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Olson’s Observations

Technology. Innovation. Science. VC. Media. :: by Eric Olson

Archive for January, 2006

Fixing the Venture Capital Model: PFB Revisited

without comments

I know that I said I was coming out with Fixing the VC Model: Part 3 this week and now you are seeing PFB Revisited. Please consider this Fixing the VC Model: Part IIa. I had to write this post in response to a great post written by Fraser Kelton today. Fraser writes about fixing the VC industry as a whole and includes a section on partial founder buyout (PFB) with a link to Paul Graham’s essay which is where I first saw the idea. Fraser also hits on other topics like customer service, raising less money, etc. Definitely worth a read. The ony piece of the argument which may be a tough sell to VCs is the following:

Focus on a Niche. By focusing on a small niche market, the VC can exploit the long tail of venture investing and enjoy a positive median return. The venture capitalist may have to give up on the ‘hit’, but they should be okay with that. They’re leveraging their expertise in the niche market to make a number of smaller investments, that will yield a positive median return.

A venture capitalist who doesn’t rely on landing a hit to prop up their other investments, and instead aims for a number of smaller returns that yield a positive median return, will be able to compete against entrenched VC firms. By going long tail, and being happy with it, the venture capitalist develops yet another competitive advantage.

Having worked in Venture Capital analytics for a while I know the returns well and I know what LPs (the VC’s investors) pay for. LPs are paying for the homerun fund (homerun compared to a mutual fund). Many times they won’t get it but that is usually what they go into VC funds looking for. To make my point I am going to have to call on two of my best friends from undergrad, alpha and beta.

With the typical 2% management fee and 20% carried interest VCs charge for their services they need to make a large return above the market or a high alpha. They are also taking a lot of risk and have a high beta which drives the desired return even higher. The combination of these leads to expectations of at least a better-than-median return.

While a VC median return is not bad at all (compared to a mutual fund), investors may be upset since they paid for better. However, all of this can be solved if a VC, trying to disrupt the market, takes a lower management fee and/or carried interest with the plan of focusing on a niche for a modest median return. Definitely something to think about. It would mean less money in the short term but could lead to a much better industry in the years to come. Let me give you a glimpse of the future. Possible headline from the 2015: Happier entrepreneurs, better VC returns and more money being made by all! Sounds good to me.

Again, kudos to Fraser for putting together such a comprehensive article. I am glad to see the discussion really picking up. Now, if I only I had some money to start putting PFB (and the other ideas) to work as an angel investor…

Written by Eric Olson

January 26th, 2006 at 4:26 pm

Posted in Fixing the VC Model, VC

FeedFlare II - SiteFlare

with 3 comments

Sounds like one of those really bad “B” rated sci-fi movies from back in the day but, alas, it is a new FeedBurner feature! I know this may seem like the FeedBurner blog lately but the new features we are coming out with are especially relevant to you, my loyal readers.

Remember FeedFlare? Those of you who read my feed no doubt have seen it many times and have possibly even used it to tag my posts with delicious or e-mail my posts to your friends. Well, we just released the same wonderful Flare except now it can be used back on my site creating an ecosystem between the site and the feed. Before FeedFlare and SiteFlare the feed and the site were very much separated (besides the sharing of content of course) but now they are forever connected and will live blissfully ever after.

I have elected to add the e-mail this, technorati (only shows up if there is a link), del.icio.us and subscribe to this feed flares to my blog and I hope they make my content more useful for all of you.

We are continuing to work on a list of 101 flare ideas so if you have any please e-mail me or post a comment. Have fun with your ideas because that is what Flare is all about!

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On a side note: just read on Kevin Burton’s blog that there is a rumor out there stating that Yahoo! has an offer out to buy Digg for $35mm. I wonder if this is a case for Partial Founder Buyout man (I really need a logo or something for that)! I think Digg could be worth more if given time to grow so if a VC jumps in with PFB they may be able to get a great investment out of the deal.

Written by Eric Olson

January 25th, 2006 at 12:26 pm

Posted in FeedBurner

USA Today and FeedFoundry

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I am very happy welcome USA Today into the ever growing FeedBurner family. As Rick Klau points out, part of the attraction to FeedBurner was a new application called FeedFoundry. Here is what FeedFoundry does (from the official announcement):

FeedFoundry provides mass feed importing, management and analysis. The service was built for commercial publishers and content providers with large numbers of feeds, potentially across multiple properties. FeedFoundry’s advanced reporting capability allows publishers to group sets of feeds and identify trends, activate services in bulk, maintain performance history and design custom reports, specific to each company’s priorities, using a standard dashboard.

So far the feedback has been great and I join Rick in congratulating our incredible design and development team on creating another blockbuster app. If you are a publisher like USA Today and want to learn more about FeedFoundry please contact us as we are happy to assist!

Written by Eric Olson

January 24th, 2006 at 1:32 pm

Posted in FeedBurner

Fixing the Venture Capital Model: Part 2

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For those of you that have not been following the comments on my first “Fixing the VC Model” piece there has been a great discussion going on. Jeff Clavier commented first and mentioned that partial founder buyout won’t really work with small deals. This is a very good point. For example, if an angel or very early stage VC wants to place $500K into a company then the partial founder buyout (PFB) would not be big enough to align the entrepreneurs interests with the VCs. So, if PFB were to be inserted into a deal, the deal would really have to be larger than $5mm or so but that $5mm could also be spread among a syndicate of investors making it an aggregate deal total.

The next piece of the conversation was lead by Adam. Adam brought up two very good points that VCs would probably consider before using PFB:

1. Control over the founders: Many VCs may believe they’ll lose some control/power once they provide the founders with a $3mm safety net.

2. Company Growth: $3mm may be better off growing the company instead of sitting in the bank.

I will talk about the last point first. First of all, let’s disregard the fact that a company can be overcapitalized killing it from within and say that, in our example, the company could use the $10mm effectively. With that said, I agree that $3mm would probably be put to better use growing the company than sitting in the founders bank account when you look only at the surface. However, when you start to dig deeper one can see that the company could possibly grow more than it would have otherwise with the extra $3mm in the founders bank account because the founders would be more willing to take chances.

On to the point about control. I mentioned to Adam that the VCs would end up with more control relating to their percent ownership in the company which he of course knew. Adam then followed up clarifying that he agreed and actually was referring to the control that VCs have over entrepreneurs. Adam and I both agree that control of the company and not control of the entrepreneurs should be what VCs strive for. I think that there are a lot of VCs out there who do not look to control entrepreneurs but there probably are quite a few that do and would, therefore, oppose PFB. This control issue is something that needs to be looked at if the VC model is ever going to align itself more with entrepreneurs.

I hope that this sum up of the conversation has helped to catch everyone up on the issues with PFB. Please be on the look out for Part 3 of my Fixing the Venture Capital Model series which I will hopefully post sometime this week. In Part 3 I will look at the Venture Capital fund structure to see if it is cauing some of the static between entrepreneurs and VCs. Until then, keep the comments coming. I think this conversation is good for the start-up community and will hopefully be a small step toward effecting the change that I think most of us want to see.

Written by Eric Olson

January 22nd, 2006 at 11:12 pm

Posted in Fixing the VC Model, VC

The Wannabe VC’s New Home

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Welcome to my new WordPress blog. I am still in the process of sprucing up the place so please bear with me. I have imported all posts and comments from the Blogger blog that you all know and love so nothing is really different other than the URL and the fact that I can do much more to make this blog useful for you, my loyal readers. Enjoy the new diggs! I’ll be back soon with a post following up on my “Fixing the Venture Capital Model” piece.

P.S. All of you that read me via RSS do not need to worry because, as you can see, I set up redirects for the feed. That means that you do not need to do anything to keep receiving my posts as soon as they come out. I love technology!

Written by Eric Olson

January 20th, 2006 at 1:43 am

Posted in General Thoughts

The Author

with one comment

Eric OlsonI am a Massachusetts native (go Red Sox!) and Bentley College alumnus (B.S. Finance w/ IT Minor - Magna Cum Laude - 2004) who now lives in Chicago. I work in Business Development/Publisher Services for FeedBurner and am also one half the founding duo of TECH cocktail which is a quarterly event for technology people here in Chicago.

My interests include: baseball, cycling, drumming, technology, venture capital, microfinance, archaeology, history, physics, movies, writing and reading.

View Eric Olson's profile on LinkedIn
To learn more about my experience (and see what is essentially a resume) please click the LinkedIn button above. If you’re not already on LinkedIn you should be. It’s one of my favorite web services!

You can also check out my Kiva lender page and my personal DNA report if you’d like.

Written by Eric Olson

January 19th, 2006 at 9:51 pm

Posted in VC

Fixing the Venture Capital Model

with 12 comments

There has been a lot of talk for a while now about fixing the venture capital model. As it stands now, there are things about the model that do not align the wants and needs of VCs with entrepreneurs. For example, VCs need exits at certain time intervals because their funds only last 10 years (for the most part) and entrepreneurs are sometimes forced to grow too quickly or be acquired too soon because of this. While the structure of VC funds probably isn’t going to change any time soon (after all, the people that invest in VC funds need their money back to pay pensions and do charitable work) the question is: What can be changed? The answer: deal structure.

The way VC deals are structured is something that, with a little creativity, can make the system much better for both parties. There is a fundamental problem between VCs and entrepreneurs. VCs want entrepreneurs to shoot for the stars and to be the next Google. Sure, entrepreneurs want that too. If they didn’t, they wouldn’t be in the game and taking the risks that they are. However, if someone comes along and offers an entrepreneur $25mm for a company he built in his spare time and for little of his own money he is going to take the cash or at least be very tempted to especially if it is his first company. However, that $25mm offer looks paltry to a VC who, lets say, put $7mm into the deal at a $22mm post money valuation (and sees the company eventually being worth $500mm). The return on investment for the VC does not line up with the return on investment for the entrepreneur.

Partial founder buyout can change this dynamic by giving the entrepreneur a little liquidity early on. Let’s say that, in the above scenario, the VC actually put $10mm into the deal but $3mm was actually paid in cash to the entrepreneur and $7mm went into the company. Now, the entrepreneur has $3mm in the bank. This is not enough to make him too comfortable but it is enough to reduce, if not eliminate, his urge to sell out quickly for $25mm. Now, the entrepreneur is more likely to take the plunge with the VC and try to become the next Google knowing that his house and his childrens’ college educations are taken care of.

If this type of situation was in practice today I think we would have already seen its effects. Let’s take Flickr for example. The founders of Flickr built the company on a shoe sting in their spare time. Network effects began taking hold and before they knew it they had an incredible company on their hands. At that point the founders needed to make a decision: do they take capital from a VC and scale the business like crazy possibly gaining nothing or do they take the “sure thing” offer on the table from Yahoo! and cash out early possibly leaving money on the table but also taking in enough money to live comfortably forever? In this case the founders took the Yahoo! deal and probably regret it today but can you blame them? They were looking at a lot of guaranteed cash or getting their ownership diluted possibly for $0 return. The same situation could be applied to a number of other companies including del.icio.us.

With partial founder buyout a lot of entrepreneurs would be still out there building their companies and VCs would be left with more quality investments. Everybody wins (except maybe Yahoo! and Google since they wouldn’t be seeing any more inexpensive acquisitions). To make things clear, this is not an original idea. I have seen others write about it and have been surprised that there hasn’t been much take up. I thought I would write about it to get it back into the discussion so please tell your friends (especially if they are VCs and entrepreneurs) about this blog entry so they can add to the discussion in the comments and on their own blogs. This is something that needs to be looked at because it could change the start-up game forever and in a positive way for all involved parties.

Written by Eric Olson

January 15th, 2006 at 11:06 pm

Posted in Fixing the VC Model, VC