With the capital market turmoil raging, many argue that 2008 is going to be a tough year for start-ups to raise money, particularly follow-on capital in the form of a Series B financing (not surprisingly to any veteran viewers of Sesame Street, Series "B" follows Series "A" rounds of financing).

Series B financing processes are all about credibility.  Does this management team have its act together to build a great, valuable company?  As such, behaving like a pro during the fundraising process is critical.  If the management team demonstrates they can run a great fundraising process, they can run a great company.  If they look like this is their first time through the process and they are scrambling to react to questions and requests for materials, their ability to successfully execute on the business plan will be heavily discounted.

For VCs, the Series A is a “hopes and dreams” investment thesis.  Do I believe the vision and this management team’s ability to bring the vision to life from nothing?  The Series B investment thesis is all about “metrics and momentum”.  The management team needs to provide a compelling case that their company and their category has tremendous momentum, in fact accelerating momentum, and that the Series B money is going to be used to cement their leadership position in a valuable market.  It is not a speculative bet.

In a first meeting with a management team, typically lasting 60-90 minutes, a VC firm’s job is to decide whether to have a second meeting.  If so, the VC firm will typically articulate to the management team the key issues or concerns there have with respect to the business that they’d like to understand better and see addressed.

If a VC firm is interested in continuing the process after the first meeting, they’ll typically invite the team back for a second meeting with a broader group of the partnership and try to understand the business at a deeper level in the context of the key issues.  If there is interest in doing “real work”, the due diligence process begins and it is "game on".  Note to entrepreneurs:  if a VC keeps meeting with you and isn’t doing "real work", it’s a yellow flag that you are on the back-burner of their "top new projects" list, of which there are typically no more than one or two.  Typical materials that are asked for to assist in due diligence in a Series B process include:

• Capitalization table
• Management team bios
• 3-5 year Financial plan and model – the CFO should be prepared to walk through; which should include a 10-15 page PowerPoint presentation on the business model, key metrics and assumptions and how those metrics and assumptions impact the financial model
• Historical financials, audited and unaudited
• Note that the financial model should be packaged in an Excel file in such a way that can be send to VC firm associate/principal to tear through and tweak assumptions and run sensitivity analyses
• Sales pipeline – VP Sales should be prepared to walk through
• Management team references
• Customer references
• Partner references
• Technology review – VP Eng should be prepared to walk through, ideally with PowerPoint presentation as guide and architecture document as back-up
• Major contracts
• Product roadmap – VP Marketing should be prepared to walk through; ideally with PowerPoint presentation as guide
• Exit valuation comparables and scenarios – CFO should have matrix of public company and private exit comparables that show typical revenue and EBITDA multiples

A thorough but efficient diligence process typically takes 4-8 weeks from first meeting if everyone is focused on it.  A few pieces of good news should be sprinkled in during the process to underscore the momentum story (e.g., “By the way, we signed X” or “By the way, we were 50% ahead of plan last month”).

At the end of the day, the fundamental VC math a firm will need to be sold on for the Series B goes as follows:

• What is the post money valuation on this round?
• How much additional capital will be required, if any, and what’s my blended post money going to be across the two rounds
• Multiply that number by 5-10x. 
• Can I convince myself and my partners that I can generate that exit valuation based on the industry comparables during a rational market period over the next 3-5 years?

If the answer is "yes", you get the term sheet.  If no, rinse and repeat with next the VC firm!

Microsoft’s unsolicited $44.6 billion bid for Yahoo is an exciting, bold move for the Redmond, WA software giant who is desparately trying to compete with Google for the $800 billion in global advertising dollars, of which only $24 billion will be spent online in 2008 (a rate that is growing at over 20% per year).

But if VCs needed yet another signal that the exit environment is getting tougher, here is another one.
First, the IPO window is closed thanks to choppy stock markets and recession worries.  Then, some of the most popular technology company acquirers, like HP, IBM and Cisco, get battered in the stock market along with eveyrone else.  And now two of the most popular media and Internet acquirers, Microsoft and Yahoo, get frozen in their tracks as they try to figure out whether to combine.

What happens to VC-backed portfolios when the exit windows close?  We saw it occur in 2001-2003 and it’s not pretty.  The companies who had the investment thesis, "if you build it, they will come", find that no one is coming to their party.  And the companies that had the investment thesis, "get a few leading customers and then let’s sell to Yahoo/Microsoft/Google" are seeing two of the three candidates go into hunker down mode for the forseeable future.

Bottom line:  if you are raising capital and have the option, raise a bit more.  And if you have set your 2008 budget, reset it…a bit lower.

With yesterday’s 0.75% rate cut by the Federal Reserve, the press has been rightly focused on the ripple effects that the soft economy will have on the US and the world.  Amidst the high-level analytical fervor, the mainstream press has not probed on the implications to the venture capital/start-up economy, which fuels so much innovation, particularly here in Massachusetts.

There are two interesting competing forces at work.  First, venture capital investments are obviously negatively impacted by the down turn.  Start-ups that were funded during what will be seen as the "go go days" of 2005-2007 will struggle to maintain their growth and momentum through the economic head winds.  If VCs invested in these companies at inflated prices and, on the margin, over-capitalized these companies, their returns will suffer.

But on the flip side, looking prospectively at the VC asset class, one might argue that it is suddenly looking more appealing than ever, particularly on a relative basis (reminds me of the joke about the two "buddies" being chased by a bear realizing that they don’t have to outrun the bear, just one another).  Over the last five years, our later stage private equity cousins benefited tremendously from cheap debt, a rising stock market and a robust IPO market.  Spectacular buyouts could be executed with modest capital at risk relative to the total deal size and then flipped for a nice profit 2-3 years later.

As a result, limited partners began to pour a greater share of their "alternative" asset class dollars in private equity and holding their venture capital exposure relatively costant.  But with a choppy stock market and evaporating IPO environment, suddenly those easy buyout returns don’t look so easy any more, particularly given its dependency on the US banking system, which is the sector of the economy that appears hardest hit.

In contrast, the venture capital asset class is looking pretty good right now, with its 10 year window that in theory can skate through a few economic cycles and a sector exposure that’s more dependent on IT budgets (which appear to be remain reasonably robust, with IDC forecasting 6% growth in worldwide IT spend to $1.3 trillion in 2008) and the shift of marketing dollars to digital environments such as the Web and mobile (which appears inexorable, with Internet advertising forecasted to grow to $24 billion in 2008, almost a doubling from $14 billion in 2006).  It is interesting to note that on the same day that the Fed announced its rate cut, the Dow Jones announced a modest increase in 2007 of VC dollars invested of $30 billion (8% above 2006 across the same number of deals) and a nice balance of fund flows with $32 billion raised.

The last economic cycle demonstrated an interesting lesson for VCs – start-ups that were created during the 2001-2003 downturn have proven to be terrific investments 5-6 years later.  Incubating small companies during economic downturns, forcing managers to be prudent with their capital and quietly positioning themselves for strong growth and leadership when the market turns, is an age old start-up playbook for success.

My advice to entrepreneurs – don’t wallow in self-pity about the negative impact the economy will have on your 2008 performance.  Instead, this is a great time to hunker down, steal incremental market share and build a valuable company that will be poised to take advantage of the predictable upturn around the corner.

As I did in 2007 as well as 2006, I thought I’d throw out a few predictions for 2008.  So here we go, in no particular order…

1) No Recession. As Agent Maxwell Smart would say:  "missed it by that much".  I am short-term bearish about the US economy and, like many of you, have watched with great concern the emerging credit crunch, real estate asset bubble, US dollar devaluation, rising oil prices and inflationary pressures.  That said, I think the US economy will power its way through 2008 without slipping into a recession (which is technically defined as two quarters of negative GDP growth).  Yes, we’ll see anemic growth and more stock market turmoil, but corporate profits and international markets remain strong and I believe consumer confidence will return, particularly with the completion of the presidential election likely to usher in a wave of hope and optimism – no matter who wins.  The implication in our business is that young start-ups will have a harder time accelerating revenue, but the fundamental pillars of the US entrepreneurial economy – VC capital, IT spending, advertising spending – won’t radically dry up.  The CIOs and CMOs that I talk to and the survey data I read suggests budgets will be flat or modest growth rather than sharply down.

2) Web 2.0 – pop goes the bubble?  Billions of advertising dollars are shifting to new media venues, with online being the most popular.  This shift will continue to fuel speculation about what will be the most valuable online media properties and audience aggregation opportunities.  But although this shift represents a real opportunitiy for a few winners, I believe that the so-called Web 2.0 sector has been grossly over-funded over the last few years.  I think the weaker economy will cause this bubble to pop in 2008 when advertising budgets stop rising, there’s more pressure on experimentation, and investors realize that customer acquisition economics are proving harder than expected.  The particularly strong inflation pressures on search engine marketing (SEM), as more advertisers direct their dollars to this performance-based category, will make this emerging problem even more acute.  Talk to any of the CEOs of the major SEM-based businesses and they will tell you about margin pressure due to the rising cost of traffic acquisition.  VCs who are over-exposed to the consumer/Web 2.0 sector may be in for a rude awakening.

3) Enterprise IT – the comeback kid.  Look at the last few IPOs and mega-exits in New England and you see a pattern:  the return of enterprise IT companies.  Acme Packets ($600 million market cap), Big Band ($300 million market cap), Bladelogic ($700 million market cap), Equallogic ($1.2 billion acquisition by Dell), Starent ($1 billion market cap) and Netezza ($750 million market cap) are signs that the post-bubble hangover IT departments have been suffering from has finally passed.  IT is willing to invest in young infrastructure companies and new technologies to improve efficiencies and modernize their capabilities.  These investment opportunities will continue in 2008, despite macroeconomic conditions exerting some pressure on IT budgets.

4) Wireless – slow and steady.  The chokehold that carriers maintain over the wireless market continues.  Meanwhile, advertising dollars are moving to mobile more slowly than expected due to ecosystem immaturity.  There is simply too much friction in the business for an advertiser to place a $1 million purchase (lack of inventory, fragmented and nascent ad networks, handset fragmentation – to name a few).  Thus, 2008 will likely be an incremental growth year for the wireless industry, not yet a breakthrough year.  Breakout conditions (pervasive 3G networks, video and rich content, a more mature advertising ecosystem) still feel 2-3 years away.  Good fodder for early-stage investors, but not an area of hyper revenue growth.

5) And our next president will be…who the heck knows??  This race is a toss up.  I would’ve predicted Clinton vs. Romney, with Clinton winning in a tight finish, but Romney has faltered despite all the money he’s poured in and Obama and Clinton are neck and neck.  This will be an interesting race to watch, for sure!

That’s it for now.  Let’s see what 2008 holds for us all!

I am pleased to have as a guest blogger, Nitzan Shaer, who was an Entrepreneur in Residence (EIR) with us at IDG Ventures for the first half of this year.  Nitzan had previously started Skype Mobile and prior to that worked at Microsoft Mobile.  Nitzan recently left us to take the COO position at Mobivox, a mobile voice-over-IP start-up (sound familiar?) we funded a few months ago with Nitzan’s involvement in the company.  Since serving as an EIR is becoming a more common occurrence in the VC and entrepreneur community, I asked Nitzan to share some of his observations on the pros and cons of the job.

Nitzan’s submission:

The opportunity to explore your own business ideas, to gain access to top minds in the industry and to get paid for it all, sounds to many like a dream job. The truth is, if it plays out well, it probably is. However, not all EIR’s feel they spent their time wisely. Based on my personal experience as an EIR, and reflecting on talks with other VC’s and five EIR’s, I assembled my observations into a short 10 step guide for ‘would be’ EIR’s. Or in short, Shaer’s 10 points on becoming a successful EIR. Disclaimer: success is not guaranteed, but at the very least, I hope it will make for a good read. Advance at your own risk. 

The idea of becoming an EIR was introduced to me after I started considering my next steps at Skype. Following two adrenaline packed years at Skype (at the time the company stood for “The Whole World Can Talk for Free”), and almost a year post the acquisition by eBay, I decided it was time for me to jump on, yet again, to an early stage opportunity and help grow it to be mega big.

Three options were on the table: join an early stage startup, start a company of my own, or become an EIR. Honestly, there was no start up I found that excited me, but there were a bunch of ideas that I wanted to pursue – not all of them in my direct area of expertise, so I knew I would need time and advice. After living in London and Seattle, my network in Boston was limited so I set up meetings with Boston VC’s and listened to what they had to say.

The first thing I learned from meeting eight VC’s was that there were nine different definitions to the term EIR. Boiling it down, there are three areas EIR’s typically focus on: identifying new investment opportunities, helping portfolio companies, and ultimately launching or joining a new investment (the ‘Exit’ even for an EIR). Some VC’s expect you to bring your own ideas for a company, dig into it, and launch it. Other VCs have an idea they have been seeking to pursue and ask you to join up and build it out. Most, but not all, will offer a salary. Some will want the right of first refusal to invest in your idea if they like it. Others will let you do your own thing, even if they don’t like it (just for the benefit of having you hang your hat in their office and engage in constructive exchange of ideas). To succeed in the eyes of the VC, you would need to bring at least one investment into the company which they would not have made otherwise. [Point 1: whatever you do, be sure to bring at least one great investment to your host VC – that is what they live for]. If you think about it, with today’s competition on good teams intensifying EIR’s are a great way for VC’s to get first dibs into a great team and for that team to get to know, and trust their VC.  [Point 2: Be sure to meet A LOT of people. Soon you will be back in the trenches building a business, and times like this will be a vague memory].

However, the EIR role is not for everyone. Risk #1 is stagnation – after 12 or 18 months you may be empty handed and start to overstay your welcome. You will not have much to show for your time as you were not actually in a start up gaining experience. Even worse you may feel pressure to jump onto a company that you are not in love with. [Point 3: At any given moment, you should be working on at least two backup plans so you don’t have to start from ground zero if you hit a dead end]. [Point 4: have the drive to define your own path and the conviction to know what the right business is for you, even if your hosts do not want to invest in it].  If all does go well, chances are you are not only choosing an employer for six month, but also an investor and board which will be with you for years to come. [Point 5: Choose your host VC with the assumption you are entering a marriage – most likely they will be there for key decisions in your life for years to come]

I was fortunate to be introduced to IDG Ventures by two HBS classmates – one of which IDG invested in and the other who co-invested with them. After meeting all the partners, talking to their CEO’s and cross referencing them with other local investment professionals, I concluded that this was the perfect match for me. They had deep operational experience (i.e. they knew in practice rather than in theory how to build a company). Second, they took the approach of mentoring rather than instructing their portfolio CEO’s (not typical in VC land unfortunately). And third, they knew what seed investments were all about, and did not have such a large fund that a small investment would make no difference to them in the grand scheme. [Point 6: Find a VC that matches your personal and business goals: small vs large investments, involved vs. unengaged board members, expertise and connections in the industry you are seeking].   

For me personally, the EIR experience played off extremely well. As in any business, the outcome is defined by the people, the timing and a healthy dose of luck. During a period of six months I spent around half of my time sourcing investment opportunities (which means getting to know all the restaurants in Boston up close), [Point 7: keep close track of who you met and how they can help out in your new venture. You will rely on these meetings for years into the future]. The other half of my time, I spent working on three business plans which I was passionate about. I was privilege to get a look at inner workings of a highly talented investment team and at the same time spend quality time investigating some business plans. The GP’s opened up their personal network to me and helped set up meetings with the movers and shakers of the ‘direct to consumer’ market which I was after. [Point 8: Keep an open dialog on going with the GP’s. Meet frequently, solicit their advice, and update them on your observations. The last thing you want if for someone to ask ‘remind me again, what is that guy doing in our office’?)] [Point 9: Before you get started, have a clear definition of what mutual expectations are and how success is defined].

During those six months, IDG invested in two companies which I played a primary role in identifying and qualifying (for every two completed deals, I don’t have to tell you how many ‘almost’ make it to the finish line). The second of the two investments, was MOBIVOX, a company that provides free international calls from any phone. After the first few hours with Stephane (CEO), I realized this is one of those companies that does not come round the block every day. It has a practically unbound market potential, given the fact that it works from any phone – landline or mobile, globally, with no need for download of applications. People finally have the opportunity to make international calls from wherever they are no need for a PC or calling cards. After two months of detailed due diligence, both the partners and I decided we could not pass on this one. I joined as COO and board member and IDG Ventures brought in the rest of the family too. IDG China, IDG Vietnam and IDG Boston joined together to invest in a global opportunity which they all felt passionate about. Chapter one ended very happily for IDG Ventures and me. Now, we all have our eyes (and hearts) on making MOBIVOX a global success !

In conclusion:
1. EIR can be a dream job, but it is not for everyone. You need to set and adhere to your agenda. It could end up great, but it could also end with nothing much to show for.
2. Choose your VC firm well – they will most likely be your investors and partners for years to come.
3. And finally, Point 10: Have fun! If you do decide to do it, relish every minute. When else in life to you get an opportunity to work on your own ideas in such an environment?

While many consumers are focused on the hectic holiday shopping season, many CEOs are focused on the hectic annual planning season.

Each of my eight VC-backed boards are in the throes of this annual ritual – trying to gaze into the crystal ball to divine what next year’s results will look like and how to develop a plan to get there.

Having done this for a number of years, I’m struck by how similar best practices are across a range of companies – whether they’re consumer Internet companies (note how deftly I avoided the tired label "Web 2.0"), software companies, medical device or something in between.  Since many companies are wrestling with this process as we speak, I thought I’d share a few thoughts on what I’ve observed to be useful tips and techniques.

Set one and only one plan of record.  Many CEOs like to get "cute" by having a "board plan" and an "internal or stretch plan" which are different (with the internal/stretch plan being more aggressive).  In the end, this tends to confuse everyone more than it’s worth (yes, I used to do it, too, and I confused myself!).  The sales team will typically have a quota that in sum is greater than the plan of record, but there should be one and only one plan of record and it should never change throughout the year unless the board explicitly agrees to a replan, say midyear.  All performance during the year should thus be compared to the plan of record.

Set a 70% confidence plan.  When I was an officer at a public company (Open Market), we used to always set expectations with the public markets against a plan we were 90% confident we could beat.  In a venture-backed company, this is known as sand-bagging and it has a negative side effect, which is that you will tend to under-invest in future growth and infrastructure if you don’t set a plan that anticipates faster growth.  Another common mistake CEOs make is setting an unrealistically aggressive plan – the "if everything goes right" plan.  I’ve often had companies see revenue growth of 3x year over year, but feel like they’ve "lost" because they set an unrealistic growth plan for 5x.

Articulate your strategic goals on one page, then cascade.  The financial numbers tell only a part of the story in a plan of record.  The important plan elements in a growing, VC-backed company are the strategic objectives that will position the company for value creation 3-5 years down the road, not just what happens next quarter.  These should be articulated at a corporate level on one page so that the board can track them alongside the CEO, and then translated by each VP/department head into their own set of summary objectives.  Only by linking the objectives from top to bottom with the financial numbers can you be sure that the plan "holds together" and doesn’t have any conflicting assumptions or elements.

Make it count.  Assign CEO and executive team bonus dollars against achieving the financial and strategic objectives and measure them quarterly.  That way, it’s more than just words on a paper, but makes keeping score a part of everyone’s top-of-mind activity.  Some entrepreneurs find it funny to have $10-20K at stake against quarterly objectives when they’re really aiming for a $5-20 million equity payout, but by putting some real dollars against the shorter-term milestones, it helps everyone focus their energy and attention to the small steps along the path to the bigger success.

Discuss the "what if" scenarios with the board.  In almost every board planning meeting I’ve been in, someone inevitably asks the "what if" questions – "what if revenues are half what you think?" or "double?" or "what if revenues are zero?".  The last thing you want to do as a CEO is get caught flat-footed mid-year when things don’t go according to plan and the board hasn’t agreed to a set of actions.  "I just assumed you guys would bridge the company", is the last thing a board wants to hear 60 days before running out of cash!

What are some of the planning techniques you’re applying this year?

As readers of my blog know, I never flog my portfolio companies, but tomorrow is CyberMonday and as a fan of e-commerce over the last 12 years in the industry, I find it hard to not do a little cheerleading in general and for Mall Networks in particular.

According to shop.org, 68.5 million people will shop for holiday gifts from work, up substantially from last year, and 30.2% of holiday sales will be influenced by the Internet.  It’s an incredible transformation and it’s hard to imagine what the next 12 years will bring given the pervasiveness of broadband, mobile and the forces of globalization.  It’ll be interesting to see if consumer worries about the housing slump, mortgage crisis and other economic woes will slow down e-commerce spending tomorrow and beyond this holiday season.

Before memories fade too quickly, it’s worth noting what a great event we had Friday night when we hosted TechCrunch’s inaugural Boston MeetUp event.  800 entrepreneurs, VCs, press and other industry players came to network and celebrate the beginning of the holiday season.  A number of local start-ups use the opportunity to launch themselves to the market.  Below is a pic of me with the ubiquitous Don Dodge from Microsoft.  Special thanks to Michael Arrington and TechCrunch CEO Heather Harde for organizing the event with us.

Rumor has it that we will finally hear the news on the Google phone today.  The search firm’s every move is closely watched, but lately even the parochial Boston technology community is abuzz about what’s happening in Silicon Valley.  For months now, both the Boston Globe and the Boston Business Journal have breathlessly reported Google’s every move, including its real estate and hiring forays, with hundreds of engineers briskly hired and crammed into office space in Kendall Square – apparently nearly all of whom are working on its planned mobile offering.  When I was at the wireless trade show conference (CTIA) last week in San Francisco, there wasn’t alot new to talk about, and so Google’s reported entry into the spectrum auction and top-secret efforts to create a phone operating system loomed particularly large.

And yesterday’s Sunday NY Times raves about the gadget prowess of the executive in charge of the effort Andy Rubin.  Meanwhile, the stock price has never been higher, closing yesterday at over $711 per share with a market capitalization of $222 billion, surpassing even Cisco.

The parochial debate in Boston is whether Google’s presence is a net plus or minus. The grander debate on the world stage is whether Google is a Netscape-like flash in the pan or truly a history-making enterprise?  My vote on both accounts is huge "net plus" and "history-making".

Google’s vision is breath-taking: the company is after no less than the $800 billion of advertising dollars that are currently spent worldwide by giants like General Motors and P&G down to your local dry cleaners. With only roughly $20 billion in that advertising spend happening online in 2007, the data shows that online ad spending, although growing at a torrid pace, has not caught up with the time consumers are spending online as compared to other media (insert here the usual diatribe about the decline of the newspaper, network television and the like along with the required gratuitous reference to the "Long Tail" of content and entertainment). Its ambitious plans into the mobile market are merely a natural extension of this strategy. Google is following the consumer eyeballs – and consumers worldwide are more and more turning to their mobile phones as a source for news, information, games, entertainment and video.

What some people don’t fully appreciate is that Google is actually after more than the online and mobile ad market. They are after the offline ad market as well. The vision isn’t just about the transformation of advertising and content to digital media. It’s also about making advertising measurable.  Google is in the midst of a huge experiment in television advertising (thanks to its partnership with EchoStar), radio advertising (thanks to its acquisition of dMarc) and magazine advertising (through a strange reseller/price arbitrage arrangement that is merely an excuse to get down the learning curve).  And through this powerful connection with advertising and marketing as its core focus, Google is entering into technology arrangements and developing offerings that are threatening Microsoft’s core business of Windows, Office and the enterprise.

Can Microsoft stop them?  Consider this: at General Motors, I would venture to guess that the CIO has periodic meetings with Steve Ballmer to review strategy, future plans and important high-level requirements.  I would guess the CMO has the same meetings with Eric Schmidt.  Google apparently has hundreds of employees now based in Detroit servicing the auto industry marketers.

So should we welcome Google’s entry into the Boston market? With open arms!  We VCs may not like the impact of the added competition and downstream price inflation on Boston high-tech talent – the predictable result of Google’s giant sucking sound.  But having Boston serve as one of the talent hubs for Google will allow us to get a window into one of the most important industrial companies in the world, serving as a base grooming strong managers (which there is a dearth of in Boston) and a potential source of interesting M&A and partnership opportunities.

Thus, the message to Google from Boston VCs and the broader high-tech community should be:  "Bring it On".  Hire as many as you can.  Buy a few things while you’re here.  And somebody should tell Eric Schmidt to spend as much time in Nantucket as possible!