Media VC

Wow! I knew Q1 was bad, but...

...I had no idea how tough it really was.  An investment bank that we work with shared some internal data which showed that over 85% of deals that got done in Q1 were at either flat or down valuations.  That's off of approximately 50% the prior quarter.  Averages are 30%-40%.  And of course, the "protective" provisions got even tougher for issuers (multiple liquidation preferences, etc.)

When I asked the banker to rate the health of the financing market right now on a scale of 1-10, he said 2.0 - 2.5, up from 0 to 1 in Q1.  I rate it higher, based on the activity levels our portfolio companies are seeing, but based on the numbers there's no doubt that Q1 should be considered the bottom for raising capital.

The New 4 P's

In a recent seminar,friend and Legend advisor "Growth Guy" Verne Harnish offered his replacement concepts for marketing's traditional 4 P's, opting instead for the 4 E's:

• Product has been replaced by Experience
• Price is now Exchange, or lifetime value
• Place is Everyplace
• Promotion has been replaced by Evangelism

The threads underlying these changes are consistent with the rise of Web 2.0:  real time feedback, deeper connectivity, nearly complete reduction in the cost to distribute information, and citizen influencers.

It's Official: The Model is Broken

Today the National Venture Capital Association released its long-awaited answer towhat ails the venture capital industry.  In a four pillar plan presented here:

NVCA 4-Pillar Plan to Restore Liquidity in the U.S. Venture Capital Industry

View more presentations from NVCA.

the association hopes to jumpstart a recovery in the IPO market, which has been dismal and shows no consistent signs of recovery.  They are also promoting alternative forms of liquidity such as Second Market.  Notwithstanding all of the thoughtful commentary and analysis, I couldn't help focusing on the wrenching simplicity of slide #7.  It  shows that the median age of a venture company that exits via M&A has grown from 3 to 6.5 years and the average age at IPO exit has increased from 4.5 years to 9.6.

This to me is the crux of the problem.  The fact is, you  cannot insert 3-5 years into the venture cycle and hold the other variables constant (e.g., average exit value) without breaking the model.  On a risk adjusted basis, the IRR's simply won't stack up against the relative returns of other asset classes.

At the possibility of alienating my VC colleagues, I can't help wondering whether it's our partnership structure that needs to change rather than trying to return the regulatory environment, tax code and financial services industry all to their prior states.  We can argue that those were the good old days, and for us they certainly were exceptionally good.  But there were tons of abuses in the system that investors and the public at large got fed up with: directed share programs, pump and dump by the i-banks, the list is long and undistinguished. 

Instead of going back to the past, it's worth asking whether we shouldn't reconsider our current model.  We've been using the same general partnership structure since the 1960's and I think it's time to ask whether it still makes sense.  When you consider that it takes 9.6 years to build a company that is even eligible to exit via IPO, a 10 year locked-in partnership with a 4-year investment period, backended partner compensation that is subject to clawback, steadily reducing fees, and in certain cases joint and several liability, it's no surprise so many smart people went to hedge funds. 

But what if you're like me and truly love early stage venture?  Some recent conversations I've had with a few very savvy investors suggest another path.  In the past 2 months, I've spoken with several venture investors who are simply going to a deal by deal model and forgoing the structure of a formal fund.  Using well-established networks of co-investors, they are pulling syndicates together for individual investment opportunities, generating fees (portions of which are re-invested in the deal) and earning carried interest on the success of each investment.  It's a hybrid private equity/merchant banking model applied to early stage.  For some very capable people, it's a more viable alternative than recreating an ecosystem that time, regulation and technology have altered permanently.  I'm interested in what this smart community thinks is the right answer.

Financial Pornography

In his Portrait of the Artist as a Young Man, James Joyce asserts his views on Proper and Improper Art.  The latter according to Joyce appears in two styles:  Didactic and Pornographic.  He defines Pornographic Art as anything designed to inspire the observer to possess the object being rendered.  All advertising art is by definition pornographic according to this construction.

With the arrest of Bernard Madoff, we are seeing the financial equivalent of Joyce’s formulation, where the observer is the investor and the art is his forever-reliable fund and its wondrous returns.  Investors lusted after and briefly held the ultimate investment prize:  a steady, reliable investment that was as safe as cash, as predictable as bonds, but which generated such boast-worthy returns as to make a Madoff investor the envy of the three other gentlemen on the seventh tee box at the Palm Beach Country Club.

And the come-on was devilishly simple:  “I make money if the market goes up, I make money if the market goes down.  I just don’t make money when the market stays flat.”  It’s so straightforward anyone can understand it…and, of course, when have markets ever stayed flat?  The strategy is always in style.  Even better, churning just below the simple mantra is the suggestion that there’s some secret mathematical algorithm that tames the market’s inherent volatility and makes it serve the investor, rather than harm him.  Simple enough to describe to a friend, sophisticated enough to sound legitimate.  Perfect.

Combine the aura of exclusivity where not qualifying for the fund indicated inferior social status or (gasp) insufficient current wealth (“Perhaps next year you’ll have enough”), and you have all the requirements for even the most temperate and experienced businessmen to abandon everything they’ve known and preached about diversification, due diligence and fiduciary restraint. 

But all pornography is by definition a caricature and an ersatz experience to reality.  In Joycean language the pleasure that comes from possessing the object is fleeting. What is agonizingly real, however, is the destruction of billions in wealth, particularly Jewish wealth painstakingly created since the first wave of Eastern European immigrants in the late 19th century and expanded over generations ever since.

In the US the impact will be seismic, if quiet.  From the destruction of individual families’ financial scaffolding to the fiscal plans of universities, hospitals, charities, foundations, and many corporations, institutions that were already coping with reduced capital from a recessionary economy will now face even fewer resources and possible bankruptcy.

What is also very real is the further destruction in brittle investor confidence. In a financial system based entirely on the twin pillars of trust and a belief that the future will be better than the past, calamities like Madoff can dampen investor behavior for years.   There are still handfuls of people who remember the Great Depression and invest as though it happened yesterday.  Today, investors reel and roil in uncertainty due to the credit crisis and its aftermath.  Tomorrow new generations of investors will timidly refract each investment decision through the icy prism of capital preservation rather than the warm ray of optimism that originally created such vast wealth in the first place.

Eventually, however, investors will dust themselves off, extract some liquidity and get back in the game.  Warren Buffett is famously quoted as saying “Be fearful when others are greedy and greedy when others are fearful,” and it would take the stoutest of investors to approach this latest misfortune with that much brio right now.  But, the buying opportunities are just too compelling to stay on the sidelines indefinitely.  For those that ultimately do come back, this may be the once-in-a-generation opportunity to build the next great fortune or recover the one that just got away.

Dems: FCC Chairman Fails Congeniality Test

Today Network World, the Washington Post and several other outlets reported that FCC Chairman Kevin Martin failed to play nicely during his tenure and hurt the feelings of several members of the House Energy and Commerce committee and their staffs.  The Committee report further accuses Martin of behaving in a political manner in executing the Commission's business.  Finally, and most damming of all, he stands accused of not telegraphing every controversial policy priority far enough in advance to give opponents an opportunity to kill his initiatives.

This would all be comical if it didn't cost thousands of dollars of taxpayer money and endless hours of Committee and Commission staff time.  The report clearly indicates there was no violation of law.  The report also finds no instance where major mainstream communications priorities suffered.  It simply says that the committee would have preferred him to be nicer and more open.  I'm frankly surprised it wasn't signed by Comcast and the other cable companies as well as John Dingell, given Martin's stance on a-la-carte pricing.  It's a specious hit job while Martin is on the way out the door.  Let's hope the next chairman will be given an opporunity to focus on the nation's communications infrastructure instead of supercilious Congressional witch hunts.

Globalgiving.com - Charity 2.0

This year instead of sending holiday cards we're sending gift cards to Globalgiving.com, a great web site that connects donors to the charity program of their choice with the least amount of friction possible.  I received a gift card recently and donated to a project for clean water in Ethiopia (most folks have a climate issue that they particularly resonate with and water's mine).  There are projects across the globe that deal with children, disaster recovery, climate change...the list (unfortunately) is endless.  Each project is described in detail, with progress reports, contacts for project leadership and the remaining fundraising goals.  I actually picked the charity with my kids, which, while hardly experiential, gave them a sense of the challenges others are facing.  I encourage everyone to check it out and give generously.

Grandiose and Juvenile Impulses

In his book Prisoners, The Atlantic's Jeff Goldberg poignantly describes how at the end of his duty as a prison guard in the Israeli desert he asked jailed Palestinian terrorists for their addresses so that he could come visit them were they ever to gain release.  It was a distinctly American idea:  if he could only spark a dialogue with them then maybe they would understand each other better and perhaps someday in the future something incredible would result.

In a recent speech Jeff self-deprecatingly dismisses this gesture as a "grandiose and juvenile impulse", something from a bygone era of his life.  But I wouldn't be so quick to pass judgement.  First, Jeff did in fact establish a long-standing and complicated relationship with one of the former terrorist inmates that continues to this day.  Who knows where it might lead?

Second, over time I've become a big believer in Grandiose and Juvenile Impulses and wonder where our country would be without them.  Was it pragmatic and mature for a junior African American senator to think he could defeat two of the country's toughest political machines to become president?  Was it pragmatic and mature for two Stanford computer students to reject an early acquisition offer from Microsoft in favor of building their own independent program that only did web search?  Was it pragmatic and mature for Southwest's Herb Kelleher to think he could replace bus service with jets for the same cost?

Indeed, all the successful ventures we've funded began as a grandiose and juvenile impulses.  They are the lifeblood of the venture business and tremendous careers, fortunes and communities have resulted from them.

Unfortunately, what happens in economic climates like the current one is that the flow of these impulses turns into a trickle and is replaced by safe bets that marginally improve what's already out there.  Could somebody create the microblogging space today with the successful launching and funding of twitter, or would the lack of an obvious business model kill it?  In today's environment would the envy and hubris required to build Hulu be enough to garner the corporate backing to launch a Youtube competitor? (Well, probably)  I suspect there are multiple grandiose and juvenle impulses that aren't getting acted on right now.

But are we missing the opportunity of a lifetime?  Entrenched competitors in every market segment are focused inward triaging their operations, some of the most talented human capital is being purged from businesses en masse,  and there's tons of money sitting on the sidelines waiting for an inspiring idea to fund.  I'd argue that If we're to get our economy going again, it will be because of the rare individuals with the courage and confidence to act on these impulses and the will to see them through.

Rejoice

http://online.wsj.com/article/SB122697024336935679.html?mod=article-outset-box

Best Summary Yet of the Financial Crisis

The NY Times blog has the best summary yet of the current financial crisis here:  Diamond and Kashyap on the Financial Crisis. Money quote:  

     "A reasonable reading of the recent bailouts suggests a simple rule: if a firm is on the verge of collapse and its ties to the financial system will lead to a cascade of chaos, the firm will be saved. A bankruptcy will be permitted only if the failure can be contained."

Evidently, with a new RTC in the works Paulson, Bernanke & Co., are telling us it's getting harder to distinguish between what might cascade and what can be contained.

Scary Headlines...Thought for the Day

 “No Federal Help in Firm’s Last Hours” Sub-headline:  “Bush Administration says, ‘Drop Dead’”
Washington Post, February 15

“Crisis Management Dominates SEC Chairman’s Agenda”
LA Times, September

“Markets Take Worst Hit Yet on Gulf Uncertainty”
Washington Post

However, all dates are 1990.

Reference to Drexel Burnham(not Lehman, Goldman, etc.), Dick Breeden at SEC, not Chris Cox and the S&L Crisis.  Within two years of these scary headlines one of the largest economic expansions in world history began…just a little thought for the day.