Web 2.0 Podcast: Disruption Opportunity - Venture Capitalby Daniel H. Steinberg
Web 2.0 Summit program chair John Battelle talks to two venture capitalists about investing in technology. Ram Shiram focuses on the small seed angel round of funding. His investments include Google. Roger McNamee's investments take content businesses and try to connect them directly to their audiences.
This episode is sponsored by the Intel Software Partner Program .
Transcript created by Casting Words.
ANNCR: Web 2.0 Program Chair John Battelle talks to two venture capitalists about investing in technology. Ram Shiram focuses on the small seed angel round of funding, he invested in Sticket, which was announced at the launch pad. He also Invested in Google a number of years ago.
Roger McNamee's investments take content businesses and try to connect them directly to their audiences.
Here are Ram Shiram and Roger McNamee with Web 2.0 Program Chair John Battelle.
John Battelle: The next conversation we are going to have, these two folks probably don't need any introduction, but I thought I am going to let them introduce themselves because they are both very well known in the Valley, they have taken some very interesting positions, one side being large private equity, mezzanine sized, lots of zeros, and the other small seed angel, not so many zeros.
One of them happened to turn into an awful lot of zeros but we'll get in to that. So, please join me in welcoming Ram Shiram and Roger McNamee, come on up guys. Ram, here, you guys can sit here. Roger, how are you doing.
Roger McNamee: Good to see you.
John: So, I guess the first thing I want to ask you guys is just to tell me what you are up to, what do you do? What do you do all day Ram?
Ram Shiram: Well, StickIt just launched at launch pad here, I think Tuesday.
John: And you are an angel investor in StickIt?
Ram: Yes, I think it's a cool new productivity app, this is the future, it's a little Ajax app, but it is a web-based productivity app much like many others that you are seeing now and you are likely to see others.
John: Now you invested about eight, nine years ago in a little productivity search app called Google, as an angel, how did that work out?
Ram: Pretty good, but we need others.
John: Good, I'm glad to hear it. So, you focus on those, on the small, sort of seed angel round of financing.
Roger: So, my focus is on trying to take content businesses and connect them directly to their audience. I don't know about you guys but I live in a world where I just don't have enough time for all the things I want to do and it's my sense that whether you are looking at journalism or whether you are looking at music, whether you are looking at video games or any kind of online content, any kind of real content that technology has totally disrupted the business model of the media industry, those guys have absolutely no clue what to do about it and the world needs somebody to align themselves with the creators of content and with the audience, and to take it to the next level.
So, I am, to a specific thing, the most recent investment we've made, we bought a big piece of Forbes and the goal there is to re-invent business journalism, ten-year time horizon, we've invested about a quarter of a billion dollars and we think over ten years we are going to help everyone in this room and everyone else in the world deal with the fact that they have to make really important decisions, they've got like a hundred things in their inbox, two of them are actually important and nobody can figure out which two and our job is to figure out over the next ten years how to help you find the two that really matter.
John: So, you just said $250 million, what's the average size of your investment Ram?
Ram: It can range from a $100,000 to less than a $1 million. Today, the start-up internet venture has never cost less money than it does today commodity hardware, open-source software, small development team.
I actually don't look for a business member of a team early on, I think the business model can be invented as you go. So, I truly think that the threshold or the barrier to entry for starting a young internet business has never been lower. The cost of failure therefore is also very low, other then, you know, it's hard to find talent and the energy you need to put in to it needs to be a hundred and ten percent.
John: Right, right. Just before we go any further I want you guys to now that because we have these two guys on stage and I now that about forty percent of you out there are entrepreneurs, I really would encourage you to come to the microphones and make this more of an interactive dialog, so at any time something strikes you, just come up to the mikes and we will bring you in, please.
So, pretty small size investment, really early, lots of money, getting a big brand like Forbes and figuring out pretty much the same thing: How do I take a big brand like Forbes and sort of turn it into something that.
Roger: So, if you think about the difference in the problems that we are trying to address, in many ways Ram's going after individual needs that people have, with a very specific solution that can be addressed with technology and we're going after things that we're, the content is the issue rather than the technology and so there are issues of trust and authority that come in to this.
If you are going to make a decision on buying a home or you are going to make a decision on investing your capital, you're not going to do, you know, a tool is important but it is only a step, what you really want is somebody to help you make those decisions. And you are not going to rely on somebody you don't trust and you are not going to rely on somebody who is not authoritative, so building a brand from scratch in those areas is very hard to do and takes a tremendously long period of time.
I think it is going to take us ten years at Forbes to do this new model of Journalism, and I think if you are trying to do it from a star-up you would have to count on something wildly longer than that.
John: Yes. I've done a few of those content startups.
Roger: So have I.
John: Mine are still around.
Roger: A lot of mine are still around but they were all a lot harder work than I would have liked and none of them is as big as I would have hoped.
John: Right. Now, both of your models strike me as not at all like what you might consider traditional venture capital models, and there are a lot of VC's in the audience, I mean, of those of you that are in the Venture, how many of you consider yourselves traditional? Yes, that was a set up.
But really there is a very well understood traditional Venture Capital model and, you know, we a have Mike Moritz, Ram sits on the board of Google and Mike Moritz is also on the board and John Door, these are some of the traditional powerhouses of venture capital who, you know, work in the deal range of five million to twenty million dollars and that's, and when they come to folks like Rael Dornfest who is launching StickIt and Rael says five million would be great can I take 100,000 of it for my business and spend the other four nine on, you know, food.
Because they don't know what to do with that kind if money. Is this model imperiled, is this model threatened?
Roger: Well I don't know if it's imperiled but I think if you take five million dollars when you need less than a million dollars to actually successfully launch a business, I think you end up sort of making mistakes, it's a problem of too much money and I'd rather see start-up's be scrappy, frugal, nimble, you know, on a lean diet of Rahman Noodles and not expensive food.
So, I just think it's important to have that sort of laser-like focus on even if it is a feature, at some that feature can expand to contiguous areas that then becomes a product and, you have to build a beach hut, so in StickIt's case, it's to do lists, it's a little notepad application that's sort of universal across different applications on the internet.
If you think about the challenge of venture today, it's that the funds are pretty big and as you say they typically want to put five or ten million in the first round, twenty five million over the life of the investment and they often do these things in tandem with another firm.
So, one of the challenges is that a lot of the money winds up going to places that can actually use that kind of capital as opposed to going into the most attractive ideas because a lot of the most attractive ideas need something less than a million dollars.
Roger: And... That's a different game plan. A lot of those guys what they need is Ram. They need a venture capitalist. They don't need somebody who knows what he knows. It is a different skill set. In the angel market there is a small number of guys who dabble and then there is a small number of people and anybody who doesn't know this guy [indicating Ram]... I mean... this a totally different ballgame that we're talking about here. OK?
Ram: Thank you. Thank you for that commercial but... I would.
Ram: I would say the following which is also the math doesn't work today if you are going to put out a lot of $5 to $10 million investments from a $500 million fund. The challenge ends up being "How do you ultimately produce many more YouTube type successes?" My belief is they are going to be few and far between that are either exits through M&A or exits through IPO greater than a billion dollars.
There will be a lot of companies that are bought in the sub hundred million dollar range and that really means there is huge pressure on that IRR model that everyone is trying to aim for that...
Ram: Higher and bigger number. And there is also a problem now of too much money. So, I think if you are entrepreneur in this room it's wonderful because if you have an idea you could raise money. You will never go short of money. And if you have a really good idea and a great time you probably can go to an auction model and raise a lot of money.
So, then comes the challenge. Don't equate raising money to success. The next stage is then "How do you grow from there?" The challenge is if your value keeps going up in these valuations... with venture capital money that you are raising, eventually your exit becomes expensive and there are only six or seven guys out there that can buy your company. There are three or four media companies and there are three or four large internet companies. So, you then have to figure out how to sell it at a price that is either lower than your last venture round or if you are able to build a good enough business, you would get a multiple of that.
John: Yes. Hang on one second. I did want to bring in these questions since I did promise to let these guys...
Ryan: Hey, Roger and Ram. My name is Ryan Carson from www.dropsend.com and Carson Systems. We built our web app for about seventy five grand and we're in the process of selling it right now. Roger, I understand from your model that there are plenty of companies that need hundreds of millions of dollars to do what they need to do but Ram, my question is more for you. We didn't...
Seventy five grand isn't much and we launched it and it seems successful and we're going to sell it for a multiple that is many times that. Besides your experience and your connections, why do we need you? Can you help me understand that?
Ram: Very good question. You don't need me. I think most people that can actually bootstrap and build a business and can get to that early validation... The beauty of building an early internet consumer venture is it's about making sure that when you launch, when you build your field of dreams - if the users come, then it's half the battle won.
Then you need to figure out a business model. But if the users don't come and you're not user-centric enough to have that focus to say "How do I get those users in?"... not just day one but over a period of time... and keep them there, then that's the challenge you have got to work on. Not figuring out who you want to take money from. That's less important.
Roger: If I could make an observation both about venture and entrepreneurial opportunities for those of you who are doing it. First thing to keep in mind is that in any endeavor, whether it's the investment business or entrepreneurship in general, you don't want to be doing the same thing as 25 other people.
And so, when you talk about traditional venture the biggest problem here is that if you're undifferentiated in venture you have the same problem as if you are undifferentiated on the web. You really need to have some unique position.
So, when I say we invested a quarter of a billion dollars in Forbes - they are not going to spend $250 million of our money to do something new. A big part of that was buying a very large, substantial... a piece of a large, substantial company but there is real money, real capital available to do what they need to do. But it's a web business, you know? And we do it all the same way any other web business does. And it's all on open source stuff with really good people doing it.
The thing that I would encourage you to think about it is--Ram's talked about how you get people to your site and keep them there. I believe there is a whole untapped market, which is part of what we're going after, which is the person who doesn't have the time to go to your site. Let's think about this for just a minute. There are two really compelling things going on right now.
The first thing that is going on right now is user generated content. Now, if you listen to media guys, they all tell you this is the appetizer and eventually people are all going to just watch Hollywood movies. I think that's bullshit. To me, user generated content is about self-expression.
This is an alternative to passive entertainment. I think it's going to gain -- for at least the time period of the current generation -- is driving through the python. And the reality is the amount of really cool stuff going on to service that market is really limited. To me, if I were doing a content business today, as an entrepreneur, I'd be looking at things that enabled new and cooler forms of user generated content.
The second thing that is going on is this issue of time. As I said earlier, everybody has got a hundred things in their in-box and they have probably got three or four in-boxes. If you were to let everything go for six months you would discover that 98 of the 100 items go away. They just don't matter.
The problem is that the two things that really matter - it's really hard to tell what they are ahead of time. If you can help people figure out what those two things are you are going to be very rich. That's the market I'm in with Forbes and move.com. In the video game business, we're in the market of helping people move towards user generated content and towards using their time in a more fun way.
But I think those two aspects of time, saving people time on the one hand, and helping them make better make use of the time they have on the other, those are the two big themes I would focus on.
John: We have another question over here.
David Fox: Thanks. Hi, it's David Fox from the Astrologer. Maybe we can help you find those two things. I just want to say thanks for stating the value of authoritative content, in this rush to user generated content, there is real value in authoritative content. It costs money to put authoritative content together. So, I just want to state that.
John: I agree.
Roger: It does, and I'll tell you something. It drives me crazy what we are seeing in the media business today. The newspaper industry has an average profit margin of 24%. Not because that is the natural profit margin but because that's what you can get if you harvest those businesses. There's not a major city daily paper in American that couldn't be growing today if it ran on much more normal margins but all of these guys are harvesting these things. It just drives me crazy.
The notion that you are going to depend on Yahoo or Google for your news... I mean, you can get that for data that's happening in real-time but you can't run your life off of real-time new services. Every once in a while you need someone to give you a perspective.
John: Can I ask you guys, in both your cases... It seems very clear, if you look at the last two years, you mentioned seven companies, maybe there are eight. So, ever so often one show up that you didn't think would do something, like The Times, and they buy about.com or something like that, for four hundred and some odd million dollars but generally there's a pretty well understood set, once you get to a size.
The IPOs market is closed. For young, aggressive, successful, interesting start-ups who may only have two or three quarters of profits - even if that is the case. Is it closed because the markets don't want it or is it closed because the markets are terrified of what happened to them last time or is it closed because the entrepreneurs don't want to go public?
Ram: Well, let's understand the current state of things. There is a lot of money for private funding of young companies. But the public market... This is the difference between the bubble and now. The public markets are very clear that they are only going to support businesses that truly have profits and have growth. So, two companies have gone public in the last six months and it is kind of instructive to see how they perform.
One was Shutterfly and the other is eHealthInsurance. Both of them are sub $500 million companies. We live in this area of Sarbanes-Oxley where companies that are less than a billion dollar in market capital don't get enough coverage from analyst, therefore they sort of languish in some sense. So it is almost better, unless you are able to larger business and seek an exit that is through M&A which is one of the reason I fear that there are not going to be too many over a billion dollar public companies at least that I can see in the short term in the next twelve to eighteen months. This can of course change, if the sentiment of the public is to change, but that is the situation as it exists at this moment.
John: Now is your exit with Forbs after ten years of course, I am assuming. Right? Of public markets?
Ram: Who knows? I mean, I spend twenty years managing funds that at least has some kinds of components in the public market. You know there are phases and cycles and right fear dominates, but eventually greed will come back.
Ram: You know, here is the thing. Look, fear is transitory, greed is permanent. That's one thing you can count on. The thing I tell you is this. I don't worry about my exit. I only worry about the things I can control. We execute our strategy well, the exit will take care of itself. We are in the transformation of this. We are not actually in the private equity fund. We are private equity structure. Private equity funds are about extracting cash from excessive capacity in the economy. We are about trying to transform...
John: ...well that you have done that before.
Ram: No. no, no. My Silverlake was also a transformation fund. Silverlake today is a private equity fund. But the first one, the one I....
John: Oh, I misunderstood....
Ram: Yes, I mean we did Seagate and Garner, and a whole bunch of other things that are really being transformed into a really positive way of Merrill trade, so I really believe that when you look at something like the media business, there is a real audiences. People desperately need to be entertained and they need information.
And they needed it in a lot better form than they are getting it today. Everything is mass market it today, even Forbs. We have nine hundred thousand circulation of magazine, sixteen million monthly unique visits in the website, and we target mass markets. Well guess what?
Ten years from now, we are going to try to build a relationship with you that allows us to personalize this stuff that solves your problem. I mean a year ago, I don't know if any of you guys... you people here are actually really smart so you didn't have this, but if you had a five year balloon arm... A year a go what you need was someone grab you by the collar and said, "Stop whatever you are doing and go refinance your mortgage".
The problem is that there is no one to do that. Well, sometimes in the next ten year, either Moves, or Forbes or both will solve that problem for you. And, you know, we will have to build a higher level of trust into the fellow from the [inaudible] you know that we will have to have that authority to be able to do that. That's hard work and it will take a lot of money and if we do a good job....
John: It will take care of itself.
Ram: It will take care of itself.
John: Question over here.
Laura Hansen: Hi, my name is Laura Hansen, I am a graduate student from New York city, and also an entrepreneur. I have a college website launching this weekend, The College Voice, My question to you, my friends and I have been bootstrapping this project, we talked to a few VCs. My concern is figuring out evaluation and also how to not get kicked out of your company once you go into the VC cause that is my biggest concern.
Ram: Good concern. I say it would be crazy for anyone to kick the founders out of their own business. Because if anybody has passion for the business they are building, it's got to be the founders. So, unless there is an issue of ethics, or an issue of lack of commitment that happens post of funding that something. Unless there is a dynamic that causes that problem to be a bad issue that they have to eject the founder.
I would say that is the last thing that any investor would think of. And that includes anyone out there that is investing, However, as far as evaluation, I wouldn't get too hung up on it, I think you have to decide what value are you seeking from that investor. Do you need just their money? In which case take their money.
If you already know how to build your business with the respect of the partnership you need, the people you need to hire, and all of that. If on the other hand you need smart money, than figure out what are the things that you need help on, and is that investor able to provide that help for you.
Roger: Can I add one thing to that, and this is really important. I am a huge believer that what matters is the size of the pie, not the size of the slice. And most entrepreneurs actually have difficulty judging whether they need smart money or not.
I have always believe in my own. I started three businesses, and each time I have made the choice to bring in all of the resources I can possibly bring in to make it successful, you know, kind of a belt and suspender thing. I won't talk about the percentages of my first businesses I gave to Client Perkins, but it was very large.
But I have the opportunity in 1991 to be partners with John Doer inside his office for the next twelve years. And the fact that I gave away too much of businesses in the first round, turns out to be immaterial, because the pie got so big, who care. And I would just tell you if you fixate on the percentage of the pie that you own, give it up now. There is no point. You are going to have be so lucky to make it work if that is what you are worrying about.
Ram: Wait a minute. I started a few businesses too. Stay over 51 as long as you can if you want to control your business.
Roger: Yes, but hang on, I just think of this notion of controlling the business is ridiculous. I....
Ram: You were the industry standards....
Roger: I do, I do, hang on, but, fair point.
Ram: I mean, so maybe it's an outright example.
Roger: Hang on, I just want her to understand that I am not just saying this out of self interest. My Altera Price I was the only guy. When I started Integral, I had one partner plus Client Perkins. And at Silverlake, three partners. At Elevation, five partners. So, my percentage has shrunk, every single time, OK? Now, you sit there and you said, wait a minute, I am the only common element among all those things, why does my percentage keeps shrinking?
The reason is because I am less interested in failure each time. I am putting in the insurance policy to avoid that. You have to make your own choice in this. Like Rob said, if your judgment is that if you can get away with dumb money, that's great, but the number of people who have great ideas that failed because they took dumb money, unfortunately exceed the number of people who had great ideas who took smart money, and then, you know.
Audience Woman: Do you mind if I ask a follow up question then?
Audience Woman: How do you determine who is the smart money?
Audience: [laughter] [clapping]
Roger: You are looking at it, look at my right and left and that is the definition of smart money. My own judgment of how this thing works I think it is very situational. People tend to look at the firm first, and the person second. I remind you it is all about the person and the situation. Somebody who is brilliant in one situation is not going to be as good at something else, right? I mean John Dore was good at Penn Computing. He has had bad days. I had a bunch of serious clunkers. Rob has never had one....
Ram: That's not true. Here's how I would answer it - I agree with Roger - don't look at the brand name of the firm, that matters less. Look at the person in the firm who is likely to work with you, or who is sponsoring your deal or is excited about you. Do you respect that person, do you feel that they could sit down with you and actually help you? That's a judgment call you have to make. When you make people judgment calls even to this day I make mistakes.
Roger: Yes, but this is the essence of entrepreneurship. Making judgments about people is the single most important thing a founder does. You have to make judgments about your team. Guess what, your investors are part of that team. You should not view them as an externality. The way I think about it is, is this the person who at two in the morning I want to call whether I have good or bad news? If it's bad news I call because I think they're the best person to help me. If its good news, I'm just so overjoyed I want to call somebody and they're the one who at two in the morning wont mind that I've called with good news.
John: Question over here.
Audience Man: Hi, I'm with Replica. We agree with this thesis that it's about discovering unique information for people and really narrowing it down to deliver to people the best that they can have. The problem for us, and in our case the two questions I have, is that when we got into this, it's a very serious problem. It's a supercomputer problem, not something that's easily solved.
We couldn't start a company for $5,000 and a couple of pizzas, the technology underlying what we did we had to license, and then we needed a really good team. Question is, we ended up putting the money in - fortunately myself and the other guy were able to do that - but where do people go who need to get the money pretty quickly, people who might not have the technology they can develop for $10,000, and do you think that this model for the web currently, with just that $75,000 and I've got an application, does that stifle innovation?
Are VCs really investing mainly in the community? Because even now, it wasn't until Entre and Barcelona that the VCs really started to get what we were doing. That's my question. Is it stifling innovation, and do you really think these technologies are defensible and good investments over time? Because one of the pieces of our project is the way we deliver information, and I don't want to get into what's that saying right now, but what's wild about that is that we duplicated what other companies have been using as their platform in 30 days. So, I'm curious as to how you see that.
John: Let me make sure I understand that, which is where do people go if they don't have the same model that we've been talking about, which is disrupting, but might need somewhere between five and 15. Can everybody in the audience who is willing to do that raise your hand. [laughter] I mean there's a lot of people who are looking for that opportunity, am I wrong?
Ram: I don't think you will find any shortage of capital if that's what you need in order to feed your business or idea or innovation engine inside your company. At the moment at least, in terms of company formation and new funds that have raised money, outside of the bubble period, this is the highest it's ever been. So, I'd be very surprised if any idea doesn't get funded at this time. Which is a little bit of an issue because it's not a bubble but it's frothy. So, therefore, I would not say that will be an issue for you.
Audience Man: I don't think it is, but just the point is it's really at least it was not my experience that it was that easy. We have a very strong management team, some success under our belt, and we went to some VCs early on - I guess it is too early, that's what they were telling us anyway - until finally we just got frustrated and said OK lets just put in the money and get this thing rolling. I didn't find it to be the case where you can find a really good technology which NASA is using, literally, and get the money like that.
Roger: I think your whole frame of reference is flawed. The key thing is the more value you can add before you take outside money, the bigger piece of the company you will own - in answer to that woman's question. You want to maintain a large share, do a lot of development before getting outside money. Here's the thing. It may have been in how you presented it, it may have been the people you were talking to were getting divorced. Who knows? [Laughter]
No, I'm serious. This is not easy, nor should it be easy. I've started three businesses, not one of them was easy. You've been involved in a million things, it's just hard work. If that's not exciting to you, you should be doing something else. My simple thing is, if you've got an idea you're so passionate about you can't think about anything else, do that. But if you can think about anything else, do that instead. Entrepreneurship is not for lightweights.
Audience Man: Thanks, that was my [inaudible]. [laughter]
John: Over here.
Austin Health: Hi, Austin Health, hey Roger. Question for you you mentioned trusted media sources with Forbes and entertainment and gaming, but I also know you have an interest in music, have partners involved in music. How do you see the future of media relating to music and movies, where trust may not be as relevant as just the entertainment value? And obviously the issues with DRM, where do you see that kind of media?
Roger: I'll go in reverse order. DRM stands, to me, for "Doesn't Really Matter." I believe that trust matters a lot. Fans do not rip off the creative people they like. You're a fan of a musical artist, then you respect that that's this person's living. If you are a real fan of a director, whatever, you're probably not going to steal their stuff you know, unless you're totally destitute.
Our view of this whole thing is it's all about relationships. In contrast to the fellow with the NASA application, we're not looking for things where technology is a solution. We're looking at technology as a delivery platform, but our stuff is about human creative endeavor and human editorial. We have been working very hard on music for a long time. It's a hard problem.
I believe it's easier to solve the problem with Move and Forbes, which is to say addressing the finance side of people's lives, simply because the business managers in those businesses are more ready for change. The music industry has just been getting hammered, and the people are terrified. It's hard, but we'll be there, and we'll be in a bunch of those other categories. This is important stuff, and right now those businesses are being run by people who are harvesting them.
John: For those who don't know, one of the partners the questioner was referring in elevation is Bono. How'd you pull that off, by the way?
Roger: It was his idea, it was pretty easy. [Laughter] He came to me with the idea, he knows a lot of people in the investment business, but I was the only one he knew who liked music.
John: I've seen his band a couple of times, it's pretty good.
Roger: He spends a lot of time, as you know, on humanitarian endeavors, and the band said to him "can you take a piece of that energy and apply it to fixing the problems in music business?" It was a good question. Here we are three years later and we still haven't got the answer.
John: Microsoft has the answer. It's called Zune.
Roger: Well yes, you know, maybe it is, maybe it's not.
John: Our time is up, we have a lot of questions. Tell you what, would you guys be OK going out into the hallway there and answering questions for me?
John: Thank you very much for coming.
Roger: John, thanks for a great time.
ANNCR: Ram Shiram and Roger McNamee at the Web 2.0 Summit 2006.
Daniel H. Steinberg is the editor for the new series of Mac Developer titles for the Pragmatic Programmers. He writes feature articles for Apple's ADC web site and is a regular contributor to Mac Devcenter. He has presented at Apple's Worldwide Developer Conference, MacWorld, MacHack and other Mac developer conferences.