Summation

A Second(ary) Chance for Venture Capital

note: the article below was first published yesterday in BusinessWeek -- please check it out.

Troubled VCs need to rethink how long they invest in startups; many should fund early and then sell to a secondary firm after a few years

There's plenty of fretting in Silicon Valley and beyond over the venture capital industry, how broken it has become, and what needs to be done about it. Proposed solutions abound, with some favoring a government bailout, others saying the ranks of venture capitalists need to be slashed dramatically, and some proposing the creation of a market where equity in startups is bought or sold like shares of publicly traded companies. Each has its merits and weaknesses.

But in my view, what's needed is a fundamental rethink in the way startups get backing. VCs need to take a fresh look at when they invest, and for how long. VCs and other investors that have expertise in early-stage companies ought to invest at the outset for a few years, but then sell to companies that specialize in—and have more to offer—more mature companies. To understand why this approach makes sense, consider the shortcomings of the existing model.

Currently, many investors buy stakes early on and then add to those investments in later years. For instance, a typical early-stage firm might invest $3 million to $5 million in what's known as an A or B round. Then over the life of a startup, they'll put in another $3 million to $5 million to maintain their share of ownership and the rights that come with it. The model has been sacrosanct for the past 30 years.

A 10-Year Life But the wait for an exit, through an initial share sale or a buyout, can take a decade from the time of the A round. Remember that most VCs have a "life" of about 10 years. And if, say, a VC invests in a company in year three of its fund, there's a good chance the firm will be managing the investment past the life of the fund.

What's more, the time to exit is getting longer, not shorter. Companies like YouTube, purchased by Google (GOOG) for $1.65 billion less than two years after it was founded, are rare. In the future, big wins will more closely resemble Zappos, an online apparel retailer. Zappos is incredibly well run, and all VCs wish it were in their portfolio. But Zappos is having its 10-year anniversary this year, and it might be another few years before its exit.

Longer waits are bad not just for the VC calculating the return on investment (ROI). They also result in impatience on the part of limited partners such as university endowments that invest in venture firms. It's also demoralizing for individual venture capitalists. There are many well-regarded VC partners that have never had an exit. Some venture capitalists are leaving the profession altogether and firms are shrinking.

Here's where secondary VCs can play a vital role. These firms, most of which did not exist 10 years ago, specialize in buying stakes in private companies from VC firms. Some examples include Saints Ventures and W Capital Partners, which are among the most successful firms this decade. Secondary firms now account for roughly 3% of the VC market, but their clout is increasing as they do more deals. San Francisco-based Saints now has more A-list portfolio companies than most traditional VC firms. Its investments include Facebook, eHarmony, and QuinStreet.

Increased Return It helps that increasingly, many VCs are open to selling their positions to secondary firms. While selling early will lessen the long-term value of investments that become hits, it could increase a VC's actual return on investment by letting them realize returns much faster—say, three years rather than 10 years.

What's more, increased dependence on secondary investors will let VC partners focus on what they do best. Different skills are required for an A-round investor than for a late-stage investor. A venture capital firm should deliver and focus on its core competency and move on. Just like startups change CEOs as they mature, shouldn't companies change VCs as they mature? If there is a good startup CEO, shouldn't there also be good startup VCs? Some people can take a company from startup idea to billion-dollar business, but most need to be replaced along the way—this is true for both management teams and board members.

Early-stage VCs could focus on early-stage issues and later-stage VCs could focus on later-stage issues. Their investing timelines could be shorter, they can better plan for the future, and they'll need to keep less undeployed capital, or "dry powder," on reserve. They'll probably also do more deals.

My guess is that firms that invest in an A round might not necessarily invest in the B round. Instead, they might look to unload some or all of their shares in the C round.

Take Gains Early

I know a few angels who already follow this model. One sold half his interest to a particular VC in the C round and later sold the rest of his interest to that same VC. He made about 250% in three years. That's not bad—especially when compared with the current market. Sure, he may miss a big pop in share price. But he's become a very successful investor through his strategy of taking gains early.

Why don't more VCs and angels follow this strategy? As an angel, I have a lot of good advice for a company that's just getting off the ground, but if I'm intellectually honest, I don't usually add much value after the second venture round. Still, I haven't followed the model I outline here. Maybe it's time I should.

you could be a part-time model (but still keep your normal job)

my brother, Jonathan Hoffman (yes, he got the normal first name), turned me on to this fantastic video:

Popularity of Michael Jackson and three other rock stars

Here is an interesting study from Rapleaf on the popularity of the four biggest pop stars on social media BEFORE the death of Michael Jackson.

Popularity and fan demographics of Michael Jackson, The Beatles, Elvis, and Madonna across social media.

group dinners and collecting money

If you go to dinner wit 6 people or more, you're in for an interesting lesson in utility, economics, and social convention. Here are some random thoughts:

Some people at group dinners are always takers while others are always givers. If you don't drink much wine, you're a giver. Because the check is pretty much always divided equally and wine is often one of the biggest expenses. Also, if you're not a big eater, then you are a giver. And, if you often pass on dessert, then you're definitely a giver.

Givers subsidize takers.

And what about the etiquette of ordering something expensive? I was out with 5 other people at a technology conference when one of the people (a former MySpace Europe executive) ordered a bottle of champagne. Not being much of a drinker, I had a few sips and gave the rest of my glass to the guy that ordered it. None of us thought much about it and when the check came, the guy calmly collected all our credit cards and gave them to the waiter. Not until after they were all charged did he disclose that he had ordered a $3000 bottle of champagne ($600/person). One of the people who was with us started crying.

And collecting money is always interesting. There are some friends that when I collect money, I'm somehow down an additional $50. there are other friends where I am somehow up and additional $50. (I prefer hanging with the latter). this is especially true when people leave early. Some people overpay and others underpay.

I was at a group dinner recently with Mark Pincus (CEO of Zynga). Mark had to leave early and left $100 (the dinner came out to $60 ... I still owe Mark the extra $40). Mark is a good example of a giver. This week I was at another dinner when another CEO (who will remain nameless) had to leave early. He left $17 (why seventeen??) and the dinner came out to about $50/person (we won't be inviting that guy to dinner again).

stats on getting enineering dev offer at Rapleaf

Here are some interesting stats from our recruiting process:

• 1/4 of resumes to Rapleaf get the go-ahead for online interview
• 1/8 pass on the online interview
• 1/5 pass first round engineering phone screen
• 1/2 pass second round with VP Engineering
• 1/2 pass full in-house interview and get offers.

so out of every 1,000 resumes we get, roughly 1-2 get offers.  

FW: Clear to Cease Operations

I got this message today from Clear. It was a good idea but ultimately doomed to failure...

I wonder if they will ever refund me :(

-----Original Message----- From: Clear Customer Service [mailto:clearsupport@flyclear.com]
Sent: Monday, June 22, 2009 7:44 PM To: auren
Subject: Clear to Cease Operations

Clear to Cease Operations

Dear Auren Hoffman,

At 11:00 p.m. PST today, Clear will cease operations. Clear's parent company, Verified Identity Pass, Inc. has been unable to negotiate an agreement with its senior creditor to continue operations.

After today, Clear lanes will be unavailable.

Sincerely, Clear Customer Support

most common names on Facebook

Here is a study we did on Rapleaf on the most common first names, last names, and full names on Facebook.   the results are very surprising:

http://blog.rapleaf.com/rapleaf-study-most-common-first-last-and-full-names-on-facebook/

Everything you learn in college is wrong

In college, they teach you to use big words to make things sound important. If you are writing in college about the problems at GM, Ford, and Toyota, you'd write about the "automotive industry." Today, you'd make it simple and talk about "car companies."

In college you need to double space everything. Why was double-spacing so important back then and so never-seen today?

In college, they teach you to dress up for work and dress down for social gatherings. In the real world, you dress down for work and dress up for social gatherings. (In the one business class I took in college, they taught us how to wear a suit to do the presentation. In the 13 years since then, I have yet to ever wear a suit for work.)

In college they teach you to write papers for your professor. In the world, you need to write documents for everyone.

In college, longer papers are better. In the real world, shorter is always better.

In college, grammar is really important. In the real world, people just don't care.

In college, they give students little autonomy over their destiny. The administration often sets the rules with little regard to students. In the real world ... well, it is the same.

In college, you learn how to consume massive amounts of beer and try to find romance. In the real world, people consume massive amounts of wine and try to find romance.

In college you eat huge amounts of instant noodles and cereal. In the real world, you spend your entire paycheck on Whole Foods and tofu.

In college, you spend all your time on Facebook. In the real world, you spend all your time talking about Facebook.

productivity tip: Always schedule meetings that last an hour

Even when I have a quick call on my calendar, I always try to block off an hour.

That does a few things:

First - if the person is late to the call (I try never to be late ... more on that below) ... then you can still talk to the person and not reschedule.

Second -- You'll never have more than 10 meetings scheduled in a day. Which is important for your sanity.

Third -- you will also have lots of opportunities to carry out your microtasks (like keeping up on email) throughout the day - because if your meeting only lasts 20 minutes (which is the avg length of my phone meetings), you'll have another 40 minutes for tasks, meeting follow-ups, etc.

Fourth - you won't be late for meetings and you'll be able to respect other's time as you would want them to respect yours.

light and happiness

getting access to sunshine and light leads to happier people. if you can, try walking to work (or get a sunroof for your car)

Productivity gains in software engineering are powering innovation

Engineers are the best deal – so stock up on them

Everyone is more productive these days. This has been a consistent trend for at least the past decade, where productivity gains have been particularly strong within the business sector.  According to data from the U.S. Bureau of Labor Statistics, today’s business industry workers are on average 30% more productive than their 1998 counterparts (productivity growth of roughly 2.6% per year).

 
(Source: U.S. Bureau of Labor Statistics)

Within the technology industry, productivity has increased more.  Thanks to smartphones, improved search engines, better CRM software, and ever-increasing bandwidth, salesmen and marketers can find, receive and process information faster than ever. 

The most dramatic gains, however, have occurred within software development.

Software engineers today are about 200-400% more productive than software engineers were 10 years ago because of open source software, better programming tools, common libraries, easier access to information, better education, and other factors. This means that one engineer today can do what 3-5 people did in 1999!

The advent of open source software makes engineers particularly efficient.  One VP Engineering that I talked to gave me an anecdote about one module where they used open source files with about 500,000 lines of code and then wrote 7,000 lines of code to stitch it all together.  Open source software is also free.  In the company I was running in 1999, “software” was a huge budget line item – we had to buy databases, testing suites, libraries, and more.  Today all that stuff is free … a start-up might spend more money on sodas for the office than it does on software. 


We’re all familiar with Moore’s Law – that the power of computers doubles every 18 months.  In my 15 years of software development, I’ve seen 5x-10x productivity gains in engineers.  Which could mean that the productivity of a well-trained engineer doubles every five years.  (note that this Law is much harder to prove than Moore’s Law – but potentially just as profound).  That would mean that the productivity of an engineer is growing at roughly 14.9% per year!  That’s fast ... really fast ... much faster than the 2.6% yearly gains the population as a whole is making. 


This means that today’s companies are able to do more software engineering and build more stuff with fewer people.  But should they do more with less? It could be much more prudent for a company, especially for a small company, to do the opposite ... and to double-down on engineering.  You can use the productivity gains in software development as a strategic advantage and invest aggressively in engineers. First, doing so contributes the most to progress and also increases the chance for breakthroughs in innovation. Second, engineers – as opposed to salesmen and marketers – can often hit the ground running (assuming you have a good on-boarding system) and have a positive impact within a few weeks. 

Alternatively, many large traditional companies might be able to get by with FEWER but DIFFERENT engineers.  These companies might need to change their approach to engineering to take advantage of the new tools.  The companies that can benefit from fewer engineers are likely ones that haven’t changed their technology platforms radically in the last ten years.


Although engineers contribute more to an organization than ever before, their pay – relative to other functions in a company – hasn’t followed suit.  I’ve polled a few dozen companies and have found that over the last ten years, an engineer’s pay has held the same relative salary to marketing and sales.  This is odd behavior … usually when something outputs more, its cost goes up.  So why have engineers’ wages in the U.S. stayed constant relative to salespeople and marketers?  Here are two contributing factors that lower demand:

1.    Off-shoring.  Because of new technology and higher bandwidth, more companies are off-shoring their software development.  But this does not fully explain the flat salary phenomenon since firms are also off-shoring sales and marketing (though to a lesser degree).

2.    Need for software engineers has decreased.  Because software engineers are so much more productive than they were ten years ago, many firms are opting to hire fewer of them.  If a company is not doing hard-core engineering, it actually needs fewer engineers as a portion of its total workforce than it did ten years ago.  (I personally think this could be a big mistake … but I will get to that later). 

Both the off-shoring and the decreased need for engineers has led to a lowering of the demand which has likely put a check on wages. 
 
One problem, of course, is that measuring “output” of an engineer is a really hard thing to do (as opposed to the output of a salesperson) … so it is really hard to quantify the productivity gains.  And even if you can measure output in engineering, it is sometimes hard to tie that to an increase in profitability.

And, like sales, the quality of engineers varies wildly.  A great engineer is potentially 2-4 times more productive than a good engineer.  Ben Ling from Google pointed out to me that some great engineers are massively compensated – because they tend to be the early hires at a company and get lots of stock (most of Google’s first 50 employees were engineers). 

Let’s recap:  The productivity of a software engineer has increased 2-3 times that of a marketing person in the last ten years.  Yet their relative compensation has remained about the same.  That means if you are a savvy company, you should stock up on engineers.  In fact, you would want as many great engineers as you can get a hold of. 

This engineering productivity boom will only increase and continue to create dislocation and creative destruction.  While the extent of growth and industry makeover are hard to gauge, what is certain is that corporations relying on technology and engineering paradigms from the 1990s or before will find themselves hard-pressed to compete with the new and nimble movers. 



(special thanks to Jonathan Hoffman, Michael Hsu, Ben Ling, Jeremy Lizt, Naghi Prasad, and Dave Selinger for their feedback and edits).

solving California's political crisis by making elections more non-partisan

One way for a state to start to solve its problems is to become a little less partisan. Too often politicians are cornered by their party label and have trouble looking beyond that for solutions. This is especially true in some of the biggest issues of our time: education, budgetary matters, fiscal controls, and investing for our future.

One way for California to make lawmaking more optimal that is to make all races for office non-partisan. That means that no party label (like "Democrat" or "Republican") will be allowed n the ballot. That way races become more competitive and the people will look to solve problems more rather than be anchored by their party.

This isn't the be-all end-all solution. California cities (which generally do not let candidates declare their party on the ballot) are not the panacea of collaboration and success ... But with all the party pressure state-wide, having office-holders be a tad less partisan might be a big plus.

A Summation food for thought ...

on search engines, bigger is still better (yes, size matters)

If you look at the top three search engines - Google, Yahoo, and Bing - all of them deliver very good search results. All are very impressive. And all do a good job with making search relevant and delivering results.

If you actually play with all three search engines, you'll find that Google does not do a better job of getting the most relevant results in the top three. In fact, often Google does a worse job than Yahoo or Bing.

But what Google and Yahoo do better is sheer scale and size. Google's index and Yahoo's index are MUCH larger than Bing's. my guess is that it could be ten times bigger. That means that Yahoo and Google will likely have much better results for longer tail (or more specific) searches.

For instance, as of today, Google has indexed 413 million pages on Facebook. Yahoo was indexed 214 million pages on Facebook. And Bing has indexed 125 million pages (even though Microsoft is Facebook's search partner).

For MySpace: Google (229 million); Yahoo (149 million); Bing (6.15 million)
For Typepad: Google (4.3 million); Yahoo (11.7 million); Bing (190 k)
For Friendfeed: Google (5.67 million); Yahoo (14.73 million); Bing (86 k)
For Lefora: Google (265 K); Yahoo (450 k); Bing (22 k) For GoodRec: Google (218,000); Yahoo (3,348); Bing (16,400)

After using the Yahoo search engine for the last few months, I personally think it gives the best results ... but it likely doesn't have the breadth of Google yet. Bing/Microsoft still has a long way to go (but they are on the right track).

what are best questions to ask references of people you are interviewing?

I recently asked the question "what are best questions to ask references of people you are interviewing?" over Facebook, LinkedIn, and Twitter and here are some of the responses I got:

AS:
"If you were in my shoes, would you hire this person?"

RF:
What advice would you give me as a future manager this person?

ET:
What are the major accomplishments of the candidate? Are there any areas that are development opportunities for the candidate?

SV:
Based on what you know of this person's desires and capabilities, what do you see him/her doing in 3-5 years?

AC:
(other than making sure to contact references other than the ones they gave you) - how about "do you trust this person's integrity, capacity, and intellectual curiosity?"

MC:
does he know if he has 5 pairs of white socks and 5 pairs of black socks, and he HAS to get dressed in the dark... how many socks does he have to pick to actually find a pair?

or just, would you work with this person again???

SM:
Are you friends outside of the work?

LK:
Why do you no longer work together? And how come you haven't hired him/her already.

MY:
is there anything else that I should know about so and so.. last question.. the truth comes out usually if they have been lying..

SP:
I'll pay you $500 if you save me from not hiring this person. A great person will have sufficiently impressed that reference so that they would reject this.

AM:
What kind of a drunk is he/she?

JT:
i always ask if the reference would hire that person again to work directly for them. usually gets a good response.

book conversations and the imposition of the Kindle

Today I was reading a real live book at a café. Normally I only read books available on the kindle but I was reading the "Evolution of God" by Robert Wright (because the book itself does not come out officially until next week). Great book.

But the point is that two random people came up to me in the café and asked me about the book and we had a conversation about religion, good books, and more. Now I frequently get people asking me about the kindle ... but that is a more common technology conversation. Here we had a real conversation about real ideas.

I did that the other day when I saw someone reading Atlas Shrugged on an airplane. But as we all move to reading books on our devices, we wont know what people in our proximity are reading anymore and conversations between strangers will go down. (maybe this is happening anyway as you're much less likely to talk to someone with headphones in their ear).

stockpicking and wine experts -- the Emporer still has few cloths

squarely in the Nassim Taleb camp (sometimes known as the Emperor-has-no-cloths camp) is an article forwarded to me from Fabrice Grinda and written by my friend Ramit Sethi about wine tasters and stock pickers.   excerpt:

If I invited you to a blind taste test of a $12 wine versus a $1,200 wine, could you tell the difference? I bet you $20 you couldn’t. In 2001, Frederic Brochet, a researcher at the University of Bordeaux, ran a study that sent shock waves through the wine industry. Determined to understand how wine drinkers decided which wines they liked, he invited fifty-seven recognized experts to evaluate two wines: one red, one white.

After tasting the two wines, the experts described the red wine as intense, deep, and spicy—words commonly used to describe red wines. The white was described in equally standard terms: lively, fresh, and floral. But what none of these experts picked up on was that the two wines were exactly the same wine. Even more damning, the wines  were actually both white wine—the “red wine” had been colored with food coloring.

Think about that for a second. Fifty-seven wine experts couldn’t even tell they were drinking two identical wines.