By Georges van Hoegaerden

As an investor, and especially a venture capital investor you need to have the ability to predict the future within an acceptable degree of accuracy. And that is exactly a skill many venture capitalists (VCs) so miss out on and generate such mediocre returns. The value of their innovation is simply not meaningful enough.

Venture Capital differs fundamentally from (other forms of) Private Equity in that it requires an extraordinary level of foresight and prescience. After all, one needs to believe in something that does not already exist and little proof exist it ever will - or is there?

It is impossible to predict what technology will prevail

VCs today are still too focused on technology, even though many proclaim to understand markets (more on that later). The reality is that rarely any business without a technology demo gets funded these days. Yet popular technology flavors change frequently (every three years or so) and betting on technology is a foolish game. We should know by now.

Driven by the urge to produce results within ten year vintages and complicated by the (we claim, self induced) lack of IPOs and M&A, the majority of VCs have retracted to a short term investment focus, massive diversification and fragmentation of investment dollars. Quite the opposite of what should have happened to the venture business.

But how do you tell someone to step into the circus ring to tame a tiger, without having had the confidence and prior experience to do so. It is just not going to happen. Change in the venture business needs to come from the top.

Limited Partners who do not refresh their VC commitments and requirements now, are bound to lose big-time on venture pipelines stuffed with sub-prime investments with no place to go.

It is easy to predict what macro-economics will prevail

Warren Buffett said it right in a recent interview with Charlie Rose in that the future long term is a lot easier to predict than the short term. Or the way I tell my wife; I don't know where I'll be during the day, but you can count on me coming home for dinner.

In business, long term value does not discount the need for short term planning, but short term without long term (or macro) is a loosing gambit. Here are some examples of the lack of macro-economics and its failures :

- The venture ecosystem

The venture capital ecosystem consists of ten(!) layers of diversification before the dollars from a Limited Partner lands into the bank account of the company of an entrepreneur. No matter what your views on the venture business, but anyone who has attended business school should know that this kind of over-diversification leads to a morass of accountability and in-transparency of results. Without fundamental change to the way venture works today, venture is poised to become more mediocre than its today. Venture is macro-economically broken. The reason why we provide a solution for Limited Partners here.

- The VC intake model

Most venture capitalists sit impatiently through an entrepreneur pitch, checking their blackberry's until the product demo. Not only does this communicate the VC has no empathy for the macro-economics, it also communicates that technology risk is the only risk they think they can assess. Per previous analogy, those VCs are the wives who call their husbands twenty times per day, just to know where you are. They demonstrate a lack of understanding and lack of faith in macro-economics and an improper assessment of investment risk.

- Entrepreneur pitches

Perhaps dumbed down by the only pitch process that leads to getting money from (sub-prime) VCs, many entrepreneurs pitch technology without understanding the macro-economic forces at work that prevent a pure technology play (albeit perhaps better) from having access to paying customers. When a large incumbent owns the access to the majority of customers through perception, a proprietary business model or otherwise, technology innovation without a fundamental disruption of the business model is worth very little. Entrepreneurs need to think business and include macro-economics.

- Marketing experts

Markets do not exist. Yep, I said it (and yes, I have worked in "marketing" too). Market definitions are stale and artificially extrapolate people that once exhibited a common purchasing decision into individuals that from then on behave the same way going forward. They don't.

We all know instinctively that every individual is different (even when that individual represents a company), that none of us like to be put in a box and that our reason for purchasing is unique and more than simply price/performance ratios. In addition we participate in multiple competitive and complimentary marketplaces in whatever order we deem appropriate. And any attempt to put marketplace participants in a fixed market bracket is therefor hopelessly self-serving.

Markets do not exist, but marketplaces do. The impetus to participate is extremely complex, complex to quantify yet not complex to qualify. A simple need for improved relevance and better value - based on individual needs and objectives. Marketplaces are no longer one-to-many, but have become many-to-many, with social networks emphasizing and echoing those individual requirements. The long tail of supply is met with a long tail of demand.

So, macro-economically the basis of marketing is flawed. Product success is not driven by marketing, but rather by how true the product is to its promise. And that means marketers who make product decisions based on market numbers are wrong and so are the investment decisions derived from market analyses.

Be ready for the swing test

Macro-economics really matter as it defines whether you have a chance of making it big, but not without careful micro-economic fulfillment. As an entrepreneur "dating" the right investor you need to be prepared for the swing test that goes roughly as follows:

Explain the vision, explain the product experience, explain the business model, explain the technology, explain the scalability, explain the product requirements, etc. etc. going back and forth between macro and micro until the swing comes to a halt with no questions left unanswered. Now, investor and entrepreneur have a common understanding of the risks involved for the road ahead.

A new investment focus

As experienced technologists we know we have many technology options to support a macro-economic need, and technology development is the least of our risks. The real question is whether the application of technology makes acute macro-economic sense. And surprisingly enough and again in agreement with Buffett, macro-economically we are not much different from a hundred years ago.

We like to play music, iTunes anyone? We like to stay connected, Facebook anyone? We enjoy free-trade, eBay anyone? Many other macro-economic desires remain unfulfilled with technology. Opportunity abound.

Fulfilling support for that macro-economic need is what Venture Capital should be all about. And it will again when we as Limited Partners tell the referees (the VCs) that the rules for investing have changed. That our expectations for VC are to chase macro-economic impact, rather than to allow the mindless technology herding to continue.

Endless opportunity for great returns

Supporting existing macro-economics with a more meaningful technology experience that meets the needs of 5/6th of the worlds population, that still does not use a meaningful internet application, makes for a fantastic and highly scalable investment thesis. One that we should allocate more-not-less money to as Limited Partners.

But we need to change our tune, now, before it all comes crashing down on us.

Tags: VC, Innovation, Marketing, Marketplace, Business Model, Investment

By Georges van Hoegaerden

[The article has been supplemented by a more recent "Why VCs really need relevant operational experience, now"]

I frequently get asked by individual Venture Capitalists (VCs) whether I really think General Partners (GPs) need operating experience to be more effective (as if my blog is not clear about that). And just recently HP's Venture Group seems to agree with me.

That topic was also recently challenged by Daniel Primack from Reuters' PEHub (I know he likes a good debate) who decided to make a statistical point that there is no correlation between fund success and GP operating experience.

Yet my short answer is: "yes, but it depends".

What my answer does not depend on is Daniel's statistical analysis of the Forbes Midas List and loosely matching credentials to his sample. With more than 90% of VC not making a real profit (above the asset class expectation of it), the 10% Midas sample can hardly be called statistically representative. And even if it would, a highly inefficient market (created by the ineffective "dating service" VCs currently provide) does not statistically represent the workings of the efficient market we wish for. And the majority of the Midas List GPs have their "success" firmly rooted in a timeframe when "turkeys could fly". Should I go on?

But most importantly, statistics are derivatives - not drivers - of market behavior, in the same way liabilities and assets are opposites (read "Rich Dad, Poor Dad"). It is unwise to apply a derivative (statistic) as a driver for market decisions. All experienced entrepreneurs know that.

So, my answer depends on whether you reference the actual or supposed workings of VC.

In today's VC

In today's venture capital ecosystem it is very important for every GP to have relevant operating experience, with the emphasis on relevant. Relevant experience as that of an early-stage CEO in tough times, still producing success.

Many GPs can only flaunt past experience from behind the confines of a large brand name conglomerate, rather than the experience of an early-stage CEO, investing his own money, defining a unique company ecosystem, living on borrowed time, raising a few rounds and selling the company. The VCs with that level of operating experience are hard to find and so are their successes.

Why is VC operating experience important:
1/ Many venture funded companies today are built with what I coin as the sub-prime VC model. Amongst many things it means founders need to prove a lot of technological capabilities (see my Khosla reference) before they see an investment dime, and when so, usually receive too little money to hire an experienced CEO. As a result, the board (of investors) runs the startup and thus their relevant operating experience becomes pivotal to the success of the startup.

2/ Relevant operating experience matters, not just any operating experience. Successful startups rely on a clear definition of a unique ecosystem (with divisional expenditures and conversion rates). The last thing an entrepreneur needs is a group of investors who can barely deviate from their business school thesis to meet reality and a world that is in flux.

3/ GPs need to be entrepreneurial to recognize and weigh one. The success of a technology startup is not just dependent on how cool the technology is but requires an operational assessment to figure out whether the business model is sustainable, and whether the application of that technology to a demographic makes economic sense. Operating experience is crucial to validate the combined value of operations and innovation.

I can name probably a hundred other reasons, but that would extend beyond the artificial limit of this blog and your patience.

In new VC

In a new VC structure I would argue for a more balanced makeup of economic managers and operational managers. But that structure can only work when all GPs share responsibility for every deal, rather than today's norm of every GP managing his own subset of companies within the portfolio. Many more things need to change in order for VCs to accurately calculate startup risk, snippets of which I've covered elsewhere in this blog and will cover extensively in my upcoming LP seminar "The Inconvenient Truth of Venture Capital".

Alignment with the entrepreneurs

So, until we change the fundamental workings of VC are we bound to hire GPs with relevant operating experience, those that combine that operating experience with the ability to accurately calculate upside risk and align with the entrepreneur.

But a VC firm without relevant operating experience is a risky investment (for LPs) and a bad strategic partner for the entrepreneur. The great difference between Private Equity and its sub-class Venture Capital is that the latter can create massive returns, albeit with GPs that are capable of recognizing a diamond-in-the-rough and performing a little bit of heavy lifting when needed or desired; by applying experience and influence.

That, as an operator, makes Venture Capital so much fun for me.

Tags: Eco-systems, Subprime, PE Week, Innovation, Experience, VC, Business Model, Limited Partners, Entrepreneurs

By Georges van Hoegaerden

I visited the entrepreneurs week at Stanford this week where many MBAs were walking around with new business ideas. Since we raised a fair amount of money ourselves in the last 10 years we've been focused on startups, I wanted to give some advice that may be helpful to any first time entrepreneur:

1) Define the end goal of the company in a newly defined market
The determination of pre-money valuation, even for the first round, should be based on the disruptiveness of the company when it grows up. The goal is to find the investor that understands the path to that goal, not an assessment of the current value of the company. The starting valuation then becomes a reverse calculation from that goal.

2) Don't set a valuation, but have one in mind
The valuation is usually suggested by the investor, but ofcourse, you don't have to take it. Ask your potential investor to value the company after you give them the pitch, the outcome of that tells you whether the investor really understands your unique proposition. If it is too low, it may be because the clarity of your pitch. If not: walk away.

3) Have an operating plan ready
An operating plan defines how you turn technology into a business, without it there is simply too much room for debate and depreciation. Show investors you know how to run the business. The more you do the easier it is to cement your use-of-proceeds.

4) Find an investor you truly like
Every entrepreneur deserves to be treated with respect. Waste no time talking to deep pockets with awful personalities, but don't be afraid to get some straight talk. Check TheFunded.com for war stories and ask around. Later, when business gets tough bad guys usually get a lot worse.

5) Define business disruptiveness
Building technology is one thing, but yielding a disruptive business value is even more relevant. The latter is defined by macro-economics, not just a more clever way to improve existing technology.

6) Take passion over domain expertise any-day
Find a lead investor that has passion for the business problem you are about to solve. An investor that claims to have domain expertise is usually the one that doesn't understand disruption within or across that domain.

7) Don't get squeezed
Investors like to put investments into past investment categories and make an assessment of how much it costs to build your business. Don't let them stray too much from what is in your operating plan, if you do you will get punished for it later, both on the execution side as well as in excessive dilution.

8) Know the investment allocation
Usually a little harder to do with angels but VCs should have a total investment amount allocated to the business. Ask them for the total allocation upfront, so you know when you need to go shopping somewhere else. Also, don't be afraid to ask who else needs to sign off on this deal within the VC firm, in most cases it is a very democratic process internally with a primary sponsor. After your first meeting you should get in front of a General Partner, talking terms.

9) Control your own eco-system
Investors like to wiggle around and determine how much money should go into R&D, Sales, Marketing, Business development, Support and G&A. Too much money in marketing is usually an indication the product or service lacks real viral adoption and that should be avoided. If the balance of this eco-system is not guarded heavily by the entrepreneurs the result is an excessive bleeding and further dilution in subsequent rounds.

10) Balance your board
A board without a balance of technical and business expertise can really bring a company down when the going gets tough. The technical board members will spend too much time validating deep technology progress without real affinity for the bottom-line. On the flip side a demand for too early revenues can have disastrous effects on product or service readiness and customer experience. Keep them both in check.

Be honest and transparent, too much talk without real interaction with a prospective investor is a bad sign. Paint a realistic risk-management picture, in which you describe both the pluses and minuses, not unlike the way a VC sells their risks in a Private Placement Memorandum (PPM) to its limited partners. Feel free to e-mail us if you need help.

Tags: Investment, VC, Angels, Markets, Eco-systems, Business Model, Startup, Innovation

By Georges van Hoegaerden

Getty-Images appears to be having trouble getting sold for $1.5B according to an article in The New York Times today. Perhaps the 40+ investment banks on Wall street and an equal amount of large private companies that visited our website really took our Puffer Fish analogy to heart.

So what could be done with Getty-Images? The problem with finding an acquisition partner is Getty-Images' hybrid business model. For a technology acquirer the services business with staff photographers is a burden they will not want to swallow. On the flip side, very few other services companies than perhaps the Associated Press can find solace in the photographer factory that is an integral part of Getty-Images.

1/ Buy company at a decent value
2/ Separate content producer business from content distribution
3/ Privatize each
4/ Sell content production business
5/ Revamp content distribution

ad 1/ To establish a fair price I am eager to see the operating plan metrics separating content production from content distribution in order to find out to what extend both lines of businesses have suffered from being under one roof (there may be some opportunity hidden in there)

ad 2/ Content production is a business model that, in today's world, needs to be separated from distribution. With the internet in place as the conduit for distribution, very few company can still afford to compete with the content produced by a "free-market". There is some remaining value left in the production of "premium" content for a "premium" audience, in the same way the Associated Press is able to provide this service to a confederation or co-op of newspapers.

ad 3/ Build companies that focus on what they do best, one produces content - one distributes it. Not within a single company or P&L or board. Each with its own growth trajectory.

ad 4/ Just like in the "premium" production of news articles (where bloggers compete), the news media will require a "premium" production of editorial photographs that has some trust associated with it. Perhaps a deal can be struck with AP - or a new version of AP can be created with identical goals. Getty-Images already has established a large installed base of agencies who can lease resources on a subscription basis.

ad 5/ Long term, content distribution is where the money is. The Long Tail of photography is massive, much larger in total image exchange than any Super-Store will ever be. Thanks to the Internet. But to build an effective free-market, a core of premium supply is needed to create its initial pull, Getty-Images certainly has that. To make this new company a winner though, it needs to truly support free-market principles, something very few companies can pull off.

We'd be happy to assist in the assessment of the Getty-Images acquisition value along the lines of the aforementioned strategy and even more in the post-acquisition execution. Our passion for photography, the ever increasing reach of the internet, and the value produced by all photographers around the world creates a fantastic new opportunity.

Tags: Getty-Images, Wall-Street, Investment Banks, Associated Press, puffer fish, Hybrid, Business Model, Content, Premium, Bloggers, Free-market, Super-Store, Long Tail

By Georges van Hoegaerden

While attending Tony Perkins' Media 100 beer-and-burger bash at the Alpine Inn, I was confronted by another opinionist that questioned Oracle's foray in the Enterprise Collaboration business. Indeed, it has been a long road; Oracle*Mail, Oracle Office, Oracle Library, Oracle Documents, Oracle Workflow, Oracle InterOffice Suite, Oracle InterOffice, Oracle Collaboration Suite is the reincarnation Oracle's installed base has been hit up with since 1990. As the lead salesman (or should I say Director of Worldwide Marketing), more than 7 years ago for Oracle Office and InterOffice I learned a few important lessons that stuck with me forever.

For one, technology does not sell. Oracle's collaboration tools were then, and are now some of the best in the business.

Two, deliver a proposition to sales people that matches the vendor's existing business model. Incompatibility of business models is why 800-pound Gorillas can't buy themselves into new categories.

Three, commission sales people competitively to other proven product offerings. Don't let your weakest sales people hide behind selling the "impossible". Again, Oracle's technology is not the problem, incompatible business models is the real issue. I see a bright future for Oracle's Collaboration Suite as the software-as-a-service solution for customers who have bought into Salesforce.com's business model.

Now, Digital Asset Management, often erroneously merged into the Collaboration substrate, is a market category that Oracle needs to own and quickly. "Unstructured" data and corporate media management markets are currently growing at a clip of 45% a year, faster than RDBMS or ERP growth. If Oracle wants to be the database for all corporate data, digital asset management is the real opportunity, not only because it works best with Oracle's organic business model. I've got suggestions for Chuck (Rozwat and Phillips) of who to buy to get in quick.

Tags: Oracle, Media, Collaboration, Digital Asset Management, Business Model