Geithner on Lending Levels

And switching over Timothy Geithner's speech this afternoon... He stated that the program proposed is to (paraphrasing) "insure that lending would be greater than without government intervention."

Read: We're putting money in the market so that we can spur lending and open the credit markets.

That's what I thought they were trying to do.

Secondary Market for Private Equity

Interesting post from Joanna Glanser at PEHUB about the number of private equity partnership shares trading hands. From the brief article:

The forecast released this week by secondary market maker NYPPEX predicts that sales of limited partner stakes in private equity partnerships will soar by 68% to $27 billion in 2009.

This highlights the stratosphere of markets that can and should exist to enhance market efficiency - allows one owner take possession of an asset that another is no longer willing or able to hold. Fred Wilson touched on that during his panel discussion at a recent conference. Marketplaces such as SecondMarket should exist to provide an exchange mechanism.

Venture Capital Panel Discussion: Fred Wilson & Jordan Levy

This morning's sessions at the InmanNews Real Estate Connect Conference in New York City included a panel discussion with Fred Wilson of Union Square Ventures and Jordan Levy of Softbank. Some interesting insights and perspectives regarding the state of venture capital and the general economy.

From Fred Wilson (who also authors the A VC blog):

• Spoke the prospects of building additional business applications on the Twitter API - labeling Twitter more as a platform than a service.
• Said that given the economies of scale, a viable internet business can be built on $20 million of revenue instead of the traditional $50-100 million models.
• The issue with the smaller revenue scale is finding venture capitalists to invest in these enteprises since it presents an exit problem for VCs. Assuming a 25% profit margin, a $20 mln business yields $5 mln in profits. If a VC owns 50% of the venture, that equates to an annual dividend of $2.5 mln which doesn't mesh with the 10x IRR models on which VCs operate.
• As a result, he discussed SecondMarket as a potential market location to buy and sell private shares of these start-ups to enable better liquidity of these smaller internet companies even though the company was initially developed for bankrupcy and vendor claims.

From Jordan Levy:

• Read some well-known statistics about the number of IPOs in the market (8 total in 2008 and none in the second half of 2008)
• Said that the VC industry as a whole has returned 0.2% over the last seven year period.
  
• Relayed the regulatory burdens hindering the IPO market by using his own attempt at an IPO that cost $3.5 million and utimately led to the decision not to go public. This is a well-documented problem also described in Michael Malone's recent WSJ article.
• Said that there is still lots of venture and institutional money available for good ideas, but given the current economic state, competition for that money will continue increase.
• Felt that angel capital is less robust ("the angels are scared") which doesn't bode well for small scaling companies requiring start-up capital in the $50K - $3 mln range that falls below the VC channels.

Michael Lewis - "The End"

Just in case you missed it, here's an interesting piece from Michael Lewis, author of Liar's Poker (a book about Wall Street back in the 1980's that you should read if you haven't). His new article - "The End of Wall Street's Boom"- is a new perspective on the current financial market situation. It's about 18 pages printed, so grab a cup of coffee first.

(Chris M. - thanks for sending to me...)

Reviewing LinkedIn's Valuation

After writing my weekend post about LinkedIn’s $1 bln valuation ("Locked in on Linked In"), I did a bit of reading about how some others viewed the matter. (I wanted to come to my own conclusion without being influenced too much by others who already wrote about the topic…)

Michael Arrington wrote a nice article back in June about social network valuations, using the “average Internet advertising spend per person in the country they live in.” Arrington mentions the same problem I alluded to in my article – not too many data points from which to base valuations in the social networking industry (Facebook’s at $15 billion, MySpace at $580 mln and Bebo at $850 mln by acquisition). He doesn’t come to any conclusions as far as viability of the current valuations, but the metrics and his responses to commentary make for an interesting read.

Many postings announcing the $53 mln Bain Capital investment mention rumors of how LinkedIn was striving for a $1 bln valuation, seemingly to justify its targeted user base of higher-than-average income user base that can be used to generate higher-than-average advertising revenue. Caroline McCarthy mentioned this back in May on CNET, as did Arrington in his May 5 posting.

Overall, the initial reaction out there is that the validity of the valuation remains to be seen, but the unique nature of LinkedIn’s user network appears to have some merit according to the first wave of observers. Of course, there were those with a hearty defense of the Facebook valuation when it hit $15 bln last year as Jonathan Richards wrote about in October.

Locking in on LinkedIn

I read about the recent $53 mln Bain Capital investment to LinkedIn and I was prepared to write an article again questioning the valuation of another social/business networking site. Like many, I'm not particularly enamoured with the current $15 billion valuation of Facebook, so my initial reaction to the $1.035 billion valuation of LinkedIn was - "here we go again..."

Because LinkedIn is a private company, their financials and revenue sources aren't available. I did some scouting on the site and they make money in a few ways:

1. Advertising via their Large Budget and LinkedIn Direct Ads to provide targeted advertising to its members.
2. Subscriptions to Premium Services that allow the user to directly contact people out of their network with "InMail" and send "Requests for Introduction" emails. These services range from $20-$200/month.
3. Perhaps some others such as data analytics based on membership statistics and activity (though this is only my conjecture...).

Johnathan Richards wrote an article following the June 2008 venture investment and estimates LinkIn revenues to be around $80-100 million, with "about a quarter" of the revenues coming from subscription services. At first, I was a bit surprised to read that subscription fees could be so high, until I considered the number of recruiters that have contacted me via LinkedIn, as well as my own activity. (I personally subscribed to their $20/month plan when searching for a job a while back, and was able to link up with a great recruiter at Russell Stephens as a direct result of an InMail.)

With the current $1 billion valuation based on revenues of $100 mln, that's 10x revenue valuation, without any knowledge of their profit margins. The News Corp acquisition of MySpace for $580 million back in 2005 supplies some relativity to the $1 bln valution. Though a social site, not a business site, MySpace does parallel LinkedIn in terms of its ability to focus on a large market segment, it's networking component, and the fact that the business world has placed a valuation on it. Since the acquisition, MySpace has reportedly been a boon to the New Corp's Fox Interactive Media Group. (According to the most recent 8K report from June 2008, News Corp reports that Fox Interactive Media grew revenues 57% and increased "operating profits five-fold on strength of advertising and search revenue growth at MySpace.") Two years after the aquisition, things seem to be looking rosy for New Corp according Murdoch in this Wired Magazine article.

Considering the virtual aspect to LinkedIn's product and the scalability of subscription services, I suspect that their profit margins are healthy and growing as LinkedIn acheives a greater lock-in effect with users - becoming the main destination site for business networking. The caveat to acheiving this lock-in effect will be the quality of service and networking effects. However, by providing the ability to remove connections and requiring a subscription for the ability to directly contacts individuals outside of one's network, LinkedIn drastically removes the diluation and spam factor to their networking functions. Additionally, LinkedIn boasts (as they should) that their audience has an average household income of $109,000, about 2.5x's the median US household income of $48,200 according to the 2007 US Census (though I'd like to know the median LinkedIn income to see how much top executives on LinkedIn skews this average figure).

Looking LinkedIn's development, they've taken a deliberate and apparently successful approach so far - develop a user base, find a way to quickly monetize activity with premium subscription services, and then analyze the user base to leverage it for targeted advertisers. From this perspective, LinkedIn is now completing the foundation of its business with the Series A, B, C financing of about $30 mln, while this most recent $53 mln should be intended to move the company into a mature state with specific long-term goals for continued rapid growth.

The most compelling part of LinkedIn's situation is its $1 bln valuation based on $100 mln in revenue. It's high, but justifiable given the apparent success of others in the networking space, and the unique niche of its business and professional membership base. Like everyone, I'm interested to see how quickly it can convert the valuation to practice, or to see if it can utilize its valuation to grow by:

1. Acquisition of higher-end job sites such as TheLadders.com or Vault.com
2. Targeted content partnerships such as their recent NY Times agreement
3. Integration of specific industry content and membership groups such as BAFT, VCExperts, or others to serve as a clearinghouse of industry information for its users.

So here I am at the article's end, completely reversing my initial reaction to the valuation - seems to be okay after all...

Getting Started with Bootstrapping Your Business

Traditionally, angel capital became known as “angel capital” because they were the first investors – the “pre-seed” funding, but with deals becoming more numerous and requiring more stringent expected ROI requirements, the entrepreneur in need of $50K or $100K in seed capital is left to bootstrap their business. If you are looking for that first installment of seed capital, here are some concrete ideas to consider.

1. Attend local start-up events. Get out and meet people. Yes, you’ve heard this time and again. Check you calendar. When was the last time you attended an industry event? If it’s been more than a month ago, that’s too long.
   
   Here in Silicon Valley, I’ve been a huge fan of the Silicon Valley Association of Start-up Entrepreneurs (SVASE). You probably won’t find funding at one their events, but you will surely uncover great ideas from their guests, panelists, and speakers.



2. Keep a regular blog. You don’t need to divulge company secrets, but keeping a regular blog provides you with some very tangible outcomes. First, a blog provides a written history of your idea’s development, so if you meet a potential investor or partner, you can show them your progress over time, not just where you are at the moment. It shows the outsider that you can keep a commitment to yourself and are able to communicate effectively with the outside world. Or perhaps a potential investor will find you when they are out searching for projects.
   
   Second, this helps you to see your own progress. As an entrepreneur, it’s easy to feel discouraged when you’re developing a new technology or innovation. You can’t always look back at the end of a weekend grinding away in your garage to see your progress. A blog enables you to see your accomplishments over time – everything from setting up an LLC to installing and understanding some new project management software to jotting down thoughts or ideas you’ve recounted from meetings and events you’ve attended.
   


3. Ask for advice and then listen. At a recent SVASE event, one of the panelists mentioned (to paraphrase) – “If you ask for money, you’ll get advice. If you ask for advice, you might get some money.” As an entrepreneur, you need to learn how to take constructive criticism and listen. Listening skills are the foundation of good sales skills, and enables you to improve your idea without taking the criticism personally. Remember Dale Carnegie’s book – “How to Win Friends and Influence People.” And if you haven’t read this book at least once in the last three years, then good back and read it again.



4. Ask for referrals. Memorize this line – “Thank you for your time and your advice. Do you know 2 or 3 other people that I can talk to for their advice as well?”



5. Carry a 5” x 3” Memo Book. These are about $1 at the local Walgreen’s and fit in your back pocket or jacket pocket. Great for writing down ideas that you get at the spur of the moment, or for jotting names and phone numbers of people you meet.



6. Stay positive. “It's supposed to be hard. If it wasn't hard, everyone would do it. The hard is what makes it great.” (Jimmy Dugan, played by Tom Hanks, in "A League of their Own" in response to Dottie (Geena Davis) saying she's quitting the team because "it just got too hard.")

H1B Visas: E2 Visa Requirements

I came across an interesting article on TechCrunch that provides a straight-forward guideline to the categories of work visas available for foreigners seeking entrance to the US, especially those seeking employment in Silicon Valley's technology sector.

One of visa categories is the E2 visa - this visa is designed to permit entrance to the US for a foreign investor that adheres to several strict requirements. I did some quick research, and found the specific guidelines for attaining an E2 work visa from Workpermit.com (unfortunately the US Customs and Immigration site doesn’t lay out the requirements as clearly as this…):

1. There has been and will be a substantial capital investment in the US. There is no specific cash threshold defined, but $40,000 is probably an absolute minimum, and any investment below $100,000 would need a very strong case to support it.

2. Risk Capital has been Committed; the investment must entail some risk to the investor (it may not be all in the form of unguaranteed credit). At a minimum, there must be a long-term lease of an office in the US.

3. The investor will control his/her investment. In this respect control is considered to entail owning over 50% of the US enterprise.

4. The cash invested is not marginal when compared to the total investment. In general, unless it is common to the industry to have higher amounts of 'leveraging' (such as in the property industry), 51% of the investment should be in the form of cash equity. Where debt is secured against other assets of the investor, it is considered to be 'at risk', and may be considered as part of the equity invested.

5. The enterprise is (or will be) active. In order to be 'Directing and Developing' their investment, the investor will require an enterprise that involves active management. 6. US workers are (or will be) employed. The treaties envisage more than just creating a job for the principal investor, but there is no requirement to employ a particular number of US citizens. Obviously, employment of large numbers of US citizens would be viewed very favorably.

7. The enterprise, or its principal investor, has a past history of successful trading.

8. That the 'investor' has sufficient acumen to direct and develop the investment enterprise. 9. That the principal investor, and any other E2 staff, are able and willing to leave the US upon termination of their E2 status.

As you can see, the requirements are strict and complete. The E2 Visa should not be considered to be a loophole or back office channel, but for foreigners that are willing to invest in the United States, it can be a very effective entrance opportunity to the United States. With the value of the US Dollar compared to the Euro and British Pound, this might be a good time to think about investing in the United States from abroad if you are a business owner overseas.

Michael Arrington’s complete article on TechCrunch includes a guest posting from Peter Nixey, founder of Clickpass, a start-up firm founded in the UK and now based in Silicon Valley.

The Venture Capital Confidence Index - A Leading Indicator

Mark Cannice, Chair of the University of San Francisco Entrepreneurship Program, provided some great insight about how venture capital and venture capital activites may foreshadow overall financial market activity.

In his video interview on The Wall Street Journal Online, Mark pointed out that venture capital operates at the "intersection of public and private finance," providing an interesting future perspective regarding the health of the financial markets. If VCs are seeing fewer exit opportunities via IPOs or acquisition, that may serve as a leading indicator regarding the overall financial market.

The complete video interview on MarketWatch is available for public viewing (no logins/subscriptions required).

Google Valuation - Decidely Undecided

In early April when Google stock was trading at the mid-$400s, I started thinking about its market valuation and price per share. Maybe it was a good buying opportunity since coming down from its all-time highs in the $700+ range late last year.

In the spirit of the analysis I’ve done in previous articles with valuations Facebook, Starbucks, Bear Stearns, and Yahoo!, I jumped into Google’s financial statements to see what I could find. Happily, I discovered mystery, love, and intrigue – certainly enough for a good story.

I’m drawn to an elemental approach that looks at intrinsic value, even with dynamic technology companies like Google. In taking this approach, I focused my research on the growth of Google’s assets, and more specifically, on the growth of Google’s shareholders' equity. Because shareholders' equity is what’s left after subtracting a company’s liabilities from its assets, it provides a clear of what is left for shareholders after debts are retired from a company’s assets (thus the term “shareholders' equity”).

Starting with the 2003 year-end reporting through 2007, the growth of Google’s shareholder equity has declined fairly rapidly –

From their financial statements, Google’s Total Shareholder Equity (in 000s) over the past five years –

2003: $602,641
2004: $2,929,056 (an increase of 386% from 2003)
2005: $9,418,957 (an increase of 221% from 2004, but a 42% lower growth rate)
2006: $17,039,840 (an increase of 80% from 2004, but a 63% lower growth rate)
2007: $22,689,679 (an increase of 33% from 2004, but a 58% lower growth rate)

Notice the trend? Of course, maintaining triple-digit shareholder equity growth isn’t realistic, but it does show the effects of Google’s increasing company size and asset base.

There are about 313 million shares outstanding. If we divide the current shareholder equity of $22,689,679,000 equally among each shareholder, that comes to about $72/share. So if Google liquidates today and pays off its liabilities in full, there will be $72/share to distribute.

Google isn’t going out of business today, so looking at this number in comparison to a $450-550 share price probably isn’t the best option in determining the true value per share. Another option is to consider current and future Cash Flow/Share (CFS), with future cash flows discounted back to today using a reasonable required rate of return. Google’s Beta is 2.01 and the US Treasury 10-year bond yield is about 3.75%. Using the CAPM, that calculates to a 12.25% required rate of return. To account for the current economic downturn and innovation risk, let’s call it 15%.

Google’s CFS was $17.66 in 2007. If we assume a 10% growth rate per year for 10 years, how does that shake out in valuing its shares after discounting future cash flows to today? With a 15% required rate of return as the discount rate, the sum of the discounted CFS for the next ten years is $101.91. Again, not quite close to the recent $450-550/share trading range.

Extend this 10% growth rate in Cash Flows into perpetuity with the same 15% required rate of return and we get a value of $353/share. But is a 10% growth into perpetuity realistic? Probably not, but it’s hard to argue against it given their Quarter 1 results for 2008. Their ability to innovate is the wild card.

All in all, I’m still undecided about what to decide… I first contemplated this about two weeks ago when the price/share was in the mid-$400s. Now in the mid-$500s, I don’t have any better answers as to whether or not the valuation feels right. It seems a bit high based on fundamental research and intrinsic valuation.

There's a nice article that looks at Google's valuation in a similar, but different way using a "scenario approach." It's worth a read.

It’s clear that investors are flocking to the stock after selling off in recent months. But is in investing or speculating? That’s the part I can’t figure out…

Economic Arguments for Abandoning H1B Visas

Supporters of America’s H1B visa system argue that firms such as Microsoft and Google (both opposed to the existing system) should simply send these jobs overseas by expanding their current operations in places like China and India. The problem with this argument is that it does not follow economic logic.

There are several economic factors that influence the ongoing development of technology-based industries in the United States. These factors further support the position that the H1B Visa system should be significantly restructured (or abandoned altogether).

1. Agglomeration Economics – As firms in related industries (“clusters”) work in relative proximity to each other, several positive effects are felt:

--> The overall cost of production is reduced because of the increased competition of suppliers and the greater number of firms consuming production inputs. This includes such items as laboratory equipment, software, hardware and other necessary production inputs to developing new technologies .

--> There is an increase in the number of innovations through implicitly shared knowledge.

--> Positive externalities develop - that is - the number of “knowledge spillovers” occur.

These economies of scale and externalities cannot be artificially manufactured by establishing a research park in a foreign country. Economic clusters are complicated organisms that have evolved over time. The organic systems resulted from years in response to market dynamics and locational factors.

2. Labor is not the only factor of economic production. Capital – meaning machinery and related technical equipment - is also a major factor. (Together, Capital and Labor compose the basis of the Cobb-Douglas Production Function upon which economists such as Robert Solow, Greg Mankiw, and Paul Romer have based parts of their research.)

Collect a labor pool of scientists with PhDs from the best universities in world and put them together in Siberia with no research and testing equipment. Their output of new innovations will fall to negligible levels. This basic fact creates another significant advantage to economies such as the United States, and more specifically places like Silicon Valley, that have an inherent base of both private, public, and education sector research and development facilities.

3. Enforceable property rights legislation and intellectual property protection in the United States support research and development better than other developing nations. Countries such as China have a well-documented global reputation for poor enforcement of patent and copyright laws. The ability to develop a new technology and maintain a monopoly on their innovation and idea provides the necessary for profit-maximizing firms to operate. Economies that do not protect a firm’s ability to maximize its profit are not adequate environments for technology firms to effectively operate.

4. And finally, the proximity to a market where the developing firm will be likely to sell whatever technologies it develops plays a role. Technological innovations are likely to be adopted and integrated into the world’s most developed economies first, then eventually trickle down to lesser developed economies. Because firms seek to minimize costs and maximize profits, it makes good business sense to develop technologies in countries where these technologies will be purchased and utilized.

The United States’ comparative advantage in technology industries requires that it be supported the best and brightest global minds regardless of the individual’s country of origin. Without such support, our economy runs the risk of unintentionally developing other “technology clusters” manned by scientists and researchers in other countries. The end result could be the loss of our comparative advantage and our leadership position as the world’s innovator.

The single best solution to maintain our technological leadership is to leverage the privilege of living and working in the United States to attract foreign workers. This labor competition will also pressure the domestic workforce to increase its knowledge and capabilities, resulting in a more effective, innovative labor force.

H1B Visas & American Innovation

Recently, the H1B visa issue has received significant media coverage. In the Wall Street Journal, Miriam Jordan wrote about this issue on March 31 and Shikha Dalmia wrote an editorial in Saturday’s edition.

As Milton Friedman free-marketeer, I share Bill Gates’ viewpoint (detailed in his testimony last year to the US Congress) that the current system should be scrapped to open the American borders to a more effective labor force populated by the best available human capital (labor) available.

Paul Romer, developer of “endogenous growth theory” (or “new growth theory”) showed that technological progress is a primary engine for an economy’s economic growth. The notion of “building a better mousetrap” is the key motivation for profit-maximizing firms in a competitive environment. In short, ideas are “nonrivalrous” – meaning that the developer of a new innovation or idea has a natural monopoly on that idea’s implementation and use. This leads to increasing returns to scale and firm profits. In the context of economic growth, creating an environment where new innovations and ideas are abound results in subsequent increases in an economy’s growth. (Romer’s complete academic article – “Endogenous Technological Change” - is available in The Journal of Political Economy, October 1990.)

The H1B visa system handicaps American firms from employing the world’s best and brightest minds where these individuals could be developing new innovations for these firms, providing increasing returns to its research and development investments.

For obvious national security reasons, developing and enforcing stringent background checks should certainly be required for all emigrants to the United States, but limiting the number of foreign workers solely to protect American jobs frankly sounds a bit socialistic to me. The competitive nature of the market, including the labor market, is a key ingredient to the ongoing success of the US economy during increased economic globalization. Why should we deliberlately disadvantage American companies?

What if the United States decided in 1933 that we had reached our quota of foreign workers, disallowing Albert Einstein’s entrance to the country?

Illustrating Market Value vs. Intrinsic Value with Starbucks

Starbucks is favorite company of mine to use in various finance and business strategy lectures, (and to get a jolt before our Sunday strategy meetings at Altos Research). Over the past decade, Starbucks enjoyed a steady rise up, initiated aggressive international expansions plans, and with their recent reappointment of Harold Schultz as CEO, is now working to repair some erosion of their brand and product quality.

Most recently, I’ve been watching the Starbucks’ market valuation plummet over the past year with great intrigue. The current share price movement provides another great illustration of the difference between "market value” of a firm and the actual “intrinsic value” of a firm

In early January 2007, SBUX traded at about $35/share, yielding a market capitalization of over $25 billion (=$35/share x 725 million shares outstanding). At Friday’s market close, SBUX traded at $17.05/share, yielding a market valuation of only $12.36 billion.

While the company is focusing itself on re-establishing its brand, quality, service, and products, there certainly haven’t been any fundamental shifts in the demand for coffee. It doesn’t appear that Starbucks customers are flocking to Peet’s Coffee & Tea or Caribou Coffee to get their daily caffeine fix. Share prices at Peet’s are down about 20% since last year, and shares of Caribou have fallen from about $7/share to $2.75 in the same period. McDonald’s is rolling out a plan to compete in the specialized coffee business and their stock is up from $45/share to $55/share over the past year, but can they really take significant market share from Starbucks? Probably not.

So have operations at SBUX really taken such a negative turn that the company is now worth less than half of its value from early 2007? Clearly stock market thinks so, but this is why there is a difference between market value and intrinsic value.

When SBUX traded north of $30/share, that run up was based on increased demand for the market supply of shares (the 725 million outstanding). Strangely, in the middle of this run-up, the stock had a 2:1 split which changed the supply from about 362 million shares to the current 725 million shares outstanding. Supply doubled and the demand continued to force the market price per share to the $40/share range. The change in price reflects increased demand for shares, not necessarily a change in the intrinsic value per share of Starbucks.

According to Starbucks’ financial statements, the company increased its net income over 33% and increased their assets by over 50% in this two-year period. Let’s look at the market price per share during this same period.

In January 2005, SBUX traded at about $30/share. Taking into account the 2 for 1 stock split in October 2005, this means that the shares trading at nearly $40/share in April 2006 were really trading at $80/share. From at the same time that SBUX increased net income by 33% and increased their company assets by 50%, individual shares (actual pieces of ownership of the company) increased in value by over 250%. This means that the market value of a share of SBUX was increasing at a pace much faster than the actual value of the Starbucks.

Remember, market value ≠ intrinsic value.

Read the financial statements. Look at the assets and cash before making a decision on any company’s value – public or private. This isn’t my own idea, Ben Graham and David Dodd wrote about this in Security Analysis and this has long been the mantra of Warren Buffett.

Bear Stearns, Portfolios, and Waldo

Where's Waldo?

Courtesy of the Bear Stearns 10-K for the year ending November 30, 2007:

Some basic math indicates that 33.4% of Bear Stearns' portfolio was held in Mortgages, mortgage- and asset-backed securities. Add the Derivatives line item and you come to 47.5% of their portfolio is relatively risky assets. So how does this compare to a few of the other bulge bracket investment banks?

Hard to say in some ways with the numerous write-downs recently - $8 billion by Merrill Lynch, $9.4 by Morgan Stanley, $17.4 billion by Citigroup. But, some digging reveals how Bear Stearns is certainly outside of all of these firms regarding their risk exposure.

According to some recent 10Ks/Annual Reports:

Goldman Sachs - 11.9% of their portfolio is held in Mortgage-related. Add Derivatives, and 35% is in these two security types.

Merrill Lynch - 11.9% of their portfolio is held in Mortgage-related (no, that's not a typo - it's also 11.9%....). Add Derivatives, you get 43% in these two securities.

Lehman Brothers - 28.4% of their portfolio is held in Mortgage-related. Add Derivatives, and you get 42.7% of their portfolio.

This is a fairly cursory analysis, but looking at the most recent and pending results of the firms above, perhaps there's a linkage in there somewhere? There are many-a-bankers asking themselves what sort of business strategy that Bear Stearns was undertaking, and certainly comparing results might yield some cause and effect in retrospect.

Or maybe Bear Stearns just missed the memo....

Venture Capital Investment Trends since 1995 (Deals by Stage)

Doing some research about Venture Capital trends, I came across some interesting data provided by PWCMoneyTree.showing convergence in the number of venture capital deals between Early Stage, Expansion, and Later Stage deals, while the Start-up/Seed Stage dropped considerably over the past 12-13 years:

Reading nothing more than the data presented in these graphs, I'm hypothesizing that this decline was a function of a number of factors:

1. Venture Capital followed itself.

If there were a plethora of start-ups in the mid-1990s at the start of the internet/tech bubble, then it would make sense that targets that received venture capital in the "Start-up/Seed Stage" would then receive subsequent rounds of funding while in their "Early Stage" and "Expansion Stages", then eventually as "Late Stage" investments. Seems there may be some evidence of this effect as you examine the decrease of Start-up/Seed Stage funding with increases (and then decreases) in Early Stage and Expansion targets. These Early Stage and Expansion investment targets then became targets for Late Stage funding.

2. Venture Capital has become more risk averse.

Following the fallout of the last tech bubble in the late 1990's, venture capitalists turned their attention to firms that were past the start-up stage and had a better chance of survival. This would certainly explain the dramatic rise in the percentage of deals in Later Stage companies from approximately 10% to 30% of investments.

3. Venture Capital has become more selective

Certainly there was not a drastic decrease in the number of firms seeking Start-up/Seed Stage funding during the past 12-13 years - just the number of venture capitalists willing and able to fund these start-ups.

4. The ongoing emergence of Angel Capital

As angel capital groups continue their emergence, they may be filling the void - funding Start-up/Seed Stage companies instead of traditional Venture Capital.

I am actively researching these thoughts to support with further evidence, but this certainly provides some interesting fodder for discussion. I'm interested in your feedback on this thought process.

Mike's Case Against Venture Capital

Mike Simonsen, our fearless leader at Altos Research, wrote an article for FoundRead this weekend entitled "My Case Against Venture Capital."Interesting how he and I wrote our articles independently this weekend, but advocated similar positions - heeding caution with respect to venture capital's role in funding your start-up endeavor.

Maybe its the "Altos Research Cultural Bias" in play. Since the founding of Altos Research, the company has bootstrapped - paying for growth as cash comes in the door (no pressure on the sales guy here though....). I've been on the other side working with start-ups with considerable cash (Aplia, Inc. with $10+ mln) and my own firm that I operated for 2+ years on angel funding. Now that I'm on the side of the "pay as you go" model, I don't think I'd go back unless there was a viable reason. There's a certain feeling of autonomy at Altos Research that I didn't feel in my previous tenures, including my own company...

His article is chock full of great examples and outbound links that are guaranteed to get the gears grinding if you're considering venture capital for your business.

Venture Capital is not the end goal

It’s interesting when talking to start-up CEOs and entrepreneurs how often they are enamored with landing venture capital, as if receiving the funding itself is their main business objective. Venture capital is the beginning of any start-up's journey- a vehicle to speed product development, expand market reach, and grow the firm more rapidly than what would be possible through self-funding from revenues. Venture capital is never the destination.

Just remember the VC's rough equation:

10 investments = 7 failures + 2 breakevens + 1 successful exit

You're one of ten - there's a better chance that you're one of the future failures in this model than the successful exit.

Just as bankers provide small business loans to firms that meet their expected rate of return hurdles, venture capitalists invest in start-ups that offer the opportunity for them to meet their own capital growth goals. This is not philanthropy. One rarely hears an entrepreneur express delight for their pending small business loan from their banker, yet closing a round of venture capital is met with valedictory celebration.

In many ways, it would seem logical that the bank loan should be the capital event to spark celebration at a small business, since the bank only wishes to be compensated with interest payments, instead of preferred shares. Of course, most start-ups don't fit the lending criteria of most banks - this is illustration is meant to offer some perspective.

Certainly venture funding is vitally important to fill the investment gap between angel investors, private equity, and traditional lenders. The start-up entreneur should just remember that there are two sides to any transaction. If a VC is willing to invest $5, $10, $15+ million in your biotech, software, or patented technology, that money will come at a cost. Be sure to weigh the cost/benefit of the transaction before considering venture capital funding to be the end game.

(There's some solid reading and perspective on venture capital and angel investing at The Smart Startup).

Some Basics on Angel Capital

While doing some reading tonight, I came across a couple of very informative articles regarding angel capital and seed stage start-up financing.

• Jim Roberts provides his Top 10 Tips for Entrepreneurs Seeking Venture Capital - a nice list of practical examples that focuses on developing relationships and taking the long view when considering angel funding.
  

• An article from The Huntsville Times written by an angel investor offering the "blocking and tackling" basic advice that is always good to remember when approaching angel investors.

• Some cautionary advice from BusinessPundit.com.

The key factor that I read time and time again, is that angel investing is an option and an opportunity for entrepreneurs. But remember, angel capital doesn't mean "manna from heaven."

The Facebook Multiplier: Economic vs. Market Valuation

I get the social part of it. I just found a friend of mine from high school, spent 10 minutes with my wife perusing pictures to put on my profile, and even reviewed 20 results for “Sambucci” including two in London, one in Glasgow, and one in Ecuador. I don’t get the 100x revenues to determine its $15 billion valuation.

Facebook’s foray into tracking member purchases went awry. Advertising dollars reach their ceiling quickly unless you’re Google.

The Facebook marketplace is less than overwhelming. There are 2598 items for sale in Silicon Valley, CA at the time of this posting. When I click “For Sale", the first page results include a 5"x5" cheese cake for $50, Oracle SQL/DBA Training for $360, and a 2007 Hybrid Ford Escape 4WD for $26,000.

Huh?

A marketplace is a place of aggregation where economic activity transpires. On the Internet, eBay is the typical example - an established marketplace with buyers and sellers. Defining the market more loosely, the same occurs when someone uses Google or another search engine to find a product that they eventually purchase. Members join Facebook for social networking, not to directly engage in economic activity.

With no indications that Facebook’s revenues are rising exponentially, it’s likely that direct revenues Facebook will generate for itself will remain relatively low compared to the true online marketplaces like eBay (~ $7 bln in 2007) and Google (~$15+ bln in 2007).

If this is indeed true, they why use Facebook’s revenues as the metric for valuing the company (currently at 100x revenues according to Microsoft’s recent investment)? Maybe there’s a more accurate way…

Let’s assume that because I’m a Facebook member, I meet up with a long lost high school friend in New York City and have dinner. It’s fair to assume that this happens frequently with many Facebook members – connecting with friends either directly or in part because of Facebook – which results in economic activity of some sort taking place (a $100 dinner in this case).

By taking this approach, we can then begin to connect a certain amount of economic activity attributable to Facebook. Some members are “power” users and others are more cursory like me. But overall, there is likely some average amount of economic activity per member that can be measured. Economists use “mulipliers” to calculate these “down line effects” of some event or activity. (In fact, the consumption multiplier is the rationale for the recent tax cuts approved by Congress and President Bush.)

If we can quantify these economic activities per Facebook member, then why not use a “Facebook Multiplier” to determine the firm’s value? This multiplier is not related to the revenues of Facebook. Instead, the newly-created revenues of other market participants as a result of Facebook existing become the determining factor to establish Facebook’s economic value to the market. Using the multiplier establishes a true intrinsic value for the firm, not an arbitrary market value as was done with Microsoft’s investment in Facebook.

This proposed multiplier may indeed show that Facebook’s firm value is indeed 100x revenues, but not because we use Facebook’s revenues as a basis for arriving at the valuation. Instead, Facebook is valued based on its contribution of total economic activity. This multiplier can be justified going forward because of the lock-in effect of Facebook, and possibly the growth of the multiplier as Facebook members utilize Facebook more frequently.

This creates a clear divide between Facebook’s economic value (its contribution to the economy as a whole) and its shareholder value (market value). To the displeasure to future Facebook shareholders, the multiplier approach values Facebook on the total revenues that it creates in the general economic, not revenues that it collects as a participant in the market.

The result? Facebook’s economic value is different than its market value. In fact, its economic value is greater than its market value. We assume that shareholders value a firm based on future earnings due to them as a part owner of the company. Shareholders that purchase shares of Facebook based on the market valuation of $15 billion established by Microsoft will be sorely disappointed if the firm’s personal revenue growth of Facebook remains at its current level.

In the end, I’m not contesting that Facebook is worth $15 billion. It could be even more than that. I just disagree that Facebook’s market value is $15 billion. The firm may hold an economic value of $15 billion with the resulting multiplier effect, with the market value falling far short of this number.

(Also consider that perhaps Microsoft established a $15 billion market valuation for Facebook to artificially inflate the market price to other would-be suitors…)

Caveat emptor.

Funding 2.0 - SVASE

Last Thursday, I attended an SVASE event - "Funding 2.0 – How To Build A High Growth Startup Fast And Cheap." It's always interesting to check out the mindset of the Valley's newest entrepreneurs and hear what its successful members have to say.

Panel members were:

Mike Cassidy, Entrepreneur in Residence, Benchmark Capital
Matt Mullenweg, Founder, WordPress
Naval Ravikant, Partner, The Hit Forge
Peter Yared, Founder & CEO, wdgtbldr

Here are a few memorable one-liners (might be slightly paraphrased, but I think I'm close....):

Mike Cassidy on developing a strong Web 2.0 company:
"Find the lock-in effect; the network effect. That makes it hard for users to switch."

Matt Mullenweg referring to start-ups that are beginning to turn the corner:
"When you're in the green, the best times are ahead of you."

Peter Yared about outsourcing hardware:
"There should be no IT people in a software company."
"Why buy the elephant when you can ride the elephant?"

Naval Ravikant on making money on the web:
"Most money on the web comes from search mistakes."

I spoke to Peter for a couple of moments before the Panel began. Unfortunately, I didn't know of his success as an entrepreneur - our conversation was rather light. Had I known, I would have pressed him for some advice about Altos Research and our AltosCharts application...

SVASE continues to impress with their abundance and quality of events. I recommend their events to any enterpreneur that wants to get out, practice their pitch to strangers, meet people like you, and learn more about what to expect in getting your ideas from concept to realization. Must have been 150 people there.