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Beware the Headless Horseman

January 30, 2011

Brad Svrluga

I was struck Friday morning when I opened up VentureWire and read the announcement of Storenvy’s $1.5MM Series A financing.  This statement stopped me in my tracks: “co-led by Spark Capital and First Round Capital with participation from Charles River Ventures and Kleiner Perkins Caufield & Byers and a group of angels including. . .”

Not that we needed any further evidence that the venture landscape has been turned on its head in the past year or so, but man. . .a $1.5MM financing that has CRV and KP as the also ran followers?  It’s a brave new world indeed.

Storenvy CEO Jon Crawford is a lucky guy – he’s grabbed 4 of the top names in venture for his series A, plus a host of prominent angels. And I’m sure he also realizes he’s now got 4 very hungry institutional mouths to feed and answer to. Fortunately, everyone around that table has been to these movies more than a few times before. But this story got me thinking again about an issue I’ve been really worried about in the new seed and Series A landscape we’re living in these days.

I’ve seen a lot of Headless Horseman financings recently, and they scare the heck out of me.  This is the round where a whole bunch of angels, and maybe 1 or 2 (or 6!) small funds all pile into a $1-2MM round.  There’s lots of smart folks around the table that the CEO has gotten to know and like through the financing process, tons and tons of good intentions, and an impressive array of networks and relationships assembled to help the company.  So what’s the problem??


Well, the CEO is presumably in charge, but on the investor side of the table someone needs to be in charge, too.  There’s a really, really, really good reason that deals have historically had lead investors.  It’s not because one of the VCs has a huge ego and needs to be called Top Dog (well, it’s at least not always because of that. . .).  It’s because when there are multiple investors involved with a company, it can become a communications and management disaster if nobody is in charge.

It’s been said more than once that if you’re the CEO, VCs involved in your company are a lot like martinis. . .one is great, two is fantastic, three starts to become a problem, and get to four or beyond and you’re asking for trouble.

Things get complicated in early-stage companies, and at critical times it’s very, very easy to end up with too many cooks in the kitchen.  As a CEO, that can be a disaster – come to a crossroads for the company and suddenly you’re trying to herd a whole bunch of cats into a decision, or fielding anxious phone calls from all directions.  Without a strong lead investor helping to manage her co-investors through that process, you as CEO are in for a splitting headache.

The good thing about the Storenvy round – and not surprising given the pros involved – is that there is clear separation of lead investors (Spark and First Round) from non-lead (CRV & KP).  Someone (or two people, which is OK) is in charge here.  I wish I could say that about a lot of early deals I’ve seen recently.

If you’re a CEO pulling an early stage round together, make sure you work with your syndicate to identify a lead.  And once you’ve done that, manage key communications and decisions in concert with that lead.

If you’re an investor, you should want the same thing, even though it may mean not as much TLC from your favorite new CEO. Either nominate yourself, or get out of the way and accept that someone else will be in charge. Your CEO will thank you for it, and the company, and as a result you, will be much better off in the long run.



Outside Directors, Part Deux: Thoughts on Pickin’ ’em

January 26, 2011

Brad Svrluga

In a post last week I offered some thoughts on why I think outside directors are so important to early stage companies.  Once you’ve accepted the value and importance of building a diverse board you get to the hard part – identifying the right candidates.  It can be a difficult process, but I’ve never met a compelling company with a solid CEO fail to recruit some real talent to the boardroom unless they just didn’t try.  It takes work, and it needs to be managed (as I suggested in my prior post – make one of your otherwise useless venture investors manage the process, and hold them accountable!), but don’t fall into the all-too-common trap of letting the challenge of the process lead to inaction.  You know it’s important, now you have to make it urgent.

The first thing, as with any good process, is to define the successful outcome.  What are you actually looking for in a director?  That will depend greatly from company to company – sometime it’s industry connections, sometimes it’s product expertise, sometimes it’s general strategic savvy.  Only you can identify what you need.

In general, I’d encourage you not to undervalue general savvy in favor of something hyper-specifc.  There’s nothing more valuable, over time, than having a really great thinker and strategist around the table with you – an athlete who can add value across a range of issues.

To help get started thinking about candidates, I offer a few thoughts and tips here on some different types – four good, and one not-so-good.

  • Current venture-backed CEOs. Often the most appealing candidates given strategic fit, but be careful – if they’re running their own high growth company, they may not have the time to focus effectively and do a good job.  Generally the more mature the company, the better.

Niraj Shah, founder/CEO of CSN Stores, is a good friend who has served brilliantly as an outside director for a couple of my companies.  But his “startup” is 9 years old and doing hundreds of millions in annual sales now.  He’s got a lot of lieutenants that enable him to leave the office and focus on other things.  When he was a $15MM company it would have been very different.

  • Cashed out in your industry. These guys can be perfect – they know the landscape, they’re proven winners, and they get the entrepreneurial thing.  Frequently they’re in demand from a networking perspective, so they stay very much plugged in and can be super-helpful with recruiting, bizdev, etc. A word of caution here – some successful entrepreneurs become overly enamored of the way they did it in building their success story. Make sure as you interview candidates you explore to make sure they have open minds and are good listeners and broad thinkers.  They should be generally interested in and curious about your business and how you’re building it, not just walking into the room pushing their personal agenda.
  • Successful entrepreneurs from outside your industry. Discount them at your peril. CEOs & boards frequently get overly focused on finding that perfect candidate from a precisely defined industry, passing on people who are just good startup thinkers and company builders.  My friend Pete Willmott, a recently retired 25+ year member of the FedEx board, amongst others, tells me that FedEx has always had some ‘obvious’ board members, like the COO of Northwest Airlines. But he maintains that the non-obvious ones have often been the most valuable.  He cites a former senator (George Mitchell), a university president (RPI’s Shirley Jackson), and a baking turned spirits CEO (Pilsbury and later Diageo’s Paul Walsh) as true standouts. Not a lot of global shipping and logistics expertise amongst that trio, yet they consistently made huge contributions to FedEx strategy. If those folks can be critical contributors at FedEx, doesn’t it seem a little silly to categorically decide that the founder/CEO of a successful payments company couldn’t bring real value to the table in building a SaaS infrastructure business?

So much of what’s hard in building early stage companies is the stuff that’s common across verticals – challenging HR & hiring issues; strategizing around negotiating key partnerships; capital strategy; product and engineering issues.  Having a sane, objective outsider who’s been there before but hasn’t consumed the KoolAid of your sector can really help.

  • Retired executives from your industry. For non-startup execs, where you’re looking for industry knowledge, I have a strong preference for recently retired.  I had a great experience a few years back bringing Garry McGuire, the immediately retired CFO of Avaya, onto the board of Allworx, a telecomm equipment company we had invested in.  Garry was just stepping into a life with no day job and he wanted to find some projects to keep him engaged and focused.  So he had plenty of time and energy to give to the company.  He had been an active executive in our marketplace only a few months before, so his relationships, market knowledge, sense of the competitive landscape, etc. were all current, and ultimately quite valuable.  If you’re looking at a retired candidate who does not have current and valuable networks then I’d suggest you keep looking.
  • Execs with no startup experience. This is for me all but a non-starter, unless you have a large board and are also including one or more startup-savvy outsiders. Rising through the management ranks at GE to become a division president is a great way to become a brilliant manager and strategist.  But it doesn’t teach you much about wrestling with growing a business from 10 to 100 employees.  Some executives are great at making the shift in thinking, but many others are not.  In most cases, if it’s someone without any startup operating or board background, I probably won’t want to be their first startup experience.

Once you’ve decided what you want, the trick is holding the bar high enough, but not too high.  Have the same standards for excellence that you would have when hiring key employees, but also understand that filling the seat is nearly as important as filling a key operating role in your company. If you’ve worked your networks hard, been aspirational about reaching out to some “dream” candidates, and come up empty, then don’t turn your nose up at the great-but-not-quite-perfect candidate that’s eager, available, and willing to work.  Fill the seat – I know you need the help.  And remember, directors are like employees – if they turn out to be no good, the board can fire them and try again.

Bottom line – outside directors can be real difference-makers for young companies, and are an essential part of good governance.  Finding them will never become urgent, so make it a priority and put someone in charge of the process.  If you’re clear on what you’re looking for, work at it, and hold your standards high, you won’t regret it.

I’ll save some thoughts on outside director compensation for a conclusion to this series next week.


Virtue is a Virtue: Flat World Knowledge Raises $15MM led by Bessemer & Bertelsmann

January 20, 2011

Brad Svrluga

One of my very best friends, and Village Ventures co-founder Bo Peabody, wrote a brilliant little book a few years ago called Lucky or Smart (great excerpt/summary of it here from Inc. magazine).  If you’re an entrepreneur and you haven’t read it, you should.  It won’t take long, and it offers some invaluable lessons and perspectives on what matters and what doesn’t in building a successful entrepreneurial enterprise.  And, most importantly, it offers Bo’s golden rules of entrepreneurship (my term) – which I’ll very liberally paraphrase in these three points:

  1. Success in business usually requires luck.
  2. The best entrepreneurs create companies that get disproportionately lucky

And, most importantly. . .

  1. “Lucky things happen to entrepreneurs who start fundamentally innovative, morally compelling, and philosophically positive companies.”

I’ve been fortunate to work with a few such entrepreneurs.  Steve Ellis, who founded and ran Pump Audio, which we successfully sold to Getty Images a few years ago, is one.  Steve created a truly better mousetrap for pairing quality soundtrack music with professional and user-generated content.  Critically, he did it in a way that empowered and financially rewarded independent musicians, opening whole new opportunities for these struggling artists to make money. And he did it in a way that, from the get-go, treated the artists equitably and respectfully, not just as mass of powerless suppliers. That “fundamentally innovative, morally compelling, and philosophically positive” approach to his business paid enormous dividends.  Customers LOVED the offering, talented startup engineers and music industry executives were desperate to work for the company, and the network of musicians who were the suppliers of Steve’s product became, at no cost, his very best marketers.  It all seemed quite easy, frankly, because Steve had created a company that got WAY more lucky than the average company.

Today we are celebrating another such company.  Flat World Knowledge, the leading 21st century higher ed content company – has closed a $15MM financing jointly led by Bessemer Venture Partners and Bertelsmann Digital Media Investments.

Flat World is wreaking absolute havoc in the $8 billion higher ed textbook market.  This is a market characterized by a product that hasn’t changed in 200 years – the 6 lb., $150, take-what-you-get doorstop.  Enter Flat World, offering fully customizable, multi-media delivered, Creative Commons open-licensed “textbooks” that can be customized by faculty and read by students online for free, or by paid downloads as audio books, printable pdfs, ordered in 4 color print, or all of the above.

FWK was founded in 2007 by Jeff Shelstad and Eric Frank, two seasoned higher ed publishing industry veterans.  After trying unsuccessfully to change what they perceived to be their “broken” industry from the inside, Jeff & Eric left the safety of Big Publishing to pursue the enormous opportunity available to create a totally new business model for content delivery in the higher ed market, going directly after the traditional publishers in an effort to knock them off their oligopolistic perch.

Jeff & Eric made big bets about each of the key constituencies in the market when starting Flat World:

  1. That top authors wanted a more dynamic, flexible platform on which to write, and that they would take the risk of working with a new type of publisher to gain that flexibility
  2. That professors wanted to be able to customize textbooks for their unique needs – reordering and reshuffling content, adding their own contributions, and integrating real world resources, and that they also really cared about the economic burden that traditional textbooks placed on their students.
  3. And that students wanted to purchase content a la carte, and in a variety of different formats, just as they consume other media.

To see how that all adds up to a winning formula, check out this brilliant little video – one of the best company intros I’ve seen to date:


Three years later, it’s working spectacularly well.  The model is having a dramatic impact on both the bank accounts and learning outcomes of tens of thousands of students across the country.  It is particularly impactful at the state and community college level, where the economic pressures are the most acute.  In a world where the average community college student’s textbook bill equals a full 72% of her tuition and fees, a remarkable Gates Foundation study – With Their Whole Lives Ahead of Them: Myths and Realities About Why So Many Students Fail to Finish Collegeshowed that unaffordable textbooks are in fact a leading contributor to students’ inability to successfully complete their degrees.  Faculty and administrators are now reporting to us that use of Flat World content is leading to higher student retention and better learning outcomes, because there is no longer any excuse or economic barrier to getting the content.

Saving money for students and helping to promote better learning – what could be more virtuous than that?

Not surprisingly, this has been an extremely fun and rewarding business to be around.  And it’s been my best illustration yet of the value of Bo’s Golden Rule.  You can’t help but be struck, when working with businesses like Pump Audio and Flat World, by the degree to which “Virtue is a Virtue.”  Nothing sells – to customers, employees, and partners alike – like a powerful and virtuous mission led by compelling, committed entrepreneurs.

Evidence Flat World’s phenomenal team – the company has had a remarkably easy time recruiting top notch talent from day one.   People who join Flat World aren’t just taking a job, they’re signing up for a crusade.  It’s a compelling pitch.

Channel partners want to work with us.  Authors want to write for us.  Investors want to buy our stock.

In short, the virtuous story that Jeff & Eric have created – the fundamentally innovative, morally compelling, and philosophically positive company that they are building – has become a magnet for talent, capital and resources.  As investors, we’re in the envious position of getting to feel good about ourselves for being a part of this important movement while reaping the benefits of the company’s success.  It’s a great way to win.

Congrats today to Jeff & Eric on this latest milestone in the Flat World story.  We’ve got a long way yet to go, but I’ve got all the confidence in the world that with this virtuous tailwind at our backs and these guys’ exceptional talents as entrepreneurs, we’ve only begun to scratch the surface of what this will be.

And as an investor, I’ll continue to look hard for companies that have similarly virtuous missions.  After all, it’s a lot easier to win when people keep helping you to get lucky.

Recruiting Outside Directors: Get off the Dime

January 17, 2011

Brad Svrluga

Devil boardroom

I was talking recently with my good friend and mentor Pete Willmott about building great boards.  Pete’s got a decades long career of success as a CEO and entrepreneur that started with his role as the original CFO (and then a Director for three decades) at FedEx.  He’s served on a ton of corporate boards.

Pete is a master strategist and a real student of good governance.  And he believes, like me, that truly great boards can be amongst a company’s most powerful assets.  We also agree that boards cannot be great unless they have exceptional outside directors.

In my experience, startups too often fail to make it a priority to find great outside directors.  While sometimes you bring that perfect person on coincident with a financing event, more often the right candidate isn’t yet known, and a seat is held open for a search that likely never gets done.

Why is that? It’s a classic example of the tension between urgency and importance.  Finding that director is accepted as important, but it’s a long way from urgent. You’ve just closed a financing and you’ve got a hundred urgent pots on the stove that need tending to. So the important/not urgent list never gets tended to and that board seat sits empty.

Shame on all of us who let that happen.

Some of my peers in the venture business argue that outside directors are in fact not even that important, and rarely add value.  In fact, one of our companies was recently raising a later-stage financing round and the new lead investor tried to insist that we would never have any outsiders, because he thought they were consistently useless.  Lunacy. If you haven’t had good experiences with outside directors, you’re just bad at picking and recruiting ‘em.  Try again.

So why, as an investor or entrepreneur, should you get religion on this topic?

  1. You’ll need a disinterested party somewhere along the way to vote and opine on inside financings or other complex issues.
  2. You don’t ever want to be in a position where it’s just the investors vs. management in a key debate. These things happen, and a third party in the room makes all the difference.
  3. As a CEO, you deserve a safe haven for conversations that you might not feel comfortable having with your investors, or at least a place to dry run an idea or complicated issue before having to go to the investors with it.  As an investor, you want your CEO to have this sort of outlet.
  4. Getting consistent, focused help from experienced business-building superstars is always a good idea. And when you make them real stakeholders, they’ll give you that much more focus and attention.
  5. The deep industry perspective of someone who’s operating in your industry can increase the company’s odds of skating where the puck is going in a very different way from your investor board members.
  6. Last I checked, hanging out with folks who have high-level relationships at strategic partners, customers, or potential acquirers of the company never hurts.
  7. If they’re very well known and/or very relevant to your industry, they can add real credibility, which can help with attracting investors, customers, or employees.

And the list goes on.

Trust me – you’re going to really want that outside perspective for one reason or another eventually. But if you don’t bring it to the table right away, by the time it becomes more urgent (like, you could really use an outsider with industry ties to help guide an M&A process) it’s too late to start looking.

Ideally, we should do these things concurrent with a financing, when we can ride the PR and momentum of that event to support recruiting. But there’s no excuse for not starting now, regardless. If you have a seat open, get to work on filling it. And if you don’t have any seats designated for outsiders, have a serious discussion about creating one or two.

Like anything, someone needs to own the recruitment process. Here I say put ownership of this on one of your VC board members, and make him report regularly on progress. The CEO will have to be closely involved, but she’s got enough other things to worry about and this can easily be managed by another director.

Finally, when looking, don’t let perfect be the enemy of good. The ideal candidate is rarely attainable, if they even exist (I, too, would love to have Steve Jobs on the board of one of my companies). Sometimes it makes sense to find everything you want through two people. I’m a fan of pairing one outsider with deep expertise and relationships in our industry with one from outside who’s just a killer company builder and strategist. That pair will almost certainly elevate the dialogue around your board table by a notch or ten.

So get off the dime and start looking. To help focus those searches I’ll share some thoughts on things to look for and to avoid in director candidates in a post next week.

Good luck!

Exit Happy Talk: Don’t Believe the Hype

January 13, 2011

Brad Svrluga

Jeff Bussgang is a terrific VC, and a blogger I enjoy and respect. I had to chuckle a bit yesterday morning, though, as I read his most recent post, Walking Away from Liquidity.  In general, I agree w/ the post – as usual, Jeff makes some great points about how to think about when to sell an early-stage company.  But in an effort to make the point more personal, he refers to a couple of recent examples where his companies decided not to sell and “walked away” from exit opportunities.  In doing so, Jeff alludes to the “VC-like returns” that might have been generated by those transactions.  And so he joins the legions of VCs (present company decidedly included) who play that favorite game of obfuscation, Exit Happy Talk.

What are “VC-like returns,” anyway?  Does he mean deal returns that might truly carry a fund, like a >10x cash-on-cash deal?  Or does he mean the level of returns we expect to deliver across a whole fund, more like 2-3x, cash-on-cash.  Knowing how VCs talk about this stuff, I suspect the latter.  If that’s the case, then given the realities of how we make money at the fund level, these specific deals sound more likely to have been pretty mediocre outcomes.

In general, if we’re not quite sure how to read a statement about returns when we hear a VC talk about an exit, as in Jeff’s post, then we can be pretty confident that it really wasn’t all that great.  I can talk ambiguously about outcomes as well as the next guy – I’ve been heard in this very blog and elsewhere to use the language “very nice” when describing one of my own exit outcomes – a decidedly blasé one.  Trust me, when they’re great, we won’t risk you not quite understanding.  (Note: I’m not picking on Jeff specifically, and I know nothing about the specifics of the deals he references, so I could be totally wrong in this instance, but the language he used is illustrative of the broader point.)

Note: I had a good exchange with Jeff Bussgang on this over the past couple of days, and he offered me some specifics on the deals (and clarified in his original post, as well).  I was clearly out of line in suggesting that the offers were not strong offers – I didn’t know, so I shouldn’t have drawn any conclusions.  Turns out that, in fact, they were both in the 5-10x range – good outcomes, indeed.  So I owe Jeff and my readers a big mea culpa for singling him out.  I wasn’t intending to be critical – just to illustrate a point.  And while the point still holds, I need to be, and will be, more thoughtful in the future about how I choose my examples.  Congrats on the success of those companies, Jeff – I, too, hope time proves you guys to have been wise for walking away! And thanks for the advice as I work to get my sea legs here at Can I Buy a Vowel.

My point, really, is that people on the other side of the table from us should understand that VCs work very hard to make every exit sound terrific.  Entrepreneurs want to know that you’ve been involved with companies that turned to gold.  So we spin them gold.  LPs love nothing more than receiving checks from us – it’s what they really pay us to do, after all.  So we make sure to celebrate every one we send, even if it’s the result of a mediocre deal.

Bottom line. . .don’t believe the hype.  VCs are really, really good at inflating perceptions of exits.  So if you don’t know for sure, discount your assumptions heavily.  Here are a few hints on how to read through the spin:

    1. Hearing clear statements of cash-on-cash mutiples is the only way to really know how the VCs did.  And if it wasn’t a 6-8x cash-on-cash deal, then it really wasn’t something to get crazy excited about unless it was a really fast flip.
    2. If it’s a private company sold to another private company and no financial details are offered, forgetaboutit.
    3. If the multiple isn’t disclosed – public or private acquirer – and if the VCs don’t say anything about it, it probably wasn’t a very good deal.  Trust me: if it’s even remotely good, the VC will find a way to talk positively about it.
    4. If you don’t hear words like “extraordinary return,” “grand slam,” “incredible outcome,” etc., then it wasn’t a big win.  Even “home run” can’t be trusted – I’ve heard that term used in its literal “four-bagger” sense, by people describing a 4x return.  Remember, folks, if our best deals are 4x’s, we’ll have the luxury of not having to waste all that time trying to raise the next fund – we can go straight to updating our LinkedIn profiles.
    5. Don’t fall into the trap of believing that the relationship between capital raised and exit value tells you much about the actual outcome.

This last point is a particular pet peeve of mine.  It confuses the point, and implies that a lot of so-so outcomes were actually real winners.

Take this example from the December 17 edition of VentureWire, about AOL’s acquisition of Pictella.  (Disclaimer: I know nothing about the actual details of this transaction)

[Avalon Ventures] was the sole institutional investor, helping the advertising technology company raise $3.5 million. The Wall Street Journal reported the acquisition price to be between $20 million and $30 million, signaling a quick and lucrative return for Avalon, which invested in 2008.

VentureWire is very clear in praising this as a great outcome.  “Quick and lucrative.”  But all we know is how much the company raised and a range of possible exit outcomes.  And if we take that information and apply 1/3 as a relatively standard ownership position for the money in a company of this profile, then a $20MM exit might only represent a 2-3x return, and $30MM likely not better than 3-4x.  And while that’s a nice turn on a horserace, in the venture business, it’s nothing to write home about.  (But don’t worry, Avalon has plenty to write home about, with a great portfolio – including a big stake in Zynga, and a just closed and way oversubscribed fund IX)

The point is not the specifics of this deal, though – and depending on how it was structured, it may very well have been a fantastic outcome for Avalon.  The point is that VentureWire makes no effort to suggest that given that ratio of capital in to exit value it could possibly have been anything other than a great outcome.  That’s plain old misleading.  And it encourages the widely accepted notion that 3x and 4x deals can be great outcomes for VCs, which they aren’t – a topic worth addressing in another post.

Bottom line?  Understand that only a tiny percentage of exits each year drive true venture returns – 8-10x or better (or maybe 5x+, if it’s really fast).  There are many, many more deals that are made to sound good.  Learn how to sift through the smoke and mirrors and you’ll start to really understand who’s doing well rather than be fooled by doubles masquerading as home runs.

Introducing VillageVines

January 10, 2011

Brad Svrluga

Just before the holidays I took a colleague out to lunch at Devi in Union Square in NYC.  It’s widely regarded as one of the best Indian restaurants in the country.  We enjoyed their spectacular 5 course chef’s lunch menu over a leisurely 2 hours.  We each had a drink.  The total bill?  $68.  An incredible steal.  And they were thrilled to have us.

You want to do it tomorrow?  You can.  You want to do again on Wednesday?  Be my guest.

I’m thrilled today to announce our latest investment here at High Peaks – we’ve joined a terrific set of partners – Hearst and GrandBanks Capital – in a Series A investment in NYC-based VillageVines.  VillageVines is the leading online source of discounted dining experiences at America’s top restaurants – think for restaurants.  More details below, but first, a step back.

So quick – name the only thing the world needs less of right now than another VC blogger?  If you said another daily deal site, you’re right.

The proliferation of Groupon clones represents without question the most remarkable burst of me too-ism I’ve seen in my 12 years in the very me too-ish world of venture-backed startups.  I’ve seen counts ranging as high as 1,200 daily deal sites around the country as of the dawn of the new year.  A bubble, no doubt.

It’s a bubble driven by low barriers to entry and spectacular unit economics.  Aside from a sales guy who runs around signing up merchant partners and someone to write copy and do a minimal amount of design work, there are very few variable costs to these businesses, zero inventory expense, and cost of goods that don’t have to be paid for until weeks after the revenue cash comes in the door.  TechCrunch did a nice teardown of Groupon’s economic model here.  It’s a pretty sweet business model, and dead simple to get started.  I expect that the low startup cost and terrific unit economics will lead to a surprising number of these clones surviving.  They won’t be big winners, but I’m sure there will be dozens and dozens of profitable, niche players still around in a few years.

My partners and I have spent a bunch of time talking about the opportunity created by the fantastic job Groupon, LivingSocial, and the like have done in training both consumers and retailers as to the power of these business models.  In particular, I’ve been thinking a lot about the merchant side of the equation and how to better address their needs.

Groupon, while incredibly effective at driving new customers, is not always an economic picnic for the retailer.   This has been much discussed – a recent Rice University study highlights the challenges faced by retailers.  And independent of the questions around the profitability of the deals for retailers, we’ve heard again and again that merchants want solutions that can help them out every day, not just episodically.

In a world where, Priceline, and others long ago proved that there’s an enormous opportunity in helping the owners of high value perishable travel inventory (hotel rooms, airline seats, etc.) dispose of that inventory and thus optimize capacity utilization and better manage their bottom lines, it’s taken a long time to start treating restaurant booths, salon chairs, or massage tables the same way.  The same fundamental principles apply to perishable inventory in these businesses – if a salon owner is paying a stylist to be in the shop, every incentive is there to get him working rather than standing and waiting, even if at a substantial discount.  And while many people think restaurants must be different – food is expensive, isn’t it? – the reality is that most restaurants know that they are overstaffed most Sunday through Thursday nights.  With food costs typically running only 25-30% of revenue, if you can control when discounts are redeemed, there’s a lot of margin left to play with in driving more people through the door and more money to the bottom line.

With smaller transaction values (and thus lower absolute gross profit) than travel, consumer and merchant acquisition costs have previously kept these markets from opening up.  But thanks to the Groupon phenomenon and their (a) training of consumers and merchants to the deals concept and (b) innovation around viral customer acquisition models, I think the economics of these businesses have now fundamentally changed.

So I started last year looking at models that integrate deeply with the business practices of the retail partner and become a reliable way to dispose of excess inventory every single day.  Be more than just a sporadic driver of new business (a merchant can get onto the Groupon calendar not more than 2x/year), become a critical part of how the merchant plans and forecasts their business.  In short, be a real partner.  Do that, and they’ll never let you go.

I first looked at a few opportunities in the high-end personal services space – Brooklyn-based LifeBooker has the right model there.  Then in early fall I met Ben McKean and Dan Leahy, co-founders of VillageVines, shortly after they re-launched their business and expanded from NYC into Chicago, DC, San Francisco and LA.  These guys are super bright, incredibly thorough and analytic, and very hungry.  And I think they’ve got the formula nailed for the restaurant business.

Restaurants use the VillageVines platform to upload inventory that they need to fill. Those tables are then offered to VillageVines customers at a 30% discount off the entire food and beverage bill.  Amazingly, it includes everything – order a $1,000 bottle of wine, pay $700 – the more you spend, the better the deal.  And they make it dead simple for the restaurant to sign up – it takes less than an hour to get a new partner into the system.  In NYC they’ve signed up almost 100 restaurants, including a bunch of big names like Le Cirque, Delmonico’s, Kittichai, and Aquavit.

It costs you $10 to make a reservation (refundable if you cancel).  When you arrive at the restaurant, you do everything like you normally would, but then when the bill arrives, the 30% has already been magically deducted.  There’s no coupon, no special card, nothing else to do.  You could take someone out on a first date or a client out for an important dinner using VillageVines and your guest would never know.  This seamless experience has greatly enhanced adoption and usage of the service.  And it’s naturally viral – I make a reservation, we go out together and split the bill, you save 30%, you go home and sign yourself up.

As a consumer, I’m addicted to the service – I’ve had 8 VillageVines meals in NYC in the past month, and have a reservation for tomorrow.  But it’s even better for the restaurateur – a no-brainer tool that enables them to take an otherwise unfilled table and fill it, while not risking driving discount diners on days or at times when she doesn’t need the business.

The early results are awesome – membership is growing very rapidly in all five markets, and restaurants have really figured it out and are starting to come to us in large numbers.  Adding to the appeal, restaurants report that VillageVines is bringing them attractive, high-end clientele who end up ringing up larger than average checks, driven by the healthy discount.  They’re getting a great boost to their top and bottom lines while opening up a new channel for customer acquisition, enabling waitstaff to earn more tips, and giving consumers a great deal.  Everybody wins.

We’re thrilled to be investors, and I’m thrilled to be a consumer.  While I can’t offer you the chance to invest, if you live or travel to one of our five markets, I can certainly encourage you to become a member – join the fun and have some great meals on us at  And if you’re not in those markets, don’t worry – we’ll get to your city soon!

Go LinkedIn, Go! (or why you should care A TON about internet IPOs)

January 7, 2011

Brad Svrluga

About a year ago, we successfully exited our investment in Threadsmith, in which we had been the seed investors in early 2008.  We ultimately ended up selling to a very logical strategic acquirer, NASDAQ-traded Vistaprint (VPRT).  It was a good outcome, and we made a very nice, if not spectacular return.  But our process was severely compromised, and the ultimate value realized was considerably lower than it could/should have been, because each of the two very best fit potential acquirers were private companies stuck at a standstill in the IPO pipeline.  While still private they didn’t have the cash, we didn’t want their private stock, and they felt like they shouldn’t be doing anything dramatic strategically as they prepared themselves to go public.

While Vistaprint was without question on every Threadsmith board member’s list of the 5 most logical acquirers, the strategic logic was stronger and the likely value greater for two other interested parties.  These two companies, had we been operating in a 2006-2007 IPO environment, each would have already been public.  We know based on conversations with their management that they would have loved to have owned us.  If public, they almost certainly would have been interested bidders, eager to do the deal and tell Wall Street about how Threadsmith was going to be a great driver of new growth for them.  But in late 2009, as they languished waiting for the IPO market to improve, their hands were tied.

So we went from probably 4 really strong possible acquirers down to 2.  When one of those two dropped out early, our opportunity for a competitive process was gone.  And so, for a $50MM fund working through what in the grand scheme of things was a relatively tiny trade sale, the state of the IPO market had a dramatic impact on our outcome.

I tell this story because with the wires all abuzz over the past week about LinkedIn’s plans for an IPO this year, I’m still hearing entrepreneurs and investors say “So what? We don’t need IPOs to make money.”  So what??!!  Thank god, I say!  We ALL desperately need a wave of this stuff to start rolling this year.  While there has been much written recently about the challenged state of the IPO markets and the fact that many entrepreneurs and investors think they’ve gone out of style (Bill Gurley has been particularly thoughtful, as usual), I haven’t seen enough people talking about why we so desperately need more activity here.  If anything, I’ve heard too many of my peers in the seed & early stage markets saying they don’t care.

2010 – “The Year of the Super Angel” – saw no shortage of claims about the old rules being dead and how these new forces in the VC landscape were responding to the fact that everything has changed.  Some of these claims are perfectly valid, especially around the various elements of the lean startup – it indeed no longer takes a $5MM Series A to build a fantastic web service, achieve product-market fit, etc.  But the claims I’ve heard from a lot of new entrants to the seed and early stage investing landscape about our collective freedom from reliance on a robust IPO market just don’t hold water.

Small VCs (like me) and, increasingly, so-called Super Angels and MicroVCs, love to say that amongst the reasons we can consistently drive great returns is “As a small fund, we’re not dependent on the state of the IPO market.  We can make plenty of money, and drive great returns for our investors, even if we never sell a company for more than $100MM.”

I’ll confess – I’ve been guilty of making exactly that claim to LPs and others.  But I won’t be making that case anymore, because it’s simply not true.  Or at least half of it isn’t. Let’s parse the quote above into its two statements:  the second is indeed true – we can have a great fund without a $100MM+ exit; but the first is without question B.S.  We are ALL dependent on the state of the IPO market.

The problem is that the second statement is so dearly dependent on the first.  In a world where great companies aren’t getting public, we end up with a paucity of buyers for our terrific, smaller companies.  In aggregate, exit opportunities, and values of those exits, are greatly dependent on the number of public buyers out there.   Public companies have two things that private companies don’t have – (a) a good stockpile of cash (admittedly, Facebook and others are finding their own ways to build such stockpiles, but they are very much the exception) and (b) a liquid, non-cash currency for making acquisitions.  So when fewer companies are getting public, you have a decrease in the number of buyers who feel like they have the resources, currency, or strategic flexibility to do deals.  And thus lots of people feel the same pain as my Threadsmith story.

Here’s a remarkable fact:  over the past 10 years, the total number of NASDAQ-listed companies has shrunk every single year.  Or, said another way, in each of the last ten years, the number of potential public buyers for private companies has been smaller than the year before.    Ask any infrastructure/enterprise SW investor if it’s helpful for their portfolios that Oracle has, in recent years, purchased (and taken off the table as potential competitive buyers) public companies like Sun, BEA, PeopleSoft, ATG, and Retek, amongst others.  Ask any digital media investor if they think an AOL-Yahoo merger would improve the exit prospects for their companies.  Of course not – it takes a buyer off the table.

Now sure, as small funds, we don’t need IPOs or $300MM trade sales in our own portfolios to move the needle for our LPs.  As I said before, the second half of that quote above is true – our two funds at High Peaks, at $25 and $50MM, can each drive great returns without ever selling a company for more than $100MM.  However, you simply can’t say that makes us immune to the state of affairs in the IPO market.

We should all – investors and entrepreneurs alike – actively cheer for more IPOs.  As long as they’re good companies (and lord knows there’s dozens of good ones out there languishing in the public markets’ waiting room), the more the merrier, for sure.

To all the seed and small fund investors out there – let’s stop conveniently denying the interconnectedness of our ecosystem.  The IPO market matters to all of us in a big way. Super Angels and MicroVCs are no silver bullet solution for LPs looking to make money in venture while the IPO pipe stays frustratingly tight.  I’m a fan of the small fund model, but we need to be intellectually honest about how we describe it.

That said, that honesty can and should include trumpeting the fact that with the exception of a tiny handful of large, diversified funds, smaller funds are in fact better positioned to make money.  Despite the conventional wisdom, small funds have in fact consistently outperformed their larger brethren over the past 30 years, as last year’s Silicon Valley Bank study on small funds illustrated so compellingly.  We’re at the most profitable end of the market – let’s just avoid discrediting ourselves by lying about why.

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