Don Dodge on The Next Big Thing

Madonna and Radiohead dump record labels and go direct

Back in my Napster days there were several big name artists interested in working with Napster to sell their music directly to customers. They were tired of giving up the vast majority of their CD sales to the big record labels. Even the most successful music acts only got about $1 from every $20 CD sale.

Those artists who wanted to work with Napster were still under contract to the big labels. As soon as their contract expired they wanted to go direct with Napster and sell their music for $1 per song...a lot better that $1 per CD. Madonna, Green Day, Limp Bizkit, MC Hammer, Courtney Love, and several other artists talked to Napster about doing a distribution deal.

TechCrunch says "And the walls came tumbling down: Madonna dumps the record industry"  Madonna announced that she will not renew her contract with Warner Brothers. Last week, Nine Inch Nails announced that they would do the same thing. British music group Radiohead has taken the unusual approach of allowing their fans to buy their music direct and pay whatever they feel it is worth.

Napster was too far ahead of its time. See my earlier post Napster, The Inside Story, for more behind the scenes details. Napster wanted to be what iTunes is today, the online distribution site for all music. We wanted to discover new artists and target them to the users who enjoyed their genre of music. We wanted to work with big name artists who were ready to leave the big record labels. Unfortunately, we got sued out of existence before we could make it happen.

Today the world has changed, partly due to what we did at Napster. Today artists have the opportunity to take their music directly to the public. They don't need the record labels. The opportunity was always there, but the announcements from Madonna, Radiohead, Nine Inch Nails, and others makes the vision a reality.

Will the record labels adapt? Or will they continue to sue their customers and take advantage of their artists? They still have time to adapt, but I think I know how this story will end. If you are an investor...go short on music companies.

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TechStars in Boulder

TechStars is an entrepreneur boot camp similar to Y-Combinator's twice annual boot camp. TechCrunch reviewed the TechStars program earlier this year. TechStars selected 10 teams from a pool of more than 300 submissions. They funded them with up to $15,000 per team, provide office space, operational support, and mentorship from former entrepreneurs and business leaders. TechStars takes a 5% equity position in each company.

The teams moved to Boulder for the 3 month summer session. They work together in a large open office with each team working around a table of 2 to 4 people. There is lots of collaboration between the teams and evening group sessions several times a week. I was there earlier this week with Dan'l Lewin, Corp VP of Microsoft, and my colleague Dave Drach from the Emerging Business Team.

TechStars is the brainchild of Brad Feld, David Cohen, Jared Polis, and David Brown. They provided the money, offices, and mentor support for the companies.

The TechStars companies are all quite interesting. Here is a quick review of a few of the startups;

StickyNotes - A post-it-note type app for Facebook. One of the top 50 Facebook apps, over 250,000 users signed up in just two weeks.

IntenseDebate - A way to track and manage blog comments. It includes a reputation ranking system and usage statistics.

SocialThing - A way to consolidate all your digital content; blogs, photos, music, friends, links, in one place. Leverages the content on existing social sites and provides a layer of functionality on top of them.

MadKast - A new way to share (push) blog posts with friends. It is a widget that can be placed on a blog to allow readers to send the blog post to friends in their network.

BrightKite - Notifications via email, IM or SMS. The notifications are all about location or what they call "place-streaming". Streaming content about a "place" from a "place". It could be used for conferences, events, or public places.

EventVue - Social networking for conferences and trade shows. Allows attendees to find each other and network during and after the conference. In private beta.

I will check back with these companies at the end of the summer to see how much progress they have made. There is a very good chance that several of these startups will move up to the next level and be ready for seed stage funding.

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VC and Angel funding - How much is too much?

Marc Andreessen has a blog post about raising Venture Capital money, and the dangers of raising too little, or too much money. Marc believes you should raise as much money as you can, and then talk and act as if you raised too little. Good advice.

I have found significant differences in raising money from VCs versus Angels. Raising money typically falls into distinct stages.

Seed Stage -  Seed Stage is "idea stage" meaning pre-revenue, pre-product, and many times even pre-demo. Friends and Family normally fund the Seed Stage. Some Angels will jump in here but only if they know you, or the business, very well.

Startup Stage - At Startup Stage you have a demonstrable product, some beta users, and maybe even a little revenue. The product is not complete, the revenue model is untested, and the team is in the embryonic stage. Angels will jump in at this stage and fund between $500K and $2M. They may give you the money in several installments based on meeting milestones like shipping V1.0, converting some number of beta users into customers, or hiring your first sales person. Some VCs will do Startup Stage funding but typically only if they know you from a prior company, or the VC knows the business segment from a prior life.

First Round Funding - Most VCs want to get involved when the company has a product, a significant number of users, early adopter customers, and a proven revenue model. They like to be the first "institutional" money in the deal, and dictate the terms of the Series A investment. They want the Friends & Family and Angels to hold convertible notes with little or no conversion preferences or warrants. VCs like to invest $2M to $10M in the first round.

How much should you raise, and who should you raise it from? It really depends on the stage of your company described above. This is the single most important thing to remember when raising money, always raise as much money as you can at each stage. You will never look more attractive to investors than you do right now...regardless of stage. Huh? What do you mean? I mean, don't try to raise Seed Stage money twice. You will never look more attractive to F&F investors than you do right now. Don't try to raise Angel money in two rounds. Raise as much as you can from Angels in one round at that stage.

Raising money is very time consuming, and sometimes depressing. It takes precious time away from building your business. Put the time in to raise all the money you will need to get to the next stage, and then get back to work.

How much is too much? Yes, you can raise too much. But take Marc Andreessen's advice; raise too much and then think, talk, and act, like you raised too little. Many startups fail because they raised too much money and start acting like they have it made. They don't. I once worked for a startup that raised so much money they were making charitable donations before they were even cash flow positive. Crazy! Here are Marc's points on the danger of raising too much money;

• Dilution - raising too much money causes equity dilution at low valuation points.
• Liquidation Preferences - these preferences can significantly raise the price necessary for a profitable exit via M&A or IPO.
• Cultural Erosion - Too much money makes a startup lose that hungry attitude. As Marc says "a culture of complacency, laziness, and arrogance."
• Hiring too many people - It is easy to hire too many people when you are sitting on a pile of cash. Until you are cash flow positive the CEO should personally justify every single hire.

How much is too little? The simple answer is if you need to raise money again before you reach the next funding stage...you have raised too little. Don't stop fund raising until you have reached your goal. Accept more money over your goal if it is there at the same terms and conditions. Don't worry about giving up too much equity at an early stage. If the company is successful you will be very rich. If it isn't successful then holding 60% versus 30% won't matter anyway.

Most companies fail because they raised too little money...not because they raised too much. Of course most companies fail for reasons that have nothing to do with money. Just buy yourself some "insurance" and "run way" by raising plenty of money from all your sources at each stage.

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Tech vision blurs after 30- Dave Winer vs Fred Wilson

Ask any eye doctor and they will tell you people start to lose their vision in their late 30s and need reading glasses by 40. It is true in technology too. Dave Winer disagrees with Fred Wilson on this. Technology visionaries lose their "vision", but not their brains, by the time they hit 40.

There are rare exceptions. Steve Jobs comes to mind. But if you look at the most innovative startups today, or even 20 years ago, they were mostly started by people in their 20s. Facebook, MySpace, YouTube, Google, and lots of others were started by "20-somethings". Back in the Web 1.0 era, Netscape, Napster, Paypal, Amazon, and many others were again, started by "20-somethings". And way back when...Apple, Microsoft, Sun, Lotus, and many others were started by "20-somethings". It is hard to remember a significant "new vision"startup that was started by someone in their 40s.

Young people have vision for what is possible, and are not blinded by "knowledge" of what is not possible. Young people are great at starting things, but in most cases, not so good at building big businesses. There are of course exceptions here too. Steve Jobs, Bill Gates, Scott McNealy, Mitch Kapoor, and a few others were great visionaries AND good at building large sustainable businesses.

Older, more experienced people ( I am an old guy) are typically better at taking a startup idea and building it into a business. Older people are great at understanding the potential of "paradigm shifts", but not great at seeing them beforehand. Just as our eyesight fails us in our late 30s and 40s, our vision, or ability to see and predict the future also fades. Once a young visionary brings the idea into focus, us older guys quickly understand the implications and how to capitalize on it.

Don't get upset about it. It is just the natural order of things. Yes there are exceptions. Fred Wilson, and most VCs, are just watching the trends...and they are pretty clear. Investors are looking for companies with young technical visionaries supported by older business and marketing guys. That is a winning combination.

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Red Herring coming to Boston June 26-28

I have been a Red Herring reader since 1993 so it was a real treat to be invited to speak at the upcoming Red Herring conference on Innovation and Opportunity. Red Herring East 2007 will be held at the Hyatt Harborside Hotel in Boston, June 26 through the 28th.

Red Herring has assembled an all-star cast of speakers including; Jim Lanzone, CEO, Ask.com, Dixon Doll from Doll Capital, Marshall Phelps, Corporate VP, Intellectual Property at Microsoft, and Alan Spoon, Managing Partner at Polaris Ventures.

The agenda covers innovation, entrepreneurship, venture capital, Web 3.0,  web search futures, Advertising 3.0, Killer Apps in Mobile, M&A, and other topics.

The agenda covers all the usual topics, but the speakers really make the conference. Several sessions are interview style where a Red Herring editor will interview a panel of industry experts on the topic.

You can sign up for the conference here. Please stop by and say hello. I would like to meet as many of you as possible. 

Angel Capital Association Summit - Angels invest $26B in 2006

The Angel Capital Association is holding its annual meeting in Chicago this week with over 330 angel investors from around the country (USA) representing more than 250 angel groups. Angel investing is big. In fact, angels have invested more dollars in more startups than VCs over the past 4 years.

Angels invest just like VCs except they do smaller investments $200K to $2M and they do about 10 times as many deals. However, Angels have the same investment criteria and expectations of significant returns. The "average" angel group makes 8 investments per year for a total of about $1.8M. The average deal size (seed stage) is about $250K.

The larger angel groups in Silicon Valley and Boston do significantly more deals and invest between $350K and $600K per round, and maybe $1.5M to $2M per company.

James Geshwiler, Managing Director of Common Angels in Boston, provided this profile of the Common Angels;

• Currently 66 Members and 130 investors in the CA network
• Most members are founders, CEOs of tech companies
• Common Angels members currently serve on more than 80 Public, Private boards (ie., large market reach)
• Members are expected to invest $50K-100K/year in at least two companies, make at least 1/2 the meetings, participate in diligence & sit on boards
• $10M Co-investment Funds + $30M in capital from our members ='s $40M investment plan over next 4-5 years.
• Investment strategy: target the "capital gap" and back new areas of technology
• Typically invest $8-10M/year in 4-6 new companies & as many follow-ons
• Invest $500K-$1M in the first round; 2-3x over life of company
• Seek $2M-3M Series A typically & <$20M over life of company
• Funded 33 companies; with >$37M from CA + >$100M from co-investors (ie., when we invest, it's very likely to have VC $ at the same time or after)
• We lead 3/4th of our investments.Those investments have generated >$200M in liquidity.

Average returns in Angel Capital are similar to average returns in Venture Capital. Meaning, the top quartile of angels or VCs do very well, the second quartile does OK, and the bottom half lose money. Angels and VCs understand this is a high risk game.

The Angel Capital Association did a survey of its members and got data on 590 deals that achieved an "exit".

• 47% lost money
• 26% returned 1X to 4X multiples
• 15% returned 4 to 6 times their investment
• 8% returned 6 to 30 times
• 4% returned 30X or more

Luis Villalobos of TechCoast Angels has been angel investing for 10 years. Their returns were better than average. Luis said the average for 10 deals is;

• 30% are a total loss
• 20% - will lose about 50% of your investment
• 30% - get a 3X return
• 10% - return 10X
• 10% return 30X plus
• Overall average expected return is 4.8 times investment.

I suspect that VC portfolio investments follow a similar pattern. One big winner can cover lots of losers. Angels do 10 times as many deals as VCs, but on average the success rate is about the same.

Other interesting factoids from the Angel survey;

• 40% of investments are seed stage = pre-product and pre-revenue
• 40% of deals are "start-up stage" = revenues of less than $150K
• Fail fast - Failed investments were held for 2 years before dying
• Exits normally happen within 5 years

Jean Hammond from Hub Angels presented some interesting data on IPOs in 2006.

• Average market cap $165M
• Amount raised $42M
• Last Quarter revenues Annualized $46M
• Price to Sales multiple - 2.7X
• 56% of Nasdaq companies have a market cap of less than $300M

The Toronto Stock Exchange did a presentation on listing profiles and alternative financing vehicles. The TSX is very innovative and is making a huge market in small IPOs. They have something called the TSX Venture Exchange for small start-ups to gain some liquidity. The TSX profile;

• 270 IPOs last year
• $3M is the average amount raised
• $26M is the average market cap after one year
• Average revenues are $5M with a forecast to $9M, and then $13M
• Many of the Venture Exchange companies graduate to the TSX
• Average TSX market Cap is $143M

Boston has around 20 Angel Capital groups. Some of those in attendance included; Beacon Angels, Boston Harbor Angels, Common Angels, eCoast Angels, Hub Angels, and Launchpad. See the Angel Capital Association site for leads to angel groups in other parts of the country.

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Widgets - The Remora Business Model - Photobucket and MyBlogLog figured it out

BusinessWeek has a story "Sharing the Widget Wealth" that talks about the effect of widgets on social networks like Friendster, Facebook, and Bebo.

Widgets like Photobucket, MyBlogLog, Lijit, and others ride like a Remora on the wave of social networks. Photobucket attracted millions of users and was recently acquired by its "host" MySpace for about $250 million. MyBlogLog is a cool widget that rides on many different blog "hosts" and was recently acquired by Yahoo (NASDAQ: YHOO)  for about $10 million.

I use MyBlogLog on my blog for free. I have no idea how they make money...no advertising that I can see. MyBlogLog is that widget on the right sidebar that shows the pictures of registered users who have recently visited my blog. Pretty cool, but I wouldn't pay money for it.

Lijit Wijit for search. Starting today I am using Lijit for searching my blog. My friend Brad Feld invested in the company and suggested I try it. I have tested it out and it works great. The installation was simple, automatic, and flawless. I was up and running in a few minutes. Lijit uses Google Custom Search (NASDAQ: GOOG) to build a custom search "Wijit" just for your blog. They also provide some really cool statistics to show you what readers are searching for. Very interesting! Try Lijit and let me know what you think.

What is the business model? Free services layered on top of other free services doesn't seem to be a very compelling business model to me. But...some of these services are getting acquired for big bucks...so there you go. I guess I don't yet understand all the nuances of the Remora Business Model. But, if Brad Feld is investing in it...there is money to be made somewhere.

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The worst Billion dollar Internet acquisitions

There were lots of bad acquisitions so it is hard to keep the list to just ten. But, here are my nominations for the worst Internet acquisitions of all time.  To get on my list the acquisition must be at least a Billion dollars, must have disappeared from view or lost the market share race, and must have been acquired at least 18 months ago. It takes a while to really know if an acquisition was a success or failure.

10. Mapquest - AOL acquired MapQuest for $1.1B in December of 1999. A nice service but worth $1.1B? I actually like MapQuest and it has decent market share but I couldn't find another billion dollar acquisition that looked worse. Any ideas?

9. Ask Jeeves – IAC/Interactive Corp acquires Ask Jeeves for $1.85 Billion in March 2005. Less than 4% market share and losing ground to Google. AskJeeves definitely has value but it is hard to justify the nearly $2B price tag.

8. Overture - Acquired by Yahoo for $1.6B in October 2003. Yahoo has spent the last year of so building "Panama" which will replace most of the Overture technology. There is some value left in Overture...but not much.

7. AltaVista - CMGI acquired a controlling stake in AltaVista from Compaq Computer for $2.3 Billion in June 1999. Later acquired by Overture for $140M.

6. GeoCities - acquired by Yahoo! in May 1999 for $3.56 billion

5. Netscape - acquired by AOL in November 1998 for $4.2 billion.

4. Broadcast.com - acquired by Yahoo! in July 1999 for $5.7 billion.

3. Excite - acquired by @Home in January 1999 for $6.7B

2. Lycos - acquired by Terra Networks for $12.5B in May 2000. Terra then sold Lycos to  Korean company just 4 years later for $95 million.

1. AOL - merged with TimeWarner in January 2000. AOL was valued at $160B. Today AOL is valued at about $20B, based on Google's investment of $1B for a 5% stake in AOL. Losing $140B of market value is really hard to do...almost unheard of. This is the number 1 worst Internet investment of all time.

Honorable mentions, but less than $1B;

Blue Mountain Cards $780M acquired by Excite

MySimon $700M acquired by C/Net

Too soon to tell;

Skype - acquired by eBay for $2.6B with performance bonuses that could push the total price to $4.1B. Huge price tag for a free VoIP service. My guess is that Skype will turn out to be a bad investment for eBay and eventually take a place on the Top 10 Worst Billion Dollar Internet Acquisitions.

YouTube - acquired by Google for $1.65B. Time will tell, but it looks very expensive right now.

MySpace - acquired by Fox Interactive for $580M. Too early to tell but this could turn out to be one of the BEST Internet acquisitions. A relatively low price for a really hot Internet property.

Tom O'Keefe maintains a pretty comprehensive list of Internet Acquisitions on the ResearchConnect.com site. I used this list in compiling my worst billion dollar acquisitions of all time.

What do you think? Are there other Billion dollar acquisition blunders? Would you rank them differently? Doesn't this make you wonder what happened to the executives that made these decisions? Only in America...

Conversations with Mark Cuban

Mark Cuban was a guest on "Conversations with Michael Eisner" tonight on CNBC. It was a very interesting show, starting with Ted Turner (Turner Broadcasting, CNN), Sumner Redstone (Viacom) on the show as well. I have had several conversations with Mark over the last several weeks. He is an incredibly bright, passionate, and funny guy.

Ted Turner started off the show talking about how he built TBS from nothing in the early days of cable TV. Turner built the first "super station" WTBS, and was one of the first cable TV entrepreneurs. Turner said he got rich buying all the companies that Eisner (ABC / Disney) passed over. Eisner passed on buying Hanna/Barbera the Saturday morning cartoon producer. Ted Turner bought it for $550M. Ted said others saw a library of cartoons, but Ted saw "The Cartoon Network" and decided Hanna/Barbera would be the basis of this new network he would build.

Turner and Cuban see things that the average person doesn't. I had a conversation with Mark a few weeks ago about the market value of YouTube and the legal issues. After Google acquired YouTube for $1.65B I sent Mark my financial analysis that pegged the value at about $600M.

Mark's sage response? "the thing about  valuing these companies is that its not about what they do now. Its about what their prospective buyers can turn them into. If they have some vision, maybe that price is cheap. If its just about doing business as is, maybe that price is expensive."

On High Definition TV Mark said "I looked at HD TV and I saw a PC. Everyone else looked at it and saw a $10K monstrosity that no one would buy."  "I just started working backwards in terms of bandwidth. If every TV network goes Hi Def, there is not enough bandwidth to go around. They just don't see it yet."

Mark Cuban is a visionary, but deep down he is just a passionate guy that loves to compete. Eisner compared Cuban to Sumner Redstone and said wouldn't you like to be in his place? Cuban said "No, I would rather build it than buy it...build it and go through the process. To me, the fun is...the sport of business. That is what I get into."

Sports and business are Mark Cuban's two passions. He does both at a very high level. Mark has plenty of money. It is all about the competition...and the fun.

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Tucows bought Kiko for good reasons

Tucows, the long time shareware site, bought Kiko, the web 2.0 calendar company for $258,100 on an eBay auction.  Tucows is also a domain name registrar and back office solutions provider for things like CRM and hosted email services. Kiko calendar will be integrated with their hosted email service.

In my earlier post about Kiko I said "Calendars are a feature, not a company. Not only are calendars just a feature, but they have only been successful when integrated with your email/communication system. I don't know of a single calendar product that is successful on a stand alone basis."

The Kiko purchase made sense for Tucows because they already had an email service but lacked a shared calendar. Perfect fit.

Elliot Noss of Tucows outlines their thought process for buying Kiko rather than building it themselves. It is a standard "time to market" and "reduced risk" argument and it makes a lot of sense for Tucows. In addition, the build versus buy cost equation  actually favored buying.

The interesting part of the analysis for me was his explanation of how different buyers would value the same company very differently depending on a few key factors.

1. If the founders / engineers were part of the Kiko package the price would have probably been 10 times the eventual $258K price. A different set of buyers would have been interested and paid a lot more if the founders were part of the package. However, Tucows would not have been interested at 10x the price.
2. The Kiko user base and name would be worth more to some buyers. Tucows didn't need the user base or the brand name. The lack of a large user base eliminated another set of buyers. Again, a big user base would have driven the price up to a point where it would not have made sense for Tucows.
3. Tucows figured it would take them 2 to 3 man years to build similar functionality, which is about what it took the Kiko guys to do it. Tucows fully burdened cost of engineering and management for 2 to 3  man years would have been more than $258K.

I would add that Kiko as a stand alone calendar company wasn't even worth $258K. But, integrated with an email service it was indeed worth the price.

The lesson for entrepreneurs here is to remember that your company has very different values to different sets of buyers. They all have very valid reasons for their valuation. Don't try to convince the wrong buyer to pay up for your company. Spend the time finding the right buyer where their is a good match in expectations, needs, and strategy. Then the price will make sense for all involved.