Today’s example: The Internet is a new platform for consumer media. That’s a striking revelation . . . in maybe 1994 or perhaps as late as 1998. This may be hard to believe today, but there was a time when it was revelatory to describe the Internet as a new form of popular media, rather than as a niche technology.  Today most people would declare the Internet as the second most important form of media (behind TV).  It seems so obvious now that the Internet is a consumer media delivery system.  And yet, it’s easy to find ways to overcomplicate this simple picture.

Take for example the argument over whether The Web Is Dead. Putting aside the easiest objection – that many claims of death are exaggerated – the thesis basically says that “the Web” was supposed to be this great open playground that changed the world forever, but a variety of closed systems now threaten the promised paradise. We are supposed to get hysterical over the idea that content that was free on the Web will not be free forever, and that there will be special access channels that only some people will be able to afford.

But the Web isn’t dying, it’s just evolving the way that consumer media have always evolved.  The history of consumer media is littered with similar patterns of free and paid content, amateur and professional content, sponsored and bought content. There are many examples where a new medium was popularly established with free content, and evolved into a tiered system of both free and paid content. Look at television – once it was free (i.e. ad-supported), then cable TV came along with both an ad-subsidized paid model (basic cable) and an ad-free paid content model (e.g. HBO, PPV).

The same thing is happening with this wondrous new medium of the Internet, and the most wondrous thing of all is that anyone thought it would be any different.  The Internet is wonderful and has changed many things in the consumer content landscape, in terms of interactivity, variety, engagement, and low production and distribution costs. But one thing it hasn’t changed is that consumer media, as a whole industry, will always trend toward payment for quality content, and toward concentration of media power in the hands of a relatively small number of players.

I wish that weren’t true, but it is true today and will always be true for as long as we remain human beings.

We like to think that technology frees us from the scarcity-based economics of the past.  And it’s true that changes in scarcity can free up new business models.  But there is no kind or amount of technological advancement that can eliminate scarcity in two areas:

• Quality. Quality content is by definition scarce: no matter how great the aggregate improvement in overall quality, there will always be some portion that is better than the rest. The development and application of new technology to content only heightens the divide, not flattens it – because the quality of the content includes not just artistic merit but its presentation and convenience to the consumer.
• Attention. Human attention is limited, both in the aggregate and for any individual. No matter what automatic aggregation, filtering, or curation tool is ever developed, we can’t radically increase the finite amount of real human attention for consuming media. Even if we develop technology that actually stops time, our biology dictates a finite attention span – there’s only so many hours of media a brain can absorb in a day, no matter how long the day is.*

Since quality is scarce and attention is finite, there will always be an opportunity to charge money for the best content – and since this includes charging for the best quality presentation and delivery, it means that there will necessarily be a two (or more) tiered Internet. You can call it surrender, you can call it the death of the Web, you can call it whatever you want – but recognize that it’s progress, it’s evolution, it’s the future as well as the past.

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On a related (and more obscure) note, lately there’s been a lot of conversation about the evolution of certain parts of the venture capital business. I can’t do the whole conversation justice – but basically the narrative is that there is a new mode of investing in the consumer Internet sector, with smaller but smarter initial investments, giving rise to an expanding birthrate of web startups, and raising the specter of a seed investor bubble.  Again I’d ask, should we try to understand all this as a new phenomenon, or is this just a different variation of a familiar pattern?

Consider that a lot of “Consumer Internet” is no longer mostly about technology development, it is about media content development. From that perspective, a lot of the shifts in venture investing are about a certain class of savvy investors becoming media investors instead of technology investors. They’re not evolving to some kind of new model of investing, but cycling into the model of investing that you see in more mature content production businesses.

I think that consumer Internet investors will become more and more like television producers and financiers, and less like “hard” technology investors.  If that’s right, you’ll stop seeing conversation about equity vs convertible debt, and will instead see a move toward the revenue-sharing model that is common in the TV and movie industry.

Some people will regard this theory as idiotic, controversial and even demeaning (if you think being a TV producer is worse than being a VC), but for me it’s just doubling back to the basic insight that the Internet is a new platform for consumer media.  Now that the original mid-’90′s revelation has come true, you can expect that the investment economics will repeat old patterns more than they create new ones.

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* I realize that there are people who believe that in the future, technology could enhance brain function as well as create endless renewable energy – making essentially limitless time and capacity to enjoy leisure activities, including consumption of media.  Without opining on the likelihood of that future, I’d just note that it’s a future in which we are no longer human, as we understand humanity today.

We launched our beta product at Bynamite about a month ago, and were lucky to get covered in the New York Times.  I wish this post could be about “How To Get Covered in The New York Times,” because that would be some really valuable information for the startup community.  But we were simply very lucky – a friend introduced us to a potential business partner who was really interested in our story, who introduced us to the Times reporter, who had been thinking and writing about related issues for a long time.  Everyone in the chain was very thoughtful and patiently dedicated to understanding what, if anything, is interesting about what we’re doing.  Sometimes the pieces just fall into place, and that’s what happened here.

Before that series of fortunate events, we had been preparing a more traditional scrappy startup PR strategy, which I learned from the interwebs.  Balsamiq‘s marketing advice and launch homework are invaluable; in particular I was focused on the 10 PR tips from Weebly.  We had identified about 45 blogs, big and small, that I intended to contact one by one, with the holy grail being coverage in one or more of the major tech blogs – TechCrunch, Mashable, ReadWriteWeb, GigaOM and VentureBeat.  Just as I was starting to reach out to the list, the Times reporter confirmed that his story was very likely to go forward in the Sunday business section.

At that point, we had a decision to make.  On the one hand, the TechCrunchosphere is the place to launch consumer tech products – the audience is intelligent, opinionated, and early adopting.  This is an audience that understands that startup companies launch “unfinished” product.  It’s not a good idea to get mainstream press before your company is really ready for it.  On the other hand, our product goes contrary to the tech orthodoxy that had largely proclaimed that no one cares about privacy.  Would TechCrunch readers be the wrong audience for our more mainstream message?

Although these are complicated concerns, we didn’t take long at all to decide, and we were swayed for one irresistible reason: it’s the New York freaking Times!  As much as I’m with the punditocracy that declares newspapers dead, I just couldn’t help myself – I grew up reading the Times, and I really wanted to see if we could get in the paper, the good ol’ physical, dead-tree paper.  So we saved the blog efforts for a later time – hopefully after we’ve learned our lessons from the beta and are ready to relaunch with a more complete product.  It’s sort of a topsy-turvy press strategy, and there’s probably a whole ‘nother post in whether or not it’s stupid, but that’s not the point here.  The cool thing today is that we get to compare results from different PR launch paths.

Here’s the Visits graph from Udemy’s launch:

Here’s a similar graph from Bynamite’s launch:

Here’s the referral chart from Udemy:

And the corresponding chart from Bynamite:

Now, the point here is NOT to say that Bynamite PR is any better or worse than Udemy PR!  That kind of comparison would draw all sorts of wrong conclusions, not least because I’ve cheated here by including 30 days of data to Udemy’s 23 days.  Also, note that Bynamite is a browser extension that records a page view when the extension bar pops up (that’s why the Avg. Time on Site is absurdly high).  Different products are going to have lots and lots of reasons for different metrics.

But the conclusion I’m willing to draw is that getting covered in the Times is roughly equivalent to coverage in the major tech blogs.  Not an order of magnitude higher, and certainly not smaller.  So for anyone hoping to confirm the relevance of mainstream media, I suppose that’s a victory of sorts, though it’s just as accurate to be amazed that media sources that barely existed 5 years ago are now equivalent to the “paper of record” that’s been around for 150 years.

It’s also interesting to note that both Udemy and Bynamite got a secondary bump 5 or 6 days after the original coverage.  In Udemy’s case, that bump exceeded the initial coverage, and was almost entirely driven by a mention in one source, Thrillist.  Bynamite’s secondary bump was smaller than the first, and was a result in pickup by many smaller sites that focus on covering downloadable apps.  Also like Udemy, our traffic has settled down to a much quieter pace, though significantly higher than the near complete obscurity prior to the press coverage.

I’m still digging through the details – and by the way, could use some help, if anyone reading this wants to drive through Google Analytics with me, let me know!

Boat-burning advocate Marc Andreessen understands disruptive innovation as well as anyone.  At the very core of the startup culture that Marc helped create is a belief that small companies in the aggregate have a huge advantage over incumbents for bringing disruptive innovations to market.  A big company can’t become a small startup simply by destroying its current revenue model and firing all its employees – that would only result in a burned out shell, not a new startup.  A new startup can only be formed by innovators coming together to form a new company.  I realize there are exceptions to these statements, but they are very few and far between.  So “burning the boats” is statistically likely to be an exceptionally bad strategy for newspaper companies.

Tech writer Erick Schonfeld says it’s hard to watch the newspaper industry die slowly, noting that it could take decades for the newspaper industry to dwindle from $30 billion dollars a year down to nothing.  But Erick’s been covering startups for over 15 years, he’s seen successful startups kill the dinosaurs time and time again.  Like all of us in the startup world, he celebrates the success of startups against incumbents.  I don’t get the lamentation here – is it because the bedside deathwatch is comprised of relatives of the victim?  Who is burning the boats supposed to help, the dying incumbents or the anguished observers?

Given that the startups are going to beat the incumbents anyway, there’s nothing wrong with newspapers dying slowly.  Twenty years of slow death isn’t preventing innovation – all the innovators are outside the incumbents anyway.  But inside the incumbents are real people, hundreds of thousands of people who depend on their dying jobs to feed their families, many of whom aren’t going to succeed on the other side of the disruption.  Is there something wrong with letting those people eke out another twenty years of dead-end jobs?

This isn’t soft-hearted humanitarianism.  My heart’s hard enough to admire a capitalist system that sometimes causes individual misfortune.  But my point here is that the slow death of newspapers is an example of capitalism working correctly.  Big-footed incumbents are supposed to lose to startups.  Large companies are supposed to cling to their dying revenue streams while nimble competitors bring innovation to market.

Investors in those large companies have already “priced in” slow death – the stock price reflects the conventional wisdom that these companies will slowly go out of business.  The stock price for public newspaper companies most certainly does not price in a “burn the boats” strategy, which would result in irresponsible destruction of shareholder value, as well as damaging all those jobs and lives.

This is actually a place where brutal capitalism and soft-hearted compassion have common ground.  Newspapers are dying and no one is going to do anything about it.  For the love of humanity and capitalism, just let ‘em die a slow death.

Amusingly (and presumptuously), today’s report claims to define “True Twitter users” as active.  They say that a True Twitter User has at least 10 followers, follows at least 10 people, and has tweeted at least 10 times.

Why should we accept this definition?  Analyses like this often come from a position of functional ignorance.  I believe that only the company can have a “Truly” meaningful definition of “active” users, and there are often good reasons that the company shouldn’t waste time debating this definition with external observers.

This is especially true when a company has an evolving revenue model.  In those cases, “active” is only meaningful in the context of a business model cycle that some people call “Startup Metrics For Pirates” because of the acronym AARRR:  Acquisition, Activation, Retention, Referral and Revenue.  ”Active” is the second “A” here, and what matters in the definition is that customer acquisition efforts lead to active users, who participate in activity that they want to repeat and tell their friends about, which ultimately results in the company getting paid.

So if Twitter had zero customer acquisition costs, and tweeting was both addictive and viral (obviously, none of these things are strictly true), then the only definition of “active” that would matter is “user who tweets once.”  Or, if Twitter charged only users with 100K followers, and only users who had 100 followers in the first month ever get to 100K followers in their lifetime (again, not true), then the active user definition might be “user with 100 followers in first month.”  My dumb revenue models here are not the point; the point is that “active” only has meaning in context, and only the company understands that context, especially in a pre-revenue company.

Twitter, rather famously, has not publicly settled on its revenue model.  Undoubtedly they have dozens of ideas, and so they have many dozens of potential definitions of “active” – and they’re not obliged to share any of those ideas with you or me.  They don’t need to waste time with ignorant and disinterested people (myself included):  it’s no use picking over these definitions with people who are not deeply invested in the business (as employee or investor), and who therefore lack the information and commitment required to contribute productively to the discussion.

I call this the Chinese Menu approach (“Pick one from Column A, one from Column B . . .”): Group blogs together by thematic category, and then read only one blog in each category. Every once in a while, I’ll change up the one that I pick in each category, so I don’t get sick of the same meal time after time.

I add and drop blogs from categories all the time, and some blogs could be in multiple categories.  But the key is to just read one in each category.  This approach works well for me.  Switching up the meal selection once in a while helps keep me open to different perspectives.  I never miss anything truly essential, as great posts tend to be cross-linked extensively, or come to me by other means.  Incidentally, the same approach works ok for Twitter (though it’s not ideal).

In the startup world, failure is a badge of honor.  An honest postmortem of mistakes made along the way is greatly appreciated by the community.  For example:

• Eventvue
• Lookery
• Untitled Partners
• neotis wissensmanagement GmbH
• GameClay
• BricaBox
• MyCarpoolStation
• [unfunded idea]

The comments on each of those posts are overwhelmingly sympathetic, admiring and supportive.  Celebrating failure in context is a distinguishing aspect of our business culture versus many other countries.

In contrast, when the President of the US admits mistakes, the national and international coverage seems to imply that the admission itself its newsworthy and perhaps unwise.  Comments are largely vitriolic and incoherent.

Now, I think that failure can be overrated as an indicator of future success.  But I firmly believe that the openness to failure in business is one of the things that makes this country truly great.  It’s ironic and sad that this cultural gem does not extend into our political arena.

I was born in New Jersey, grew up about 45 minutes outside of the city, and went to school and started my career in NYC.  I’ve been out in the San Francisco bay area for over a decade now, and I’m firmly rooted here with family and career, but the thought of going back to The City (the one and only “The City” – pretenders begone!) still occasionally buzzes in my head like a bee in a speeding car.  However, on a trip back to New York last week, I realized that one of the things that prevented me from moving back is my own very New York attitude.

Over the past few months, a few New York based technoscenti have carried a conversation about NYC as a startup environment.  Chris Dixon said conditions are ripe for a new NYC tech revival, Fred Wilson and Charlie O’Donnell agreed but noted that NYC has been a strong tech scene for years, and Dixon and Wilson came together to agree again that the NYC startup sector is special.  All this caused me to reflect on why I left the city that I love to pursue a tech career in Silicon Valley, and why I’d do it again.

It all goes back to why I went to NYC in the first place.  I was learning the law, I wanted to be a dealmaking lawyer.  And while there’s law and lawyers all over the world, the pinnacle of the practice is in New York.  Routine transactions in New York would be considered fantastically complicated almost anywhere else, and complex transactions in New York are so far above other places that they can’t be considered the same category of endeavor at all.  So if I was going to be a lawyer, I had to try to do it in the belly of the beast.

And it was a great time, but after a few years I realized I wanted to be more connected to the creation of something from nothing, rather than the financial engineering of something into vast amounts of money.  That meant working in startups, because startups aren’t about money but about value creation (a distinction often lost on New Yorkers).  So I shifted the path of my journey, but I retained that New York attitude of wanting to play on the biggest possible stage, and in the startup world, that meant going to Silicon Valley.

There are other great startup scenes in the world, and New York is certainly a special startup environment.  But if you’re a stage actor, you don’t go to New York dreaming of playing Off Broadway; you dream of your name in lights on the Great White Way.  Because I grew up as a New York dreamer, dreaming of a startup career meant leaving New York for the biggest and baddest startup scene in the world.

It’s all a bit ironic, and I’m not saying this “big stage” attitude is right.  In fact, it’s almost certainly not a healthy way to live.  A healthier attitude would be less entranced with the size of the stage, and more focused on the production and your role within it.  I think that’s the attitude held by Chris, Fred and Charlie, and I really look forward to seeing those guys continue the public conversation (and private work) about making New York into one of the great startup locales in the world.  For those interested, Elie Seidman is another good new voice in the thread, and of course Joel Spolsky is a longtime stalwart for software engineering in NYC (or anywhere).

Dixon emphasizes that the most important thing about equity grants is the percentage of the capitalization granted, and Wilson adds that the implied valuation of the grant (number of shares times share price of most recent financing) is also useful.  While these things are true, my objection is that the probable audience for this advice is composed of prospective startup employees, and the use that they will make of this advice is to try to choose a job based on the value of the equity grant.

This is a bad idea for two reasons.  First, valuing an equity grant is only secondarily about determining the percentage of the company – it is primarily about determining the exit value of the entire company, an exercise at which professional investors in the field routinely fail. (Fred himself will tell you that 2/3 of venture investments in a successful fund will break even or lose money.)  If you are thinking about joining a startup, and you have 2 choices, you are very unlikely to have any rational basis for believing that 0.1% of one startup will be worth more or less than 0.2% of the other.

Second and more importantly, if you want to work in a startup, you should not choose where to work based on compensation.  You need to pick the project and the people that get you most excited, period.  Without a belief in the mission and an authentic fit with the team, you will not be successful anyway, so any compensation will be a waste of your time and their money. If you have other employment options, you should explain that to the place you want to join, and if they want you they will make the comp work within their range, and you should accept.  Or, if you simply want to work at the place where you will be paid the most, you should not work at a startup. (Don’t be offended, this isn’t a test of character or a judgment of your soul – if you’re not a startup person, that doesn’t make you any worse or better than the people who are.)

Dixon actually gives really good advice in his post, for those who are paying attention:  ”If management tells you the number of shares and not the total shares outstanding so you can’t compute the percent you own - don’t join the company!”  As I’ve said before, the reason to have a detailed conversation about equity comp with your manager is to test management’s clarity and forthrightness in general – not because you have any hope of making a correct equity valuation.

I would be willing to bet that neither Dixon nor Wilson has ever made a choice of company to join or invest in based on equity percentage.  They made their choices from their interests in the market, the product, the team – and then later, after a decision to join/found/invest has essentially been made, they did some optimization around the equity.  Choosing the other way around is about relying on luck, not successful choices and preparation.

[Bully for you if you know the reference for the title of this post!]

I’m working through a start up analysis based on a web-based software app. What is “options consistent” with a start up?

The short answer:  show the prospective employee a 5-figure number, and convince the employee that it makes sense.

The long answer:

This is highly dependent upon the type of startup and the position of the employee. I’ll answer for a typical situation of a VC-backed startup and a developer from entry-level to senior (sub-exec) level. You could have a very different answer for startup that was not VC funded, or an executive level position. You might even have a slightly different answer for non-developers, certainly in the areas of marketing, administration, customer support. (I’m putting aside for the moment the question of whether it is “right” to treat execs or different functional areas differently.)

Many propspective employees seem to take a highly illogical view of evaluating startup options. They compare the raw number to that in their other offers, or to offers that their friends received. (“Well I think I deserve at least 30,000 shares in this company, because my friend Jonny got 20,000 shares in his company, and he’s an idiot!“)

This seems nonsensical because the value of the options must be calculated with respect to the specific company situation, especially in terms of the company’s existing capitalization and prospects for liquidity and growth. Having 20,000 shares in a company that has 10 million shares outstanding is, absent other facts, five times more valuable than 20,000 shares in a company that has 50 million shares outstanding. That’s simple enough, but it is by far less important than the other main factor. Having 20,000 shares in a company that is about to go public might be much more valuable than having 20,000 shares in a company that has just started.

Might be. Or might not.  What if the company that has just started is the next Google, as they all think they are? The problem here is that you have to evaluate both distance to liquidity and prospects for growth. Figuring out which startups will be successful and when and how big they can get is extraordinarily difficult – these are things that professional money managers routinely get wrong. A prospective employee has very little hope in getting this evaluation right.

So let’s look at it from the other side: how do companies decide how many options to offer employees? Typically a company budgets a particular target of dilution from issuances of options over 12 to 18 months. For an early stage startup, this target is often around 15-20% of total capitalization (including the options pool). A one-year hiring plan in that stage might call for something like one new executive, 3 senior employees, and 12 employees from entry to mid level. So the company would budget its options accordingly, obviously also aligning grants with external market conditions.

A prospective employee who wants to know whether an offered grant is “fair” really has no better method of evaluating this than by asking the company to explain how they came up with the number. Ideally as an employee you’d want to ask:

• What’s the fully diluted capitalization?
• How far is the company from liquidity? What type of liquidation event does the company anticipate?
• What are the company’s business prospects for the current year?
• What is the options range for my position, and where am I in this range relative to other recent hires?
• How far into the hiring plan is the company for the current year? How many and what positions will be hired?

And you ask these questions not because you can actually value the company based on the answers.  You ask as a test to see if the hiring manager has thought through the offer, and sounds as if there has been rational thought behind your compensation.  You want to work at a place where the management can provide sensible answers to these questions, independent of whether the answers can add up to a company valuation.

Many candidates do not feel comfortable asking these kinds of questions. Worse, some companies will not answer them, and will view the asking of such questions as a sign of impudence.  I’d say you should think twice about working for any company that would be insulted by the asking of these questions, but unfortunately that company attitude is not uncommon.

As a result, the best guideline to fall back upon for many prospective employees is back to good old Jonny:   What have I been offered at other companies, and what are my friends getting at their companies?

Which turns out to be not such a dumb way of evaluating offers, because many companies use more or less the same budgeting processes and have similar investor and advisor networks. So most companies end up in a similar range of options for similar positions. For most mid-to-senior positions, this will be a 5-figure number, and as long as that number can be justified to the employee, then you can move on to more important questions, such as why anyone would want to work at this company in the first place. There should be a lot of answers to that question, and the options offer should be only a very small piece of the puzzle.

I still think no one matches Marc for the sophistication and deep experience of his posts.  But I think that once you have the background that he covers, if you are working on a startup you might want something that gives you more guidance about what you are facing day to day.  So here are a few possibilities for interested entrepreneurs:

ReadWriteWeb is running a serialized book called Startup 101 that describes the startup life cycle.  It has a number of factors against it:  the information is very broad and basic, it’s directed only at web startups, it assumes little to no experience in business generally.  Nevertheless it looks to be shaping up as a nice basic primer for first-time startup folks.

Venture Hacks has some good info, mostly about fundraising but also assorted other categories.  This is possibly the best resource for those who are mystified about how VCs think.

Eric Ries has made a name for himself around the catchphrase “The Lean Startup” – a solid summary of fundamental principles of running a low-burn, nimble business.  Much of this might seem fairly obvious to folks who have worked in modern web startups, but Eric has a really nice clean delivery of the concepts.

Steve Blank has shared the stage with Eric for “Lean Startup” presentations, so the two have a common mindset.  Steve differentiates himself with a much longer history of entrepreneurialism, which gives him great authority and many informative war stories to share.  His customer development model is highly valuable to any startup (though a bit better oriented to enterprise customers than mass consumers).

Steve’s blog has risen to another level in recent posts about how entrepreneurs can stop lying to themselves and deserve an epitaph that signify a family life well lived.  I haven’t seen any other startup blogger come closer to giving this topic the time and attention it deserves – managing the demands of a startup in balance with a rich family life is incredibly difficult.  Perhaps too few have succeeded in this to inspire many good blogs about it.

Finally, probably my favorite category of startup blog is from those who are blogging the process while they’re doing it.  Signal vs. Noise is a classic in this category, but I like to find new blogs from relatively unknown startups.  Two that I happened across recently are from the founders of Expensify and Alice.

What are your favorite startup blogs?  I’m particularly interested in finding ones from startup founders who are blogging it while they’re doing it.

We are in a time when the government’s hand in the U.S. economy is heavier than at any time since as least as far back the 1930′s.  Makes me wonder who, if anyone, lobbies in D.C. for the benefit of entrepreneurial activity?

The National Venture Capital Association has been in the news of late, as it tries to avoid Congressional and Treasury proposals to regulate “private pools of capital” – a generic term that includes hedge funds as well as venture capital funds.  Hedge fund activity in the credit markets may have contributed to the systemic failures in the financial system, but commentators indignantly proclaim that venture capital had nothing to do with the current mess.

The NVCA is the main lobbying organization of the venture capital industry, and in their stated mission and nearly all of their public policy positions, they say they have a broader mandate to “support entrepreneurial activity and innovation.”  The NVCA wants Washington to understand the VCs are not merely investors, but part of the lifeblood of the entrepreneurialism that fuels massive portions of the U.S. and world economy.

I suspect that at first the fine folks at the NVCA made this connection to entrepreneurialism because it sounds worthy and friendly to politicians, as compared to being cast as mere financial speculators.  But now this connection has become a key conceptual anchor of their argument that venture capital should be treated differently from hedge funds and other private equity funds.  Those other guys are pointy-headed number crunchers, see, who move massive amounts of money and credit with extreme disregard for our financial system.  VCs are closely involved with startup innovation, heck they are practically entrepreneurs themselves!

This conflation of VCs with entrepreneurs is even more critical in what has become the most important lobbying battle in the history of the NVCA, the fight over carried interest tax policy.  I think if more entrepreneurs understood this particular public policy issue, there might someday be better lobbying in DC for related issues that are closer to the hearts and wallets of entrepreneurs.

Briefly, VCs are typically compensated in two ways, with management fees and carried interest.  Management fees are a small percentage of the total capital commitment of the fund.  For example, a $100 million fund might have a 2% management fee, so the VCs receive $2 million per year for their operating expenses.  Carried interest is basically profit sharing on the investment.  So for example, if the $100 million fund operates for 10 years, and makes $500 million, a 20% carried interest might be applied on the profit – that would be $500 million less the $100 million of invested capital, less the $20 million of management fees (assuming 2% per year).  So 20% of $380 million is $76 million.  I’ve smoothed over a lot of variations and complexities, but this is basically how it works.

And how the U.S. tax system works – smoothing over a thousand times more variations and complexities – is that you either pay ordinary income tax of 35%, or long term capital gains tax of 15%.  Have you guessed what the carried interest tax policy battle is about?  That’s right:  carried interest has historically been taxed as capital gain, but many are now calling for it to be taxed as ordinary income.  In the example above (which would not be a particularly large or extraordinarily successful fund), the 20% difference in tax rates would mean $15.2 million less for the fund managers.  You can see why this is the Battle of the Century for the NVCA.

Now, let’s get back to this point about VCs being practically entreprenuers themselves.  In Congressional testimony, the NVCA says that venture capitalists rise above mere “financial engineers” (presumably the hedge funds and private equity guys), contributing sometimes daily management attention and real “sweat equity” into startup companies.  Some entrepreneurs may snicker at that testimony, and others may pluck their eyeballs out rather than read it.  I can freely admit that I’ve seen VCs who do make invaluable contributions to their portfolio companies, far above merely providing money.

But if the NVCA really wants entrepreneurs to view their efforts to “support entrepreneurial activity” favorably, they ought to extend their views on tax policy to the issues that really and directly affect entrepreneurs.  See, although startup founders can readily enjoy capital gains treatment on the value of their equity, some bizarre tax policies in this country often have the practical effect of forcing ordinary income treatment on the equity stakes of many private company employees.  The NVCA is fighting tooth and nail so that VCs (who are almost like entrepreneurs, after all) can get capital gains tax treatment, while saying not a single word about the policies that cause millions of startup employees to have their equity gains treated as ordinary income.

There are many ways that the NVCA could advocate tax policy for the benefit of entrepreneurs, but I’ll note the two most obvious ones, one a layup and the other a long ball in difficulty of change:

The layup is the Section 83(b) issue.  This is just an utterly bizarre policy that is harmless to entrepreneurs if you file all your paperwork correctly, but it is ruinous to entrepreneurs (and often their companies and lawyers) when there is a mistake in filing.  Briefly, founders and very early employees of startups usually receive stock (not options, but the stock itself) that is subject to vesting.  The tax code says that ordinary income tax is due as the stock vests, on the spread between the price paid for the stock and the value on the date of vesting.

That’s a real problem, because even as the stock vests, it has no liquid market – meaning that the stock can’t be sold easily.  So an entrepreneur who holds this stock in a successful company would get huge tax bills that he or she cannot pay.  Fortunately, the IRS allows the stockholder to make a “Section 83(b) election” – this is an election to pay the tax at the time of the initial stock purchase.  Since typically the price paid for the stock is the fair market value of the stock at the time of purchase, there is no spread and therefore no tax is due.

So that would be harmless, except that if you don’t file the election in the right way at the right time (30 days after purchase), you have to pay taxes the default way.  And that kind of mistake does happen, and it can cost millions – not just for the taxpayer, because ruinous tax issues for company founders and early employees can easily sink the company itself, and also typically results in malpractice suits against the company lawyers.

Why should the default position in the tax law be to pay a ruinous tax that no rational person would ever voluntarily elect to pay?  Why not just have a law that says if I don’t do a cartwheel on my lawn every 30 days, then I have to give my house to the IRS?  This is just utterly inane, so inane that it should be an easy win for the NVCA if they were to take it up as a lobbying cause.

The long ball would be for the NVCA to go after AMT/ISO reform.  This is a very complicated issue, but bear with me, because this problem does routinely affect startup company employees.  In a vast, vast oversimplication:  the problem is that the Alternative Minimum Tax requires Incentive Stock Option holders to pay a tax on exercise of their options, even though the company is private and there is no liquid market for their shares.

In a successful company, this can mean a tax vastly exceeding the assets of the employee, with no means of paying it.  A typical solution for many is to sell their shares at the mercy of the less liquid secondary markets (at severe discounts), in order to be able to pay the taxes.  And of course, a sale in that situation is typically taxed at ordinary income rates rather than capital gains rates, because of ISO tax rules.  So AMT and ISO rules conspire to mean that startup employees often are forced to sell their stock at discount values, and to add insult to injury the gain is taxed as ordinary income rather than capital gain.

So, NVCA:  you need to go after those two issues before any knowledgable person should regard you as an advocate for entrepreneurs and innovation.  Not only would you get the cosmic satisfaction of your actions actually conforming with your words, but you would also likely get grateful contributions from entrepreneurs and their lawyers.

Faith and reason, properly understood, are intertwined sources of truth. The encyclical Fides et Ratio states this more elegantly:

Faith and reason are like two wings on which the human spirit rises to the contemplation of truth

In this light, I contemplated Fred Wilson’s note about investing on faith. The implication for some may be that this is investing without reason. However, Wilson’s leap of faith is no less legitimate than “pure” reason. Unlike religion, truth for startups has an ultimate arbiter in this plane of existence: return on investment. There are legions of startups that had all the reasons in the world to succeed – great idea, huge market, killer team – and yet they failed nonetheless. I’d bet that experienced startup investors have succeeded as many times on what Wilson calls faith as they have by stacking up reasons.

Coincidentally, the next day, Steve Blank posted on the startup transition from faith to facts. It might seem hard to argue with his view that startups begin on faith and must quickly move to facts to succeed. Again, I wouldn’t draw the divide that sharply. I’d say faith is a requirement throughout the journey, and so are facts. From day one, you must believe in what you’re doing, have faith informed by reason. And also from day one, you must engage with the facts; endlessly and relentlessly collect, examine and act on available facts with all your reason supported by your faith.

I would say that ideally startup hiring managers should try to get folks who’ve been through at least two of the four private company stages, including at least one that the hiring company has not yet been through.

Well, I would say that, except I find that these “stages” are not particularly well defined by anyone.  Or at least not anyone I could find in 28 seconds of Googling.  So like any moron with a digital pen and printing press, I can just make up my own definitions.

Some of the typical “stage” terms are seed, early, expansion, and late - these are often used by investors, are vaguely defined, and don’t always track to a company’s internal status and expectations.  I’ll try to align the four stages of private company progress with some more-fun-if-equally-irrelevant quadrilateral perspectives, from psychology and Buddhism.

Stage I:  pre-product

psych: unconscious incompetence – the individual neither understands or knows how to do something, nor recognizes the deficit or has a desire to address it

Buddhist: the path to stream-entry; the fruition of stream-entry

This stage is everything before you have a product launched to anyone outside your “friendlies” (relatives, friends, close contacts) – from the idea on the napkin to your Hello World! launch to the general public.

What others call ‘seed stage’ is often short of this – just the idea through a prototype, with ‘early stage’ then following from pre-launch to revenue traction.  But although that division may be natural for funding demarcation, from a product perspective you just don’t know what you have until it’s in the hands of the buying public, so I regard all of this period of not knowing as a single period of sustained ignorance.  It is all the pre-product path before the fruition of entering the great stream of commerce.

Stage II:  maximum iteration

psych: conscious incompetence – though the individual does not understand or know how to do something, he or she does recognize the deficit, without yet addressing it

Buddhist: the path to once-returning ; the fruition of once-returning

This is the period where the company has both the maximum flexibility and the most urgent need to rapidly iterate development.  Not just product development – everything about what the company makes, does and is.  The flexibility is there because the product has been launched, which not only lifts the inchoate burden of launch, but begins the collection of data (customer feedback, product metrics, use data etc) which can now be mined for insights about how to shape and reshape the product.  The need is there because if you don’t iterate, you will not grow and then you will not exist.

And again, it’s not just product iteration but an opportunity to examine and tune everything you do as a company:  recruiting and review systems, management team and tools, compensation, cultural principles, office design, everything.  The things you do to shape the company during this period will have an enduring effect on everyone who works there for years to come.  Too bad you don’t really know what you’re doing just yet.  But now is the time to get on the path to once-returning, to reincarnation and rebirth into the next stage.

Stage III:  revenue optimization

psych: conscious competence – the individual understands or knows how to do something; however, demonstrating the skill or knowledge requires a great deal of consciousness or concentration

Buddhist: the path to non-returning ; the fruition of non-returning

Unless you were oh-so-clever enough to launch without a revenue model, the company began to enjoy early revenues during the maximum iteration stage.  Iteration remains critical, but now your flexibility is naturally limited by the existence of paying customers, who often have a limited tolerance for change.  You have to optimize existing lines of revenue while making careful tradeoffs in launching new lines of revenue.  You may for the first time begin pursuing meaningful acquisitions or divestments that could change the face of the company.

This stage may be the most difficult among the four; your hard-earned knowledge seems to have the perverse effect of increasing the challenge.  When you were young and ignorant, it served you well to underestimate the difficulty in changing the world.  Now that some corner of the world has bent to your dream, you find that the dream is a shared hallucination of many rather than your own private trip – and your role isn’t to enjoy the ride but to supply the vehicle.

Nonetheless you are on a path of no return:  in returning there is only defeat and regression to a lower form of living; you can only move forward for true enlightenment.

Stage IV:  maturity and liquidity

psych: unconscious competence – the individual has had so much practice with a skill that it becomes “second nature” and can be performed easily (often without concentrating too deeply)

Buddhist: the path to enlightenment; the fruition of enlightenment.

The mature company does not have to be moribund, there is a vitality and pleasing grace to the well-oiled machine.  You know what you’re doing and you’re at the height of your powers, freed from the mixed blessings of youth.

And no matter your personal attitude towards money, getting the company to liquidity is the last barrier to enlightenment.  (Here I’m putting aside the case of those who want to build a big, sustainable private company without calling it a “lifestyle business” – the more typical startup dream involves shareholders and employees who want to be able to freely trade their stakes in the business on the open market.)

With your first big liquidity event, you find out if the other side of that barrier really is nirvana.  You find out whether the money has changed you, or whether it exposed who you really are.

That is the startup path as self-actualization, the startup path to enlightenment.  When you’re hiring for a startup, you need to pay careful attention to which of these stages your candidates have progressed through, and uncover their self-knowledge about their enjoyment in what has been learned and their eagerness to learn what hasn’t.

btw, if you are on that path or would like to be, and have skills in javascript, php and/or other web programming-fu: send me your résumé! (just a link to your LinkedIn or other relevant online bio would also be fine.)  use the intarwebs to find how to contact me.

A lot of people might reflexively answer ‘Google’ on the belief that it’s still the most interesting and profitable company in technology.  While this isn’t as bad as saying ‘IBM’ or ‘Microsoft’ it’s still an undue faith in the benedictory power of large companies.

Not that there’s anything wrong with folks from IBM or Microsoft, mind you – I’ve worked with many and hired some, and don’t regret any incidences from either.  However, as a statistical matter, you’re not likely to find the kind of employee that really thrives in a small startup if they’ve spent a ton of time working in longstanding behemoths.

Doesn’t mean that big companies can’t innovate – in fact these days some say that only big companies can innovate big.  Of course, it may be that the people saying that tend to reap consulting dollars from big companies for advising on innovation . . .

Anyway, Google is a slightly different case than IBM and MSFT, in that it hasn’t been around as long and is not quite so large in terms of revenue and employee base.  However, because of the neck-crimping trajectory of Google as a company, I think it might be hard to get startup-ready employees out of Google:  the good ones that are still there are engaged on the big premium projects, many of the not-so-good more recent vintage are as big-company-minded as anyone, and the truly great early employees who departed are retired or VCs – too rich to be enticed into a little startup unless they start it themselves, which they rarely do as it distracts from counting the money.  Even if you follow startup news, you don’t hear so much about Google guys leading startups, with the notable exception of Paul Buchheit at FriendFeed.

So, if not Google, what company should be the most desirable to see on a résumé, all other things being equal?  I think I’d pick the one company that spawned founders and early investors and employees at YouTube, LinkedIn, Facebook, Yelp, Slide, Zinga and Yammer:  PayPal.

See, the ideal company – at least in terms of educating talent for the next venture – doesn’t have a Googlerian or Microsoftesque trajectory.  From founding to acquisition by eBay for $1.5 billion, PayPal lasted about four years and grew to a profitable company with over 600 employees, having been through a lot of growth, innovation, regulatory challenges and corporate evolution.  People in key positions through the bulk of that time saw the whole arc of company development, but never got so fat and happy that they didn’t want to do another startup.  Yep, if you’re hiring for a startup, the name you’d most like to see on that résumé is PayPal, pre-acquisition by eBay, natch.

I’m spending a good amount of time in residence with my old friends at Storm Ventures, which reminds me of the last time I sat around with them, back in 2002. Coincidentally that was also around the last time the sky was falling, though the dot-com implosion was more localized than today’s lovely global financial crisis.

Although more contained, I think in many ways that downturn felt more severe in my world, the tech industry centered around Silicon Valley. It seemed that there were more local job losses, but more than that, the feeling of panic ran a little deeper, and wasn’t backstopped by the recent practical experience that we have today because of the prior crash. When the dot-com bubble burst in 2000, the prior domestic market crash was in 1987, and 13 years is enough time for people to forget, long enough for the prime of a career to pass through the ephemeral industries of the tech world. In 2008, the last crash was only 8 years ago, so now most people working here remember what happened the last time, and they can separate the chickens from the oracles.

A lot of people say that an economic downturn is a great time to start a new business. Of course, there’s a difference between saying it because others say it, and saying it because you’ve seen it before. In 2002, one of the partners are Storm was saying it to me, and it all made logical sense: costs were lower, recruiting was easier, competition was scarce. But I hadn’t seen it before. Tae Hea Nahm and Tim Danford at Storm were sure it was the right time to incubate a company, so they formed Black Storm Networks and recruited the founding team of Ajay Mishra, Pat Calhoun, Bob Friday and Bob O’Hara. The founders huddled in Storm’s offices through the dark days of telecom nuclear winter and built the company piece by piece.  I was lucky just to hang around and watch the sweat and optimism they put into every single day.

Jump ahead to 2005 and Black Storm had become Airespace, the leading startup for a new class of enterprise wireless networking equipment.  That year, Airespace was acquired by Cisco in a great deal for both sides. I was lucky again, for by that time my peripatetic career had allowed me first to invest in the company for another firm, and then to join the team in time to help the last push.  For most people, the story of any startup ends with the liquidity event. But I enjoy watching the afterstory too; I like to follow whether the acquired product continues to succeed, whether the team has an impact in the new company and afterwards. On that measure as well as others, I’m really proud of the Airespace team.

The product and its successors achieved a dominant market position. Airespace’s CEO, Brett Galloway, has become a senior exec at Cisco responsible for all wireless and security products. Pat Calhoun is now the CTO of one of Cisco’s biggest business units. Bob Friday continues his wireless wizardry as a director of engineering for Cisco. After several successful years for Cisco, Ajay joined Airespace’s biz dev paladin, Bob Tinker, for another startup run. Bob O’Hara pulled perhaps the best move, retiring from Cisco last year to live in Twitterville.

Anyway, my fondness for that team and those days brings me back to these days, back at Storm with time to dream. I believe it because I’ve seen it:  an economic downturn is a great time to start a new business.

Update:  Bob O’Hara adds his perspective.

The Case As Greatest Startup Blogger

Have you read Marc’s blog?  (I am not on a first name basis with Mr. A, but I can’t use his last name throughout this post because I keep misspelling it, which drives me nuts.)  I challenge you to find any other blog about tech startups with a higher percentage of incredibly incisive and valuable posts.  He’ll lay out every important guideline for being a competent startup entrepreneur.  He’ll tell you the truth about venture capitalists.  He’ll give you invaluable career planning tips, warn you about entrepreneurial misjudgment, tell you how to hire, and even describe the role of luck and age.  Did you go to business school to learn how to be an entrepreneur?  Well, you should have just flushed $100K down the toilet and read his blog instead.

But wait, maybe he’s not a ”’real blogger”’ – can you be great if you’ve been on hiatus since last August?

I say yes, it’s about quality over quantity, even if you can have quality in high quantity.  I like mystery fiction and consider genre work as legitimate art, so I’ll draw analogy from there.  I prefer Dashiell Hammett over Donald Westlake, even though I think Westlake is just as talented a writer as Hammett if not more so.  Hammett put every beautiful thing in his artistic soul into about a dozen novels and short story collections, while Westlake spread it out over more than 100 volumes, using as many pseudonyms as Hammett had books.  Both were great, but Hammett was the greater artist for the purity of his delivery.  Marc’s blog is pure art compared to the good-quality-high-volume blogging by some venture capitalists and lawyer-turned-blogpreneurists.

And of course, the real authority behind Marc’s blogging about startups is his phenomenal success as an entrepreneur.  You have to listen seriously to someone who’s done it before.  But can he really be considered the greatest living tech entrepreneur?  Let’s turn to that -

The Case As Best Living Tech Entrepreneur

Well what does “most distinguished” or “greatest” or “best” mean anyway?  Here I just mean the one who knows the most about making successful tech startups, the one you should listen to if you want to be in this business.

Yes, I know that Gates and Jobs, Larry and Sergei, Bezos and Omidyar, Ellison and Slim and many others have made much more money in tech.  But sheer wealth does not settle this question.  It’s about how you got there.  I’ll eliminate guys like Carlos Slim because they made their fortunes as investors and financiers, not as the operational guys who built the businesses.  All of the other guys I just mentioned, except one, made the bulk of their entrepreneurial fortune from just one company.  I wouldn’t exactly say “once you’re lucky, twice you’re good” with these guys – they are all way beyond good with what they’ve done for their companies and for tech history – but I would value advice from MarcA over any of them, because he’s both made history and created his fortune across multiple entrepreneurial efforts.  People who have had the vast majority of their success over a single company are just statistically disadvantaged in providing the kind of advice that entrepreneurs need.

Jobs is the one to consider carefully.  Between his first and second acts at Apple, he founded an interesting business in Next and a magical one in Pixar.  But his reputation gives me doubts about whether he is capable of giving advice to entrepreneurs – it’s possible that his own genius gets in the way.  He might be like Magic Johnson:  an incredibly gifted athlete who could not make the transition to coaching because he found it hard to explain the game to people who did not have otherworldly talent.  Of course, all this is just impression from news reports and second-hand sources; it’s possible that Jobs is a great coach.  But the evidence isn’t in the public record or the rumor mill.

And now, let’s look at Andreessen.  He founded one of the key companies of the Internet age in Netscape, becoming the original tech hype poster boy.  Netscape went public, sold to AOL for billions and was finally crushed by Microsoft.  Marc suffered the hype backlash and doubts, but he got back on the horse and founded Loudcloud, which grew to a $100 million revenue business, went public and then cratered in the dot-com bust.  Marc and his CEO rebuilt the company as Opsware, built up another $100 million revenue business, and then sold for $1.6 billion to HP.

Does anyone have a record like this?  Recap:

Who is even close to this?  I actually hate giving this much love to someone in public, but this string of experience is so compelling, I had to write it down before I could believe it.

The Case As Mediocre VC

With all the love I just dropped on MarcA, how can I predict anything less than glorious success in his new efforts as a venture capitalist?  I won’t link the posts again, but you can see on his blog that the guy has done his homework and he really understands what he’s getting into here.

Part of my doubt is that I’m just playing the odds.  VC is an industry where luck plays a vast role in success, especially early in the VC career.  If you’re not lucky early, you don’t get to keep trying, because people will not keep giving you money to invest.  This is different from entrepreneurialism, where if you are determined, you will get to keep trying over and over again until you give up – you can make your own luck through repetition.  Again I’m not going to relink, but above I noted that Marc knows how to make the most of luck.  Nevertheless, it’s called luck for a reason, namely that a favorable outcome is against the odds.

More importantly and less sensibly, off the top of my head I’m not aware of any great VC who has the record of entrepreneurialism that Marc has had.  I guess that’s not surprising, since I just spent 500 words explaining that I don’t know of anyone with Marc’s record.  But as many people (including of course MarcA) have noted, there have been great VCs who were lifers in the business as well as great ones who came from operational roles and even former journalists and analysts and lawyers.

But that record of Marc’s is just too entrepreneurial.  It seems to me that guys with that kind of DNA have some difficulties in becoming, essentially, a specialized class of money manager.  Some of them can be great individual investors (investing their own money, which Marc has already done well), but they seem to have some sort of mental discomfort in managing other people’s money.  I don’t know why, but I’ve seen that quite a few times.

Mind you, if I ever got a chance to invest with him, I would take it . . . because it would be worth losing money with him as an investor to get time with him as an entrepreneur.

update 30 Aug 09:  Marc seems to have taken down his archive, which is really too bad.  Fortunately, you can still find his posts by searching the Internet Archive Wayback Machine.

I understand the compulsion to compare every hot startup to the current media darling that literally put its name next to the definition of “Zeitgeist” – but still, I don’t believe there is any practical value in that exercise.  A meaningful comparison compares things of like kind, and comparing every company to the once-in-a-decade champion is not apples to apples.  Take a look at this list of companies, which I’d say are all the same kind of apple (of course one of them is literally an Apple):

These are the true giants of Silicon Valley (plus our favorite giant from up north), all companies that have spent a goodly amount of time with a market cap over $100 billion.  Comparing any private company to these monsters is a fool’s game; it’s like comparing a college basketball player to Michael Jordan.  Actually it’s worse than that – projecting athletic talent is considerably easier than projecting $100+ billion success for a company, because there are orders of magnitude more points in a company where externalities and luck play a tremendous factor.  (I always like to recall that Intel and Microsoft were initially made giants not by their own strategy, but by the strategic decision made by IBM when it chose to outsource production of its PC microprocessor and operating system.)  These true giants are Black Swans, by definition nearly impossible to predict, and useless as comparative points except when holding both points in retrospect.

If you must make comparisons, it’s more realistic to compare to the next tier, for example:

I could put a dozen more on that list, but I’ll let you pick your own peer group.  Any one of those companies (yes, even that one that you think is irrelevant/dying/dead) could still take the multi-decade journey to giant-hood.  But even if they never do, they’ve accomplished something extraordinary in growing up from a tiny Silicon Valley startup (with one favorite from up north) to an independent company, a true a difference-maker in technology and the daily lives of millions upon millions of people.  Because they haven’t had such outstanding externalities and luck in their favor, they are a better basis for comparison.