Venturing Forth

No Scandal at Zynga

The WSJ reported yesterday that Mark Pincus, CEO of Zynga, has addressed underperformance by some of his executives by cutting their unvested equity grants. There has been lots of discussion in the blogosphere about whether or not this is ethical, or even legal. Dan Primack covered the brouhaha in his lead on PE Week today, and I read through the comments to his post and then joined the fray with the text below:

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This is a tricky issue and it's obviously controversial, as evidenced by WSJ's article and the comments below. Fundamentally, though, Pincus has done nothing unethical (based on the facts as presented in the article). Most of the comments (to Primack's PE Week post) confuse the issue by asserting that the option grant given at the time of hiring is earned at that moment - it is not. The purpose of vesting is to ensure that employees perform at or above expectations; they earn the options as they vest over the four-year period. So it is not only not wrong for Pincus to review compensation - including equity vesting - for Zynga employees, it is his responsibility as CEO.

Pincus's primary mistake was trying to nuance the issue by attempting to adjust downward the compensation with the underperformers rather than just terminating them. While in theory it seems logical that these employees may not be worth their current comp but are worth some fraction of it, in practice this is nearly impossible to manage. Making such a major adjustment downward in comp is a declaration that the employee is a "B" player - in the high-performance culture Pincus is working so hard to build, there is no room for "B" player executives. Retaining "MIA" execs (as Pincus apparently called them) is demotivating to employees and erodes the meritocratic culture Pincus is working so hard to build.

There is another and more subtle reason why it is more appropriate to maintain a "black-and-white" line between either keeping executives on or firing them. If you take my argument above to its extreme, it would almost always be in the CEO's interest to terminate early executives later in their tenure, because the amount of equity required to recruit an equally-capable replacement is far less (since the company's equity has increased significantly during that time); therefore, you could get the same performance for dramatically less compensation. This is absolutely unethical, since the early executive took on enormous risk at the time of joining and deserves the outsized equity comp as the reward. So long as she is continuing to perform at a high level.

The simplest way to manage this is ask the following question: "Is the executive performing at an outstanding level, consistent with the level expected at the time of hiring, and comparable to what would be expected from a new executive the firm could recruit to the position?" If the answer is yes, then you have your answer. If the answer is a clear and obvious "no" - and the existence of an "MIA" list suggests there were several of these - then the answer is to let the executive go.

I imagine Pincus was trying to be more compassionate by renegotiating compensation rather than terminating some of these executives, and this is when he stepped in it. show less

It Can Be Costly To Stay Private...

One of the big, recent trends among the high-profile consumer web companies has been to raise big rounds of private equity capital instead of going public. It's a great deal for the companies: 1) they get the capital they need to fund growth without having to live with the scrutiny of the public markets, quarterly numbers; and, 2) given the plentiful supply of private equity dollars (can't bring myself to use the term "venture capital" here because it isn't) chasing these deals, the companies get the rich valuations they used to have to go public to realize. Everything works with this model until the company sees a hiccup...

...Like the ones we've seen from Groupon and now Zynga.

Both companies' growth has slowed (in Zynga's case Q2 bookings declined sequentially for the first time) and so whatever valuations they would have achieved in the public markets 6 months ago, it is significantly less today. The problem is that the existing shareholders never had the opportunity to sell some or all of their positions during the run up or down. (yes, the secondary markets have provided some liquidity but not to the extent of having public float)

It's really hard for a company to keep chugging along at huge growth rates and never miss a beat. Take a look at Zynga's quarterly revenue ramp and, from the point of view of an existing shareholder, you wish you'd had the chance to sell before the laid an egg in Q2. Unbelievable premiums are paid for companies that are forecast to grow at huge rates - and valuation corrections of 50+% are common for high-flying companies that show a single sideways quarterly number like Zynga's Q2. By staying private, the company is locking all shareholders into the bet that the current growth rate will continue... Zynga's shareholders just lost that bet.

LinkedIn has managed to have the best of both worlds. Over the last 6 months, the company has gone public at a great valuation, provided liquidity to private investors and public float for new public shareholders, and seen its valuation more than double from the offer price. Fantastic.

It was inevitable that the "piling in" to some of the Consumer Internet high-fliers will slow down - the aggressive moves made first by DST (and more recently by AH and a number of other firms) to "pay up" to get into the category leaders at ever-higher valuation premiums can only go on for so long before it's no longer a winning strategy. I would expect some of these investments to slow considerably. Then it will be interesting to see if Airbnb, OneKingsLane, Tumblr and others decide to pursue a public offering and establish a public market for secondary trading, while their performance numbers are still up and to the right.

Really Looking Forward to URES Tomorrow...

Tomorrow I'm hosting the 4th annual URES (University Research and Entrepreneurship Symposium) - an event that keeps getting better every year. We'll have 300+ investors, entrepreneurs, and startup executives in the audience hearing 10-minute presentations by 30 technology entrepreneurs who have developed, and intend to start companies around, technologies within world-class research universities around the US. This year we've expanded to include 3 tracks: Life Sciences, Energy, and IT. Having worked with the other members of the Executive and Steering Committees (which include Jeff Fagnan and Bruce Booth at Atlas Venture, and Bilal Zuberi and Hemant Taneja at General Catalyst, and David Cappillo at Goodwin Procter) over the last few months to select the projects and then working with the entrepreneurs on their presentations, I can vouch for the quality of the ideas presented and the caliber of the entrepreneurs.

The proof's in the pudding. Of the 50 projects presented in the first three years of URES, 5 companies have been funded. With any luck, I'll soon be able to claim URES led to an investment for Flybridge - I recently reached agreement to lead an investment in a company I first saw at URES 2010!

Gonna be fun tomorrow...

Calling All University Spinouts - Present at URES 2011!

University Research and Entrepreneurship Symposium (URES) is the "go to" annual event in Boston for the country's world-class research universities to showcase their most commercially promising technologies for spinning out into startups. Over the last two years, 5 URES presenting projects have raised venture capital.

Last year, we had projects from Cornell, University of Illinois, Purdue, RPI, Harvard, Yale, and MIT among others. It's a unique event - 300+ investors, entrepreneurs, and technologists talking about startups and big technology ideas.

The criteria are simple:

• Technology must be breakthrough and disruptive... ie kick-ass
• Potential applications must address really big markets
• Project leads must at least be considering starting a company around the technology
• Funding to date must be <$1 million 

We're flexible on most all other criteria. There may be startups already formed or it could still be a research project with professor sponsorship.

Submissions are due now - see the site for guidelines.

I encourage anyone out there working on something that can change the world to submit and see if you can get on stage at URES 2011...

My 3 Favorite Books of 2010

Figured it was the time for annual lists and this topic came up over the holidays a few times so wanted to jot this down...

The Talent Code by Daniel Coyle. Coyle studies how talent is grown and developed by examining the training and coaching methods used in seemingly unrelated "talent hotbeds", from a tennis club outside Moscow to a cellist camp in upstate New York. This book literally blew me away - many of the lessons resonated with things I'd picked up or observed as a student, athlete, and parent. And mostly it just appealed to my love of a good, steep, exciting learning curve - whether it's playing the Wii with my kids, doing drills on the tennis court, or watching my son improve at chess. The concept of "chunking", the power of repeating a motion slowly to most completely understand it... Very cool stuff.

Freedom by Jonathan Franzen. The best novel I've read in a couple years. A pretty tough critique of modern America but also illuminating. I also found it oddly hopeful. And it is hilarious. I loved The Corrections, and this was better.

Open: An Autobiography by Andre Agassi. It wouldn't have surprised me to learn that Agassi had a love/hate thing with the game of tennis. But he didn't - it was hate/hate. And he overcame this only when he found purpose in his life beyond the court, late in his career. His telling of his life is insightful and remarkably candid, and it takes a lot of guts to bare his weaknesses and the many mistakes he's made along the way. A unique journey of self-discovery and ultimately transformation... and along the way he rose to the top (and bottom and top again) of his sport and profession.

If you've read any of these books, I'd love to read your comments...

A Useful and Fun Analog

Investing in startups is a tough challenge given the long odds of success, and the analysis of an opportunity is an incredibly subjective exercise. The decision inevitably comes down to judgments about the 3 primary elements of the business: team, product/technology, and market opportunity.

Getting to the right answer is in part a science, gathering data and feedback from customers, partners, technologists, domain experts, and past colleagues. But it is also an art and this is the real trick -- infusing the judgment with past experience, instincts, and pattern recognition (or "analogs" as venture investors love to say). The obvious risk in layering past experience and case studies into the decision-making process is that it is so easy to over-draw the comparisons beyond their relevance. Yet this subjective judgment and instinct is what separates the great investors from the pack. This is the art that one of my mentors, Henry McCance of Greylock, was describing when he would say "I can't describe all the characteristics of a great entrepreneur, but I know it when I see it."

While working on a recent investment I made in an online English-language learning property focused on the Latin American market (Open English), I found a (particularly fun) analog to test the central hypothesis of the business -- that for certain subjects, online instruction is actually far more effective than offline teaching. Since I couldn't very well put myself in the shoes of an upwardly mobile executive in Bogota who wanted to learn English to get ahead at work, I brainstormed about the other things I'd like to learn... and pretty soon I found myself checking out the huge number of available online guitar tutors and classes. It turned out to be a useful comp as many of the same reasons why live English instruction is better online - finding great instructors (native English speakers), flexible scheduling, on-demand availability of multimedia content, and the elimination of the anxiety associated with performing poorly in person - fit my situation as an aspiring (hack) guitarist.

In the end, playing around with comparable online learning tools was a small input into my decision to invest in the company, but it was the type of pattern-matching that helps to better abstract out and understand the drivers of a business...

...And now a month after closing the investment in OpenEnglish, I find myself with a new toy, pictured below!

Guarding Against the Recency Bias

One of the biggest traps entrepreneurs (and their investors and Boards) commonly fall into is the recency bias, aka the tendency to overweight the most recent information received. It's easy to see how this happens to entrepreneurs and how it has enormous impact on long-term outcomes, as they're typically using horribly imperfect information to make hugely important strategic decisions. As a Board member, the telltale signs usually reveal themselves over time, as the entrepreneur spends way too much time articulating the latest great idea (sparked by a customer meeting) and the company's focus whipsaws from one idea to the next.

Since nearly all of us suffer from recency bias to one degree or another, it's important to have some safeguards against it. Here are a few:

• Data-driven strategy. Make assumptions explicit and collect data wherever possible. One B2B entrepreneur I admire requires all employees to use a common template to document all customer/partner-facing meetings and then post it internally within 24 hours of a meeting. While it seems easier to collect data on the B2C side, you would be surprised by how many businesses fail to design their databases to yield all the data and insights they'll need once the product is launched (and it's hard to catch up once you have customers/bugs/revenue targets/salespeople)
• Formally documented and broadly communicated strategy. There's nothing like the permanence of a PDF to force more rigorous analysis
• Product management process. Entrepreneurs who dominate product strategy and unilaterally go to engineers to discuss prioritization of feature requests are the ones most susceptible to recency bias. Instituting a formalized process where requests are collected and prioritized and feature/function decisions are made by a team is the key. Entrepreneurs/CEOs can have the final vote - in many cases they are the ones with the best product instincts - but forcing the public debate improves the analysis and, ultimately, the decision-making. Does a lot for institutional trust and culture as well...
• Two modes. The best entrepeneurs I've worked with have both a strategic mode and and execution mode, and they're able to toggle back and forth. In the early days, the strategic mode is dominant, but as the business and team grows, the execution mode becomes dominant. Entrepreneurs that are unable to successfully scale along with the business often fail in this area. It takes tremendous self-awareness to both understand one's strengths and weaknesses across both modes AND be able to switch between them as required.

Most entrepreneurs are long on creativity, energy, and strategic insight - it's what gives them the confidence to start a company in the first place. But by using only these "dominant muscles", entrepreneurs will distract their teams. The truly special entrepreneurs are able to throttle up and down their strategic impulses and ideas while keeping a steady hand on the wheel and keeping the company fixed on a clear, long-term objective.

If We're Not Careful...

China's going to eat our lunch in cleantech.

This was the overwhelming feeling I was left mulling over during my return flight from China last week. I had a great trip, visiting Beijing, Tianjin, Suzhou, and Shanghai over five days as I looked at some new investment opportunities. It was a lot of fun – and I was really impressed by the alignment of government policy and startup-driven innovation that have China poised to lead the world in a number of important cleantech markets.

At this point a Friedman-esque rant on US ineptitude comes naturally – but in this blog post I will instead focus on what China is doing really well right now:

Investment in infrastructure. Many of the big cleantech markets of the future – smart grid, vehicle electrification, distributed renewable generation – require big-time infrastructure investment, and the pace of investment in China right now is astounding. Whether it’s the “mag-lev” train to Pudong airport, the state-of-the-art regional technology centers, the Olympic Stadiums (Bird’s Nest, Water Cube), or just simply the hundreds of cranes and bulldozers you see during the course of a morning commute, the government’s capacity to invest in critical infrastructure is mind-boggling.  In a world where the developed western world is debt-laden, this is a major advantage, and China’s government has proven its ability to swiftly make bold investment decisions.

Government’s strategic focus and resolve. China is determined to become the world’s leader in energy and clean technology. And unlike a western democracy, when China President Hu Jintao makes up his mind, action follows quickly. I was struck by examples of this routinely on my trip, but 2 examples really hit home for me:

• Vehicle electrification. China has announced its 20-city electric bus program, whereby 20 leading cities will have 1,000 EV buses on the road by 2012.  It turns out this is a very shrewd initiative. The key to the EV market is gaining real-world experience – ie miles logged – with vehicles on the road. Buses average 16 hrs/day and maybe 100 miles/day, versus 20-40 miles/day for a car – and with a bus it is easy to collect the actual drive-cycle data from a single owner/transit authority. Therefore, going “buses first” makes a lot of sense. And it’s not like the China bus market is small: by 2012, buses sold in China could exceed 200-300 MWH of aggregate battery capacity, which is roughly the equivalent of the aggregate battery capacity of Toyota Priuses sold in the US in 2009.
• Carbon trading. Though cap-and-trade legislation passed the US House of Representatives in June 2009, and the Obama administration supports the initiative, just this week the US Senate gave up climate legislation in favor of a narrower energy bill. Meanwhile, China moved swiftly into action following the talks at Copenhagen, and on Friday morning I read the announcement of China's rollout of a cap-and-trade system. What is amazing is that China took this step even though, as a developing country, China will not be subject to the same stringent carbon emissions caps as developed countries, even if/when an agreement is finally reached at a successor event to the failed Copenhagen summit last December. China’s utilities and heavy industry will be poised to succeed in what will inevitably become a carbon-constrained world in the future.

Culture of entrepreneurship. I had expected to find a layer of bureacracy and red tape in the way of entrepreneurs in China, whereby startups wait for earmarks and other subsidies to determine a market's winners and losers. I found just the opposite. I found myself feeling very comfortable in meetings with Chinese entrepreneurs and industry executives, as the ways in which they communicated (even if at times in Mandarin!) were very familiar to me. People were direct and transparent, and there was an informality that any entrepreneur in the US would instantly recognize as an important part of successful startup culture. One of my mentors in the venture business once told me, "I can't list out all the necessary and sufficient attributes of a great entrepreneurs, but I know it when I see it." I agree that great entrepreneurs share a certain je ne sais quoi - and I saw more of it in China this week than in any of my trips to Japan or Western Europe.

All in all, it was a fun week in China and I was deeply impressed by the pace and breadth ofinnovation. There is no doubt that the US remains in a class by itself in terms of fundamental research and "ideation", but the winners in cleantech will ultimately be those that ride aggressively down the experience curve and deliver the best value over the long-term. The experience curve in cleantech is influenced by government policy in ways to which US entrepreneurs are not accustomed, and this is where China is determined to lead.

Capital-Efficiency in Cleantech

In an interview  with WSJ/Venturewire yesterday, Vinod Khosla made the distinction between capital-light and capital-heavy cleantech businesses. The capital intensity of cleantech investment opportunities is the subject of much debate in entrepreneurial circles, and it's a subject I've touched on in this blog as well (link). Vinod cites the example of Stion, a thin-film solar company that recently closed a $70m Series D financing, as a capital-light solar play compared to the $100-500m raised by competitors such as Miasole, Nanosolar, Solyndra, and others. On one level, it is an important point: if Stion is able to reach cash-flow breakeven on 50% less capital than its competitors, it is an important distinction and it will drive superior returns for shareholders. But on another level altogether, I just don't get it: I don't see how early-stage venture returns can ever be reliably achieved in segments where $100m equity raises are termed "capital-light" businesses.

For early-stage venture capital investing to make sense, the early equity needs to be applied to mitigating the biggest risks facing the company. Usually, these are risks around feasibility of the technology or validation of market size. This is the logic behind Series A financings: go build the team and build the product and see if any customers care about it. The problem with the solar, biofuel, battery opportunities that require hundreds of millions of dollars for manufacturing operations, is that the single-biggest risk facing these companies at the time of inception is their ability to raise Series D/E/F capital on attractive returns, if at all. How does the Series A investor assess and discount the risk associated with a $100-200m equity raise five years out? Solyndra's recent decision to pull their IPO in mid-June illustrates that even the world's most competent investment bankers struggle to predict the market's interest a few months out...

Here's how I characterize a capital-efficient cleantech business:

• The biggest risks can be addressed and mitigated within 2 years and with the support of its initial investorsThe biggest risks can be addressed and mitigated within 2 years and with the support of its initial investors
• Product can be brought to market within 2 years and with the support of its initial investorsProduct can be brought to market within 2 years and with the support of its initial investors
• Profitability can be reached on <$25 million equity capitalProfitability can be reached on <$25 million equity capital

As an early-stage investor making investments up to $10-15 million in a business, I like this model because I can see how my capital can "de-risk" the key questions facing the company at inception.

I also believe that many of the "hot" areas for investment in cleantech do present capital-efficient (my definition) opportunities. They're not as obvious, but they exist. As an example (disclaimer: portfolio company promotion coming) I point to Digital Lumens, an LED systems company I invested in 2 years ago that recently came out of stealth and launched product to market. In a market with plenty of capital-intensive businesses innovating at the advanced materials/chip level, Digital Lumens has launched the first cost-effective general illumination LED system for the commercial and industrial market. On far less than the $25 million threshold listed above, DL has a dozen or more early customer deployments generating 90% energy savings and <18-month paybacks for their system. The company benefits from the industry's experience curve which generates cost/lumen/watt improvements of 25+% a year and instead focuses R&D to innovate in mechanical/thermal engineering, power management, and systems controls to deliver a complete solution to the market. Digital Lumens is delivering important value to the market by bringing a cost-effective LED system for general illumination to the market - but the company has not borne big financing risk.

It's true that many of the businesses Vinod mentions simply require hundreds of millions of capital to reach the market. My point is not that these can't be successful businesses - only that it's not an attractive risk/reward bet for early stage venture capital.It's true that many of the businesses Vinod mentions simply require hundreds of millions of capital to reach the market. My point is not that these can't be successful businesses - only that it's not an attractive risk/reward bet for early stage venture capital.

Energized by ARPA-E Coming Out Party

Yesterday was one of those days where you get to take a step back for a minute and take in the real progress that is being made in the US to address the world's energy problem. The ARPA-E Energy Innovation Summit was held in Washington DC and featured 100+ ARPA-E awardees, finalists, and other showcase participants. The amount and quality of the startups and innovators on the showcase floor was astounding - everywhere I turned I bumped into another world-class researcher working on a disruptive approach to solar, wind, energy storage, water purification, carbon capture... and unlike so many university lab visits, the founders/principal investigators had a fair idea of the potential applications and business opportunities they were pursuing. I attribute this to the training and feedback provided by the ARPA-E applications process - and this in and of itself represents enormous value. And then the final kicker: ~25 of the showcased companies were the actual awardees, each of which received an average of $5 million in ARPA-E funding to cross the "valley of death" from the lab to productization. The collective momentum of the showcased companies was awesome.

This is the result of 6-7 months of work of a startup team at ARPA-E under Secretary Chu, led by Dr Arun Majumdar. Arun, David Danielson, Srini Mirmira et al are themselves working at breakneck speed and are innovating as they go. From a standing start in 2009, this team will effectively become the largest cleantech venture investor in the US in the next year, investing $300m annually to move potentially disruptive technologies from the lab. By design, they are taking risks the private market won't take on, and as a result plenty of these projects will fail. The program directors are an impressive group, and as a team they are doing rigorous technical diligence to ensure ARPA-E investment dollars are put to the best use. Impressive stuff.

I was fortunate to attend a dinner hosted by my friends at NEA with Arun and his team plus other DOE executives, including Kristina Johnson (Undersecretary of Energy). Had fun at dinner with Jon Sakoda (NEA), Marcie Black (Bandgap Engineering Founder), Eric Ingersoll (General Compression Founder), and Cathy Zoi (Director of EERE). By the end of dinner Cathy had convinced me HomeStar (fka "Cash for Caulkers") was going to be REALLY big, with a goal of 5m homes audited and retrofitted versus 40k today. At $5-10k work per home, that's (a lot of jobs and) a very big market ($50 billion) from virtually scratch a couple years ago.

The event itself was pulled off in <2 months of planning. With Energy Secretary Steven Chu leading the charge, the ARPA-E team recruited Jeff Immelt, Tom Friedman, Carol Browner, Jim Rogers to headline the speakers on short notice. The event had the feel of a real team effort across the DOE, business leaders, entrepreneurs, researchers and investors. And it's a team of people worth betting on.

Congrats to Arun and team for a great event!