BloGiza

The online year that was

As today is the last day of 2007, it’s a little hard to resist looking back at the past year and trying to sum it up. So, I won’t resist. Unlike last year, 2007 is hard to summarize with one handy tag such as “the year of online video” or “the year of social networks”. There was a lot of activity in a number of different areas, the rise of a major player in the social networking space, and the rise of a new form of communication.

So, herewith a few highlights IMHO of the online industry in 2007

Story of the year: The consolidation of the advertising industry
Y’all thought I was going to say Facebook, right? Now, while the rise of Facebook is certainly the most hyped story of the year, my vote for the most significant development  (not to mention the biggest source of M&A activity) is the rapid consolidation of the online advertising space.

During the last 12 months, Google bought out Doubleclick for $3B. Shortly thereafter, Microsoft acquired aQuantive for a staggering $6B. AOL bought out targeted ad firm Tacoda, as well as Quigo which. Yahoo acquired Blue Lithium, as well as a majority stake in Right Media. WPP bought 24/7 Real Media. And the list actually goes on.

The M&A hyperactivity in this sector is an indication of the fact that online advertising has reached a certain stage of maturity. Beyond that, the consolidation is likely to have long-term ramifications, especially in regards to the rise of Google as the behemoth of the information age as well as the development of new business models online. And that’s what makes this, at least for me, the biggest development of the year.

Phenomenon of the year: Facebook
Obviously, I couldn’t not mention Facebook which gained momentum extremely rapidly this year and became the go-to social network for those of us who aren’t musicians, 14-year-olds, or skeevy perverts. Facebook only opened itself up to the world outside the university sphere towards the end of 2006. I joined up early this year. Before long, almost every high tech-ist I knew (and many I didn’t) was on it. Lately, the sphere has expanded further and everyone, their parents, and their parents’ friends are connected. Clearly we’re on to something.

Of course, it will be interesting to see whether Facebook will be an ongoing concern for most people or just a passing fad. I like it for business purposes, as a tool for microblogging, and as the communications platform of choice for a number of my friends. On the other hand, I have a hard time answering those who complain that there’s nothing to do there. We shall see.

New technology: Microblogging
The rise of Twitter and its clones provided us with probably the only real new media form we’ve had in a few years, viz. microblogging. At first, the concept seemed a bit stupid. After all, why would I want to blog in tiny, one- or two-sentence bursts? But then you start getting into it and discover that Twittering (or updating your Facebook status, which I tend to do more) is a nice complement to blogging for those times when you have something small and/or clever to say but which doesn’t warrant an entire post. Plus, it’s the first Internet app that makes perfect sense for the mobile. It’ll be interesting to see who snaps up Twitter and for how much.

Interesting development in local tech: The renaissance of the Israeli internet scene
Three or four years ago, it seemed that the Internet industry in Israel was close to dead. During the days of the ’99-’00 bubble, the high tech scene was awash in Internet startups looking to be the next ICQ. Then the bubble burst and most of the companies went under. Worse, the VC industry was burned on the subject and it subsequently became almost impossible to get a new Internet startup funded.

As recently as two years ago I regularly had colleagues in the VC world lecturing me that Israel was incapable of producing Internet companies and, besides, these types of investments weren’t suited for VC anyway. What a difference a few years and a YouTube (and a Facebook) later make.

Once again, we are seeing dozens of new Internet companies each month. What’s more, there is a real feeling of an Internet scene here, helped along in no small part by Facebook, the work of groups like the Co.ils and the Geek Garage, and of course Jeff Pulver’s social activities. Let’s hope this continues to develop and mature.

Case of possible overhype: Online video
I’ll catch some crap from friends about this, but the online video space has become somewhat overhyped in the last year. Actually, that’s kind of unfair. What has happened is that in the post-YouTube age, online video has become ubiquitous. This has led to a lot of noise and a sense of, “Ok, what do we do now?”

Towards the end of last year, it looked like the field of mid-tail, independently produced video content (e.g. Ask a Ninja, Rocketboom, Ze Frank) would be the next big thing. As of now, that has failed to happen. There haven’t been any real breakthroughs this year. Even projects as big and as hyped as Joost have yet to take off as a mass-market application.

I still have big hopes for this sector, but it may have to wait until sometime in mid-2008.

Predictions for 2008
You’ve got to be kidding me. Only fools make predictions in this online age where what you write will forever haunt you. Still, I’ll make some safe and predictable ones for the upcoming 12 months:

• There will be a number of huge-size Internet exits that will have people scratching their heads
• The whole notion of privacy will continue to erode as Google finds out more and more about you
• Mobile internet will remain where it has for the last three or four years, i.e. tantalizingly around the corner as the Next Big Thing
• Some technology or company that you’re not thinking about will be the big story of 2008

So, for all my celebrating friends and colleagues out there, I want to extend best wishes for the new year and hope that 2008 brings health, happiness and success to us all.

The return of Gary Snoman

He's baaaaack!!!

As they've been doing the last couple of years, the guys at Blueprint Ventures have sent out an animated clip for the holiday season featuring Gary Snoman, everybody's favorite ice-based VC. This year, Gary takes a trip to all the major international high-tech hot spots, including... Israel!

"Forget Silicon Valley, this is Technion search technology. You guys can't compete, I mean, you don't even have compulsory military service." Hee.

Explaining VCs part 3 - The Investment Process

Last time we looked at the investment parameters that VCs look at in general. Now let’s look at the actual process of how an investment gets made.

You can envision the VC investment process as multi-leveled pyramid. At the bottom of the pyramid are all the companies which pass through the fund each year, be it at the level of sending a business plan, pitching to a VC at a conference, or being contacted by us. At the top of the pyramid are the small handful of companies that receive investment in any given year. At every one of the levels in between, the fund will decide to pass on the majority of the companies coming in.

The numbers can be pretty daunting. To give you a rough idea, in any given year, something like 1,200-1,500 companies enter the process with a fund like Giza. We will actually meet with maybe half these companies. And the number of new investments that the fund will actually make is something like 6.

Roughly speaking, the process can be broken down into the following stages:

1. Locating potential investments – it all begins with what we call deal flow: finding the companies that are looking for funding. This comes from a wide variety of sources.

   Giza has a full-time investment manager (Aaron Rothenberg, who many of you already know) whose job it is to find companies and contact them. Other new companies come in via our personal networks. Still others contact us, occasionally submitting their business plans to the Giza website.
   
   In addition to identifying new companies, we also spend a lot of time re-evaluating companies that we have seen in the past and who have made progress with their technology and/or their business development.
   
   We drop a certain percentage of companies at this stage which are clearly not suitable for us (sectors that we don’t invest in, not high-tech, etc). Those that pass go to the next level.

2. Screening and reevaluation – Each week, the fund holds a screening meeting where the investment professionals discuss new opportunities. We look at 20-30 companies, discussing the main points of their business plan or presentation. At this meeting, team members request to meet with those companies that seem interesting.
   
   About a third of the companies make it through the screening committee and actually meet with the investment team.
3. Initial meetings – Following screening, Giza team members (often in teams of two or three) will hold an initial meeting with the company. This is usually a 90-minute meeting where the entrepreneurs present themselves, their idea, and their vision. At the end of the meeting, the VC team will discuss whether the company is worth moving forward with.
   
   About a quarter of the companies that make it to initial meetings willpass this stage.
   
   
4. Due diligence - This is the longest and most involved part of the investment process. Depending on the type of company and the complexity of its   technology, the due diligence process can take anywhere between a month   (in the case of companies going through Giza’s fast-track “Ofek” program)   to four or five in the case of companies with more involved technology.
    
     During this stage the company will be called in for more meetings at the   fund to delve further into its technology and market. Often, the VC will   call in outside experts to help the fund evaluate a company’s technology.   The company will also make a presentation to all the investment   professionals in the fund to allow them to decide whether or not to   invest. At the end of this stage, if the investment still looks good, the   VC issues a term sheet.
    
     About 5 percent of the companies which enter the due diligence process   emerge with a term sheet in hand.
    
    
5. Closing   process and investment – The final stage of the investment process   involves negotiations about the terms of the investment. The VC will   perform additional legal and financial due diligence on the company. Some companies will still drop out of the process (usually due to the company   deciding to reject the term sheet) but the rest emerge as the winners of   the VC sweepstakes.

It’s a long process, and it can be an arduous one. As one startup-ist once said, the odds of becoming a pilot for the Israeli Air Force are better than these. However, we would like to think that the results are worthwhile.

Explaining VCs part 2 - The VC Model

Last time around I gave a general introduction to what venture capital is. This let’s look at how VCs make money, which in turn influences which companies we choose to invest in.

I’m talking about the infamous “VC Model” which (if you’ve been reading the blogosphere in recent months) a lot of people claim is broken.

Marc Andreessen explains the model very succinctly:

The whole structure of how the technology industry gets funded -- by venture capitalists, angel investors, and Wall Street -- is predicated on the baseball model.
Out of ten swings at the bat, you get maybe seven strikeouts, two base hits, and if you are lucky, one home run.
The base hits and the home runs pay for all the strikeouts.

Say we raise a fund of $150-200M from our investors. With that money we will make, something like 20 investments averaging $8-10M over the lifetime of the company. In order to make the returns that our investors expect we assume that of the 20 investments:

•    Two will be huge successes and return 10X on the money
•    4-5 will return 2-3X their investment
•    The rest will either just return their investment or else get written off entirely

The successes, as mentioned above, need to be big enough to cover the inevitable losses from those companies that fail.

So how does this influence our investment decisions? For one thing it means that we need to focus on those companies which we believe at least have the potential to be home runs and return 10 times their investment.

One of the most common reasons we have for passing on companies – including a lot of companies where we think the team is great and the idea is solid – is that we feel that the opportunity is too small.

(How small is too small, you may ask. We don’t have any fixed rules, but if your total addressable market – in other words the total revenues that you could theoretically get if you cornered your target market – is less than at least half a billion dollars if not a billion, it’s probably too small for VC).

While the investment multiple is important, it’s not the only consideration. The actual amount of money which is returned is important as well. Small exits (let’s say under $40M) can be very good for a company’s founders but not so great for the VCs who invested in them. In other words, if a VC makes a seed investment of $2M and the company exits for $20M, this is not considered a big success even though it had a multiple of 10.

Why is this? Even if the VC held 30% of the company at exit (which is on the large side) it only got back $6M. In order for a $150M fund to make the returns is investors expect, it would have to have 30 or 40 exits like this, which is unrealistic. So, again, we look for exits we believe will be have the potential to be in the $100M range or greater.

Obviously we know that most companies will not have $100M+ exits. But since 7 out of 10 companies that we invest in are likely not to succeed as hoped, we need to know that the three who do at least have the potential to succeed big time.

So, why are we hearing that the model is broken?

There is a feeling that the size of exits has shrunk over the course of this decade. Fewer companies are going public, and the ones who do are doing so at a much late stage after much more money has been invested in them. With fewer IPOs, more companies exit by being acquired, which often means smaller exits.

It’s unclear to what extent these assumptions are true, but if they are then the number of exits that return a 10X multiple shrinks, which affects the model greatly. On the other hand, the costs of starting up a company, especially in the Internet world, are a lot smaller. Perhaps a larger number of companies will produce moderate exits, which will cover the ones that don’t.

So we may find that the VC model will have to be adapted. If it’s not broken, it may yet have to bend.