Greg Foster’s Blog

Great article today in the New York Times by David Carr on “The Fall and Rise of Media”.  Fred Wilson commented on the article this morning on his blog.  Basics of the article focus on the rapid decline of traditional media.  Yeah, I know, I know… same song, second verse.  Carr does a nice job of focusing his attention on the change in the way ambitious young folks are entering the “media market” in New York.  Many years ago, you would hope to land some horrible low level job at a big media brand - TV, print, something traditional.  While some still come to Manhattan hoping to break into traditional media, more and more of them are building their own access point through democratized media.  Having been an executive at one of those large media giants (VP Corporate Development at Turner Broadcasting, division of Time Warner) and also a VC investor in the new media arena, I’ve seen this happening from both sides of the curve.  My thoughts here:

1.  Traditional media, especially print, still has an opportunity to change, but time is running out.  The New York Times itself owns several digital brands that together account for roughly $500 mm in ad and subscription revenue according to some estimates (e.g. they own About.com).  Will the NYT become a smaller company to survive and then use it’s content building prowess to build the next generation of online brands?  We’ll see.

2.  I thought this particular paragraph interesting - “Certain stalwart brands will survive and even thrive because of a new scarcity of quality content for niche audiences that demand more than generic information. The chip that was implanted in me when I arrived at this newspaper — you might call it New York Times Exceptionalism — leads me to conclude that this organization will be one of those, but the insurgency continues apace.”  I agree wholeheartedly… one of the big reasons I love The Onion’s chances.  Advertisers still value certain brands over others and are willing to pay a premium CPM for access to consumers who are loyal to those media brands.

3.  One thing this article is missing is a question about whether New York itself will remain the most important geography for the media industry.  While I think young media types will always tend to flock to the city - I can see a time when Chicago, DC, Atlanta, Miami… begin to rival NY’s perennial media dominance.  One could argue that Silicon Valley, with Apple and Google alone, has surpassed NY and LA if the measure of dominance is potential for commercial success.

All in all, a very good article.  You can follow David Carr on Twitter here.

Stay tuned…

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I’m feeling something.  Since exiting the traditional VC world, I’ve spent most of my free time working with early stage start-ups.  When I say start-up, I mean real start-ups… like founder, maybe one other person, a little bit of money, that kind of start-up.  As an aside, I gotta tell you, the entrepreneurs building businesses in this kind of environment have the courage (or crazy) gene in great and peculiar abundance.

So back to that feeling… on more than one occasion, and involving more than one company (and in talking with more than one VC), conversations between acquirers andacquirees seem to be picking up.  Yes, I know, this is a small sample size, but having sat on both sides of the table (as a Corp Dev exec and an entrepreneur), I would say these conversations are the classic precursors to something bigger.  Large acquiring companies are sensing that 2010 could be a year of great activity, a year of great opportunity.  Now, they posit, is the time to get good deals before those good deals command higher prices in a frothier market.  This pattern tends to precede a time of greater activity.  If my hunch is right (who knows?), here’s how I think this could go down over the next year or two:

• It starts with small acquisitions of pure technology or tuck-in plays.  Now is the right time to have a tight technology story even if a user base around that technology has yet to develop
• Because of the winnowing of so many new start-ups over the past 12-18 months, the crop of eligible companies ready to invest in building a real user base has been limited - the economic downturn has acted like an antibiotic, killing off most anything with which it comes into contact.  But alas, those stronger companies that have survived could be poised to break out in 2010.  Quickly built momentum could translate into higher buy-out value.
• Growth in 2010 will become even more important as we begin to see the increasing affects of inflation.  To stay ahead of the game, growth through acquisition will become even more important.  Those companies which have broken through, found a growth trajectory and sustained some level of scale could see larger buy-out values as large companies try to meet and exceed Wall Street expectations.

Sure, this is conjecture based on anecdotal evidence, but the pattern feels familiar.  Here comes the cold water - all of this activity will be dampened by a still dormant IPO market.  Acquirers will still have the upper hand -acquirees still don’t have the credible threat of an IPO as an alternative to selling their business.  One more thing - there will not be a bell shaped distribution of deals - it will be skewed greatly to the left.  Lots of small deals.  That could be a good thing for small companies with solid technology and good teams.  It could also be a good thing for those investors willing to make several small bets in early stage companies.  For a while, I think, angel and venture capital will be a small in, small out game.  For those able and ready to play that game - 2010 could be a great year.

Stay tuned…

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As a former entrepreneur myself, I am empathetic to a particularly difficult dilemma many early stage companies face on a fairly regular basis – how to reconcile business goals developed by the management team with those articulated by the company’s investors. So what does this mean exactly and how does it manifest itself?

CEO of a start-up (who happens to also be the founder) has decided that a set of goals are best lined up 1-2-3, that is to say that the order in which the goals are achieved is meaningful. The CEO’s experience and intuition says that she can’t really fully meet goal 2 without 1 and 3 without 2, and, in fact, if she does them out of order, it may compromise the outcome of each goal (i.e. rushing certain strategic deals to conclusion might compromise the terms she can get from those arrangements). On the other side of the table, the investors have made it clear that without goals 2 and 3 being achieved by a certain date, it will be difficult to raise a follow-on round of financing at attractive terms. These milestones are the most important, in the investors’ eyes, to showing that the business model really works.

So there in lies the rub – the CEO’s intuition tells her that rushing goals 2 and 3 without knocking out 1 will, over the long term, be a bad decision for the business. But without further funding, predicated ostensibly on satisfying the investors’ desire to see the goals met in a different order, the company will lack the needed capital for growth. What’s an entrepreneur to do?

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I try my best not to be overtly political on this blog. The reality, however, is that the health care reform debate (and what eventually results from it) will have a major impact on several of our portfolio companies. In addition to the technology sector, we have a heavy focus on early and early growth stage health care services and medical device companies. All of these companies have dedicated teams working hard to build incredibly innovative products and services, many of which speak to the growing need to contain costs and provide better patient care at lower cost. And so, it’s hard for me to stay out of the debate.

I’m not going to go into the broad issues related to the health care reform. Should we have a government provided insurance option? Should we provide for limits on access to end of life care? These are important questions, no doubt, but they are ones that we elect government leaders to debate on our behalf and come up with solutions that make sense. And so how has the debate devolved into a shouting match between representatives of the hard left and the hard right? I would posit that this “teachable moment” is a grand case study on what can go wrong when leaders fail to lead. Unfortunately, this particular failure in leadership is playing out at a time when the stakes for so many Americans and American enterprises is so high.

My harsh critique (fair or unfair):

1. It’s OK to set a stretch goal. It’s not OK to assume followers will know the right way to reach that goal. When JFK set what many consider to be the most audacious goal ever established by a US President, to get a man to the moon before the end of the 1960s, some laughed, some were inspired. But the administration took the goal very seriously – read the history books and you’ll find that the Kennedy administration took great care to bring in the right people to see that mission through. They went to Capitol Hill and got funding for a fledgling space program by building consensus, pitching the need to stay ahead of the Russians in the space race. They (and the subsequent Johnson administration) saw to it that the right caretakers of that objective were in place, that they had the adequate support, and that they knew the administration’s objective. With what many consider one of the great mandates for change in American history, President Obama had the opportunity to do the same with health care – he had a chance to bring in the important players and say clearly “here’s what I want to get done, now go make it happen”. He didn’t. He tried a classic style which has repeatedly failed so many leaders – throwing out the challenge, and believing that followers will find a way to make it all work. “I’m going to bed. When I get up, I am assuming all this will be done”. Wrong – go talk to any great leader and ask them if they’ve ever had any success doing things that way. Effective leaders set big goals, but they also get specific on the best ways to reach those goals.
2. Quality is almost always better than quantity. When I was Student Government President at Georgia Tech, I got some great advice from a great friend – “you’ve got one year”, he said, “Do one or two things really well.” That might be the best advice I’ve ever received. My first day in office, I had that one thing – Tech needed an honor code, and if it killed me, by the time I left office, we were going to have one. Sure, other priorities suffered – student advocacy leading up to the 96 Olympics, parking issues on an urban campus, the need for a new student athletic center. But we put every ounce of energy behind something important, something we believed in, and it got done. Tech is better for it. I know, I know – SGA at Georgia Tech isn’t quite as important as the US Government. Just hang with me on this. President Obama decided early on that within his first year, he would pass the largest government stimulus bill in American history, cap and trade legislation, increased troop levels in Afghanistan, and oh, by the way, health care reform. I applaud his aggressiveness, his sincere belief that many of these issues needed to be addressed quickly. The problem is that the one issue that he knew would take the longest to resolve, health care, will most likely be the victim of his ambitious first year agenda. Many believe that the only thing he should have focused on this year is the economy – not sure if I can come up with a good argument against that. But for crying out loud – the idea that amidst the worst economic downturn since the Great Depression, he could tackle all of these issues adequately… well, it’s some combination of hubris and foolishness. Regardless, it’s a failure of leadership. It’s some young political consultant who doesn’t know how the world works saying, “Mr. President, you’ve got to make all this change at once. It’s the promise you made to the American people”. Wrong - a promise to change is not equal to a promise to change everything all at once.
3. Most Americans want smart, rationale, centrist statesmen. For all the bombast of the extremes on each side of the aisle, the reality is that most Americans want Jack McCoy. You know, the Sam Waterston character from Law & Order. Somehow, he can always figure out how to reconcile the major political differences between a liberal ADA and the right wing agenda of DAs like Arthur Branch played by Republican Presidential candidate Fred Thompson. He’s our guy – hard on the issues that he should be hard on, soft on the issues he should be soft on. President Obama is smart enough to understand that political success is derived from finding that middle ground and grabbing it with both hands. President Clinton was a liberal, but could tolerate and embrace the Southern inspired conservatism that took over Congress in 1994. Monica Lewinsky notwithstanding, he was a successful President as a result. Ronald Reagan is seen by conservative historians as a Moses character, responsible for ensuring that America “saw the light”. The reality is that for all of the ascribed conservative labels, Reagan knew how politics works. You can bet your bottom dollar he shared many a glass of strong drink with his Irish brother, Tip O’Neill as they debated the issues of the day. The debate was rarely dirty and personal. It was pragmatic, respectful of the powers that ruled the day. Statesmen do that – they understand first, act second. President Obama has failed to do that. He still has a chance to be a great statesman, but it will require a sea change in his attitude toward real concerns on the other side. Do that, Mr. President, and you might be surprised how many smart Americans support your efforts and quell the loud voices from the extreme dissidents on both sides.

And so there it is… I’m sure I have completely peeved off those readers who believe Obama can do no wrong, and those who believe he can do no right. No matter – health care reform is needed and needed badly. We need statesmen in Washington willing to truly cooperate with one another to build a real plan, even if it means putting their political career at risk. President Obama still has an opportunity to inspire those around him to do just that, but time is running out…

Stay tuned…

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One of the more interesting conversations I have from time to time with early stage entrepreneurs relates to the real goals of a VC when they make an investment. Oftentimes, the entrepreneur can show how a meaningful, albeit small (call it less than $20 mm) exit can produce a great return for a VC willing to invest in the business. The logic goes like this:

1) Invest a small amount of capital (call it $500 k) in my business

2) Even though I have a limited addressable market, I will own that market and

3) we will get a quick exit which could produce a high multiple for you, Mr. VC. $500 k to buy a 25% stake in a start-up that presumably doesn’t raise any more cash means a 10X return to the VC if the company sold for $20 mm in cash.

If the exit is achieved within a year or so, the VC would achieve a 200+ IRR. Who, the entrepreneur argues, would turn that opportunity down?

Makes a lot of sense until you look at what some VCs consider to be the more important metric – so called Cash on Cash Return. The $500 k invested in that start up produced $5 mm in cash. Again, not a bad return, but let’s look at another example:

1) VC invests $5 mm in a business and gets 15% of the company

2) Company sells for $150 mm in 3 years

3) Assuming that the VC’s equity converts to common (so the VC’s take is a straight 15% of the proceeds), the VC would get $22.5 mm in cash, yielding a 4.5X return that translates to roughly a 65 IRR

So our first investment yielded $4.5 mm in proceeds while our second investment yielded $17.5 mm in cash. So what would be the considerations a VC would make in looking at these two deals:

1) Is the tradeoff of cash-on-cash return vs. time spent on the investment a good one?

2) Which is better – doing a bunch of small investments with limited upside but short time to exit or doing fewer deals with bigger upside and longer horizons to exit?

3) What does all this mean for VCs? Does it become a game of small ball (lots of small exits) or is the key to dig in hard with a few companies and place big bets to more efficiently achieve high cash-on-cash returns for every deal?

Thoughts?

Stay tuned…

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Over the last several weeks, I have had the opportunity to speak with several seasoned entrepreneurs, many of whom are in the process of raising money for a new venture or follow on investment for an existing one. On an albeit small amount of data, I seem to have come across an interesting trend – more and more entrepreneurs are being told to sacrifice growth for capital preservation. Aside from the obvious issues around capital constraints in the market, there also seems to be a push by some VCs to build profitability sooner than the company may have originally planned for. Again, the tradeoff here is topline growth. This all makes sense, right? Position your company to increase runway, get to profitability so that you can survive this extended downturn, increase your option value once it’s time to raise capital.

But here’s the rub – macro trends and the transfer of debt from consumers to the government point toward higher inflation as we pull out of the recession. That means larger companies are going to be scrambling to find ways to grow in real terms, struggling to prove to investors that they their growth can outpace inflation. That, it seems, would point to a more active M&A market as companies try to buy up high growth companies. And the multiples they are willing to pay, it would also seem, will be connected to top line growth, not bottom line efficiency.

And so here’s the question – in this kind of economy, what’s really more important for a start-up to focus on? Top line growth or capital preservation/bottom line stability?

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In this climate, one of the more talked about issues in the venture community surrounds the way in which investors determine pre-money valuations for early stage businesses.  With little or no revenue traction, an incomplete management team, and immature technology, most early stage companies have to sell the promise of growth and market opportunity in order to justify a decent valuation.  It’s a tough sell in good times.  In times like these, it’s darn near impossible.  With fewer exits of significance and public markets still closed, VCs are increasingly back-solving from a reasonable exit value to get a pre-money valuation that makes sense.  If 90% of exits are sub-$100 mm acquisitions, and the goal of any early stage investment is to get a 5-10x return, post-money valuations on most Series A investments need to be less than $10 mm.  This is a reality that still hasn’t caught up with a lot of entrepreneurs.

So this is bad news for entrepreneurs, right?  I’m not so certain… one of the most important outcomes of these more reasonable valuations is that VCs get larger ownership in companies. Once most VCs have characterized the risk in a deal and the money has been wired to the company, they turn their attention to the opportunity – how big could this company get?  What kind of return could we see here?  With larger ownership stakes, the VC has more confidence in the potential return they may see.  That triggers a natural tendency to work harder for and on behalf of that business.  A 5% ownership stake in a company makes it hard for the VC to really visualize a great cash-on-cash return.  But make that stake 30%, and you can visualize that return – you think about it when you come in every morning, you spend that extra hour helping out where you can, you engage at a higher level.  So while it might seem painful to accept a smaller than expected valuation, smart entrepreneurs use this to their advantage – it helps them engage with their investors at a deeper level, they can expect more from those investors and they can expect a stronger follow on commitment from those investors.  Short term dilution can sometime translate into more stability in the investor base, a greater likelihood of success, and a happy investor base willing to invest in the entrepreneur’s next great idea. 

Stay tuned…

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Yes, right up there with my 2nd place finish in the 4th grade science fair and an honorable mention for my Native American diorama in kindergarten, I can now place upon my mantle another great achievement – I am joining the Board of Directors of The Onion, America’s only real, fake source of news.  With headlines like “Jessica Simpson Completes Elaborate Plan To Destroy Cowboys’ Season”, breaking news stories like “Treasury Department Issues Emergency Recall of All US Dollars”, and hard hitting journalistic triumphs such as “International Con Man Barack Obama Leaves U.S. With $85 Million In Campaign Fundraising”, it’s no wonder why The Onion calls itself “America’s Finest News Source”.

But seriously… I will be attending my first board meeting for this esteemed institution later this week and I am pretty excited.  No, NMP hasn’t made an investment in the company.  On occasion, our firm will allow a Partner to join the board of a company with which we have no investment relationship (e.g. Alan Taetle was on the board of ChoicePoint).  We make these exceptions when we believe our affiliation with the company has the potential to strengthen our network, provide valuable insight into an industry of interest, aid in the development of our portfolio, etc.  The Onion, for all of its craziness, is one of the last great independent media brands out there and has done a killer job of building several new digital extensions like The Onion News Network, A.V. Club, and Decider.com.  My hope is that the insight I gain from being a part of their board will aid in our development of better investment theories around digital media and will provide for us a deeper understanding of how high growth digital media brands live and grow.  I’m also hoping to provide a new perspective to the team charged with managing The Onion.  What started out as a small satirical newspaper found only in a handful of college towns has grown into a vast, unrivaled media empire… ok, that’s kind of an exaggeration, but it’s cool nonetheless and I’m honored to be part of it. 

Stay tuned…

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I’ve been thinking about what it means to build social capital within one’s community.  For entrepreneurs, investors and service providers in any location, big or small, one’s reputation can mean the difference between getting funded or not, hearing about that next big deal or not, getting introduced to a prospective client… or not.

We all talk and we all talk about each other – it’s the way the world works in spite of our parents’ best efforts to prevent us from gossiping, spreading rumors, talking behind others’ backs.  To make things worse, efficiency in communication compels us to categorize people and benchmark them against an index of more widely known folks.  So what does this mean for individuals making their way through a clique-y (sp?) local ecosystem?  I don’t have all the answers, but a few classifications come to mind that you want to try to avoid being placed in.  Those include:

• That entrepreneur who seems to be onto some other deal every 6 months or so – but, oh man, this is the one, this is the one!
• That VC who tweets that a top tier VC firm just invested in one of his companies and that instantly means they will be the next Google
• That lawyer who takes advantage of the doe-eyed entrepreneur by selling them on a cadre of services they don’t need
• That entrepreneur who is awesome at raising capital, but lousy at building a business
• That VC who can’t say no so he wastes your time with words like “we’re still evaluating your deal”
• That entrepreneur who applies the scorched earth theory on their way out of the VC’s office – “you guys are idiots and you don’t get it.  We’re the next Microsoft!”
• That VC who doesn’t realize that building a start-up is a team sport
• That VC, entrepreneur, lawyer who’s a taker

And here are a few classifications you want to be a part of…

• That entrepreneur guy who seems to always get the best folks on his/her team
• That VC who rolls up his sleeves and works for his portfolio companies as if he was part of the mgt team
• That lawyer who works late to review a term sheet, attends your board meetings at no charge, who seems to be connected to pretty much everyone
• That entrepreneur who seems to handle every conversation with a potential investor with grace – so much so that investors who’ve said no kinda regret doing so when they see the entrepreneur’s reaction
• That VC who doesn’t brag about the last cool deal they did, but brags about the folks at the company who are making it happen
• That entrepreneur who has that right combination of courage, anxiety and patience
• That VC, entrepreneur, lawyer who’s a giver

This is a tiny subset of Goofus and Gallant classifications – feel free to add to, edit, or debate!

Stay tuned…

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