Let the Sparks Fly!

Capital Efficiency

There has been lots of talk lately about whether the venture capital model is “broken”. It is quite a complicated question (with no obvious answer) that I will leave to others more adept at statistical analysis than me to try and answer. I have been watching and listening though.

I was at an early stage investor’s conference in the Valley a couple weeks ago where this very question was asked to a panel of well-established, Sand Hill Road-based, VCs. These investors ran the gamut of pure early-stage $150M funds, to $1B+ plus funds who also claim they do early stage. Their answers?  Well, it’s been two weeks of racking my brain and I’m still not sure that what they said makes sense.

Basically they said the model is not broken if you invest properly, and of course, they all invest properly. It must only be the guys at Sevin Rosen funds that are stupid investors I guess!

All sarcasm aside, there were a few very important issues that came up during this panel (and conference) that are worth discussing further. By far, the greatest recurring theme was CAPITAL EFFICIENCY. The tech IPO market is still on life support, and even though the M&A market is strong and providing liquidity opportunities, without a strong IPO market to goose up valuations, the average M&A valuation of less than $50M is a big problem.

Some high-level stats from the U.S. for 2006 YTD:

• $23B paid over 311 M&A deals for an average of $73M per exit, BUT the median exit is actually closer to $25M
• The median amount invested in these 311 companies - $50M
  

For a $250M fund, the math doesn’t work if portfolio companies continue to get funded with $50M when the exits average what they do...something has to change.

Hence, Capital Efficiency. Companies need to do more with less. Not exactly a novel idea here in Canada, but one that VCs in the Valley are (finally) talking about more and more. No more over-funding of companies – this is where the current VC market falls apart and appears broken. Whereas software and internet companies were being funded to the tune of $40-50M prior to an exit, the new reality is that they must be able to reach the same end-game with as little as $10-15M. The popularity of blogs, open source, the continual increase in powerful computing chips provides start-ups with a lot of options to appear much bigger, and move much faster, than previously with less capital.

So, I see two challenges with this new-found approach to the VC market:

1. While you still have less money going into companies, you still have way too many “me too” companies all chasing a limited number of exit opportunities
2. The balance between “Capital Efficiency” and being “Penny Wise, Pound Foolish”.

This second point is especially important, and one that separates the successful companies (and VCs) from those that could be, but aren’t successful. The recurring argument in Canada as to why the VC community has not posted the same positive results as the US is that we don’t fund our companies to reach $1B+ in value and are happy to settle for the $50M exits – not the “go big or go home” attitude.

How to balance this with the new realities of Capital Efficiency will separate the truly successful VCs from the rest of the pack.

Angels and VCs

I have attended a number of early-stage investment conferences over the past month and I've taken note of some common themes and controversial comments that I thought I would share over the coming days. 

The most controversial comment I heard was from a prominent U.S.based angel investor who said during his presentation (and I paraphrase) that “Angels and VCs should never co-invest”. His rationale? The interests between the groups are not aligned. Angels are investing their own money as opposed to VCs who invest the money of other people and institutions. Angels are not interested in or motivated by raising their “next fund” and therefore are much more patient investors, are not motivated by IRR (which has a time to exit aspect to it) but rather cash on cash return. Therefore time is the angel’s most valuable resource and the strategic decisions to be made by the Company are very different.

I personally don’t buy this, and neither do many of the angels I have spoken to, both locally and in the U.S. We at Brightspark have been developing a strong relationship with the angel community because we believe that our vision of early-stage investing is very much aligned with angels, and have co-invested with angels on occasion. Angels investing their own money are motivated by the same end-game as early stage VC funds – creating tremendous value for the shareholders and founders and positioning the company for the appropriate exit at the appropriate time. Angels I have spoken to are not interested in tying up their own money for 10-15 years in a single investment and while I agree that cash on cash returns are important to VCs as well, the time aspect to an exit has an absolute bearing on investment decisions for any investor. A 5x multiple on an exit within 5 years is much more motivating to an angel than a 5x multiple in 15 years. There is always a time value to money. In the latter case, they may as well buy a 15 year bond and there is much less risk.

At a Early stage investing conference in the Valley, there was a whole panel on how angel organizations presently work together with the VC community – and to a man, they all expounded on the importance of bringing the VCs into the process early on.

In my mind, this was one angel trying to motivate the angel community and give them a feeling of self-importance that they don’t need – the VC community already values the important services they provide to the start-up ecosystem.

b5media Team Grows

One of the keys to success for any startup is surrounding yourself with smart people. b5media has a great founding team in Jeremy, Shai, Duncan and Darren.  Today this team gets even stronger with the addition of Mark Evans.  Mark's announcement explains his excitement about the opportunity while Rick Segal discusses the value of operational experience.  We are also pleased to announce that Shel Israel will be working closely with the company as well.  The momentum continues!

Announcing b5media

Today, Brightspark is pleased to announce our investment in b5media, a global new media network, along with our partners at J.L. Albright Venture Partners.  As we have been watching the evolution of the media space, we have seen the blogging world evolve from a niche media to a mainstream voice.  This has resulted in truly unique ways to build a significant audience base by delivering compelling content.  Our interest has been to see early evidence that this type of network could be extended into the mainstream.  B5media has successfully built such a network.  With over 150 blogs on a wide variety of subjects ranging from entertainment and news to technology and sports, b5media delivers content written by passionate people from all over the world.  We believe that such a network will prove to be a very valuable channel for advertisers looking to reach key demographics.  With more and more ad dollars moving to online audiences, networks like b5media will play a very powerful role.  Many industry observers predicted that the blogging world was simply a fad and would surely die a quick death.  To the contrary, blogs have only continued to gain visibility and reach.  We have only seen the very beginnings of what b5media can accomplish.  With our great investor partner and a strong management team, we are very excited about the possibiities.  To learn more, please visit www.b5media.com

Banff Venture Forum

Last week, I had a chance to attend the Banff Venture Forum in Banff, Alberta.  This conference gives young technology companies the opportunity to present to early-stage investors.  The conference was well attended by Angel investor groups, university commercialization groups, as well as venture capital firms.  I also sat on a panel presentation which discussed commercialization strategies for innovations coming out of university labs.  Many feel that there is not enough early-stage private funding in the market to support the commercialization of university research.  Very often, universities spend significant provincial and federal government grants on years worth of research to develop new technologies.  This research is funded based on its academic merit as determined by the University and government professionals.    As this research "graduates" from the university lab and begins its search for outside investment, it far too frequently fails to gain private investor support.  Some investors complain that the innovations are too niche focused, while others argue that they see little market value or customer demand for the proposed solutions.  Regardless of the issue, the fact remains that universities are struggling with the commercialization process.

Rather than starting more government programs or funding more reports to assess this issue, perhaps we need a radical new way to jump start this commercialization process.  My suggestion would be to have universities partner with private investors much earlier in their process to determine which research to fund.  Venture investors have a strong understanding about industry dynamics and market needs.  They also have the ability to support emerging technologies with their venture dollars.  Why not partner these investors with the university groups to priortize university research focus?  Wouldn't it be better to understand which research is most relevant to market needs and which innovations will best be able to get external financing support? Perhaps government research dollars could be spent answering the investor's questions and concerns regarding commercialization viability? It seems to me that this would be a much more market-focused approach to funding technology research.  This way, Investors would also get a first chance to fund new and exciting innovations. By involving more partners and priortitizing their research dollars, perhaps universities can help build greater momentum for their innovations.        

Brightspark Podcast

I recently had a chance to conduct a Podcast with Sean Wise from Wise Mentor Capital.  Sean was interested to learn more about Brightspark's seed financing model and our experience with early stage ventures.  We also talked about my own adventures in the startup world including valuable lessons learned.  You can find the Podcast here.

Back to Techies Land

Entering into Fall (it sure feels like Fall with close to freezing point temperatures in Montreal last night), back from vacation with the kids, I am attending Fall VON in Boston this week. It is very busy, as one could guess and filled with new ideas, new technologies and energetic people. A great place to be for a VC, trying to figure out the benefits of the new telecom puzzle.
 
Yesterday, one of our portfolio companies launched an amazing new product called Vox.  You can visit their website at www.voxlib.com and download it for free. It gives you the ability the make a Skype call from any cell phone. We are very proud and happy about this launch. Everybody has been working extremely hard to get it right and make it happen. This first product truly demonstrates how the economics of telecommunications, as we traditionally know it, are completely transformed. This is not a new topic obviously but Voxlib brings it to another level. Judging from the level of downloads yesterday, people were quick to figure out the value of Vox. Congratulation to the team! 

On another note, I just listened to a presentation from a large VoIP provider at VON and it felt like being teleported back to 2000. Charts and graphs were presented on losses, slicing it every possible way, as a % of sales by category, tracking it over time etc. While I do understand the purpose and need of it, I can’t help having this awkward feeling. It reminds me of a few Board meetings of technology companies in the late 90s where some Board members were harassing the CEO because “you are not losing enough money, your competitors are losing faster!” However new or differently the growth an industry may be going through, this will never feel right to me.

 

Corporate culture is what gets it all done

This week, we had a reunion in Toronto for the company that I co-founded in the 80s/90s called Delrina.  (For some history, see wikipedia).  Amazingly, close to 200 ex-Delrina employees attended (see photos here at Flickr),  but more amazingly this was more than 10 years since we exited the company.  Most people at the reunion had not worked for Delrina for at least 10 years, but still came out to meet their old colleagues.

As we all know, 10 years in this industry is a lifetime.  Yet, people were genuinely interested in catching-up with others that they seemed to really care about.  And most people felt a strong connection with others.  I was amazed how many people came up to me and told me what an incredible experience working at Delrina was and how it formed a strong basis for what they have done since.

I think that a lot of what people experienced in those days was the opportunity for young, inexperienced employees to be empowered.  (A quote from an email I received afterwards: "I wanted to say that working under your leadership gave me the confidence and inspiration to be an entrepreneur.  I run a successful manufacturing business and the basic "think on your feet" management style you had is one that I have used on a daily basis in the complex world of business.")

I got to thinking about what it was that allowed us to be so successful with a team that had lots of expertise and not a lot of experience.  And what was it that has kept people connected all these years later?  I am convinced that it is commonality of purpose and a strong corporate culture.  From the beginning, we were all focused on one thing - winning.  Coming second was not an option, losing was not an option, mediocrity was not an option.

We started Delrina in 1988 and I remember being turned down by VCs in Toronto, Boston and Silicon Valley.  They all said, "You guys have never done this before, and you are based in Toronto, Canada for goodness sake".  (Yes, I have been on the "other side of the table" many times).  We were determined to prove ourselves and were driven to succeed and we found financing from other sources.  Over the next 8 years, we were constantly told how we could not succeed at this from Canada, how our products would not be competitive and why we would not succeed.  But instead, we drove sales to nearly $150M annually, sold more than 30 million copies of WinFax and then sold the company for more than $550M.

The glue that held this together was a strong corporate culture.  A culture of working together, empowerment, trust, respect and caring about the people you work with, and an executive team made up of complementary talents with common goals.  We were a community that was a bit of an island.  There weren't many (any?) other companies like us in Toronto and once we started becoming successful, we started getting noticed.  The more the focus on us being unique, the more the focus on us being public in Toronto and Nasdaq, the more our team worked together and achieved.  This same culture permeated throughout our offices in California and Europe.

I am convinced that this is the "secret sauce" that every startup needs to succeed.  When people look at our successes at Delrina such as our OEM strategy of giving away/selling cheaply WinFax Lite and upgrading people to WinFax PRO, it is often attributed to good timing or good luck.  Yes, luck helps, but before we ended out with that strategy, we tried 30 other strategies.  As a startup, the only luxury you have is to reinvent yourself at every opportunity and your competitive edge is to be able to easily make zigs and zags with ease.  And then, when something works, you need a team that can execute well and capitalize on the proven strategy.  We made this happen with a culture of "No Fear" (I still have my No Fear Delrina t-shirt), a culture of not being afraid to test out new ideas - all held together with a culture of winning.

Now I keep looking for the next Delrina to invest in...

The News is NowPublic

Today, Brightspark is pleased to announce an investment in NowPublic (www.nowpublic.com).  My partners and I have been watching the rise of “Web 2.0” companies with cautious optimism.  While I certainly am excited to see the Internet being used as a true platform for user generated content creation and sharing, the challenge for any VC is to identify the real businesses from simple feature companies.  Which companies will truly leverage this platform to create unique value in its industry?  Can this value be defended with the development of strong intellectual property?  Given our investments in the mobile and VoIP space, I have been watching with great fascination how users have so quickly adopted technologies such as blogging, podcasting, and picture messaging.  The intriguing challenge is to understand how these technologies will affect industries outside of mainstream content sharing.  This visioning process brought us to NowPublic.  NowPublic is revolutionizing the news collection and reporting industry by empowering citizen journalists to engage the news conversation.  I am very excited about the progress this company has made in such little time by building a great relationship with its user base and by making smart technology decisions.  This company is truly focused on an innovative business model which will give it much staying power in this “Web 2.0” world.

Read more about this news at NowPublic

Going to the CVCA

I am on a plane to Vancouver heading for the CVCA annual conference. (No wireless access to e-mails with Air Canada so got lots of time on my hands). For those of you not familiar with the Canadian venture capital industry, CVCA stands for Canadian Venture Capital Association. Tomorrow starts their annual conference where VCs and LPs from Canada (and a few from elsewhere) get together to network and dialogue on their industry. It is always interesting to experience the exchanges and atmosphere of the event. It does change significantly depending on market conditions. This year should be pretty bubbly (not to be mistaken with bubblish) and upbeat.

VCs can be very strange and interesting beasts. They usually compete for fundraising but not always, they can collaborate if they happen to be in different niches or geographies. They usually partner for deals but not necessarily if the market is heating up and deals become rare gems or if their Fund is too big. They usually share due diligence information and market intelligence but not always if it happens to be very proprietary and part of a “hopefully” unique investment theme.

What happens when you fill a room full of venture capitalists? I know that there are lots of jokes about this; it is like filling up a room with lawyers I guess, but this is not the purpose of this note. I think it can actually be nicely compared to a typical “woman wants a man” scenario…

First, they want to show that everything is going well; they are independent, having lots of fun and completely in control. If they talk about their portfolio companies, they are getting tremendous traction, have significant interest from partners and potential investors and can’t respond quickly enough. This is the part where you want to hook the guy. This is the part where you want the other VC to be a little destabilized (the compete part) and get the desire to investigate into those portfolio companies and also spread the good news (the partner part).

Second, they want to show that they are somewhat vulnerable to spark the “save the girl” syndrome in a man. Remember King Kong??? They touch a little on their challenges; complain about fundraising and reporting and all. This is the part where you bond and get sympathy. This is the part where you create an ally for the future. This is also the part where you gather information from your partner/competitor. What is he investing in, is he doing well? Does he have a competing play to one of your portfolio companies?

Thirdly, the woman completely hooks the man in proving how sexy she is by walking off with the other guy. VCs continuously wave at numerous other parties, usually other VCs, and they sometimes throw a little intriguing note like: “are you still coming by next week, we need to talk about this opportunity we touched on last week…” or worst, walk slightly to the side and whisper something about a potential deal. This usually is enough to completely hook the previous bait even if the whispering is only about the next round of golf you are planning to play. 

I know it seems a little simplistic and it is much more complicated than that in real life but is it really? In any case, flirting as a VC can be a lot of fun and in the current bull market, it is actually quite pleasant since at least 80% of what we say about our portfolio companies and our Funds is true or at least we believe it when we say it. You will probably find similar dynamics in any industry that strives to find the right balance between competing and partnering, succeeding as an industry versus succeeding as a company. Looking forward to it!