Today Congress is holding hearings on what, if passed, would effectively become a censorship system for the internet. The threat comes in the form of two bills, currently making their way through the legislative process – Protect IP Act (PIPA – S.968) and Stop Online Piracy Act (SOPA – H.R.3261). Below is a video that describes the bills and their potential impact (and you can read more at http://americancensorship.org/):

PROTECT IP Act Breaks The Internet from Fight for the Future on Vimeo.

The effective censorship of websites (by blocking or slowing access to them) is what I find particularly disturbing. We already have a fundamental access problem on the internet. As internet access becomes increasingly important to society – truly part of the fabric of our democratic society – lack of access to the internet (and lack of high speed access) is becoming an increasing social and economic issue. Lack of internet access contributes to an increasing gulf in our society. And it’s a problem that government has recognized – for example when it required Comcast to offer low income households favorable rates on internet access in exchange for granting approval to the Comcast/NBC merger. I’m not arguing (at least in this post) for some kind of universal service fund for broadband access (and as a “capitalist” by title, I hope that the primary solution to this can be a market driven one). I’m pointing out that we already have some challenges around access to the internet that we haven’t even addressed. And now we’re talking about layering on an access hierarchy on the other side of the equation. The vast majority of the increase in the productivity of the american worker that we’ve seen over the past few decades has been driven by technological innovation (we’re working smarter, more than we’re working harder). Do we really want to take a primary driver of that technology innovation – the internet – and set up a system that effectively stifles the ability of new companies and new technologies to reach users? A system that rewards the embedded power structure of big business in the United States? I’m not arguing in favor of web piracy. I’m arguing for common sense. And against trusting the people who sued to block the VCR and MP3 players from coming into existence (two technologies, which they later ended up significantly benefitting from) by giving them the power to effectively shut down new businesses and censor our access to new technologies.

There’s a reason that the backbone of the internet is governed by “peering” relationships. We’re all peers on the internet. Let’s not forget that.

I’ve written a few times about Trada – a business that vastly simplifies search marketing for advertisers through a platform upon which Trada’s crowd of SEM experts build and manage campaigns on behalf of advertisers. The results to far have been impressive. The company has been helping advertisers increase the effectiveness of their search marketing and lower the amount of time required to manage search campaigns. And they’ve done this for companies spending as little as a few thousand dollars a month on search to as much as $500,000 per month. The result has been a rapidly growing company that is increasingly looking to expand the reach of its platform.

Today Trada announced that it has expanded its marketplace to Facebook, allowing advertisers to leverage the Trada crowd of expert optimizers to manage Facebook campaigns. To do this they’ve also launched a creative marketplace that will allow designers to contribute to campaigns on a performance basis. More on that a bit later.

The Facebook opportunity is massive (Facebook generates somewhere around 25%-30% of all display advertising impressions on the internet), but relatively nascent – supported by a limited toolset, requiring very different strategies than search or traditional display marketing, and as a result to date much more difficult for advertisers to take advantage of. The beauty of the Trada model is that it uses humans to perform tasks that are uniquely human in nature. We’ve found this to be effective in search, and expect that the same will hold true for leveraging the unique, but often very disparate data that Facebook enables marketers to make use of. And while entire companies are being built to try to help marketers better take advantage of advertising on Facebook, Trada is using all of their learning in search to extend their marketing capabilities into Facebook – a distinct advantage.

A quick note on the creative marketplace. Trada CEO Niel Robertson and I have been talking about this idea for the better part of 2 years. We knew that we’d need something like this to extend the Trada platform to Facebook (and beyond). “Creative” in search involves the relatively straightforward creation of text ads. Creative on Facebook involves the greater complexity of images and additionally needs to be constantly refreshed (the decay curve of Facebook ads is extremely rapid). I’ve wondered if a business could have been built around this kind of creative marketplace – using performance incentives to reward the creation of various display ad types. Ultimately for Trada, they built their own system (the fact that it is closed loop within the Trada platform solves a number of key issues vs having built this as a stand-alone business). We’ve actually had a version of it up and running for our tests with Facebook for several months now and it works beautifully.

There was great coverage today of the Trada announcement, including mention in The New York Times, Techcrunch and MarketWatch.

I’d encourage you to check out Trada if you’re interested in extending your advertising to Facebook or looking for better performance out of your search campaigns.

For the past several years Shareholder Representative Services (SRS) has been publishing aggregate data on trends in M&A. These aren’t just high level observations, but rather are nitty gritty, details around the some of the most important terms contained in purchase agreements. As a self proclaimed M&A geek, I live for this stuff. And if information is power, this study dishes out plenty. And as a result helps level the playing field for companies (who transact very infrequently), their investors (who transact a bit more often) and buyers (who often have dedicated M&A practices who do nothing but execute transactions).

I’ve been fortunate to be involved in a number of Foundry related transactions in the past year. Knowing market trends (and in some cases – and here’s where your VC may really be able to help you – knowing details of a specific buyer’s historic willingness to negotiate around certain terms) is extraordinarily valuable.

You’ll find the full SRS report here. There’s a brief statement about their methodology at the beginning that’s worth taking a quick perusal through before you dig in (the data are based on the 196 transactions on which SRS acted as representative).

A couple of trends that stood out to me:

- 86% of all transactions were all cash. With a favorable borrowing environment and many companies holding on to large cash reserves an increasing number of deals are all cash.
- 24% of transactions contained an earn-out. I’m generally not a fan of earn-outs and the continued relatively frequent use of them is a little surprising to me (this figure was 25% last year).
- Average Escrow period was 15 months. The detail here is pretty interesting. The most common escrow period was 18 months (44% of deals), and 12 months was the 2nd most common period (24% of deals).
- Escrow size averaged just under 13%. This is always a hotly debated issue in transactions. Interestingly the median escrow size was over a point lower at 11.7%. There’s a chart below showing the distribution of escrow size.

One item that wasn’t covered in the study but which I think would be interesting is to see the % of transactions where there is a buyer initiated management incentive plan of size (say above 10% of the total consideration). We’re seeing more and more buyers use this tactic to either incent management (nice view) or separate management from their investors (the not nice view). Either way, they can be significant and I’d love to see how common they are and what percentage of deal proceeds are set aside for this purpose.

There’s a wealth of experience and expertise around us every day. We probably don’t give most people we pass running around our respective busy cities a second look, but rushing by you are people with interesting expertise and experience. Artists and actors; olympic athletes and monks; sailors and graffiti artists.

SideTour looks to unlock this community and enable them to market and generate income off of their unique expertise. These experts – “hosts” in SideTour’s terminology – use the SideTour platform to advertise their experiences. SideTour helps them market these experiences and handles bookings, billing, refunds, etc. on their behalf. SideTour events are designed to be shared in groups – often people who haven’t met each other before the experience (although the platform does allow for group booking). And the entire experience ultimately becomes about the event, about the host and about the participants. The results so far have been fantastic.

Importantly, SideTour isn’t just a listing service for events, as some other companies pursuing similar models are. And SideTour heavily curates the experiences hosted on its site to ensure that they are both unique and that the hosts have true expertise. The variety of experience on SideTour really show the effect of this curation (and you thought I was kidding about luging and monks).

I met the SideTour team at the beginning of TechStars NYC and immediately loved what they were up to. And I love the story of four founders, friends and colleagues for over a decade, coming together to form a business (sounds like the Foundry story). They’ve made incredible progress over the summer at TechStars.

The company announced today a $1.5M seed financing led by Foundry and RRE (there’s a great write-up on TechCrunch here). This money will help the company further build out the functionality of the SideTour platform and begin expansion to markets beyond its launch market of New York City.

It’s great to have the chance to work with them!

Yesterday we released a video written, produced and directed by my partner Jason, that attempts to capture “the human struggle of four venture capitalists trying to make the world a better place.” From the response on Twitter, Facebook and elsewhere on the web it seems to have hit a chord with people; and I hope has been taken for what it was intended – a parody of lives as VCs (certainly no one can accuse the four of us of taking ourselves too seriously!).

It was for me a unique experience, not just creating the video but also recording in Jason’s studio and watching the editing and finishing process. For 5:56 of video (including outtakes) we spend hours recording and filming (not to mention all the time Jason spent mixing, re-recording and editing). It was a blast. Especially the day we spent running around Boulder in full costume(s) filming. We turned quite a few heads and at a couple of points had a full audience watching us perform. I learned a few important things that I thought I’d share:

I can’t sing. Like most people I think I have a pretty good singing voice. I sing in the car, sing along to my iPod, occasionally sing in the shower. And I thought I really had it. So when I got to the studio I belted it out like I was feeling it (and I was). And then Jason played it back for me and it turns out that I suck at singing. It’s disappointing to admit, but it’s true. Alas, I better stick to my day job.

Brad sings even worse than I do. If I can take any solice in the fact that I can’t really sing, it’s that Brad can’t sing either. And he’s even worse than I am. So at least there’s that.

Go big or go home. There was no question for the four of us that if we were going to do this, we were going to go all out. For me that was the beard (thanks to my wife Greeley for shaving it down to JT perfection the night before the shoot!). And for all of us (thanks to the internets) the costumes. If it’s worth doing, it’s worth doing as embarrassingly as possible!

Impromptu can work (sort of). Most of our shoots were meticulously planned out by Jason in advance of the crew arriving, but the scene we shot in the shower (which I’m a bit mixed on, actually) was completely impromptu. Like “hey – do you think we could all fit in the shower?!” kind of impromptu. Sometimes you just need to go with it!

I love my partners and the fact that Jason conceived of this project and more importantly that we actually went ahead and did it is a testament to why I like working with them so much. Here’s to having a good time. And to not taking yourself too seriously!

Photo credit, Brian Sweeney (who did yomans work the entire day of filing by both being in charge of still photography but also carried around the music, carted equipment and generally did anything/everything that needed doing. His wife Megan Sweeney was the lead videographer and editor, btw.

With the performance of the public markets looking like an EKG read-out, I’ve been asked frequently in the past two weeks what effect this will have on the venture financing market. How tied are private company valuations to the public markets? If you’re planning on raising money in a few months would it be better to go out now or better to keep your original plans? Should companies be altering their cash burn projections to become more capital efficient in the face of potential funding challenges?

Here are a few thoughts:

Generally it takes some time for public market declines to make their way down to the venture market. And while I’m sure you have an opinion about the current state of valuations in the private market (who doesn’t?), there’s not a direct correlation between public market valuations and private market ones (ie., when the Dow drops 10% it’s not like term sheets headed out the door that week do the same). That said, a prolonged period of decline in the public markets, eventually has some effect on private markets as I outline below. In addition, I’d note that in this case we’re not talking about a a shock to the system but rather the natural movements of the market (shocks – such as 9/11 – tend to have more immediate effects across all market segments both public and private).

Different firms will react differently based on where they are in their fund cycle, the perceived strength of their portfolio, how well funded that portfolio is, and their view of how deep and long a downturn is likely to be. It’s worth thinking about all of these potential effects on your fundraising.

A downturn of any length of time is likely to have some effect on the fundraising market for venture capitalists themselves. This market has already been relatively difficult (with a complete bifurcation of funds into a category of “haves” who appear to be able to raise funds at will, and “have nots” who just can’t seem to get any attention from LPs) and a down market will both exacerbate this existing trend as well as perhaps move a few firms from the “have” category to “have not”. And of course there’s the well discussed “denominator” problem (which is really a numerator problem) whereby the actual dollars allocated to alternative asset classes (i.e,. venture) by the large LPs shrinks as the overall value of their portfolio decreases (they tend to allocate based on a % of assets). None of this is likely to be of any immediate concern to a company raising money in the next number of months, and because a large number of funds have “fresh powder” (i.e, money to invest) this is likely only to effect the company fundraising market if the downturn is a sustained one vs. simply short term market volatility. But its a trend worth watching if “volatility” turns into a downturn of any real length or depth.

However the perceived strength of a firms portfolio and the relative capital efficiency of the companies in which they have investeded in (as well as thier current overall funding status) are likely to have some effects – even in the short term and especially if it becomes clear that we’re in a true down market. For starters, as the markets become more uncertain there is a tendency among venture capitalists to batten down the hatches a bit. This was famously done by Seqouia in 2008 with their widely publicized CEO meeting (and accompanying PowerPoint), but was and is done much more quietly by many firms. As funding becomes uncertain VCs tend to focus inward on their existing portfolios.

A derivative of this inward focus is a tendency of VCs in down markets to focus their new investment activities more locally. Over the past few years of relative market strength, VCs have ventured further and further from their respective home bases in search of new technologies and companies (especially right now given the heated state of the funding market in California). If the markets decline for any period of time, I’d expect to see this trend repeated. This perhaps won’t effect you if you’re in Silicon Valley, but for those entrepreneurs in smaller markets – especially those with relatively weak local funding environments – there may be a real effect to their fundraising prospects from this.

So what’s a start-up to do?

For starters, don’t panic! You’re probably not like all those other startups with shitty business ideas, so you’ll be fine.

More seriously, you should think about these trends as you consider both your own fundraising strategy (and timing) as well as your plans to increase cash burn. Down markets favor ideas that are truly capital efficient (and I don’t mean just because you run your business on AWS). Think about your spending plans – you’re probably burning too much cash – and think about taking incremental spending risk, not step function risk. Gauge your current investors. Where are they in their own funds? How likely are they going to be to support an inside round if that’s required for your next round? Ask them their opinion on the current market and its effect on your future fundraising plans. If you’re planning on being out in the market in the next 4-6 months, I’d consider going out now. Better to get market feedback now when you still have more time to react, then 2 months before you run out of cash.

For good or bad, the venture markets always pendulum. And while at Foundry we believe in time diversifying our investing (i.e,. investing at a relatively steady pace), the market as a whole doesn’t work that way. Ultimately the strong venture market that we’re currently in will wane and in the long term this will be good for the overall market (although not necessarily for your specific start-up) as the market swings itself back past what should be its equilibrium to the other side of the pendulum. And then we’ll start the last few years all over again. And while I’m not certain that the current market environment will force the pendulum backward in this way, I do know that something in the future will. It always does.

One of my favorite services is unsubscribe.com. It’s a gmail plug-in that with one click lets you rid your inbox of unwanted newsletters. I recently analogized newsletters to tending a garden. You have to stay on top of the weeds or they get out of control. Unsubscribe.com lets you do that.

With this as a backdrop, I was pretty surprised to receive the following in my inbox last week:

Thank you for being one of our paying customers, your trust and support helped propel us to where we are today.

With that being said, I’m excited to tell you that beginning yesterday, August 4th, 2011, we have made our full suite of products (Email Unsubscribe and Social Monitor) completely free, which means we owe you the pro-rated amount of $9.62 and have discontinued any further billing.

Please fill out this quick form on your Account Settings page so that we can send you a refund check. We would like to simply refund your card, however that is not something we can do with our current payment processor so we will instead have to send you a physical check, sorry.

Thank you again and we look forward to keeping your inbox clean and your social networks secured.

Team Unsubscribe

I was blown away. Here was a company that was deciding to stop charging for it’s product. That’s not all that uncommon (although see my post with some thougths on free models here for a few ideas on pricing). But giving back my pro-rated unused account balance? Now that’s really taking it to another level. Here was my response:

Hi. You guys rock. Seriously. I love your product. I think it’s great that you have a model that will now allow you to offer the unsubscribe product for free. I think it’s even greater that you decided that if you were going to make the product free that you should grandfather in existing customers (even though we all signed up with no expectation that we’d receive a later discount). I’ve personally received much more value out of the unsubscribe.com service than I realized I would at the time I signed up (I’ve even tweeted about my love of unsubscribe.com a few times!). You’ve saved me countless hours either deleting emails I never had an interest in reading or trying to navigate the labyrinth of dozens and dozens of companies “unsubscribe” processes. Please keep the balance on my account. I couldn’t be happier with you guys and I couldn’t possibly accept anything back given the tremendous value I’ve received by using your product.

I love it when companies do the right thing. Even if I’m not planning on taking them up on their offer…

Before Foundry makes an investment we perform extensive due diligence. We meet with various company managers, talk to other people in industry to get their take, call current and prospective customers, exercise our own network of contacts to get background on the idea and team, perform reference checks on key management, etc. While this process varies, we’re always diligent before entering into what we view as a long term partnership with the company.

What more and more entrepreneurs are realizing is that they should be doing the same kind of due diligence on their potential funders.

We’ve been long time fans of this kind of reverse due diligence and always encourage entrepreneurs to “check us out” before making a decision to invest with us. My partners and I all have blogs which I think are good indications of our varied personalities, but we also provide a list of references (CEOs, other portfolio execs, other people who know us well) for them to look into how we really are to work with.

It’s particularly important to find a few reference points for deals that didn’t go well. You really learn about someone’s true character in those situations.

I was reminded of this fact recently. Through various activities (mostly pre-dating the formation of Foundry Group), I’m a shareholder in a number of non-Foundry related companies. One of those recently sold off a significant piece of technology for quite a bit money. The business has raised a lot of capital and struggled at times, but selling off this technology and continuing to focus on the additional technology that was to remain in the business, was a major step for the company. As a common shareholder my first reaction was “great; this deal will reduce the preference overhang on the business and there’s still some really interesting potential upside with the remaining asset.”

Sadly, I forgot the golden rule of venture: MANY VCs ARE ASSHOLES

Not all that shockingly, given who the VCs are in this case, they decided that – magically – this sale of a portion of the company’s assets could be convoluted into a liquidation of the entire business (a technical definition that relates to language in the charter and the “judgement” of the board). This helped them with a number of things. First – they achieved a significantly better tax outcome on the distribution of proceeds. More importantly, this handily resulted in their ability to completely wipe out the common ownership in the business. That’s right. Instead of paying down the preference and leaving the common in their rightful place – better off for having paid off a significant portion of the preference overhang on the business – these ASSHOLE VCs instead decided to take the opportunity to not only pay back a substantial portion of their investment but also to cut the common completely out of the cap table.

Aren’t there lawyers involved? How could they let this happen?

Here’s where working with ASSHOLE VCs really screws with you. Company counsel is a very well known valley firm. They do a LOT of work for these ASSHOLE VCs. So when it came down to it, they were on the side of the investors not the company.

How about the common shareholders? Couldn’t they do anything?

Well, unfortunately (and I am actually pretty sympathetic here), the vast majority of the common was held by the management of the business. And thanks to a (not particularly generous) carve-out program for management, these ASSHOLE VCs were able to hold their vote ransom. “We’ll push this through either way,” I suspect they said, “so either vote with us and at least get a cut of the proceeds in the form of this bonus or vote against us and lose it all.” And really management had no great choice.

The irony here from my perspective is that it actually wasn’t even a very smart economic move by the investors involved (ASSHOLE VCs aren’t always that smart). If it turns out that the company was worth quite a bit, the common shareholders will surely sue for their fair share (I will likely be at the front of that line). If it’s not, then there was no skin off their back to begin with. Of course there is a matter of the statute of limitations (even fraud, which I believe this is, has a time window for action), so there is some outside chance that they’ll rip everyone off and get away scott free.  Of course I’ll know who they are… (there’s a long story about why I’m not going after them now which isn’t something I can get into here; it’s the same reason I’m not just calling them out in this post by name).

So the moral of the story is: check out your investors before you go into business with them. They may dress in smart looking khakis and polo shirts; they may have fancy offices on Sand Hill Road and drive hybrid cars; but they may also be ASSHOLE VCs. And that would be bad for your business.

VC’s love to talk about their pattern mapping abilities. “We add more value because we’ve seen so many companies go through all sorts of situations before and we can quickly map whatever’s happening at your business to what we’ve seen in the past and leverage this experience.” Or so the logic goes. But what’s going on right now with early stage company valuations suggests that VCs may be poor judges of at least some of these patterns. Or at least that they’re incredibly human when it comes to estimating the likelihood of certain events actually happening.

In 2002 a series of random shootings rocked the Washington DC area. For a period of about two weeks, an unknown assailant killed 10 people in a sniper like fashion. Many people in the area were panicked at the possibility of being subject to such a random act of violence and drastically altered their behavior to avoid putting themselves in situations that they perceived to be potentially dangerous. In reality, DC is a city of over 600,000 people. And while the events of those two weeks were certainly shocking, the average citizen was significantly more likely to be killed in an automobile accident than by the DC sniper. But that certainly wasn’t how serious most people perceived the risk to be. Because fundamentally humans are extremely poor judges at predicting the likelihood of outlier events.

Fast forward to today’s funding environment and I believe a similar mindset is taking place. Companies like Facebook, Twitter, Zynga and Groupon are attracting so much press that investors are misjudging the likelihood that their next investment will turn into something similar (or even into something in the next tier or two down in terms of outcome). In reality, since Facebook’s first venture round in 2005 over 10,000 different businesses have received venture funding. And history suggests that the vast majority of these companies will see outcomes of less than $1BN. Actually of less than even a few hundred million. And that’s the very best of this group. The majority will either fail completely or barely return capital.

Market deviations are driven by a fundamental imbalance between two sides of a marketplace. And we’re seeing a classic case of that now in the venture capital market. Unfortunately these market deviations tend to feed themselves – at least for a while. Company X raises money at a high valuation and the markets shift their perception of the clearing price for deals of that type. Perhaps the company raises another round at an even higher valuation, validating (at least temporarily) the first investment decision. Maybe there are a handful of high profile exits that, at least in those cases, justify the high valuations paid by their investors.

Eventually, however, the markets face their moment of truth. And there will be one (as there always has been) for the current venture climate. And while I’m sure that there will be some great businesses created in this market I think we’ll look back on this time period and again be reminded that the more things change in venture, the more they stay the same.

A few years ago I was talking to a fellow venture capitalist about an entrepreneur he had previously backed. “That guy should love me!” he exclaimed, “I made him 50 million bucks!” And then moved on to some other topic which I can’t remember because I was numb with disbelief at his previous statement. He backed an entrepreneur who built a business that after a number of years had a very nice exit and he made the entrepreneur money? Obviously his logic is completely backwards. And while I don’t know that many VCs would express such an extreme view of that sentiment I do think that most believe that not only is a healthy VC ecosystem important for entrepreneurship to flourish but that VCs create that ecosystem.

I disagree - Entrepreneurs come first. Not VCs.

Boulder is a great example of this. The local capital base is anemic, but the entrepreneurial ecosystem is flourishing (Boulder is the best city for start-ups, the happiest city in America, etc. – see here for some additional thoughts on why Boulder rocks for entrepreneurs and start-ups). And while one data point doesn’t prove a theory, Boulder is a pretty powerful argument for the notion that capital follows entrepreneurship and not the other way around. And while there were some VCs involved in helping shape the great start-up environment we have in Boulder, don’t mistake participation for causation.

Entrepreneurs are the lifeblood of Venture Capital, not the other way around.