by younger Americans across the internet. Obama’s campaign uses ‘talk to each other’,’talk to the world’, and ‘coping technologies’ in amazingly complimentary ways (as did Ron Paul’s campaign which leveraged relatively small numbers of supporters into large impacts). What that means in practice is that the Obama campaign has been encouraging its supporters to produce their own content and distribute it. Some of the most talked about pieces of Obama media, like Obama Girl, Yes We Can, or the 1984 ad weren’t produced by the campaign. His campaign blog is full of open threads that allow his supporters to openly discuss anything the want.
Hillary takes the exact opposite approach. Hillary is using distribution mechanisms like her campaign website and YouTube to distribute her own content, remember her Sopranos parody? Her campaign blog is really a collection of articles and testimonials by her supporters. She is the professional, and she is talking.
John McCain has decided to corner the AdWords market, buying up adwords on Google. Simultaneously he has actively courted professional bloggers, believing they can influence media coverage. It’s an indirect route, and certainly less obvious than Hillary, but a “Professional Speaking” strategy to be sure.

And this leaves us where?
As a citizen, the different internet strategies gives me a lot of insight into which generation each candidate (or at least their staff) falls in to. As an investor, it means that I add a deographic lens to every social media play I look at. I automatically know that twitter is geared towards to a young but growing population, while Spotrunner is geared towards a large but declining market (I actually like spotrunner btw).

Maybe if people comment on this I might take these thoughts further

Kellogg is a great school, the best business school in the world according to many sources. One of the things that set Kellogg apart from other business school is our GIM program. The Global Initiative in Management brings groups of Kellogg students to every corner of the planet for a student run and organized trip to learn about foreign economies from global leaders during spring break. Unlike the vast majority of my class I did not go on GIM.

Like anyone obsessed with Venture Capital, I spent the first week of spring break meeting with VCs on Sand Hill Road. Kellogg setup meetings between 9 VC students and Scott Barkley, David Hornik, Tim Draper, Rory O’Driscoll, Peter Sonsini, Eric Young, Tod Francis, Steve Jurvetson, Asheem Chandna, and Winston Fu along with a visit to the MIT/Stanford Venture Lab. I then spent the second week of spring break working with Tim Krauskopf on behalf of Merrick Ventures on his latest startup (its somewhat stealthy, hence the lack of details).

I have to admit that I had more fun this week than on any previous traditional vacation. There is something about the excitement of talking to potential customers, setting up phone lines, hiring developers, and adjusting business models that puts a grin on my face. The energy I got from the office during the day only made me more excited about returning to Houston where I am going to be working in this kind of an environment ful-time. My evenings this week were filled with setting up this blog, joining twitter, reviewing presentations from SaasCon, optimizing the web-apps on my blackberry, reviewing the various OpenID standards, getting familiar with the content on VUZE, rationalizing my widgets on iGoogle, applying Vista Service Pack 1, and doing my laundry. I think I am averaging 4 hours of sleep a night and loving every moment of it.

I am slightly bummed that school starts on Monday. I haven’t felt this productive since the early days at ICI when I was building my team, winning customers, and helping establish us in the marketplace. The early days of a startup are like the first days of a new relationship. You are learning wonderful new things every day and can’t put away the giddy smile on your face. That goofy grin is the reason why I am devoting my career to entrepreneurs, I can’t think of a better place to be.

Today I was startled to get a bounce-back on a routine email to Randy Woelfel, Energy Director at the Houston Technology Center. Randy has accepted the COO role at Cereplast, a bio-plastic company in California.

I had the pleasure of helping Randy with the organization of the Energy Technology VC Conference, and saw first-hand how hard he worked for entrepreneurship in the city. At the end of the conference I remember hearing a popping noise and then seeing Randy pouring glasses of bubbly for all of the people who helped him through the event. Thats the kind of guy Randy is, fun and appreciative. I am sure he will do well in his current role.

Thanks for everything Randy and Good Luck!

Several people have asked me how to break into VC. That’s a tough question on many levels because there is no one recipe to get into the industry. Prominent VCs are former lawyers, entrepreneurs, CEOs, consultants, bankers, and engineers. But because so many people are asking I will try to answer the question. I’ll answer the question by walking through the skills necessary to be a good VC.  In my opinion a VC’s job is to make money for his/her limited partners by helping entrepreneurs succeed. To do this VCs have to make good investments in good companies. Let’s talk about identifying a good company first.  

Stealing liberally from Bret Maxwell, VCs assess a good company by assessing three criteria:

·         Market Risk: is there a market for this idea?

·         Technology Risk: is this service/product achievable?

·         Execution Risk: can this company pull off the business plan?

To answer the first question VCs need to have experience or deep domain connections within the industry in question. That means knowing enough about the domain to engage in a vigorous conversation about what customers in that industry really want and being able to test those assumptions by being able to call up friends within that industry. I personally spent some time today calling up potential customers for a startup to test theories about a startup venture. VCs also need to have a good handle on rival developments within the industry, which they can get from their personal knowledge of the space and through a variety of intelligence mechanisms.

To answer the second question a VC needs to be able to answer technical questions him/herself or have access to people who can through their network. This is where the engineer/ codernaut/scientist VCs really shine. One of the real problems with Cleantech investments these days is in assessing how many Nobel prize-worthy breakthroughs are really necessary for an idea to be feasible.

The last question is by far the most important, and is only really answerable after starting up a few businesses yourself. A VC needs to look at the startup team and decide if the talent and resources are really there to execute the hundreds of tasks required to launch and grow a new business. If the team can’t pull off those tasks alone, it’s the VCs job to provide suggestions for candidates to complete the team from his/her personal network.

Answering all of these questions can only tell you if you are investing in a good company. A VC still has to decide if he/she is making a good investment. Fortunately this is the easy part, and picked up using a few quick DCF or comps models which you can learn in any good MBA program.

To summarize my ideal VC candidate:

·         Industry experience at a major player to gain industry connections and market expertise

·         Startup experience within the domain to learn about execution risk

·         An MBA from a major school to gain a broad network and some modeling experience

Like I said though, there are many different ways to get into this industry, and strength in one area may compensate for weakness in another. Regardless of your qualifications, breaking into this industry is still extremely difficult which is best illustrated by a few shocking numbers:

·         There are only 798 Venture Firms in the US with around 3000 employees

·         In 2007 only 58 funds invested in 20 or more deals. My guess is that these investments were made by less than 500 VCs.

·         DFJ, the largest VC fund for the past three years in a row, only has 3 associates (although some are buried in the geography funds like me).

·         NEA, the second largest fund, only has 4 associates.

·         Most funds don’t have associates