My father-in-law, Michael Doctoroff, passed away last week of ALS.  It's been a sad series of days in the Bussgang household and we are just beginning to recover and transition back into the real world.  I am finding that when you lose a loved one, it's hard to make the switch back into our frenetic, exciting, optimistic start-up world.  But, we are doing our best and I thought a memorial blog post would be somewhat cathartic.

My father-in-law was a remarkable man.  He was the middle child in a household with three boys, surrounded on both sides by over-achieving Harvard graduates (one became a judge, the other a successful doctor – the dream of every Jewish mother!).  Yet, he charted his own path.  Although on paper he had a marvelous career (corporate executive, professor, author of a management book – pictured above), in truth he never found his true professional calling until 16 years ago, at the age of 60, when he founded Trainers Warehouse out of his basement.

Don't let anyone ever tell you that you are too old to be an entrepreneur, too old to take the risk of starting your own venture.  My father-in-law worked alone and didn't take salary for years and years, eventually building the company into a multi-million dollar leader in the corporate training supplies market.   He raised no outside money, located the office 5 minutes from his house and employed his daughter – now president of the company – and wife as well as tens of others.  Even while battling ALS, he came to work every day to design creative products for trainers to bring fun and fulfillment into the workplace. 

Despite his entrepreneurial success, his career did not define him.  His relationships with his family and friends are what made him most remarkable.  He had an amazing relationship over the course of a 50-year marriage with his wife.  Their love for each other through his battle with the disease has been inspiring to observe.  He had three lovely daughters (my wife being one of them!) who have happy marriages and functional families as well (coincidentally, each of the three daughters married a college classmate).  And he was able to foster great relationships with each of his three son-in-laws – finding special ways to connect with each of us, despite our diverse interests (an entrepreneur-turned-VC, a scientist and an author).  I think it is the mark of a great man (in this case, in partnership with a great woman) who can create such a functional set of relationships across their entire family. Fostering close friendships was also paramount to his existence.  No less than five people came up to me at the funeral to tell me he was their best friend in the world.

In his final months, my father-in-law taught me a lot about grace and courage.  ALS is a horrible disease, slowly weakening your body while your mind remains sharp.  He was funny, irreverent and attentive to those around him to the end.  I don't think I'll ever forget the night he came over our house for dinner, a week before his death, when he drew a bone on his handheld white board (he could no longer speak) and motioned to my dog to see if he could get him to chase after it.  At Thanksgiving, he had his three year old grand-nephew chasing his wheelchair around trying to beat him in tic-tac-toe.

I feel blessed to have had him in my life.

Yesterday, I analyzed the Massachusetts IPO ecosystem.  Today, I look at NY. 

Unlike MA’s robust public company ecosystem, where I counted 33 companies with greater than $1 billion in market capitalization, I was shocked to discover how very few public companies in the Innovation Economy that exist in the Big Apple.  If you restrict the geography to 30-45 minutes driving distance and part of the “scene” (which encourages mingling and productive talent and idea sharing), you have to eliminate CA, IBM and Priceline.  I think that only leaves you with the following companies that have greater than $1 billion in market capitalization:

• AOL ($2B)
• Intralinks ($1B)
• TakeTwo Interactive ($1B)

I’m sure I must be missing a few, but my informal survey of NY VCs, bankers and entrepreneurs didn’t yield any others.  There are a few smaller public companies, like Travelzoo ($660M) and Medidata ($470M), but even the sub-$1 billion market cap list is uninspiring. Given the digital transformation of media and advertising, some may argue that the big media companies and advertising agencies should be included here and certainly they play a very important part of the NY ecosystem, but in terms of pure technology companies with entrepreneurial DNA and technology roots, it’s disappointing to see how few are in NY. 

That said, when you analyze the pipeline of IPO candidates, you begin to see a very different picture.  Not only is it quite robust – there are roughly 30 companies with estimated market values of greater than $100 million – but arguably full of companies that feel more promising and explosive than the MA companies.  The chart below is lifted from the Business Insider list, but I also cross-checked with AlwaysOn, Inc’s various lists and input from local members of the entrepreneurial community.

As far as I know, none of these companies has yet registered to go public.  Everyday Health almost did, but then pulled out and raised a private round of financing instead.  Behind this list, there are tens of other strong NY-based start-ups with real revenue momentum (> $30m) and belong in the > $100 million market capitalization category.  Folks cite:

• 33Across
• Antenna Software
• BuddyMedia
• Clickable
• GLG
• LiquidNet
• MediaMath
• OLX
• Vostu
• Yext

The conclusion is that NY is missing, that robust public company ecosystem does not exist.  Unlike in MA, one doesn't see public company CEOs regularly mingling with their pre-IPO brethren at cocktail parties and industry gatherings.  If you fast forward two or three years, however, the NY-based IPO company pipeline appears quite promising – arguably more promising than MA’s – and bodes well if the investors and management teams have the courage to go all the way.  Then, the CEOs of these companies will need to heed the warning of many wise men and women before them who know that an IPO is not an exit, it’s a financing event.  The best is yet to come.

Bill Gurley’s excellent piece on Silicon Valley IPO Anxiety inspired me to take a companion look at the East Coast, particularly Massachusetts and New York, and evaluate the health of the local IPO economy and prospective pipeline.  Today, I'll cover Massachusetts; tomorrow, New York.

I first came across Bill when he was a Wall Street analyst and covered my company Open Market (IPO 1996).  I always admired his perspicacity, even if he didn’t like our stock all the time!  For purposes of this blog post, I am only focused on companies involving technology, whether software, Internet, health care or energy – which I’ll define as members of the Innovation Economy.  Note also that, for obvious reasons, I leave out any Flybridge Capital portfolio companies in my analysis.

Massachusetts

First, let’s look at my home state of Massachusetts.  By my count, there are 33 Innovation Economy companies with market capitalizations of greater than $1 billion (see chart below).  Some of these are important companies, leaders in their field, and full of great future prospects (EMC, Thermo, Genzyme, Akamai).  Others have seen slower growth, are a bit more tired, and may get gobbled up in the years ahead (Parametric, Novell, Progress).  A number of them are recent IPOs who are growing nicely and may become multi-billion dollar revenue companies in the years ahead (Acme Packet, VisaPrint, Athenahealth).  

Other recent IPOs, like Constant Contact ($720M), A123 ($960M), Insulet ($520M) and EnerNOC ($600M), are sub $1 billion in market cap, so not listed here, but are representative of a number of small market cap players in the community who have > $1 billion potential.  The headquarters of each company is within 30-45 minutes of each other, so the degree of talent concentration and social interaction is very high.  Further, acquisitions in the last 12 months such as Unica (IBM $480M), ATG (Oracle $1B), Netezza (IBM $1.7B), Phase Forward (IBM $685M) and Starent (Cisco $2.9B) show that there’s a vibrant M&A market for small cap technology companies in 2010 and will likely be a catalyst for talent to be recycled.

Yet, when you evaluate the pipeline of IPO candidates, the results in MA are less inspiring.  One interesting ranking comes from Business Insider’s list of the 100 most valuable private digital companies.  Although this is only one and skewed towards one industry sector, it contains only one company from MA in its ranks:  Brightcove.  In an informal survey of a number of Boston VCs and entrepreneurs, the same 10-15 names come up as IPO candidates in the next 2-3 years (the criteria I asked folks in my informal survey was to name companies growing fast, revenue runrate > $30m, profitable or converging on profitable and probably worth > $100M today).

They include (note – all estimates are my own judgment and highly disputable; for obvious reasons, I did not include any Flybridge Capital portfolio companies, so we are not investors in any of these):

• Brightcove ($50-60m)
• Carbonite ($60-70m)
• Communispace ($50-60m)
• CSN Stores ($300-400m)
• Endeca ($80-100m)
• Glasshouse ($90m) – registered for IPO  
• Globoforce ($80-100m)
• Hubspot ($25-30m)
• ITA ($150-200m) – Google acquiring for $700m
• Jumptap ($40-50m)
• Kayak ($150m) – registered for IPO
• Kiva Systems ($80-100m)
• Kronos ($700-800m)
• Litle & Co (>$100m)
• Name Media ($50-60m)
• Vertica ($25-30m)
• Zipcar ($130m) – registered for IPO

There are numerous divisions of public companies that historically resulted from acquisitions – like TripAdvisor/Expedia ($400-500m revenue), Shoebuy/IAC ($200-300m revenue) and Rue La La/GSI Commerce ($150-200m revenue) – but those are not included here as they’re not relevant to this analysis unless they get spun back out.

The conclusion?  There is a robust public company ecosystem in MA, which should serve as an inspiration and catalyst for other local private companies.  Strong public company talent is easily recycled at the most senior levels (see, for example, Akamai’s hiring of former Digitas CEO David Kenny as COO) and when you gather at networking events and see other CEOs who have taken their companies public, it is a wonderful inspiration.  

But, sadly, the private company ecosystem in MA is less inspiring, with only roughly a dozen private companies that could possibly be public companies in the next two to three years and only a half dozen with revenues of greater than $100m.

Tomorrow, I'll analyze the New York market, which yields a quite different picture by comparison.  

I met with a senior executive at a top 5 bank last week and he said something that has stuck with me all week.  When I asked him why he was interested in pursuing entrepreneurial activities after a nearly 20 year career at one firm, he replied, "I've decided the world is divided between attackers and defenders.  Over the last few years, I've grown tired of being a defender.  I want to be an attacker again."

This observation struck me because I heard it echoed by a senior executive at a top 5 media company who said nearly the exact same thing.  "Over the last 5 years, it's been clear that my job has turned into being a defender.  I want to be an attacker, instead."

There's something very profound about these statements.  First, it shows that the disruptive impact of the Internet and the Digital Age is still cascading throughout our economy.  The transformative power of technology is no longer merely impacting the narrow software industry, it is impacting huge swaths of our global GDP.  Second, there still remains unlocked, unrealized entrepreneurial energy embedded in our big companies.  

When mainstream senior executives are itching to abandon safe jobs for more challenging, dynamic environments, good things are bound to happen.  Ask yourself:  in your industry, are you an attacker or a defender?  And what will happen when thousands more talented people decide it's more fun, and rewarding, to be the former?

Malcolm Gladwell made famous the natural human reaction of judging other people in the first few minutes of an encounter with his book, Blink.  Like many other businesspeople, VCs and angel investors (“investors” going forward) blink and judge entrepreneurs very quickly in the first few minutes of an interaction.  That’s why the way an entrepreneur starts an investor pitch meeting is a key determinant of their success in that meeting.  Those first 10-15 minutes, where the entrepreneur presents themselves before they even present the idea, are very critical in establishing credibility and the right to continue to pitch to an engaged audience.

Yet, it is amazing to me how few entrepreneurs start investor meetings crisply and confidently.  The formula for the start of the meeting is almost always the same – you are trying to answer the simple question on the mind of the investors:  who are you and why are you here?  But when asked to review their backgrounds, entrepreneurs often fumble through incoherently, or ramble on tangents that aren’t relevant to the situation.

So, how should you start an investor meeting?  It’s as simple as ABC:  Always Be Credible.  Investors are looking for credibility – can we trust that you have a uniquely good idea or insight, are you capable of executing on it, and are you the real deal or full of bluster and BS?

When you talk to investors and ask about this opening gambit from entrepreneurs, you hear a consistent pattern about why they like a certain entrepreneur they’ve invested in. When you distill the inputs into a coherent pattern, here are the top three things you typically hear entrepreneurs should do:

• Be genuine and personable – Let your personality show, professionally of course.  At some point in the introduction, say something that makes you smile, which will make those around you smile.  If you don’t engage your audience, they’ll jump to their Blackberries.  For example, ZestCash CEO/co-founder Douglas Merrill is a charming character and, even putting aside the shoulder-length hair and tattoos, you can’t help smile when he introduces his background (raised dyslexic in Arkansas, followed an unlikely path of earning a Princeton PhD, leading Google engineering and IPO in his role as CIO for 5 years, and now has developed a vision to transform short-term consumer credit by blending online data with traditional underwriting techniques).

• Be crisp and on point – The most compelling background speeches are crisp, straightforward and very demonstrate relevant links to the opportunity at hand.  For example, SaveWave CEO/co-founder Dave Rochon gave the following brief narrative when pitching investors:  “I worked at Catalina Marketing for 10 years in sales and launched their Internet couponing business, then joined Upromise the year it was founded and built the grocery business for 10 years, serving for three years as president after the acquisition by Sallie Mae. I now want to transform the online and mobile grocery coupon business.”  Dave’s Series A round was way over-subscribed by folks like First Round, Ron Conway, Roger Ehrenberg, Founder Collective and I think it’s in no small part because his background and delivery were so crisp and relevant.

• Keep it short.  I find that the more impressive the entrepreneur, the shorter the introduction.  The worst situation – 20 minutes into the presentation, the entrepreneur is still bragging about some random product they launched in a completely irrelevant industry sector.  The VCs are already hitting their Blackberries and wondering how they can end the meeting gracefully.  And you run out of time to actually pitch the big idea.  Meandering introductions are the death of a pitch.

And here are the top three things to avoid:

• Do not exaggerate.  Assume that everything you say will be thoroughly checked out in due diligence.  If you claim credit for a company where you played a small role, it is bad form.  I recently called the CEO of a company that an entrepreneur bragged they had led during the pitch.  When the CEO told me they were a minor player and left after a brief two years, I stopped spending any more time evaluating the opportunity.  Remember, investors are professional BS detectors.  Err on the side of underselling your background because the BS alarm bells may ring in the first few minutes of introduction and spoil the rest of the presentation.

• There’s no “I” in team.   When entrepreneurs talk about themselves in grandiose terms in their introductions, it’s usually a sign of egotism.  When entrepreneurs talk about the teams they built and the smart people that somehow they were able to convince to join them in their cause, it’s a sign of great leadership.  Guess which of these two profiles investors are more attracted to?

• Don’t name drop.  Some investors are notorious name droppers, so this is a bit of the pot calling the kettle black, but investors get very turned off when the entrepreneurs name drop in their introductions.  We don’t need to hear every famous person you’ve met or pitched or worked with.  Establishing a few common points of contact is a good thing.  Acting like you are best friends with folks who wouldn’t recognize you if you bumped into them in the grocery store on a Sunday afternoon is not recommended.

Remember, be credible, humble and specific and you’ll do fine.  Take the 5-10 minutes time to establish that initial credibility, and then move on.  Investors like to back great people, so spend as much time thinking about how to present yourself in a compelling fashion as you would your idea.

In undiluted tellings of the tale, the Big Bad Wolf devours Little Red Riding Hood before running off into the woods. It’s worth remembering when considering the prospects for a wave of technology M&A to materialize.

Over the last few months, investment bankers have been eagerly reaching out to corporate buyers at the large public technology companies, as their burgeoning balance sheets have grown large enough to cause even a sangfroid, buttoned-down banker to salivate. 

The eight US-based technology companies with market capitalizations of over $100 billion (Apple, Microsoft, Google, IBM, Oracle, Cisco, Intel and HP) are sitting on over $200 billion in cash and short-term investments. Throw in the top three healthcare firms by market capitalization (J&J, Pfizer and Amgen) and the figure is $250 billion. Further, each of these companies is in a strong competitive position, competing in markets with positive secular trends thanks to the burst of innovation that is ahead of us. I can’t cite another time in the brief 50 years history of the technology industry when so many US-based companies were in such strong global leadership positions in so many compelling, growing markets.

With the economy modestly rebounding and fear beginning to seep out of the market-–the VIX index, a measurement of market volatility or fear, is down to as low as it was in summer of 2008–-it’s no wonder that many are forecasting a robust pick- up in M&A activity in the coming year. Private investors have held on to their good companies over the last two years when it was purely a buyer’s market. Meanwhile, large companies who have spent the last two years cutting costs and pushing for efficiencies are now eyeing growth. And the quickest way to grow? Buy it.

That said, private companies should be careful not to get too euphoric. A quick survey of my investment banker friends yields comments like, “a flight to quality”–-in other words, rational deals with market leaders get done, but unloading mediocre companies is not in the cards–-and “patience” or “inconsistent interest.” One banker reported to me that one or two buyers are at the table on deals that are getting done, not three or four. Further, no one appears to be in a rush. Strategic fit is being carefully analyzed and only top priority opportunities are being pursued.

So despite the fact that yields on cash are at a historic low, don’t expect those balance sheets to thin out anytime soon. And Little Red Riding Hood should still be very, very afraid.

Security Analysis is cited by Warren Buffet as one of his top four favorite and most influential books.  Written by Columbia University Professors Benjamin Graham and David Dodd, it was first published in 1934.  

The book is a thick tome that articulates the thesis of value investing – the analytical techniques for valuing securities and seeking to invest in those securities in the context of their underlying value.  The latest printing, the sixth edition, contains a foreword from the Oracle of Omaha himself as well as a preface from hedge fund investor Seth Klarman of The Baupost Group, who is regarded by many to be one of the modern masters in the art of value investing.

As a venture capitalist reading the book and trying to absorb its investment lessons, I wondered – can VCs be value investors?  After all, the philosophy of value investing, in theory, should cut across all asset classes and managers.  The precepts and principals therefore should apply to the venture capital business as well.

Sadly, they don’t.  

Klarman writes:  "Investing in bargain-priced securities provides a "margin of safety"-room for error, imprecision, bad luck, or the vicissitudes of the economy and stock market.”  

Unfortunately, VCs don’t operate with a margin of safety, even if they are able to find and negotiate good deals. Later stage investors may have downside protection if they buy smart, but early-stage VCs do not.  If a portfolio company goes bad, there is typically barely any salvage value.  

As one of my partners is fond of saying, “A good price doesn’t help a bad investment”.  That is why VCs tend to emphasize “clean terms”, which are entrepreneur-friendly rather than focus on complex bells and whistles to protect downside.  And that is why you will see large loss ratios in VC portfolios, sometimes as high as 20-30%.  In fact, if a VC doesn’t have high a loss ratio, one might argue they aren’t taking enough risk.  As one Silicon Valley veteran put it to me the other day, “I can only lose 1 time my money.”

There is a see saw debate often heard in the hallways of VC firms – does success come from being a good stock-picker or company-builder?  In other words, will a VC generate strong returns because they are good at finding the best companies and entrepreneurs to invest in, or will the returns be generated by adding value to companies through shrewd strategic guidance and savvy recruiting and team-building?

The answer appears to be both, but even the debate itself is also framed incorrectly, I would argue.  Entrepreneurship is all about people.  The VC business has evolved into a world where the challenge is less about choosing the best entrepreneurs to invest in, bur rather convincing the best entrepreneurs to take your money.  This dynamic is unique as compared to other asset classes.  Imagine a world where the highest quality forests choose which endowment they’d like as their owner; or a public stock chooses which hedge fund they want to own 10% of their outstanding stock.  Sounds ridiculous?  That’s precisely what is happening when VCs compete with each other and chase after the best entrepreneurs, offering entrepreneur-friendly terms, supportive advice and value-add.

But although the VC business doesn’t lend itself to value investing, VCs would benefit from many of its lessons.  For example, placing an emphasis on thoughtful analysis and due diligence of business models and market dynamics rather than pure, instinctual speculation.  Further, in a world of multi-hundred million dollar exits and a weak IPO environment, exerting some price discipline makes sense for VC investors, who are often pushed by entrepreneurs beyond their limits (“If you like the deal at $20 million pre, why wouldn’t you like it at $25 million?”).  Deal prices must be scrutinized in the context of realistic growth assumptions, future capital intensity and target market sizes.  As Graham and Dodd put it, when an investor is blinded by the pursuit of growth, “Carried to its logical extreme, there is no price too high for a good [company], and that such an issue was equally ‘safe’ after it had advanced to 200 as it had been at 25.”

That’s why, in the end, the VC business is still a blend of art and science.  It is part financial asset class, part creative entrepreneurial endeavor.  And, under any analysis, is not for the faint of heart.