December 2009 Archives

Dave McClure posed to Jeffrey Veen and me an interesting question over Twitter which was:

WHY aren't there more consumer internet VCs w/ graphic design skills?

This is something I've been thinking about for quite a while now. When I started angel investing and advising startups, I discovered that pretty much I was the only design guy out there angel investing, or at least that I could find. By that, I mean someone who worked in design in the industry, then switched careers and became an investor full time. For me, I felt that it was a specialty that would make unique in that I could help startups in the area of design and user experience.

However, I had always thought about why there weren't other design folks out there doing angel investing. Here are the reasons I came up with below. Note that I lump together the design disciplines of visual design, interaction design, and user/usability researchers.

1. There just aren't that many designers out there, relative to other disciplines. Anybody who has tried to hire designers knows that it is super hard, harder than hiring engineers which is already hard. Think about how many students graduate with design degrees; the number is incredibly low compared to the number of computer science graduates coming from engineering schools. This makes the probability of finding designers who become investors very, very low.

2. Now, take the very low number of designers out there, and meld that with the probability of experiencing a windfall of cash. This windfall of cash can be from any source, like a large inheritance, or winning lotto, or being an early person at a startup who had a mega-exit. Any of these cases (and others) is of extremely low probability. So again, low number of designers melded with low probability of windfall of cash to enable angel investing results in a super low possibility of this happening at all.

3. Of the people we meet in general with a lot of cash, who really wants to angel invest? I have queried some of my affluent friends and they're just not into it. Some of them don't want to, some don't feel the least bit qualified to do it, some know nothing about it and aren't interested in it. If this is true, then if we take the low number of designers who also have enough spare cash to angel invest, those who feel like investing in startups results in another very low number.

4. Knowing a bit how the venture fund industry works, I've been told that it's super hard to join up with a fund. It's not like applying for a regular job. Commitment at a fund can be a number of years, ranging from 5 to 10. Thus, adding someone to a fund's staff takes a lot of deliberation as it is not good for someone to leave a fund's team in the middle of a fund's life. A fund's pool of money is often raised on the fact that there is trust in a team to invest their money properly. If that team is disrupted, it could cause investors in the fund to pull out. Pulling from a limited pool of possible candidates, and the very low probability that any of them have any sort of design background results in just about nobody joining up with funds who are also designers.

5. If you look at who are typical venture fund partners, they are most likely ex-business people or ex-entrepreneurs. These seem to be the favorite candidates for becoming investors as they have experience in managing investments or acquisitions, or have worked in a startup and have some knowledge in startups and how to spot other good entrepreneurs. Designers are more likely to NOT have experienced these conditions and generally are not specifically looked for when a venture fund is recruiting for partners.

6. As one path to gaining successful experience as an entrepreneur, resulting in a potential windfall of cash to enable them to angel invest, designers might become a founder of a startup and grow it to an exit. However, most designers in pre-2002 days, were hired in later stages of a startup's life, thus limiting their potential return as their stock allocation and strike price are not as attractive as if they came into a startup much earlier. Therefore, even during the dotcom boom years, designers may have been able to reap in a lot of cash, but probably not enough cash to freely angel invest in post-2002 years.

If we expand the list to include design agencies, then there are design companies who invest. For example, Method Design did have an investment operation, and fuseproject is currently making small investments into some of the startups they encounter.

Still, individuals remain almost non-existent.

While all that may be true up to today, I also think that this may change in future years. For example, starting an internet company is a lot easier today than it was in years past. There is a lot more literature about entrepreneurism and general acceptance that entrepreneurism is an OK career choice. Also, it is possible to build something and not be a coder, which most designers are not. There are many inexpensive avenues to getting something built, and use of open source code and other hosted services make creating web businesses much easier.

Also, it is my belief that with the number of me-too products being so high, and the ease that one can create copycat products, design is finally becoming a true competitive advantage as core services are pretty much the same, but it is the user experience and design of the product that allows a me-too product to win over its competitors.

So going forward, we may see a bunch of designers who are part of startups from a very early stage, and thus can have enough equity to get them a substantial cash windfall upon exit, which can then result in enough spare cash to start angel investing. Over a period of time, if they get good at angel investing, then they may get noticed enough to raise their own funds, or join up with a venture fund.

Angel Odds Versus Venture Fund Odds

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When I first tried to raise a small fund back in 2006, I heard about venture fund odds on investments which was that for every 10 investments a fund made, about half would fail, 2-3 would return a little bit, and then there would be the 1 that would return everything that was lost on the failed startups and then some.

It seemed to make sense and also drove the original reason why I thought I should invest more often than not. If I put more bets out there, then theoretically I should have more chances to make my money back...right?

To date, I've made 16 investments and two exits. I invested more broadly than most angels, except for the super angels. But looking at the internet industry, the sad state of the economy, and the way early stage angel investing has progressed for me over the last 3 years, I have come to the conclusion that the one in ten odds for this biz doesn't apply to us; for us angels, it's more like one in 20, or 30, or even worse.

Why do I think this:

1. The economy sucks. Probability of exits is much much lower.

2. The economy sucks. Making money is harder. Paying consumers are harder to come by. Businesses are already slow in committing to pay for a service.

3. The internet is too crowded. Me-too products are all over the place, creating blur in consumers' minds, and making it harder to attract customers.

4. The internet is too crowded. Truly unique products and services are super hard to find now, so gaining a competitive advantage is tougher.

5. Too many small business opportunities on the internet. The probability of starting a great small business is a lot more likely. But finding a suitor with a small business is tough because it may not generate enough revenue to be attractive enough to be acquired.

6. Angel investors typically invest in the earliest, most risky time for startups. Venture funds (except for the early stage funds) usually invest after the very earliest money in. Once startups get to a size that is attractive to a venture fund, a lot of risk is taken out already; we don't have that luxury. We typically go in when there is just an idea, and maybe a prototype built, and occasionally a business up and running. We don't know if the startup will fail in a few months or not; there is no history that we can look at. With that kind of risk profile for our typical investment, it would make sense that their would be more failures in our portfolio than for a venture fund portfolio.

7. Those that survive have a high probability of needing additional rounds of funding for growth. If we can follow on invest, that helps a lot. But most of us can't do that. We may have enough capital to put one round of investment, but most likely can't invest more money in a subsequent round. Thus, dilution will limit our investment unless we get lucky and find a startup that does not require further rounds. The more investment rounds after the initial round, the more we get diluted.

So all this means that it's super hard to find that Google super-investment that makes back all that we lost and then some.

Solutions?

Ron Conway combats this by going super wide and doing more investments than we could ever hope to do. This increases the probability of finding a Google in his portfolio.

We could try to find more startups that are capital efficient, and that make money from beginning. Those that do not require a lot of cash to scale means they may not need another round. If they make money, then this also reduces the probability of needing more rounds of investment. Of course, companies like this are incredibly hard to find. Nor can we accurately predict what amount of money they will need later.

If we could follow on, this would help a lot. How about playing Lotto and winning a bucket of cash to play with?

Now, if more venture funds played in the early stage space, combining broad, early stage investment with follow on investments into the winners, this would seem to be a perfect combination. However, in thinking how many venture funds operate, it seems like there are problems with making this approach a success.

Any other possible solutions?

bit.ly Offices 12-17-09

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It's been a big week for bit.ly in the news. Lots of buzz about Google and Facebook coming out with their own URL shorteners, but but they're not down by a long shot. Bit.ly Pro is really great and of course, I setup my own URL shortener, http://www.ds.ly, just for kicks (by the way, buying a domain from Libya was an interesting experience). Also launched this week was bitly.tv, a bitly labs project that provides a view into the most popular shared videos on the Net.

Here they are in their offices, which are next to betaworks:

If you notice on the walls, there are some pretty cool paintings by local artists that we got from a gallery. For some reason, I'm a fan of this one:

Such a touching moment for Charlton Heston to kiss that ape from Planet of the Apes - touching enough for someone to actually capture it on canvas! After all, aren't we humans really just a bunch of hairless romantic apes?

Lasting Two Years

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An interesting observation I've seen amongst early stage internet startups is that more and more of them are requiring closer to two years to get to breakeven. This is because of many factors, one big one being the fact that there are too many me-too products and that distribution is the number one problem facing entrepreneurs today. But also, many startups end up in someplace different than where they started. They may find that their initial theses is wrong and need to twist/turn/adapt into some other product to be successful. This also takes time.

I talked with an early stage VC and she mentioned that she had seen the same thing, which was a large percentage of them coming back for bridge rounds after working for about a year. We talked about the fact that they always seem to raise money for about a year or runway, but yet most of them just need a few months more to get to breakeven.

Even in my own startups, there are a number of them that "just need a bit more time." If only they had a bit more runway, if only they had a bit more cash, if only they could raise more....we are seeing that startups with mediocre metrics aren't finding it easy to raise cash so they are dead in the water, and soon to die in totality.

I talked with another investor about whether or not we should get more of our startups to raise more cash at the beginning. He actually was less of the opinion that we should demand startups find a way to last 2 years from the get-go. It was an interesting conversation and I think the difference in perspectives comes from the fact that I'm an angel investor with limited resources, and that this investor had far more resources to bring to bear on successful versus mediocre or dying startups. Also, given that this was my own money I'm investing, it was far more important to me than investing someone else's money. Strategically, it makes sense for them not to care as much. We already know startups will die; it's a ruthless culling process that startups experience. A professional investor can just move on and invest in the next big one, or invest in the winners in his portfolio. But given that my personal money is at stake, I care more about startups lasting long enough to make something with their businesses.

I've been tooting the "last 2 years" horn ever since the economy tanked. But universally I have been ignored. Remember that there are two levers to apply here: one is how much money to raise, the second is the burn. However, I never see anybody produce a 2 year plan ever. A host of reasons why not:

1. Entrepreneurs are unwilling to reduce their burn. There are a number of reasons for this, ranging from families that need support to those unwilling to reduce their lifestyles, to inability to hire people at low salaries.

2. Entrepreneurs are unwilling to go out and raise more. Yes, begging for money sucks and takes too much time and is not fun. Entrepreneurs just want to get back to work building.

3. Entrepreneurs are unwilling to take the dilution. They already have sold part of the company and don't want to sell more.

4. An investor assures an entrepreneur that they will give them more money if they need it. Entrepreneur decides to trust investor.

Great reasons all, but the reality is that a huge majority of startups are all taking 2 years to get to a good place. The marketplace for products and for investment is not like it was 2-3 years ago before the economy tanked. In previous years, you could go raise money on no revenue but a ton of users. Now it's near impossible. Second chances are hard to come by. Raising money on mediocre metrics is near impossible.

One last appeal: Entrepreneurs, do what you can to last 2 years. Expect it. Raise enough money and/or adjust burn assuming no revenue. It's become unfortunately the norm.

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This page is an archive of entries from December 2009 listed from newest to oldest.

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