Chasing the Black Swan

competing views on VC secondary markets

Auren Hoffman makes the case for VCs selling to secondary buyers: "A Second(ary) Chance for Venture Capital."

Jason Mendelson counters with "Should Venture Capitalists Sell Out to Secondary Firms."

I generally agree with Hoffman, but Mendelson makes some good points - I just think his perspective is overly optimistic about LP's patience with long-term illiquid investments.  It would be nice if the world worked

To try and better understand Hoffman's point, think of VCs selling to public markets (or strategic buyers) instead of to secondary private equity markets.  It seems like all of his arguments apply to those situations as well.  So why do VCs ever sell?  Because they are under pressure, fairly or unfairly, from LPs to deliver actual cash, not make-believe "valuations."  I wish the world worked according to Mendelson's desires (and for a long time it did), unfortunately, I think VCs will be put under increasing pressure to sell out earlier on - and secondary funds will be there to buy some of those shares.

There is nothing necessarily magical about a traditional exit like an IPO or acquisition, adding exits to secondary funds will provide another useful alternative - something VCs and entrepreneurs desparately need right now.

Bottom line: more and more investors are going to consider 10 yrs just too long a time period, secondary markets will emerge as a response to this. Whether or not this will be good for the portfolio companies involved remains to be seen.

Expect a boom and inflation

It has become fashionable in right-wing circles to subscribe to the idea that our economy will be weak AND there will be inflation in the future.  This is possible - look at the late 70s.  However, that was driven mostly by supply shocks in a world that was still globalizing and had yet to take full advantage of the supply-chain cost transparency made possible by advances in IT.  There was also no ridiculously massive short-term stimulus AND well as a Fed that was asleep at the wheel based on the belief that inflation and recession couldn't coexist.

Things have changed and I don't think we will see a replay of the 70s.  Rather I think the stimulus will work.  Furthermore, the political powers-that-be in DC are firmly left-of-center and will likely be so for a while, hence every policy decision will err on the side of overstimulus rather than restraining inflation for the foreseeable future (the foreseeable future being Nov 2012 for those in power).

My best guess is that the stimulus will work - I can't think of a time when such a massive deficit spending didn't boost demand.  In fact, I think the recovery will be brisk because people have been irrationally pessimistic for some time and will quickly respond when they see that their pessimism has lost them opportunities.  Greed will drive a big part of this recovery.

The downside of all of this is that a successful stimulus-induced recovery will lead to inflation - probably not as bad as the 70s thanks to globalization and IT, but it will be a nasty bout of inflation.

The developing world will recover first and will become more consumerist and this willl help drive the US's recovery, but it will also increase import prices substantially - and these are a major driver of inflation.

The problem with a quick recovery is that inflation has a heavy trending component - higher inflation in the previous quarter will lead to higher inflation in the next quarter.  I don't think the lefties in DC care about this AND they want a speedy recovery to ensure a smooth 2012 election year (i.e. smooth being defined as Democratic victories).  So the pols are aiming for a rapid recovery - and with enough money thrown at the problem they will get it.  A rapid recovery will make everyone happy.  Prices wil yank back up at first, but that's OK because everyone's job prospects are increasing and business is beginning to boom again, etc, etc.  Then because of inflation's trending nature, price levels will continue to rise as the economy's growth begins to moderate.  That's when people will say "wait a minute" as they watch inflation outpace economic growth and corrode their purchasing power.  

My recommendation is to focus your career and investment strategies on firms with global market reach and solid pricing power.  This is one of the reasons I think advertising will be surprisingly lucrative - every firm can boost brand equity and pricing power through good ole fashioned advertising.  Put it on the internet and you've got global reach.

More ad regulation = fewer cool internet sites/services

Wendy Davis of MediaPost writes about the criticism of online ad industry self-regulation: "Critics Slam new BT Guidelines."

The problem with regulating BT (behavioral targeting) right now is that the business is still evolving - regulations at this point in time probably won't capture the worst offenders of the future and willdeter a great deal of web 2.0 innovation - which consumers clearly value.

We have a regulation happy regime in DC and popular opinion has swung in favor of more government interference thanks to the losers on Wall Street.  Now real entrepreneurs and businesses will have to bear the brunt of regulations stemming from populist agitation.

Of course, internet entrepreneurs are scrappy enough that they will eventually find a way to make web 2.0 economically sustainable regardless of the meddling done by politicians and activists.

Firms that stand to benefit from regulations on BT are those that deal mostly with mainstream corporations and don't dirty their hands with controversial operators or subject matter (e.g. affiliate marketers, porn).  The shadier companies will be hurt by regulations and their bigger competitors could swoop in and buy up their more legitimate lines of business at a steep discount.

Silicon Valley VC confidence rises slightly

According to Mark Cannice's index: "The Silicon Valley Venture Capitalist Confidence Index"

However, does this mean anything?  I hope so, but I don't think so.  

It only reflects an economy that is no longer as plagued by uncertainty as it once was.  The big issue for VCs and the entrepreneurs they back is the emergence of serious exit opportunities.  A macroeconomic turnaround is a necessary but insufficient condition for this.  

More important will be the emergence of exchanges other than traditional public exchanges, increasing interest from foreign investors for both IPOs and private equity, and declining regulatory costs (ideally driven by government policy relaxing SOX regs for IPOs, but that's unlikely, declining costs will most likely come about as companies, accountants and consultants get out along the experience curve - of course that will only work if the Obama people don't slap a bunch of new regulations on entrepreneurial enterprises.)

More marketing $$$ spent on stuff customers like (i.e. not you oldline advertisers)

"Forrester Revises Interactive Outlook, Will Account for 21% of Marketing by 2014."

But reasonable marketers won't relinquish budget because their programs are running too efficiently. Instead, marketers will allocate unused advertising dollars into investments like innovation, research, customer service, customer experiences, and marketing-specific technology and IT staff, in order to further marketing's strategic influence within their companies."

This kinda supports what I described in my previous post about how online marketing should be used to fully integrate consumers on social network sites into the product development process.

what "ad" model will make social networks work?

From Dan Dodge's "Page Views Required to Generate $1M in Ad revenue?"

"Which new model will work? No one knows at this point, but there will be billions of dollars for whoever figures it out. Beacon was innovative, but privacy concerns killed it. We are often influenced by what our friends buy, maybe just a slightly different approach will work. Social recommendations are very powerful. Back in the early days of the web there were several attempts to consolidate buyers into groups to get better prices. Could social networks do something similar? Businesses and advertisers are anxious to tap into the power of social networks. The social networks are building huge audiences but can't figure out how to monetize them. When they learn how to connect effectively the benefits will be amazing for everyone involved. This is a business problem, not a technology problem. The answer will be simple and obvious. In fact, it has probably already been considered and rejected several times. Someone will come along and put a slightly different twist on it and...Eureka!!! Don't you just love business? How do you think this will play out?"

I think this pretty much sums up where social networks are right now.  I think the key will be using far more sophisticated analytics to serve up ads that actually faciliate product discovery leading to direct purchase or a positive change in brand perception.

The key issue will be changing consumer behavior - the problem with curent social networks is that they tend to yield data that simply direct consumers to products/brands they are already going to buy - hence little value add.  Google's contextual ads do the same - BUT with the added benefit of hitting the consumer at the right time (because the consumers were searching for something similar based on keywords).

Conceivably social networks could do the same - but they are limited in their ability to serve ads at the right time because consumers don't necessarily search for a whole bunch of stuff on social networks.  Instead social networks serve ads based on data in the user's profile and that of his/her friends profiles.  However, doing so can lead to ads for products/services the consumer is already using or else is content with a cmpetitor's offering.

The real advantage will come when sophisticated analytics are used to predict what will facilitate discovery of new stuff.  I have personally already experienced this on Facebook, unfortunately, I think the only reason I have discovered a few new things is because they businesses/candidates (one of theme was a politician's site) could afford dirt cheap social media ads - it's easier to discover stuff from up and coming advertisers - but that model is not sustainable.  And none of the ads I clicked on led me to become even remotely interested in buying stuff.

Bottom line: it's going to come down to analytics - that's where the strategic power will be

Another issue is the potential for using social networks to actually facilitate product development - this is an area that will lead to fortunes being created over time, but it requires businesses understanding that they need to bring consumers directly into the literal process of product development - the first companies that do so will reap rich rewards - furthermore  these rewards will keep coming because most companies will be too clueless to change their business models.  We've seen this before in many old media industries - the next industries that will be radically disrupted will be those that offer actual products/services - in other words internet-driven disruptive innovation will start reaching backward along the production value chain from the media that offers up ads to the advertisers and their actual operation departments.

too much venture money?

there has been a lot of talk lately about how there is too much money in venture capital.  i think there may be some truth to that, BUT i think an argument could be made that there is not enough.  in other words, i just don't think there is enough evidence or analysis one way or the other.

however, the NYT gives voice to the "too much capital" perspective: "Venture Capitalists Look for a Return to the ABC's".

It lays out the general case for VC shrinkage pretty well (although it avoids many specific numbers).

I like the quote the article ends on:

Timothy Draper, founder of Draper Fisher Jurvetson, thinks there should be more venture capitalists, not fewer. “I don’t think we have enough venture capitalists to spread the wealth to the seven billion creative minds out there,” he said.

I think it's noteworthy that Draper is actually doing something about the key issue here - exits.  

I am suspicious whenever anyone says they have too much money - esp. investors.  It strikes me as blaming your client (the LP) for just giving you all that money (which BTW you earn 1-2% on regardless of performance).  

I agree with Draper - there are always an abundance of opportunities available - as long as humans complain about anything they will be willing to offer entrepreneurs money for alleviating their "pain points."

Once the exit environment improves (and it can only get better at this point as it is barely alive), then we'll probably see less complaining about VCs having too much money.

using the force

mark my words, this is going to be big five years from now: "NeuroSky's Brain Wave Tech Helps People Use the Force." 

the benefits of meditation have been proven over and over again - the problem is it's so hard to learn b/c it's based on people "guessing" whether or not they are actually meditating - with this device it will be a lot easier (of course, there have been biofeedback devices on the market for years but they are not as simple of a solution as NeuroSky's stuff.

I don't know if Neurosky will be the company that makes it big - but the market is going to be bigger than most people realize and will revolutionize the economy and society in ways as yet unseen.

You are your data

A quote from Wired's article, "The Nike Experiment:"

"We tend to think of our physical selves as a system that's simply too complex to comprehend. But what we've learned from companies like Google is that if you can collect enough data, there's no need for a grand theory to explain a phenomenon. You can observe it all through the numbers. Everything is data."

IPO market comeback

"IPO Issuance Steps Up as Life Returns to Market"

This trend will most likely continue barring any unforeseen economic catastrophes.  However, it will creep back maybe a little more slowly at first, then it will boom as investors are blinded by greed - it will not be such a bad time to be an IPO destined company at that point.