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Archive for April 10th, 2008

Entrepreneurs Need a Portfolio Effect Too

Posted by Bob Warfield on April 10, 2008

Fred Wilson has gotten me going today!

Startups involve tremendous uncertainty.  The financial world for a long time has realized that an important tool to use in controlling risk is diversification.  This is the so-called portfolio effect, and is the modern realization that you shouldn’t put all your eggs in one basket. 

I was recently having a conversation with a CEO coach.  He was helping out a CEO at a company I’m talking to.  He commented that at this stage he had simply seen too many failure modes for startups, and hence, it would be very hard for him to choose a single company to work for.  He was happy that he had created a portfolio effect for himself by serving as an advisor to multiple companies rather than focusing all his time on a single company.

Years ago, I worked on an idea I called the Enterpreneur’s Fund.  The idea was that Entrepreneurs need a portfolio effect too.  Most of the time, Enterpreneurs will have the ability to give away or sell a portion of their founder’s share.  My idea was to get company founders to join a fund where they would contribute these shares to create a portfolio.  Value of the shares would be determined by the last VC valuation with a proviso that it needed to be within the last 6 months and hence relatively current.  This new “Fund” would act just like a VC fund.  The participants would receive distributions as and if companies in the fund had liquidity events.

It seemed to me then and now that this was a good idea for entrepreneurs.  I am not aware of anything like it in existence, though many entrepreneurs do get the opportunity to invest in their VC’s funds.  What became of it?  In essence, I don’t think most entrepreneurs understand diversification.  They wanted to focus on evaluating every company in the fund before agreeing to contribute shares.  Most all of them concluded that their own company was so much better that they would be carrying the fund and would get no value.  Of course, they couldn’t all be right, but nearly all the entrepreneurs I talked to thought that way, and I eventually gave up on the idea.  FWIW, the shares I would’ve contributed to the fund would have been quite valuable as my startup was acquired by Pure Atria.

The VC’s, OTOH, completely understand the value of a portfolio.  They live and die on it.  Very few of the deals they invest in succeed.  I’ll argue they don’t understand another important component of Modern Portfolio Theory, though, and that is correlation.  It isn’t enough to have a portfolio, it’s components must be as uncorrelated as possible.  If you invest entirely in Web 2.0 startups, your portfolio is highly correlated and you have more risk.  VC’s are well known for the Lemming tendencies.  As soon as one firm hires an executive recruiter to be a general partner (as happened some years ago), the rest all followed suit.

But maybe there is an answer.  Fred talks about being able to buy and sell stakes in companies before they are public.  He mentions Goldman Sachs’ GS Tradable Unregistered Equity OTC Market.  It’s a fascinating idea.  Wall Street does a good job of “securitizing” the unsecuritized to make markets more liquid.  Reducing the viscosity is often a good thing, and it would sure help here.  Carving the deals up and spreading them around can reduce everyone’s risk substantially as well as providing some liquidity.  It promotes scaling into and out of positions, another time honored Wall Street practice.  And, it would let smaller firms lucky enough to land a winner, trade some of that stake for exposure to other near-winners they don’t have access to.   In the end, it probably reduces returns a bit, but makes them less volatile.

Just don’t forget: Entrepreneurs need a portfolio effect too.  Let them play and you’ll keep them focused a lot longer on what they do best.

Related Articles

See also What if the Chasm Has Moved?  The discussion of conglomerates like Johnson and Johnson and GE is just another successful example of the portfolio effect. 

Jeff Jarvis is on a similar vein with this post.  In it, Jeff discusses Berkshire Hathaway-like conglomerates.  Shades of my Johnson and Johns thoughts above.

It seems there is an active and thriving version of the Entrepreneur’s fund as reported in TechCrunch.  It’s called the EB Exchange fund.  It works like a VC fund in that the folks running the fund have a carried interest and “management fees.”  Interesting.  I prefer the idea of running it not-for-profit among the limiteds who are founders contributing stock.  Still, it shows the idea is viable.

Posted in saas | 3 Comments »

What If The Chasm Has Moved?

Posted by Bob Warfield on April 10, 2008

The chasm I refer to is, of course, the one Geoffrey Moore invented to describe the idea that early adopters (the “left” side of the Chasm) may behave quite differently and even require a different offering than the “mainstream” market (the “right” side of the Chasm).

As I was thumbing through various blog entries this morning, this crazy idea about the Chasm moving popped into my head.  Let me see if I can retrace my steps and in so doing convey what I’m thinking.

First, there is a Jeff Jarvis piece on Yahoo (most of these articles are Yahoo motivated) where he says: 

I think a Microsoft-Yahoo combination made little sense. It was Microsoft’s attempt to buy audience — as if you can own audience today, as if we can be bought and sold. That is the old-media way of looking at the world: they controlled content, marketed to get people to come to you, showed them ads, then waved good-bye.

It has definitely become the accepted wisdom that audiences cannot be bought and sold.  But then, neither could the Early Adopters of the Moore world.  They were always on the lookout for the new-new thing, very fickle, and very hard to hold on to.  What if this New Think, that audiences cannot be bought and sold, still only applies to early adopters?  What if the Chasm moved to the right so that there are tremendously more Early Adopters around than there used to be, or so that we can more easily reach all of them than used to be the case?  What if the shape of the Long Tail has been changed in some fundamental way by the Internet? 

Hmmm, that’s an interesting thought.  It may mean that audiences can be bought and sold as they ever were, but just that they’ll be that “mainstream” crowd.  Frankly, when I look at the original analyses of the Microsoft Yahoo venture, and saw how they almost made sense when you look at the email share that would derive, it gives me pause to consider this new idea.  Why do these two have such commanding email share?

It works like this:


Look at all that share concentrated around Yahoo Mail and more interestingly Hotmail and (cough) AOL Email.  Are these really the mail platforms of choice for the hip “you can’t buy me” audiences?  No.  These are mail platforms that people got hooked up to a long time ago and stuck with.  This is mainstream.  This is not the Twitterati.  And guess what, if they’ve stuck with it so far, they will likely keep sticking too it until something turns out the lights on them, if that ever happens.

Next post was by Fred Wilson.  It’s an interesting post, and quite long by his standards as he admits at the end.  Fred says in this latest post:

The Internet is decomposing into a vast array of micro-services that we, the end user, stitches together to make our own unique web experience. It is the de-portalization of the Internet and it is very real. And yet, these large behemoths are trying to do their normal consolidation play on the Internet. First of all, it’s not going to work. They are destroying value with all of their M&A efforts and the bigger they get, the more value they will destroy, for them and their shareholders.

Shades of Jarvis:  you don’t own us, these services matter to us, and you’re just going to screw them up thinking you can buy and sell this stuff.  Of course many a founder has had the same view of VC’s, but let’s leave that tacky business aside.  Fred goes on to cite some examples of companies that were acquired and screwed up. 

BTW, one should just assume that most companies that are acquired will be “screwed up”.  In fact, all of them will be if the definition of “screwed up” is that their character will be radically changed in some way.  Despite all the M&A activity, and the great success of companies like Oracle doing this sort of thing, these companies all remain extremely centralized.  There are no Johnson and Johnson or GE analogs in our business.  The closest thing to it might be Cisco, but they’re a very isolated case.  Every other company is convinced that its management knows best, and usually knows best very high up (e.g. Jobs, Ellison, Balmer, Larry, or Sergei know best).  It’s a definite sign of immaturity in our world, and someone will figure out the virtues of decentralizing, but I digress.

Last related blog subject:  Twitter.  There’s a lot out on Twitter as usual.  The pendulum swings back and forth and today it is on the negative side.  This time around, mostly it is about how Blogger/Cartoonist/Ad Man Hugh McLeod has deleted his Twitter talks about whole cliches along these lines:  declaring email bankruptcy, deleting your Facebook account, and so forth.  Even Scoble, in an unguarded moment, candidly admits that if you actually have to get something done, you need to turn off the Internet.

So what does it all mean and what am I trying to say?  There is a case that the Chasm has moved.  Whereas the space to the left of mainstream once was too small to make much of a business of, today it is much much larger.  In fact, one could argue that an awful lot of the Web 2.0 revolution, maybe even all of it, is founded on this much larger Chasm audience. 

How did it get bigger?  I think it is a function of the Internet’s ability to let us deal with more if we choose.  We can have more friends, albeit most of them even more shallow.  We can get through more email, read more blog posts, and yes, throw off more Tweets than ever before.  That let’s us participate in a lot more.  The buying power, as measured in the currency of Attention, has dramatically increased.

But, there is still a Chasm to cross.  Fred Wilson’s post is all about that.  The new Chasm is liquidity.  You can be quite successful, but the Chasm still looms before you are successful enough to go public, because that bar has moved too.  And the waters are quite choppy to the left of the Chasm.  Things move pretty slowly over in the land of AOL and (though they wouldn’t like to admit it) Yahoo.  Over in Google, Twitter, Facebook land, they’re pretty darned choppy.  Google has managed to get a leg in both camps, and genuinely benefits.  So has Apple, BTW.  You can tell such companies by whether they’re successfully public and hip at the same time.  Tough gig, but hugely valuable if you can get it together.

Will the Chasm keep moving?  I think it will.  The nature of the Internet has been to broaden us, broaden markets, and in general promote more change.  Can it move far enough to produce profitability and predictability?  That’s really what’s needed to resolve this liquidity issue.  That’s what’s needed to remove the fear that Web 2.0 might be just an interesting fad.  And that’s what’s needed so your favorite services can remain independent and keep doing what you like best.

Time will tell, but we’re not there yet.

Related Articles

Jeff Jarvis and I are following each other around.  No sooner did I pen this and go to lunch than I went back to find this post.  In it, Jeff discusses Berkshire Hathaway-like conglomerates.  Shades of my Johnson and Johns thoughts above.

Posted in Marketing, strategy | 4 Comments »

Yahoo Seeks Any Port in a Storm

Posted by Bob Warfield on April 10, 2008

This just in from the WSJ:

Yahoo is closing in on a deal to tie up with AOL.  Supposedly, Time Warner would fold AOL into Yahoo, give Yahoo several billion dollars in cash, and get back a 20% stake in the combined entity.  Yahoo, for its part, would then spend some of it’s own money together with all the Time Warner cash repurchasing its own stock.  Such a deal values AOL at about $10 billion.

This deal, combined with the Google test that involves carrying Google AdSense advertising on Yahoo, is intended to thwart Microsoft’s takeover attempts.

Sounds like serious desperation on Yahoo’s part as they struggle to remain independent.  Personally, as a Microsoft shareholder, I hope it does discourage Microsoft. 

Posted in saas | Leave a Comment »

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