My friend Daniel (sorry no link – he’s not a blogger) pointed me to the BlogPulse 2005 Year in Review.  I particularly enjoyed the Top Wikipedia References (especially #5 – nice to see that Wikipedia made its own list).

Enjoy.

Last week’s news that CA purchased Wily Technologies for $375m reminded me of a working theory that I’ve had for a while (which generally seems to be supported by market experience over time), which is that there are generally two time frames in a company’s life where it can extract the most value from being acquired. Below is my version of the ‘exit value curve’ for a software/technology business where the x-axis is time and the y-axis is value:The drop in value should probably be a lot sharper after the initial euphoria phase (but this image took me long enough to produce and I didn’t want to redraw it), but the basic idea is that companies are generally most valuable to a potential acquirer right as the technology is proven and then again as the company reaches scale (certainly most valuable releative to the money  and time invested). The ‘technology proof’ phase is the time after a company has built an inital produc  and installed it in a handful of key accounts but before the company has started dreaming of its billion dollar IPO; realized how difficult it is to sell to non-early adopters; taken more venture money and  therefore raised the bar on their exit; hit a zero bookings quarter; shut their doors; etc. There’s a range her  that depends on the company, the time its taken to get to this stage and the money that’s gone into the business but generally I’m describing businesses that have real bookings, but   less than around $5m in revenue. The poster child in the last few years for a company being purchased in this stage was Appilog who was bought by Mercury for $49m, but more recent deals that fall into this category include a bunch of Web 2.0 companies bought by GYMAAAE (link from Brad) such as Truveo (by AOL) and del.icio.us (by Yahoo!). Then comes what Gartner would call the trough of disillusionment but what entrepreneurs would more likely call the long hard slog (this is the part of the graph that is circled). Plenty of businesses don’t even get to this phase and a lot who do find it an extremely hard place to be. This is the ‘prove it’ stage of the business – where you need to figure out how to scale every aspect of your company – starting with sales but including product delivery and development as well as support, marketing, etc. You’ve also probably taken a bunch more money (possibly an ‘expansion round’ but just as likely through an ‘inside financing’).  Your value in this stage probably goes down – certainly on a relative metric basis, but probably on an absolute basis as well. You’re trying to build a real business now and you’ve moved past the technology experiment stage and the euphoria of your initial PO’s and handful of first customers. You work hard to grow your business and have success at it, but scaling sales is harder than you thought and that great channel partner that really had promise didn’t pay off exactly as you’d hoped. If you’ve taken more money (say your Series C) you’ll find it harder to exit in this stage at a valuation that is attractive to both your investors and your team and instead may have to opt for seeing the business through to the next phase (or if you are forced to sell you will do so for a modest multiple of invested capital). If you execute well and stick with it, however, you may just emerge – as Wily did – on the other side of this slog. While running your business doesn’t exactly get easy, you now have real critical mass and market validation/adoption. Your revenues are well into the double digits and you’re probably cash flow positive even as you re-invest in your business to keep your growth up. The Wily deal is a good example of the kind of value that can be created for a business that reaches this stage of its growth. Teams and investors that stick with it are generally rewarded in this phase of their development with solid investment returns. Obviously there are plenty of variations to the story this graph shows, and different markets reward technological promise vs. customers in different ways. Along the same lines, different individuals, investors and management teams have varying views on what constitutes a good early exit or even a good later-stage exit and success will depend on a number of factors including a team’s ability to execute and the financing strategy employed to fund that execution.

I’ll write more on how this dynamic affects financing strategy in general and VC investing specifically in the next few days.

As always, your feedback is encouraged.

(thanks to Ross for the assist with Illustrator on the graph)

A friend of mine (and Stanford alum) proudly sent me the following link to the Stanford Engineering Puzzle (apparently a regular feature on their web site).  Despite neither going to Stanford, nor frankly having had any shot of even getting into the school should I have thought to apply, I found the puzzle rather amusing.

I think Macalester is the Stanford of the mid-west . . . or something like that.

Thanks to Chris for the link.

(ok – just spell-checked this and am humbled to let you know that Stanford is in the TypePad dictionary while Macalester is not)

As much time as VCs spend with our portfolio companies, it’s important to remember that our jobs are actually to see them move on to greener pastures. Of course working closely with these companies – often over several years – one can’t help but get attached to some of them. So it’s often with mixed emotion that I see companies move on to the next chapter in their lives. It’s the natural lifecycle of investing and is absolutely key to the performance of our jobs (performance which is measured solely by the amount of money we return to our LPs). Still, it’s a bummer to stop working on a daily basis with some of the great people that run these companies. Around the end of the year two companies with which I work closely were sold and I thought now would be a good time to acknowledge some of the great people who helped make these businesses successful (and whom I will miss working with). First, Xaffire was sold to Quest Software (no official announcement to point to, but the deal was closed recently and the Xaffire web site now lists them as a Quest company). I’ve referenced Dave Jilk a number of times in this blog (and he’s a frequent commenter to posts). I first met Dave when he interviewed me for my job at Mobius (he was at the time the CEO of a different portfolio company and prior to that had been an associate at Mobius). I’ve worked with Dave in varying capacities over the past 4+ years. I know I’llsee him frequently (we ski together often), but I’ll miss the day-to-day interaction with him.

In more public news, Commerce5 was sold just before the end of the year to Digital River. Commerce5 is a great example of an outstanding management team really sticking with a business through tuff times (the company is an outsource provider of e-commerce services) to create real business value. I got to know CEO Rob Hagen extremely well over the past 2 years – even staying at his house when I was out in Aliso Viejo. He, Jan Nugent, PJ Bellomo and Geoff VanHaeren are outstanding business leaders and fantastic people.

Congrats to these companies – I’ll miss them both.

I’m in the middle of writing a few posts on the economics of venture investing (actually on venture “exiting”) and was therefore pretty interested in the VentureWire 2005 venture m&a stats that came out last week (there were a bunch of articles recapping the 2005 venture exits if you want to Google for them). Here’s some of what was reported: – m&a dollar volume rose 17% to $27.4bn -ont-size: 7pt; line-height: normal; font-size-adjust: none; font-stretch: normal;”> the number of companies bought fell to 356 (from 407 last year) -ont-size: 7pt; line-height: normal; font-size-adjust: none; font-stretch: normal;”> IT companies accounted for $11.73bn of this amount across 221 companies So if you do the math, of the venture backed companies that were bought last year the average purchase price was about $77m. IT companies were lower than the total average, coming in at just over $53m per deal. VC’s spend plenty of time thinking about the exit dynamics of their businesses (thus my future posts on the subject) – it’s interesting to consider the dynamics of tech investing in a market with these kinds of exit profiles. Specifically, sometimes exit expectations don’t match the reality of the market – and these exits (driven by both reality and perception) have important ramifications on the dynamics of capital allocation, company valuations, financing strategies and other key principles of venture investing. It may not exactly be like the real estate market (where they say you make your money by how well you negotiate your initial investment), but optimizing your capital structure is more important than ever before in venture investing.

More on this topic in a series of posts this week. They span a few categories on this blog, so I’m going to put them all under a new title – Venture Economics.

I wrote a post last year about conveying information effectively in which I talked about how difficult it is for someone to guess a song that you are tapping out with a finger (but how easy is feels like it should be when you are the one doing the tapping).  Its a true phenomenon, although I meant it as a metaphor for (or perhaps just an example of) how easy it is for people to overestimate their ability to clearly communicate their thoughts/ideas with others.

The internet being what it is, however, someone has actually put together a website that lets you tap in a song with your keyboard while it tells you what song you are tapping.  Its designed for people who have a song stuck in their head but can’t remember what it is, although its pretty fun to play around with even if that doesn’t describe your current condition . . .

Thanks for Charlie for sending this to me.

I imagine you’ve noticed that I’ve been silent over the past few weeks – taking some time off from work and blogging over the holidays.Not to gloat (WARNING: I’m about to gloat), but Colorado is a great place to live. In the same two week period I was skiing in deep fresh powder (multiple times), snowshoeing and cross country skiing with amazing mountain vistas and (here’s the really great part) mountain biking (in shorts!).

Unbelievable. I love this place!

When I worked at Morgan Stanley there was a running debate among the analysts about whether it was better to be a good analyst or a bad analyst. The theory went that if you were a great analyst you were rewarded with more work (but not much more pay, given how few analysts actually made it to the “outstanding” category at bonus time) and if you were a mediocre or bad analyst you were passed over for projects and had a much much better lifestyle (i.e., you worked 60 hours a week instead of 90 or more). Banks never really fired analysts, so one could pretty easily coast by for the time of their indenture.My own views on this are pretty clear based on prior posts, but there were a handful of people I worked with who went the other route and were rewarded with a social life.

A recent article in the Times (link here, although there have been plenty of articles in the news in the past months on similar topics) got me thinking about how often companies reward failure – sometimes in obvious ways, in the case of large severance payments for failed execs or big bonus payments for execs to work a company through bankruptcy – the same execs who brought the business into financial crisis in the first place; sometimes less obvious in the case of companies who offer their first wave of lay-offs more severance or longer tails on their benefits than later lay-offs.

One would think that venture-funded firms are generally able to avoid this type of behavior, but you’d be wrong – it happens in all types of companies. I think it sucks and I’m going to be more conscious of this phenomenon. High performance organizations reward individuals who truly contribute and, while treating their employees fairly, don’t let people take advantage of sub-par performance.

In the category of “big news that no one seems to be talking about”, two days ago IBM announced that it was launching a new licensing program with the venture community to allow easier access to IBM’s broad patent portfolio for start-up companies. This is actually a big deal (it is to me at least, which is why I’m shocked at the lack of press on the announcement). IBM is vastly simplifying how companies can gain access to its patent portfolio. It’s catered to the venture community (the program is intended to be administered through the companies’ venture investors) and was in part put together by IBM’s venture capital advisory board. In a nutshell if you are a company that has less than $10m in revenue you can access the entire IBM patent portfolio for $25,000 for a 3 year term. Companies with above $10m in revenue sign a customized five year agreement (the information I saw suggested that the license fee would be 1%).I’m not a big fan of our country’s IP laws – patent law is kind of like the IRS code (its overly complicated for the sake of being complicated, doesn’t do a good job of driving desired behavior, but works just enough for most people to figure its not worth the incredible pain in the ass of trying to reform it). But for the moment, at least, we’re stuck with the current system and moves like this one from IBM vastly simplify the process of navigating the patent waters. Hopefully more companies with large patent portfolios will follow suit.

One of the things that I like about spending most of my time with start-ups is that there are very few of the trappings of larger companies – people answer their own phones; leave their own outgoing voice-mail messages; everyone can fit in a single room for a company update; all employees can give feedback on products; etc. I remember fondly the early days at my last company before we had an office – when we could hold our management/company meetings sitting around a single Starbuck’s table. Of course things tend not to stay that way (if you’re successful) and very quickly these days are forgotten history. At NewsGator’s board meeting today we had what can only be termed a start-up moment when our conference phone went down. Below is a picture of Mark Nass, NG’s VP of Finance pulling a dedicated phone line through the ceiling so we could connect back into the board call. That’s CEO JB Holston in the foreground.

Something fun to look back on one of these days . . .