Monthly Archives

May 2011

The Springboard accelerator

By | Venture Capital | No Comments

I spent a great day today at Jon Brradford‘s Springboard accelerator programme up in Cambridge. They have 10 companies there who are three weeks into what is effectively a three month bootcamp.

A lot of the emphasis so far has been on meetings between the companies and mentors, and that was the case today as well. Each of the teams has now met circa 100 mentors with the idea that they will really hit it off with a few who will then become mentors on a longer term basis.

The meetings were one on one between the mentor and the company and lasted for 20 minutes. I like that format as it gives long enough to properly get into a couple of topics but is short enough that the day felt high tempo. Any shorter than 20 minutes, or with more than one mentor or company and it would have been too short.

I also liked the quality of teams. There was a mix of levels as you’d expect, but overall the level was good. One company, MiniMonos was over from New Zealand and is thinking of moving here. I espescially like that, and I hope they go through with the move.

Without exception the teams are getting a lot out of Springboard which was great to hear.

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When raising VC doesn’t make enough difference to be worth it

By | Uncategorized | One Comment

Over the weekend my former colleague Cedric Latessa emailed me a link to a blog post by Rand Fishkin, CEO and founder of SEOmoz, where he talks about his decision whether or not to raise VC (warning: I two of my laptops have thrown up malware warnings before letting me through to Rand’s blog).  I like the way he thinks about the decision, weighing up the pros of faster revenue growth and a bigger exit against the cons of more dilution, the impact of the preference, the risks that come with bringing a new director onto your board, and the way that raising a venture round rules out some lower value exits (at least in the short term).  His emerging conclusion is that it would be a mistake to raise another VC round.

This graphic from Rand’s post shows the key facts:

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Looking at this it is pretty easy to follow Rand’s logic and see that all the work of raising $10m venture capital and getting to a $240m rather than a $168m exit is barely worth it for the existing shareholders who only get an extra 15% or so in their pocket as the lions share of the increased value goes to the new investor.  The maths comes out this way because raising the $10m doesn’t bring enough extra growth – the chance of being 42% bigger in revenue terms in three years ($60m revenue with funding vs $42m without) isn’t really enough to compensate for 20% dilution and all the additional risk and hassle.

From the information presented it feels like Rand is reaching the right conclusion.  I have a couple of caveats though:

  1. Key to this analysis is the revenue growth assumption, and one of the reasons Rand wrote the post is to explore whether he is being sufficiently ambitious in this regard.  Right now he can’t see where the extra might come from/it feels kind of risky, but that doesn’t mean it isn’t there.
  2. There is no consideration of the competition.  Solid growth from $12.5m to $42m is a lot less exciting if a competitor has hit $60m over the same period and will go on to be 2x your size the following year and maybe 4x the year after.  Customers coalesce around industry leaders.

I am always saying that venture capital is only right for a small percentage of companies and SEOmoz is an interesting case study because it is on the margin.  For many companies the decision whether or not to raise venture is more straightforward – the money makes a big difference or it makes little difference, but either way they should go through the same thought process as Rand. 

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50 Questions: How does a VC consider barriers to entry?

By | 50 Questions, Startup general interest | 5 Comments

Twenty-second in a series of weekly posts by myself and Nicholas Lovell of Gamesbrief which answer the fifty questions you should ask before raising venture capital.  We expect the series to run for a year after which we will collate the posts into a book.  You can find the rationale behind the series here, and the list of questions here.  We welcome your comments on any and every aspect of what we are doing.

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Barriers to entry, sometimes also called sources of unfair advantage or sustainable competitive advantage are hugely important to VCs.  A business with good barriers to entry is able to compete more effectively against competitors because the barriers prevent the competition from offering equivalent product.  Further such companies typically command a higher valuations on exit because acquirers know they will struggle to build an equivalent product themselves and/or public market investors are less worried about competitors.  Finally, there is a good correlation between strong barriers to entry and good margins as businesses scale.

The best and most valuable source of competitive advantage is network effects.  A business has network effects if the value for existing customers goes up when new customers join the network.  The classic example of a network effects business is a telephone network, prior to interconnect regulations the more people that were available to phone and could phone you the more valuable the service to you (and everyone else).  Once a critical mass of users has been achieved no one wants to jump ship to a competitors network with none of their friends on it.

Businesses with strong network effects often destroy the competition to such an extent that they end up as monopolies and then get regulated.  This has happened to telecoms companies around the world who are now forced to interconnect with competing networks at regulated prices.

Social networks exhibit some network effects as all users benefit as the number of users increases.  However, the low switching costs and ease of participating in two or more social networks simultaneously means these network effects are weaker than one might think and explains the demise of former industry leaders Friendster and Myspace.  I think Facebook and LinkedIn are safer because they have managed to create high switching costs as well as massive scale.

Intellectual property (IP) is the other barrier to entry that VCs look to first, and is at the heart of many cleantech, medtech and semiconductor (and some software) investment theses (very few internet businesses have meaningful IP).  IP is attractive to startup investors because it can be seen and touched much earlier in the life of a company than the other sources of competitive advantage. We use the term IP to cover both clever innovations that will be hard to replicate and inventions that are protected by patents.

Below is a list of the other barriers to entry we look for.  Most of them are only available with scale and at the point of investment we look at the business plan and the inherent characteristics of the model and the market to assess the likelihood of any of them driving value to the company over the three to five years of our investment.

  • Data – increasing numbers of web companies are able to harness the data generated by their customers to improve their service, often a very powerful barrier to entry.
  • High switching costs – common for software companies where it is a pain for their customers to switch to alternative providers.  A medium strength barrier to entry.
  • Know how – many companies develop detailed knowledge of industries, manufacturing processes and product or service assembly that make it harder for competitors to enter the market.  A weaker barrier to entry.
  • Brand – most large companies use their brand to keep competitors at bay, but some smaller companies do a great job in this area with more limited resources, particularly in the consumer space.  Our portfolio companies Graze and Lovefilm stand out in this regard.  Having a good company name helps.  Brand is a medium to weak barrier to entry, particularly at the early stages.
  • Scale – sheer scale often makes it hard for competitors, due to economies of scale, ability to spend more on marketing, and appearing as the safe and obvious choice for customers.  For large companies like Facebook, Google, Microsoft, IBM and Cisco scale is a very strong barrier to entry.  For smaller companies, including nearly all venture backed companies it is obviously less strong.
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DFJ Esprit portfolio has big share of Euro M&A market

By | DFJ Esprit, Exits | 10 Comments

The table below is taken from a presentation we made to the investors in our Fund I last week and shows something my partners and I are pretty proud of, namely that our portfolio companies figure prominently in league tables of recent European exits.  In fact, if you tally up the numbers you will see we were investors in companies representing 54% of the value of M&A in Europe over the last twelve months. 

And we have a couple more in the pipe :).

A couple of caveats are appropriate, the table below is limited to the areas in which we focus, and thus includes only IT and MedTech deals, and excludes biopharma deals.  It also excludes IPOs, of which there were a few good ones last year, including Betfair, Qliktech and Logmein.  Finally, it also excludes the Skype-Microsoft deal, which was announced after the slide was put together.

Additionally, there were other VCs in all bar one of the companies from which we exited, and funds like Index, Accel and Balderton have also profited from these deals.

Without being cheesy, I want to finish with the obvious point that all of this success is down to the hard work and brilliance of the entrepreneurs behind these businesses.  Hats off to them.

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When consumer internet companies should get a business model

By | Business models, Consumer Internet | 2 Comments

Frank Lee, who is a new partner at Lightbank, the VC behind Groupon gave an interview to Business Insider last week.  His comment on consumer internet companies and business models summed up my own thinking neatly:

the point that I’m cognizant of is that at the end of the day, these things [consumer internet companies] need some semblance of a business model at some point. There’s notion that you can create something and you’ll figure out a business model much later on, after we’ve aggregated all these users with a ton of engagement. It’s valid, and it has happened, but statistically speaking, the odds of hitting that lottery are pretty slim.

To the extent that you’re not limiting yourself by being tied down to a specific business model, all that said, I think that you still have to be mindful that there is a path to creating a real business at some point down the line.

The kicker for me is the part in bold in the final sentence (emphasis mine).  It is often the right strategy to grow traffic first and monetise second but if there is no clear path to driving revenues then you are into the lottery that Frank describes.  The path may change, in fact it probably will, but at least you know early on that there is a path.  Otherwise there simply might not be.

Twitter Weekly Updates for 2011-05-15

By | Weekly Twitter digest | No Comments

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Twitter Weekly Updates for 2011-05-15

By | Weekly Twitter digest | No Comments

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A sad rationale for Microsoft’s acquisition of Skype

By | Exits, Microsoft | 5 Comments

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By now I’m sure you have seen that earlier this week Microsoft bought Skype for $8.5bn, or 32x trailing EBITDA, a price tag that Business Insider described as “silly on a stand alone basis”.  There must, therefore, be a strong strategic logic, and the best explanation that I have seen is the defensive logic as set out in the article below from the Financial Times:

Trying to justify Microsoft’s $8.5bn price for Skype by increasing growth estimates is impossible without entering stratospherically silly numbers. But what happens if the acquisition is considered a defensive move, rather than an offensive one?

Perhaps Microsoft was thinking only about protecting the current franchise. If Google or Facebook got hold of Skype, they would be closer to building a suite of products that could shake users loose from Office/Windows. To prevent that, Microsoft was prepared to pay an amount that, on traditional metrics, looks insane.

If investors follow this logic and view acquisitions like Skype, or the $6bn purchase of advertising firm aQuantive four years ago, as the price of maintaining Microsoft’s current business, such purchases suddenly look much more attractive. Microsoft exudes free cash: almost three dollars a share of it over the past 12 months, for a remarkable free cash flow yield of 11 per cent. (Which is why value investors like the stock.) And even if Microsoft periodically lays out massive sums to keep the old cash machine running it barely makes a difference. Assume that Microsoft has to make a Skype-sized deal every three years. Take that out of future free cash flow and the stock’s free cash flow yield only drops from 11 per cent to 10 per cent.

This makes much better sense to me than the more offensive rationales I’ve seen (e.g. to boost Windows Phone 7, or to get a presence in video ads), but it doesn’t bode well for the future of Skype as a service.  Atlas, the key product line at aQuantive, hasn’t prospered since the Microsoft acquisition and if the logic for buying Skype is indeed defensive then it is hard to see Microsoft investing adequately to keep Skype at the forefront of its market.

Whatever the logic the deal was a good one for Silverlake and the other investors who bought Skype from eBay last year.  They made a 3.3x return in just eighteen months.

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The amazing story of Amazon

By | Amazon | 3 Comments

I’m a long time admirer of Amazon as a business.  I’ve previously posted videos from Jeff Bezos and written and talked about their incredible track record of innovation.  The first big shift was from simple ecommerce store to a market place – on its own that would be impressive.  But to my mind the achievements of launching market leading products in completely different areas with completely different business models deserve even greater kudos.  I am (of course) thinking about Amazon Web Services and the Kindle.

This slide deck from faberNovel sets out their whole story brilliantly, and I will be very surprised if there isn’t something new in there for even the most dedicated Amazon watcher.

My favourite new fact is that Amazon achieved faster revenue growth than Google, reaching $2.8bn in its first five years compared with Google’s $1.5bn (slide 5).  On the flip side though they did chew through a lot of cash, racking up $3bn in losses from 1995-2003.

Amazon.com: the Hidden Empire

View more presentations from faberNovel
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Some Equity Kicker stats

By | Announcement | 8 Comments

I’ve been running analytics from London based startup GoSquared on this blog for a couple of weeks now.  They have a nice real time dashboard that shows where your traffic is coming from, what pages are popular etc. and it has provided some surprises for me.  That said, I’m guilty of not having looked into any of this stuff as much as I should have previously.

Number 1 – sources of traffic

The split between search, referred and direct perhaps isn’t that surprising

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More surprising was the split of the referral traffic.  Twitter dominated more than I expected, surprisingly little from Facebook, and a significant contribution from WAYN and Innovation America that I had no idea about (thanks guys).

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Number 2 – Location of readers

I was surprised to see the US top and relatively little for the Europe outside of the UK.  I always thought of this as a fairly Euro-centric blog.

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Number 3 – systems and browsers

I picture my readers as being early adopters and tech savvy so I wasn’t surprised to see Firefox and Chrome as the top browsers.  I was a little surprised that so little of you use Safari and Mac OS X though.

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