Launchpad LA today announces it will accept applications for its third class of Los Angeles-based tech startups. There are significant VC commitments (listed below) – every entering company will get $50,000 in funding, mentorship from top VCs and successful entrepreneurs plus free office space. For any company interested in applying please visit the website.

History
For the past 2.5 years there has been an initiative in Los Angeles called Launchpad LA.

The goal for this organization is four-fold:

• To provide mentorship for some of the most promising young companies based in Los Angeles or willing to relocate to LA
• To give visibility to these companies to: Sources of funding (angels / VCs), business development partners, mentors who have themselves built successful companies, the press and potential employees to hire
• To show these companies that they can remain in LA. There is a robust eco system, great leaders and the ability to build companies with enormous exits.
• To provide an opportunity for VCs and senior executives to engage with the community by giving back rather than just attending more cocktail parties

How has Launchpad LA done? 23 companies have gone through Launchpad LA. Of these 19 have received funding (10 have received significant amounts of VC funding) and 5 have been acquired (2 for more than $30 million). But the most important metric has been the deep and lasting relationships that have been built with startups and also between senior executives. One senior mentor to Launchpad LA recently said,

“I got more out of Launchpad LA than I even put in. One of the people I mentored is now a senior executive at AOL in NY. And my company is hugely relevant to what they’re doing so having an advocate at senior levels there is certainly a help.”

We get feedback like this often.

So What is Different for Class Three?
The first two years of the program focused on education & mentorship. There were regular events where experts talked about: fund raising, term sheets, constructing a team, product development, establishing biz dev partners, M&A, dealing with the press, etc. This education will continue.

But this year there are two new components: funding & a facility.

Each company will receive $50,000. Several funds and firms are participating in this investment including Rincon Ventures, Idealab (Bill Gross built the original incubator and there will be active support from Allen Morgan), Baroda Ventures, GRP Partners, David Cohen (founder of TechStars), David Tisch (founder of TechStars NY), DLA Piper and Stubbs Alderton.

Office space will be free and is in Santa Monica, walking distance to the Third Street Promenade.

Each local participating VC will base themselves out of this facility at least 1 day / week and plan to spend time actively with any company that is admitted into Launchpad LA.

There is also an amazing group of VC & Individual advisors who will help participate and steer the direction of Launchpad LA including:

VCs: 500 Startups, BlueRun Ventures, First Round Capital, Foundry Group, Menlo Ventures (Shervin Pishevar), MK Capital
Individuals: Jason Calacanis, Paul Kedrosky, Peter Levin (Principal, GeekChicDaily/Nerdist Industries), Howard Lindzon & Eric Ries

This is in addition to great mentors and this list keeps growing.

Superstar Sam Teller has joined to run Launchpad LA. He previously co-founded Charlie, a Los Angeles based media company and interactive agency, where he worked on projects for Samuel L. Jackson, Tumblr, and Dick Clark Productions. Sam was also a member of Barack Obama’s presidential campaign and inaugural new media team and previously worked for Google, Credit Suisse, The Colbert Report, and Senators John Kerry and Hillary Clinton.  Sam was born and raised in Los Angeles and is thus a huge champion of the LA startup community. He received a BA from Harvard, where he was business manager of the Harvard Lampoon.

Adam Lilling will continue to be an active leader in running Launchpad LA. Adam played a hands-on role in helping many of our last class through funding and even took some board seats and advisory roles. Sam & Adam will be joined by Josh Webb who I have worked closely with and who formerly worked at Idealab.

But wait, does that make Launchpad LA an incubator now?We always wanted to be seen as a “mentorship organization” where people are asked to give back to their community. But having an

office space would allow us to spend more time together and also allow others when they’re visiting from out of town to have a place to hang out and to get to know some of LAs most promising companies. So we went ahead. And everybody seemed to want to see us have a fund so we’ll do that, too.

We sort of think of ourselves as an “accelerator” who provides strong education & mentorship.

There are at least 6 incubators now being set up in LA. Can the community support them? I use the words of one of the wisest men in this space who started much of this revolution, Bill Gross of Idealab who said:

 ”I think that the more initiatives, the better … I think it’s the many initiatives and variety that make Silicon Valley, Silicon Valley and that we need to do more of that here.”

So we’ll be supportive every initiative in town and doing all that we can in LA to encourage more tech entrepreneurship across any startup incubation or acceleration programs.And we agree with that. If our community supports more potential entrepreneurs to try, if it funds more people with dreams, if it surrounds talented people with mentors, if it coaches them through their first deals and their team formation … that’s got to be a great win for society overall and for LA in specific.

This is in addition to some great colocation facilities such as CoLoft.

Some recent funding & M&A successes:

Here are some examples of recent news from Launchpad LA companies. Not exclusive and in no order. All are big successes for LA. Some needed us more, some needed us less. All have become valuable contributors to the LA ecosystem and is what makes things here so great.

1. MovieClips – Announces $7m funding from MK Capital, Shasta Ventures, First Round Capital, SoftTech, VC and Felicis Ventures.

2. Sometrics – Acquired by American Express for a reported $30m after being funded by Greycroft Ventures & Steamboat.

3. Cramster – Acquired by Chegg the leading online book rental company

4. TechForward – Raises $7 million from NEA & First Round Capital

5. Pose – Raises $5 million in 2 rounds from GRP Partners, True Ventures, Mousse Partners & Founder Collective

6. GumGum – Raises $11 million financing. CEO on front cover of Entrepreneur magazine.

7. DataPop – Raises $2 million from Rincon Ventures, IA Ventures and others

8. Gendai Games – Raises $7 million from Steamboat, DFJ Mercury, DFJ Frontier, Greycroft, ff Ventures and others

9. Ranker - Raises $1.3 million from Rincon Ventures & Tim Draper

and so much more. MobileRoadie, TicketMob and many others.

Come be a part of our future success. Apply here or send this post to your friends who should apply. Or if you need to reach us our email is launchpadla@gmail.com

We look forward to working with you.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

I haven’t had too many board meetings lately so I want to get this timely post out now lest somebody think I’m talking about their company or board in particular. This is a post about ALL boards.

Back when I ran board meetings as a CEO, the biggest annoyance was Blackberrys. You would always be able to tell what was going on by seeing the unhealthy infatuation board members had with staring at their crotches. Somehow they imagined you didn’t notice that they were glancing beneath the table secretly firing off one-line emails.

Every entrepreneur I know bitched about it and the smartest boards banned Blackberrys.

Fast forward to today. We now have ultra-lightweight laptops (MacBook Airs) or iPads and totally available Wi-Fi connections. So every board meeting I’m at has laptops opened and iPads on. They are just there to “be productive” and review your material. Um, yeah. This is a mistake.

Why a Mistake?
The board meeting is the one time you have as a management team to engage your investors. If you’ve raised money from meaningful people then you really want to maximize every minute of this time. That’s why I advise startups to get the board packs out early (so board members actually read them) and to focus as little of the board meeting as possible on “updates” and as much as possible on “strategic discussions.”

If you want to know how I believe you could run better board meetings you can read my 3 posts on “Running More Effective Board Meetings,” “The Agile Board” and “How to Communicate with Investors Between Meetings.”

But you know in your core that there is no positive gain from investors or management having laptops open. They don’t need to “go through your deck,” “access the financials,” “look at your competitors products” or any of the other BS reasons to have a laptop open. They should be engaged 100% in the meeting. And even they would prefer this. But given the temptations when your laptop is open that are elicited by those little popups of incoming email it’s impossible to not “just quickly read this message and fire off a response.”

We are all guilty. We are all human.

The reality is that over the years I’ve sat in 100′s of board meetings and I see what people do on their laptops. They flip between your presentation and email or the Internet. If any of us have our laptop sopen in any meeting we can’t help it. Which is why I don’t open it. It’s why when I go to a romantic dinner with my wife I leave my Blackberry in the car (at least I intend to ) – because given the temptation we just can’t resist. We’re human. Even your management team members with laptops get sucked into other work.

The only solution to maximize your meeting – no laptops. Period.

What to Do About It?
If you have a 3-hour board meeting I recommend that you take a 20-minute email break 90 minutes in. Tell people in advance. Tell them that you have a “no laptop” policy so that you can maximize your time with them. Send them this post and blame it on me – I don’t care.

But if they know in advance that they’ll have a chance to get to email to “sign off on that important deal they’re supposed to close” there is no excuse for not giving you undivided attention for the time you have together.

Just Say “NO”
Ultimately it’s up to us as VCs to enforce the behavior amongst our peer group. There needs to be collective pressure to really be engaged in our board meetings or why have them at all. If we all agree to leave our laptops in their bags (not even on the table where we’ll be tempted to open them!) in exchange for an Internet time out every 90 minutes then we can all drive better behavior.

Think of it like a smoking break for email addicts.

And … Just say “no” to laptops in board meetings. I’m taking the pledge today.

You?

Image courtesy of Fotolia and the generosity of Ryan Born

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable

Later today I’ll be giving a keynote at the VCJ Venture Alpha conference here in San Francisco. I was asked to speak about the topic of “what is going on in the venture capital world and what is the next big thing after social networking?”

Tough topic but I have some views. I thought you might enjoy reading the presentation before even others see it!  It is pretty self explanatory. You can view here or go to DocStoc to download it (no, I’m not an investor, it’s just a great repository for docs).

Next week I promised to follow up on PE Hub, the main journal VCs read about our industry, with a detail description of some specifics that are happening. Watch out for that – I will have a lot more details.

I’ve listed some great VCs in the presentation. I’ve left off many great ones. It isn’t intentional. You can’t cover everybody in a prezzo. Please don’t read anything into that.

And all feedback welcome! See you in the comments.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

Everybody knows that when you raise money at a startup your ownership percentage of the company goes down. The goal is to have the value of the startup go up by enough that you own a smaller percentage of a much larger business and therefore your total personal value goes up.

The simplest way to think about this is: If you own 20% of a $2 million company your stake is worth $400,000. If you raise a new round of venture capital (say $2.5 million at a $7.5 million pre-money valuation, which is a $10 million post-money) you get diluted by 25% (2.5m / 10m). So you own 15% of the new company but that 15% is now worth $1.5 million or a gain of $1.1 million.

But understanding how you’re likely to get diluted over time is a more difficult concept. And figuring out how much your equity may be worth over the course of a 5-year stint at a startup is even more complicated.

I’ve had to simplify a bit, but to make it easier to understand I’ve teamed up with Jess Bachman at Visual.ly. If you want to see a view of the power of their work check out this Steve Jobs infographic. I’m a huge believer in Infographics and the ability to create deeper understanding of complicated topics through visual means. As “Big Data” becomes more pervasive the power to visualize will become increasingly important.

And Jess is awesome at his trade. His personal blog with some great example is here.

So here is our crack at explaining the world of dilution to you. Let us know what you think. And if you want more goodness like this don’t forget to sign up to my newsletter and to follow Jess on Twitter. We’ll bring you some more goodness again. Let us know what topics you want us to break down for ya.

Listen, understanding the world of valuations and how equity gets split on a sale is a whole lot more complicated than the graphic depicts. I hope it gave you a flavor. If you want a deeper dive I shot some video on calculating ownership and dilution over time. And make sure to read VentureHacks.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

A month ago I applauded Reed Hasting’s bold decision to split his business into two components. Today he’s announcing that they’re backing out of this decision.

Netflix as a service has always prided itself on movie recommendations that are tailored specifically to you, plus user ratings on the quality of films. So let me use their ratings system to judge their actions to date and explain how I think things will break in the future and why.

The big price increase: 5 out of 5 stars. The remainder of this article will deal with this decision but it comes down to the different economics of DVD rentals due to “the first sale doctrine,” which gives Netflix a complete library of films and the fact that the first-sale doctrine doesn’t apply to digital downloads. This makes their business types very different. Some customer segments value the DVD business and these may be more price sensitive. Some customer segments value the convenience of instantly available films. They might be willing to pay higher prices (and perhaps not an “all you can eat” price but a “pay as you go” price per film). They are potentially different business models. Netflix needs to segment their customers and charge each what is appropriate.

The decision to split the businesses: 3 out of 5 stars. I really like the clarity of two business units—whatever you name them. Each with its own head, its own financial reporting and its own content strategy, pricing strategy and marketing strategy. Did they need to be separate legal entities? No, probably not. But creating better visibility for investors of the profitability of each unit and accountability for bosses of each to perform well according to differnet metrics is a good & important idea. Perhaps they should have just created business units called: Netflix DVD & Netflix Streaming. Or take a play out of Coca Cola and called them Netflix Classic & Netflix Digital (note: in the future they may want to have downloads and not just streaming so I like “digital” more than “streaming.”)

The handling of the announcement to split the businesses: 1 out of 5 stars. Netflix announced the changes to its company via a blog post. A blog post! While I loved the sentiment of what was written in the post, the lack of the human touch made it DOA. Netflix needs to borrow the marketing prowess of Salesforce.com. You need to plan big announcements. You need some showmanship. You need to invite the press, talk to them, let them ask questions. You don’t handle major announcements via a blog post and no touch points. Of course the press is going to roast you. Duh. They don’t understand the complexities of your business. They need to grill you with questions and look in your eyes as you respond.  Not a freakin’ blog post. So how will consumers react? Basically their reaction is heavily correlated with the press coverage of your rollout. Here’s a brilliant post that they *might have* written but didn’t.

The name Qwikster: 1 out of 5 stars. I was asked by a journalist at the NYT if I thought it was a clever name since it was perhaps intentionally retro. I responded, “no, it’s not clever. They thought about it for 5 minutes. Probably the 5 minutes before they wrote their blog post. What is my evidence? They didn’t even bother to get the Twitter handle for it. A quick read of the Qwikster Tweet stream talks about “bible studies” and the like. I, for one, read the Tweet stream right after Qwikster was announced. I can assure you that it was most certainly not about bible studies. It was filled with profanity and pretty dirty commentary. Much of this has been deleted, me thinks. That’s not how you handle a major announcement in your company. WWMBD?

The decision to have two IT systems for Netflix & Qwikster: 1 out of 5 stars. One of the biggest things that came up in the 255 comments to my original post was how disappointed people were in having to have two separate IT systems for Netflix & Qwikster. Two separate rating systems, two separate queues, etc. Yeah, I thought that was pretty dumb, too. Again, I think nobody had really given much thought to what customers would want in the rollout. I stated in the comments that I felt that even with separate legal entities they could have had APIs between the IT systems that allowed for reviews, queues, billing info, etc. to be synchronized. This is the main reason the tech elite roasted them. Dumb, da-dumb, dumb, dumb.

The decision to back-out of the splitting of the business: 3 out of 5. Given how badly the announcement of the splitting went and their inability to control the PR cycle (or their stock price!) I guess it’s not the end of the world to unwind their decision. Right? Well at least this time they’ll handle the announcement of the change more carefully. Or …

The announcement of the decision to back-out of the business: 0 out of 5. JFC. Really? Major change by blog post again? How’d that work out for you last time?

Fan Summary of Netflix Redux, the movie: 2 out of 5. Netflix is a great business. I use it all the time. I’m a 99% streaming guy so I do want a bigger library. There are some films I find on iTunes or NVOD that aren’t on Netflix. I pay for them separately. I’m in the convenience “I want it NOW!” customer segment. But they sure need somebody at the top handling their marketing and PR better. Maybe the person that runs this is tremendously talented and Reed Hastings is setting the agenda. Or maybe they need to hire somebody with more gravitas / experience. But if I were on the board that’s what I’d be complaining about more than the changes to the business, the separation of business units, the loss of some customers, etc. Because poorly run marketing can negatively affect a company. And it ain’t rocket science.

So with that out of the way …

Is it ever ok to fire your customers?

Netflix increased prices by 60%. They are projected 1 million losses of customers beyond what they had expected: 200,000 from streaming and 800,000 from their traditional DVD mailing business.

Is this suicide? Is it ever a good idea to “fire” your customers?

Before answering let me preface with the following to take them off the table in the debate:

Customer Segmentation
I’m sure you’ve all heard of customer segmentation before. In case you haven’t there’s a primer here. It basically means that you split your customers into “like groups” that can then be analyzed as a constituency and different groups. An example of how a customer segment discussion inside your business could take place is in this post I wrote on Customer Segmentation (“Elephants, Deer & Rabbits”).

Each customer segment of your business needs to be analyzed to determine whether they are profitable enough given ongoing costs to serve them relative to the revenue you would receive and the retention money you’d have to spend to keep them with your service.

Once you’ve run profitability analysis on each of your customer segments you need to decide whether you have the operating model that allows you to serve each segment profitably and even if you do whether you want to divert management attention to serving these customers.

In Netflix’s case, I’ll bet that there are a large number of DVD customers who don’t want to pay for streaming. They’re the “cost conscious” segment and perhaps overlapping with the “technology laggard” segment. The problem with this segment for Netflix is that they may not be profitable at the current price points and at a minimum servicing them isn’t pointing at where Neflix knows its future will be. Netflix estimates that only 10% of its 24 million customers would be “DVD only.” If this is right then some of these 2.4 million customers might have actually gotten a price decrease. If they were on the $9.99 all-you-can-eat DVD + Streaming plan they can now pay just $7.99 for DVD only. A 20% savings for a cost conscious consumer.

If you’re cost conscious and want “streaming only” service you can get that also for $7.99 / month. If you’re like me, the “convenience customers” I don’t mind paying $6 extra per month for the right to have DVDs and a broader library even though I never seem to use it. If that segment is 25% of their users then they’ll rake in a cool $432,000,000 extra per year with very little additional costs. That extra profit will go a long way toward buying content rights for streaming plus making up for the lost customers who abort from Netflix altogether. So probably not a bad bet to fire the low end of their customers.

Here are some more examples of where businesses haven’t wanted certain customer segments:

1. Hypermarkets & convenience shoppers—In the local super market industry it would be heresy to not have a “quick check out” aisle for people with less than a certain number of items to purchase. The local residents who shop there expect to be able to come by frequently for items such as milk, bread or diapers. They don’t want to wait alongside those with their weekly shopping basket.

But did you know that many “hypermarkets” intentionally don’t have convenience lanes? Yes, customers complain. By the hypermarket business is based on turning over large volumes of product and making money on the number of “turns” that each product has and on the banking “float” (when you get paid versus when you have to pay your suppliers). They price cheap, stack ‘em high and want to move a ton of product.

As a result they’re often crowded. They don’t want to discourage their $700 shoppers with $10 shoppers buying milk. “But if they built a new lane then they could serve both customer segments, right?” Not necessarily. The high-volume merchant is built on a different model. They don’t want that $700 customer not shopping because they can’t find a parking spot taken by a $10 shopper. Yes, there is an economic cost to parking space scarcity.

They have security personnel that check you out as you leave. They don’t want to increase the volume of people flowing through this queue.  And so on.

A customer is not a customer.

2. Magazines—Magazines make their money through a combination of subscription or purchase revenue vs. ad revenue. Each mag has a different mix. I once had a discussion with an industry insider who told me of times in the past where magazines intentionally raised prices in order to dissuade more readers. What? Not possible.

He explained that much of their revenue was advertising based and they relied upon high-minded advertisers. As their subscribers started to move downmarket they started losing important advertisers. By raising prices they could control their customer segments and therefore drive higher ad revenues.

3. Apparel—You’d think that all retail brands would want to maximize the amount of product that they sell. Not true. Many apparel brands and cosmetic companies will actively fight against discount channels like Ross carrying their products. The moment you see lower-end customers wearing your products it loses cache for the upper end segments. I personally find this all a bit Sneetch-ish but it’s basic human nature. So in order to keep prices & profits high they spend serious money trying to fire the lower-end segments of their market.

I know of at least one major high-end cosmetic & fashion brand that actively limits stock of its most sought after product to even their best customers. They create limited availability in their most exclusive brands to segment even the upper-end tier of their most loyal customers. Strange, I know. But that’s the way the world works.

My argument isn’t to stay focused on the most exclusive customer segments. Sometimes that is the best strategy, sometimes it is not. But you need to understand your segments, choose which ones to serve, figure out an effective operating model to serve them, be careful not to divert your management attention to every segment and be willing to fire your customers if they’re taking you in the wrong direction.

This is a guest post by Mark Suster, a 2x entrepreneur turned VC with GRP Partners where he focuses on early-stage technology companies. Read more about Suster on his startup blog and on Twitter at @msuster.

Venture Capitalists typically have partners’ meetings on Mondays. Why is that? Who knows. But probably because as a group we travel a lot. So the industry formed around a day of the week when all partners could avoid having company board meetings or traveling.

Yesterday was a Monday. And not a pleasant one.

Rewind. When I first got into the industry it was 2007. Valuations were enormous relative to progress in companies. Web 2.0 was still a term being bandied about. Companies with less than $2 million in revenue were asking for $50-60 million valuations and getting them. My partnership was pretty bearish and scratched our heads a bit at price tags.

It was a great learning time for me. I spent my days meeting companies, figuring out what areas of the market interested me and trying to get a sense for how VCs thought about fair valuations. I thought about things I never had to as an entrepreneur: check size, ownership percentage, deal stage, portfolio construction and risk.

2008

By 2008 I had gotten more serious about championing companies through our investment process. I started showing my partners more deals that I found interesting and doing loads of analysis on the future of markets I thought were ripe for disruption.

I have always believed that TV was ripe for disruption. The parallels to the music industry are too obvious even though the industry players, the medium and the cost structures are different. US TV advertising is $60 billion in its own right. I had found my industry and a deal I really liked in it.

I introduced my partners, we spent weeks with the team and felt good rapport. And just when I thought I had the deal that was worthy of bringing to the investment committee the world changed. It was September 2008. The market had tanked. Lehman Brothers had filed for bankruptcy. It was many events that led to the crash but perhaps this was the pin that pricked the market.

The following is a 2-week graph of the end-of-week price of the Dow Jones Industrial Average (DJIA) in Autumn 2008.

And while the market was off 24% in two weeks, it’s worth remembering 2 other things

• The market was actually off 40% from its Oct ’07 peak
• The market wouldn’t bottom until Mar ’09. On Mar-6 it hit 6,626 or 53% off its peak

We thought the following:

• No new deals close until we figure out WTF is going on with the market. We need some visibility.
• Let’s review all of our existing investments. Let’s make sure each has enough cash. Cut where needed. Finance where needed. Anyone not going to make it?
• Who has deals in process? Let’s help get their funding get finalized or the company sold if it’s already in play.
• Fawk, man. This is really bad. Depressing. Harrumph.

It felt awful. Kind of like you felt as personal investors, no doubt.

My deal got dragged out and eventually never happened. Mostly we got to see the team operate in stressful times and that changed my perspective on the deal. I need leaders who manage in good times and bad. To build a large company you need to manage through economic cycles.

2009

Come 2009 we felt really bullish about the future for startups because the froth was gone and so, too, were wantrapreneurs. The people left standing had a compelling vision to build companies and we backed many in 2009.

When this period was fresh in September  2009, I wrote a very detailed assessment of what I thought had just happened.

tl;dr summary

• Companies raised too much money in 2005-08 and had high burn rates
• VCs were very active in this period
• When the market tanked they had the “triage problem” – which portfolio companies to save, which to kill
• So no new deals got done. Everybody focused inwardly
• And VCs scrambled to raise their own funds. Making even less time for new deals
• VCs hate downrounds to even good companies struggled to raise money

But by late 2009 life had started to return to normal

• Eventually you have to invest. It’s your job. You don’t get paid to sit on the sidelines. So when the market started showing good signs (iPhone, Facebook, Zynga, Twitter, stock market growth) it was happy days again
• M&A returned. For the same reasons. You would think it would be better for M&A to be more active when the markets are down – better prices. But I guess you could say the same about VC.

So I encouraged entrepreneurs to think about raising their funds as quickly as they could because

• Consumer spending 70% of the economy and vulnerable (wealth effect, build up debts)
• Unemployment likely to rise
• Risks of these two factors to the stock market
• Stock market declines would bring back dog days of VC

The full articles are linked below. If you want a comprehensive summary of the industry in this era it’s worth a read:

VC Ice Age Part 1 – What Happens When a Market Comes to a Standstill?
VC Ice Age Part 2 – Why the Market Started Moving Again?
VC Ice Age Part 3 – What The Future Holds

In particular part three talked about what happened if we saw a double dip in 2010-11 or a “lost decade.”

2010

We did not see a double dip or the drying up of VC funding. In fact, fundings boomed as you know. 2010 was the year of the “super angel” and 2011 has to date been the year of unbelievably highly priced B,C & D rounds of venture capital. The so-called “billion dollar club.”

Fast forward a year to September 2010 and I wrote my treatise on the 2010 economy. It has some detailed charts you may appreciate if you’re wanting to understand the current economic situation. I show charts on housing, structural unemployment, home equity re-financings that we spent meaning less spending power post crash, new housing sales, debt-to-income ratios, public-sector job problems that will cause crises in cities and states across the US.

Summary version? No chart was good.

At least you can’t accuse me of being inconsistent. My year-over-year summary sounds very similar upon re-reading them.

2011

I have a young entrepreneur friend who IMs me a lot. He was working on a VC round in the early Summer. He pinged me for advice. I told him (verbatim), “close your round by August 2nd. After that, all bets are off.” He’s literally on IM right now in my other browser tab saying, “you called it.” I can’t say his name yet because he hasn’t announced funding. But he got it done. Maybe he’ll reveal our conversation when he announced.

I told another friend the same. He’s still optimizing on price and hasn’t accepted his term sheet. It expires this Friday. I wonder what will happen. I guess in part we’ll see how the stock market plays out this week.

August 2011. What’s happening?

The fundamentals in our economy are mostly not on more solid footing than when I wrote the posts in 2009 and 2010. On the positive side, corporate profits are up, their balance sheets have been repaired and they have recapitalized themselves to have lower amounts of debt relative to equity. Not just tech companies but industrials, too.

But you’d have to be a pretty heads-down coder to not have noticed the past 2+ weeks in the DJIA.

Most of the informed people I know are telling me that the sharp sell-off has more to do with European national debt (PIGS as it is called: Portugal, Italy, Greece & Spain) than the current US dilemma of a S&P downgrade of the US government debt. But it must also be on the minds of investors that perhaps the flu will end up on our shores, too.

I know that investors must also be aware of the civil unrest in the UK. Yes, it seems to largely be thugs. But social unrest is created in harsh economic times and we’ve seen this in Greece before. Expect it to spread. It does weigh on the mind.

And while I cannot tell you for sure what was going on in VC partner meetings across the world today – I’m a data point of exactly one – I think I have a pretty informed guess. And depending on which way that economy heads I can tell you what the story in entrepreneur land *might* be in 60 days, “funding is getting harder, valuations are slipping, companies are running out of cash, M&A is slowing down.”

So let me give you the news 2 months early. If the economy and the stock market continue to languish that’s exactly what’s going to happen.

I’ll bet most partners’ meetings this week consisted of looking just a little bit closer at the cash needs of their portfolio companies – making sure they’re “fully funded.” I’ll bet many of them did a review of their “investment pace” as in – how quickly should we be investing. I’ll bet many did a slow roll on deals that might have gotten approved today. Not a “no” but not yet a “yes.”

It’s impossible to sit in a partners’ meeting on a day like today without having an iPhone on watching the stock market free fall and no matter how much of a public tech cheerleader you are – privately I guarantee there was much concern.

If we do head South it will take a few weeks or months until the memos to portfolio companies get published and the Powerpoint presentations get sent out. But the internal conversation started today – trust me. VCs will take a “wait and see” approach right now. Don’t want to call it either way. It’s too early.

Me? I feel confident telling you to, “Watch your pennies. Raise your money. Don’t spend like it’s 1999. If we’re not heading for a double dip recession at least you’re still being prudent.”

Maybe we’ll bounce right back? Anybody who says they know for sure one way or the other is a bit of a shaman. But I have to imagine the speed and severity of the stock market decline and political instability will likely weigh on investors for some time to come – even if we rebound.

And I’ll tell you what worries me: Jobs, growth & political malaise. And don’t think tech will remain immune.

I guess that’s why I encouraged people to raise money while the getting’s good (PPT slides & video).

My prognosis?

1. Jobs
I’ve been parroting this for 2 years. We have a two-track economy. We have the inability to hire engineering in Silicon Valley or brand sales people in NYC but the country still has very high structural long-term unemployment. Check out the graph below from the Economist magazine. It plots employment changes from the peak GDP quarter of the previous boom. What you’ll see is that it takes about 2 years to recover jobs from the normal recessions of the past 50 years (as if there was a “normal.”)

This recession?  We’re 2.5 years in and still down 5% from the peak.

What gives? I’m guessing many of these jobs ain’t coming back any time soon. The last big recession was in the early 90′s where IT and globalization were in their infancy in terms of impact. We need a plan to replace these jobs long term. That can only come through education, training and investment in regions of the country that are not IT centers.  There’s no band-aid solution and no quick fix.

Whatever you think about tax policy, I’m certain that it’s not driver one way or the other to fixing this problem. Anyone who says it is a driver is selling you political malarky.

We gotta fix jobs.

2. Growth
The story here is no different.

My message to entrepreneurs has been, “It’s coming soon to a theater near you.” You know – the “butterfly effect” on a local and tangible basis. Consumers hurting in Detroit or Biloxi will not continue to spend money they don’t have and income they’re not earning. It will impact retail. It will impact brands. These companies advertise. On your tech platforms. These consumers buy iPads, iPhones, Androids. You’re counting on them for up-sells to your app. For buying virtual goods. You need consumers – they’re 70% of the economy.

Trouble is – they don’t have jobs. Those that do still have too much debt. Their 401k ain’t what it once was and it just got whacked again. They still have too much personal debt. And the equity in their house isn’t rising. They’re doing what economists call “de-leveraging,” which means spending less, saving more.

And you don’t see it. You don’t see it because the world you likely live in if you’re reading this has been booming. And even if you’re not physically in a booming tech market you’re likely in the market spiritually, metaphorically. You’re reading TechCrunch, aren’t you?

3. Political Malaise
I think here I’ll just quote myself from my analysis a year ago to avoid sounding like I’m jumping on the bandwagon of this week’s quarterback analysis:

“While there was a momentary unity in the US government for bailouts & stimulus spending that were initiated in the Bush administration (many people conveniently forget this now) and continued under Obama, it is clear that this era of consensus is over.  Keynesians will argue that this is a bad thing and fiscal conservatives will argue that it is a necessary discipline. 

Either way, the gridlock that is now the US congress will prevent any real economic responses and it seems likely that this political malaise will last beyond the 2012 election as the Republicans look to make big gains in the 2010 mid-term elections.”

Maybe the stock market drop will bring some clarity to congress. Maybe it will bring some bi-partisan spirit to solving the nations problems. Maybe. But evidence seems to the contrary. Right now people seem to be angling more around November 2012. And that sure sounds a long way away to me.

What does this mean for the tech and VC markets?

I’m characteristically still bullish on our long-term trends for companies who get through the toughest times. Here’s what I know:

• Television will be consumed dramatically differently in 10 years from now than it is today. Creative destruction will continue to create opportunities for people who understand the deflationary economics of the Internet. I’m long.
• Cash will continue to become less relevant in 10 years as electronic & mobile commerce continue to proliferate and new technologies like NFC drive change. I’m long on payment technologies.
• Computing will be an order of magnitude more mobile 10 years from now, changing the way applications are delivered and the way we interact with our real social networks. I’m long Mobile. And Social.
• Businesses will continue to realize that the Internet is one big information utility and will continue to move operations to the cloud. This will create whole new segments of the tech market for databases, data-as-a-service, real-time information processing, cloud mapping & visualization technology, etc. I’m long the cloud.

Venture capital is an industry best served up from 7-year aged casks. As many people have said, “We over-estimate the impact of technology in 3 years and under-estimate the impact in 10 years.”

Make sure you’re still here in 10 years. Get yours. Then go build your companies.

Top image courtesy of Fotolia.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

tl;dr version:
If you’re an entrepreneur or VC or will be working in this industry - buy this. read it. live it.

When I first started as a startup CEO in 1999 there were no guides on raising venture capital. There were no explanations for all of the confusing details outlined in a term sheet.

Drag along rights? Um, OK. That sounds fine to me. I barely understood it. I asked my lawyer for an explanation. He gave me the human explanation for what the term meant. It sounded logical enough, so I moved on to the next point. Only later did I learn how it could be used to screw me.

Redemption rights? Sounds harmless enough. But know that every term in your term sheet is there as a result of some dispute of the past between shareholders or between shareholders & management.  Founders don’t often think about “primary” stock vs, “fully diluted” stock in terms of voting rights. I never did. VCs always know the voting thresholds and no number in your term sheet is there by accident.

To this day I’m still surprised how few CEOs really understand the differences between 2x liquidation preference and a liquidation preference with a 2x cap. Or what “participating preferred” stock is and how it can screw you. Or what “flat spots” on a cap table are.

If you want to see a quick summary of some terms & a video that walks you through how VCs view a cap table my colleague Kelly Hwang & I produced a quick tutorial here:

In fact, some of the biggest surprises I learned about term sheets were:

1) how the language never says anything remotely like “blocking rights” for terms that VCs want to use to block certain actions of your company. Liquidation preferences never say things like “participating preferred” although we all talk about it. It’s hidden in legal language. Blocking rights and liquidation preferences exist for rational reasons and when used properly are fair. Used egregiously and you’ll have problems later. You need to understand them.
2) how seldom lawyers walk you through the “how can this term be used against you” scenarios or the “pragmatic guide to VC terms” overview. They are helpful, certainly, but often if you don’t know the right questions to ask you’ll be left unawares.
3) VCs are anal about things like voting thresholds, seniority of their stock, protective provisions, etc. – entrepreneurs never seem to focus on anything other than ownership percentage.

It’s no surprise that I got a bit fawked on my first company. There was no guide. No book. VCs were negotiating with asymmetric information. Brad & Jason’s, Venture Deals, aims to change this.

I was significantly wiser by 2005 when I started my second company. Even so, I found myself reading Feld.com every day. I think that’s around the time when Brad & Jason did their famous “term sheet series,” which was the authoritative guide I never had the first time. I read every post several times.

This series inspired me to start my blog as a VC. I also decided never to spend much time on term sheets on my blog because they had already covered it far better than I thought I ever could (Jason was a lawyer with Cooley Godward, one of the top VC law firms, after all).

From there VentureHacks was then launched which gave entrepreneur advice on fund raising from your point of view. It is also a must read.

Now Brad & Jason have raised the bar. They’ve written this comprehensive book called Venture Deals that should be read by anybody dealing with funding of startups – whether you’re a startup CEO, CFO or other founder or whether you work in the ecosystem (lawyer, debt provider, banker, VC). It goes far beyond any other book I’ve seen on the topic in helping you understand the key terms, plan the negotiation and understand the motives of the various actors at the table.

It’s a gem. I think the industry works better when all sides are informed. The fact that Brad so routinely puts out information like this is what earned him the number one spot on this list of VCs that entrepreneurs most respect. And while Jason is less high profile as the ever-present Brad Feld, I think even Brad would acknowledge that when it comes to the knowledge supplied in a book like this, Jason is the man with the deep knowledge.

Let’s get rid of the information asymmetry problem. Every startup needs the knowledge in this book.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

I recently wrote a post about the open nature of Twitter and why I’m long on its future. I know it’s easier to write “horse race” stories about who’s signing up more users, raising more funding or who’s “hot” lately.

But something more nuanced is at hand that is worth debating – is the future of the Internet & global communications more open or more closed?

I’ve discussed this on StockTwits with Howard Lindzon before, so if you want the longer view check that out.

Twitter is open.

Not just the fact that you Tweet publicly versus privately, but also that they’re open in letting their Tweet stream flow into other products & services. They’re an open feed.

It is open also in the same way that Google was open in its early days. Google started as a place where you came to be taken via links to other people’s websites. I know many of you don’t remember the context, but that was heresy when Google started. Google was duuumb. Sending traffic to other websites, ha!

The rule of thumb then was “stickiness” – remember that? Get people to your website and never let them leave. Clooosed. That’s what AOL was. A “walled garden.”

In a world where it’s easier to judge the immediate value of a business, I know that metrics like “time on site” matter. That’s why Facebook is totally rocking it right now. And they will continue to do so.

I just want to point out that longer-term value is often harder to perceive when a product is still going through its growth stage. So we value things like ”referral traffic” much less. But we know that Twitter has become a major source of referral traffic. As you become a large, open network for referral traffic your long-term strategic value goes up. That’s the Google lesson. As companies like Google grow over time the pendulum swings and even the great link generator Google starts to think maybe it would be good to drive traffic to Google monetized properties. Still, at its core I believe Google’s instincts are open.

No prizes for guess who today’s AOL is. Strategically really well positioned today. Not so open. Brands who build pages there are not building equity in the open Internet, they’re building it in today’s walled garden. The “Internot.” And some tech companies are growing like wildfire helping brands to find more people who “like” them. I’m starting to spend my time evaluating companies that can help brands simultaneously build within the fortress but also maintain social value in the open web.

I think this fortress company knows open will win over time and I think their instincts (or the market) will lead them in the right direction. I’m hoping that HTML5 + mobile will lead them down a more open path. It’s clear to me that other major vendors have less open instincts in their blood.

Openness.

That undervalued attribute in life and in tech. I was on NPR this week with Peter Thiel and Gregory Zuckerman of the WSJ. The topic of social media came up and one dial-in caller lamented the fact that all Silicon Valley was producing was silly social media companies. I understand this sentiment at the surface. But as I pointed out on the show, look deeper at the impact of social media as a tool to organize crowds, hold public debates and spread information in a decentralized way. These are core attributes of a healthy democracy.

We want a media system where you don’t have one powerful leader who controls the media and you also don’t want a system where you have one powerful media who controls the power.

Social Media helps change that. As in Tunisia, Egypt, Syria & Iran. I’ve lived and worked all over the world so I’m not so naïve as to think that social media ensures revolution or even explains it. But person-to-person communications is vital to enabling democracy and you can’t deny the role of media in driving social change. People need to be able to self-organize to resist the temptations of the power to control them.

In the first place, media helps show people in places where they don’t have rights what life can be like in places where the world is more open. If you really want to understand the politics of the Middle East better you can read my favorite book on the topic.

And that brings me to the US election.

By now most people acknowledge that social media helped play a role in candidate Obama’s 2008 election campaign. Ranjit Mathoda said it best in the previously linked NY Times article:

“Thomas Jefferson used newspapers to win the presidency, F.D.R. used radio to change the way he governed, J.F.K. was the first president to understand television, and Howard Dean saw the value of the Web for raising money. But Senator Barack Obama understood that you could use the Web to lower the cost of building a political brand, create a sense of connection and engagement, and dispense with the command and control method of governing to allow people to self-organize to do the work.”

In 2011 it is too early to say what the story of the 2012 election will be, but I’m certain that social media will play a large role in it and that it won’t look like the social media campaigns of 2007-08. I’m sure there will be some Macaca moments, but I’m excited to see what other innovations there will be.

I’m interested in watching initiatives that help make politics more open.

I was recently contacted by an open, Twitter-based jobs company, TweetMyJobs to participate in an online, open discussion about jobs in America and the election.  My interest was piqued.  This morning, 7/19/11 we will hold an open Twitter conference on job creation in America. Please join us. You can dip in for 5 minutes or stay for an hour.

The company claims it’s the first of its sort. I’ll be there to answer anything you have to throw at me regarding job creation.

I will be in a forum with Lou Kerner, the best read social media analyst working on Wall Street. Just use the hashtag #jobs4USp (that way I’ll see it). I’ll be on at 11am PT.

The event’s Tweetnote will be Tim Pawlenty at 9.15am PT, who is a candidate for the Republican party and is the former governor of Minnesota. Questions for him with #jobs4US

TweetMyJobs is a startup that interests me because it uses an open social interest graph to help job seekers and companies find each other. (no, I’m not an investor in the company).  Companies such as Starbucks, McDonalds, IBM, Motorola & SAP are using their platform that is now generating more than 1 million job leads per month according to the company.

This election will be about jobs. And while we in the tech sector don’t feel it acutely (unless you work for Cisco), believe me that much of the country is still in pain. You wouldn’t know employment was a problem if you frequented the restaurants & bars of San Francisco, went shopping for a house in Palo Alto or visited the high-end malls of Los Angeles.

I was glad to see Jon Bischke, one of the most likable guys in Silicon Valley talking about unemployment & the two-speed economy this week on TechCrunch. There’s a real problem with job creation in this country that we need to deal with or even those of us in the tech sector will be affected.

That’s what I plan to talk about at the TweetMyJobs conference. I look forward to debating with all of you in real time. On the open web. Using the Twitter stream. On a website that Twitter probably doesn’t even know exists. Where I’ll drive my Twitter followers. With an open link that refers you there. See you then.

Image credit: Melanie Cook

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

Most web publishers measure where their traffic is coming from using an analytics package such as Google Analytics, Omniture or Core Metrics.

These were good packages in the pre social media world at helping figure out who was driving your traffic.

Today they’re wrong. Terribly wrong. And figuring out who is referring your traffic is a very important part of determining how you allocate your marketing budgets. It is almost certain that Twitter is driving much more of your referrals than you think.

Possibly up to 4x as much.

Jonathan Strauss is the gentleman who did all the number crunching and has written an excellent post on why this is.

I’ve been a user of awe.sm (his product) before I invested in his company (disclosure) so the understatement of Twitter as a referral source is a problem I’ve known about for a long time. Let me give you the simple explanation.

Take a look at the Google Analytics log for BothSidesofTheTable.com for yesterday. I had 8,502 visitors yesterday of which 1,669 are listed as “direct.” Direct traffic are people who typed in my URL directly. They weren’t “referred” by anybody.

But look at the second line. This says “direct – bothsid.es / bothsid.es – twitter” and shows 1,423 referrals. Line 5 says twitter.com / bothsid.es – twitter” for 712 referrals and line 9 shows twitter.com for 170 people.

What does that mean?

awe.sm tracks all of my social media sharing behavior. What awe.sm does is it allows publishers to be able to track each individual share behavior to a level of granularity that no other campaign tracking tool I’m aware of allows.

In ordinary tracking line 2 would have shown up as “direct” traffic and I would have assumed that I was getting a lot more direct traffic than I really was. I would have assumed I was 36% direct and just 10% via Twitter when the reality is that I’m 20% direct and 27% via Twitter.

In fact, the actual Twitter referrals are generally up to 4x as much as people think is happening. And the same is almost certainly the same for most publishers in terms of understating referrals.

This is a problem because publishers might then under invest in Twitter campaigns relative to others because they don’t get “last mile attribution” right.

This happens with other marketing campaigns, too. Often you hear a radio ad, see a TV ad or read an article in a magazine and you type the results into Google to find out more details about the product or service. The problem is that marketers assume that Google drove the traffic. They did not. So you ramp down your TV or print campaigns and suddenly your search volume goes down.

Doh!

Last mile attribution is very important to understand marketing ROI. For the above problem the best company I know of is called Convertro. I’m not an investor in the company. But Jeff Zwelling is one of the most informed people on last-mile attribution with whom I’ve spoken.

And in social media the problem is even worse than I described. Twitter is an amazing generator of social hooks to websites. Some of that comes from Twitter.com or other Twitter clients. But since many other websites pull in Twitter data, including links, you don’t always know who is referring the traffic to you.

Case in point: LinkedIn. Many Tweets are now being sent to LinkedIn and then the publisher assumes that the source of the referral is LinkedIn. In some ways it is because that’s where your user engaged the content. But get rid of the Tweet and you get rid of the referral traffic in the same way as I described the loss when you cancel your TV commercial.

So when I see MG Siegler announce that LinkedIn is sending more traffic to TechCrunch than Twitter – I’m not so sure. I understand why he would think that – Google Analytics tells him so. But I’ll bet a hefty amount of LinkedIn clicks were originated on Twitter. And I’ll bet a whole lot of TechCrunch “direct” traffic is from Twitter.

With proper social media attribution you need to generate a unique URL for EACH share behavior. So if you click on a “Tweet this” button on a website to send an article to your friends, that link needs to be individual to you and to that exact share instance. By making the URL link unique to its point of generation you can then track it better as it spreads to other sites

And importantly when anybody else then shares the link to this site it maps out a “parent / child” link relationship. So if the original Tweet was on Twitter and then somebody builds a “Tweet this” from a product like LinkedIn, you can still tell that the original source of the the story was Twitter. Call it, “last mile social media attribution” and when you’re a brand spending money on products & marketing you need to know this.

They also cookie users so that we can better track who it was that drove viral adoption of campaigns. It could be that one influential person send a Tweet but he doesn’t have a lot of followers. If Ashton Kutcher follows that person and suddenly shares if with his 7 million followers it would start to snowball.

So there you have it. The story is never quite as simple as the data might lead you to believe.

Image courtesy of Fotolia.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

I recently spoke at the Founder Showcase at the request of Adeo Ressi. I asked what the audience most needed to hear and he said, “They need an unbiased view of the fund raising environment because there is too much misinformation and everything seems to be changing fast.”

This was an audience of mostly first-time entrepreneurs. They have seen one side of a market where many of us have seen the ebb and flow multiple times. Still, market amnesia by ordinarily rational actors always surprises me.

I spoke about a lot of things during the keynote. If you are interested the Vimeo is here. I spoke about whom to raise capital from (funding options), how much I thought they should consider raising (18-24 months), how fast they should spend it (lean until product/market fit, then fat when they’re ready to scale), how fast they should raise it (now, now, now) and at what valuation (at a fair price that I call “the top end of normal“).

I spoke about how Amazon Web Services deserves far more credit for the last 5 years of innovation than it gets credit for and how I believe they spawned the micro-VC category. I said that I felt that Micro-VCs were the most important change in our industry. I believe that. It is great for entrepreneurs and great for VCs.  I will write more about this in the next 2 weeks.

I also spoke about why I believe we’re in a “localized” bubble. I suppose I should have imagined that this line would get more press than all other comments combined. Fair enough.

But a certain amount gets lost in the headlines – especially when not everybody actually heard the video and knows the nuance of the message.

So here is what I have been telling entrepreneurs privately for the past 6 months.

1. Why I believe we’re in a bubble
People get too worked up over the word. I’m no great scholar on bubbles – I have more interesting things to spend my time worrying about than the exact definition, but having been around a few I have at least given them intellectual consideration. I know that most people who are close to them tend to deny their existence, as we saw in the great housing bubble of 2002-2007 and the dot com bubble of 1997-2000.

I believe a bubble occurs when a market is willing to pay greater than intrinsic value for an asset class. That asset class need not represent the broader market. As any historian of bubbles will tell you – there were periods of bubbles in assets as arcane as tulips, South American trading companies, dot-com bubbles & housing bubbles. They are often bound by geographies and asset classes. But they also often have a rippling effect on broader markets as all of our economies seem to be intertwined these days. I said that at the Founder Showcase, too.

The fact that today’s Internet bubble does not represent all companies does not disprove its existence.

Ah, but today’s Internet companies have real revenue! and profits! Sure, that makes them better companies than those of 12 years ago. But that doesn’t mean that people are paying rational prices as investors based on intrinsic value. Rational people can disagree and some may argue that today’s prices are rational and under-pinned by economic drivers. That’s fine. It’s just not my judgment based on the data I see.

In the past I have publicly commented on some specific companies that seemed over valued. Responses ranged from, “hey, they’re in a HUGE market” to “it is an amazing company and their technology rocks.” Sure. But everything has intrinsic value. And you may choose to overpay hoping that the future value will be worth your while. That doesn’t mean it’s not a bubble. It’s like people arguing that there’s a beautiful beach house in 2006 that represents great long-term value due to scarcity of similar property. All of that might be true, but the 2006 price might still be over-valued

What I believe is happening is that private-market investors are getting ahead of themselves for fear of FOMO: fear of missing out. If you are an early investor in Facebook, Twitter, Zynga, Tumblr, GroupOn, LivingSocial, etc. – you’re very well positioned as a fund. I guess that makes USV, Spark Capital, Foundry Group, Accel, Benchmark, Revolution (along with several others) pretty happy right now. And well they should be.

But this mania to not miss out on the next big thing is driving some investors to pay growth-equity prices for traditional market risk (as in, they’re paying up before it is clear there is product / market fit). And so on down then line.

In addition to FOMO it is partly driven by massive increase in valuations for earlier-stage companies who raised money at bit seed prices but who still have product risk. If a company that would traditionally raise $500k at a $3.5 million pre-money valuation is now raising $1 million at a $12 million valuation the next investor has nowhere to go but up (or sit out the investment). Just because the valuation in absolute terms isn’t a big difference does not mean that people aren’t paying higher than intrinsic value for these investments.

And this is happening in mezzanine (pre-IPO) deals as well. And post IPO deals, although these tend to correct more quickly.

Why does all this matter?

2. There are fewer big deals than people imagine
If everybody is over-paying for early-to-mid stage deals you’d imagine that these all need to feed into a frenzied M&A and IPO market that will garner big returns for these risks investors are taking. Perhaps this will trend up massively but historical data doesn’t bode well.

source: Capital IQ

In any given year there are about 50 venture-backed companies or so that are bought for $100 million or more. And for many of these they were (over) funded 7-10 years ago and don’t necessarily all represent great returns for investors or founders. I would guess (I don’t have the data) that less than 5 companies / year are purchased above $100 million that have been funded within 5 years of the being started and have raised less than $10-15 million in capital.

And as you probably guessed the data aren’t any better on IPOs with less than 20 / year average for the past 10 years. Yes, everybody expects a continued uptick given the euphoria of  LinkedIn & Pandora and long anticipated Facebook, Zynga, GroupOn and one day, Twitter. But it’s not enough to justify over-paying for deals.

source: Capital IQ

3. What a bubble means for each entrepreneur
To anybody who asks my advice I repeat the same line, “I don’t know whether this party will last 6 weeks, 6 months or 18 months. But it will end. And when it does the market will shut off immediately. Investors will focus only on protecting existing deals. They will enter the “triage phase” of the market where they figure out which of their existing deals will survive. Many good companies will not get funded. New investors hate down rounds. Vultures will start circling looking for deals. Get funded now, if you can.”

Note: I did not say, “funding is easy” as some people have quoted me. I said, “It’s much easier now than it was in 2008/09.” That’s a fact. And for some it is actually easy. For others it feels like a two-speed economy, where rules apply to hot tech startups that don’t apply elsewhere. Huge structural under-employment in much of the country and full employment in some niche tech markets where it’s impossible to hire developers, designers or sales professionals. You know what I’m talking about. You feel it, too. It’s surreal.

So I’m not advocating panic or a need to rush your funding round. I just think that some entrepreneurs try to “optimize” too much for short-term prices. They hope to delay fund raising (or only raise small amounts now) so that they can raise at a much bigger price later. That may happen.

That’s the problem – you never know when the party’s over. And time is the enemy of all deals so start sooner rather than later, as anybody who was planning to raise in October 2008 will tell you.

And for some that means that despite waiting they may see worse valuations in the future than now. Or worse yet they may never get financed. That happened a lot in 2002 and again in 2008.

I tell people to raise money when you can, but don’t ramp up your spending in a crazy way afterward. Have a cushion. Raise at “the top end of normal” but not so high that future financings in a corrected market become impossible.

4. Bubbles are inevitable
I guess it’s an inevitable process that we seem to go through where markets heat up, get euphoric & irrational and then external market drivers remind us all at once that we were being irrational as a market. We go through our “Bear Stearns moment.” I learned long ago at the University of Chicago where I got my MBA that investors tend to want to invest when markets become over-valued and sell when they become undervalued. Exactly the opposite of what a rational investment strategy would advise.

Why?

In a booming market your investment is worth more than you paid almost instantly. You come in at a $10 million price and somebody else invests at $50 million 6 months later. Feels good.

In contrast, when the market is falling, by definition your investment is worth less THE DAY AFTER you have invested. In a public market this is measured immediately. You are “catching a falling knife.” You have to have patience, which is hard when you see red. So people sell or at least don’t invest.

Some people argue that we’re not in a bubble because the prices are not as crazy or as inflated as they were in the late 90′s. That may be. It may also be that this lasts another 18 months. But when it’s all over and they define the era of this mini run up in stock prices I suspect they’ll include 2011 in the “over valued” category.

5. Good things may come out of bubbles
Bubbles are not all bad. There are great societal benefits that sometimes come out of bubbles. One example is that the telecom bubble of the late 90′s left both the US and the international markets with a greatly expanded footprint of fiber-optic cables laid at the expense of many an over-zealous investor and entrepreneur. I can’t argue that this is better than slow, rational growth. I only point out that there are side benefits of the bursts of energy, enthusiasm and investment dollars.

And the bursting of bubbles isn’t bad for everybody. Those with strong business models suddenly stand out when the tide goes out. An obvious example is Google who may have gotten less market attention if there would have been 8 well-financed competitors during the 2001-2005 timeframe. Or Salesforce.com who rose to prominence in this same period where they were ramping up PR and shouting from mountain tops when everybody else in the market was mute.

6. Why the bad side of bubbles affects entrepreneurs & investors alike
Another misconception of bubbles is that they only hurt investors. That’s not true. When you’re building a startup and can’t hire the engineers you need, can’t retain staff, can’t get press coverage and can’t hire sales people – it certainly affects you. When your competition does irrational things to grow fueled by low-cost capital it makes it harder for you to compete by playing by the conventional rules.

I remember in the late 90′s trying to charge fair prices for software when my well-financed competitors were giving things away for free.

7. Why the bursting of bubbles also affects more than investors
I also point out that bursting of bubbles also affects us all. Sometimes callous observers say, “Who cares if some VCs lose money in a bubble?”

Um …

• many people also lose their jobs when bubbles burst
• some founders lose their life savings
• people who poured their hearts into projects see their efforts vanish over night
• customers who paid for services often get burned
• many ancillary businesses (legal, real estate, services) are affected
• and those VCs are actually investing money from places like state pension funds & university endowments

Trust me, we’re all hurt when bubbles burst. Just think about how you felt the impact of the real estate bust even if you didn’t own property or if you bought well before 2006/07. This market will be the same.

8. The road ahead

I’m not an alarmist person, I’m rational. The sky isn’t falling. There are many things to be encouraged about.

I see opportunities for disruption all around me and am meeting amazingly talented entrepreneurs. I’m looking for ones that understand that in order to build huge, meaningful companies they’ll need to likely build through these boom years and some lean ones. When I find people like that it’s great chemistry.

When I look at the headwinds we face as a country and as a society they are also big. This concerns me about the growth rates we can anticipate for the next 5 years.

I’ve wrote about this 9 months ago. If you want a more detailed analysis see that post. Nothing has changed in my mind since then but it does go to show how difficult it can be to predict the timing of economic impacts. In economics we call these “exogenous events” and if they happen (Greek debt crisis, problems raising the US debt ceiling, trouble in Saudi Arabia) – you will not be shielded.

That said, for every set of global challenges there are entrepreneurs dreaming of solutions, solving big problems and ready to lead us into the next 20 years. It’s what I love about entrepreneurship and about venture capital. We get the opportunity to serve these amazing talents that hold our futures in their hands & minds.

9. Why I will still be investing
I know prices are higher than the norm right now. I am confident they will be lower at some point on a relative basis. But as an investor you cannot simply sit out period of great innovation. As Fred Wilson once pointed out to me, he invested in both Twitter & Tumblr during a high-valuation period.

So at GRP Partners we’re very active now. We’re just conscious to invest in realistic entrepreneurs who know that it will take years of hard work, who are committed to building large businesses over time, who have exceptional skills & passionate about the disruption they’re causing and who are cost-conscious enough to be around for the long haul. Building billion-dollar businesses requires 7-10 years which means operating through at least one full economic cycle, if not two.

We may invest at the “top end of normal” but not at such a high price that we create future problems. We’re not cheap, but we’re disciplined. We are definitely still open for business.

Bubble image courtesy of Fotolia.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

WWDC. The annual Apple event where no real hints about what products they plan to release are floated in the public domain in advance. No private head nods are given to small startup companies to help them prepare. We’re in a market where 800-pound gorillas throw their weight around and the rest of the market races to react and survive.

Any company who develops products reliant on iOS spends weeks crapping their pants before WWDC. No vacation schedules allowed for weeks before or weeks after. The announcements come out in one day and then even if you survive the annual release announcements you often still have to scramble to make sure your product is ready to work on time.

It’s madness.

This happens with Google, too. Every change in the algorithm wipes years of effort off of the traffic numbers of affected companies as anybody hurt by the Google Panda release will tell you.

Or Twitter launches its own photo-sharing app integrated into their product.

What is a startup to do?

For starters, fear not. The world seldom ends. You just have to deal with some insufferable VCs and journalists for a while. They risk little but of course knew better all along.

It is the same movie I saw 10 years ago when every VC would say to me, “yeah, I get that you’re an online document sharing service, but what’s going to happen when Microsoft enters the market? You’ll be dead.”

Puh-lease. Tell that to DropBox. Or Box.net. Tell that to DocStoc, Scribd or SlideShare.

Right. Just like Microsoft stopped AOL from winning the early online wars. And AOL stopped Yahoo! from winning the Internet portal wars. And Yahoo! in turn killed Google when it came to search. While Google stopped Facebook in their tracks when they built a social networking company. And Facebook stomped out Twitter from building an open social network. And we know how Facebook stomped out FourSquare.

And on and on. eBay / StubHub. Amazon / Zappos. Twitter / Instagram.

Focus wins.

In your head you know that the reality is that bigger companies simply cannot compete effectively on all fronts. Focus by extremely talented teams beats breadth. It’s why we all exist.

The golden rules to live by are:

• Platforms are channels not businesses. Don’t confuse the two. If you put all of your eggs into one platform shame on you, not them. If their business torpedoes you, you should have been diversified.
• You need to be clear on what your sources of differentiation are from the biggest competitors or you’re dead anyways. If your product isn’t 10x better in your own mind, hang up your cleats now.
• You need to be “known” for your sources of differentiation so even when the press declares you dead because Facebook, Google, Apple, Twitter are going to eat your lunch they are describing the threat in terms of them copying you. When they talk about “check-ins being dead” it’s because you created them. Or “gamification.” Innovation has become synonymous with you.
• You need to stay focused. Have clarity of purpose. Don’t be scared. Be willing to shift positioning based on new market information but not lose your inner core.

Here are some examples.

FourSquare – I was recently asked on Quora whether I thought FourSquare was dead now that Facebook was going to launch “Places“. Others feared Yelp. Me? I chuckled. Sure, if Zuckerberg thought that check-ins were the single most important part of his future business and put 200 engineers on the problem and all of their market might, they’d squash FourSquare like a bug. That’s not going to happen.

In reality Facebook will have a small team on it. They’ll have to integrate with every other initiative on Facebook and adhere to common internal standards. They’ll fight for resources. End users come to Facebook to share photos, chat with friends or play games. Checking in is an afterthought for most. FourSquare is a different and unique product. The law of large numbers means Facebook will have plenty of check-ins on Places but that doesn’t negate a focused competitor.

I can’t tell you whether FourSquare will end up being a huge and lasting company or not. I’m not on the inside. But I feel confident that its future is its own to execute and innovate on and whether it succeeds or not will have little to do with Facebook itself. I have on several occasions said publicly that I felt the biggest challenge for FourSquare is to know what comes after the check-in? What is the next major innovation. They seem to have several interesting ideas.

It will certainly be interesting to watch.

Group Messaging –  We just came off of another annual WWDC. In it Apple announced its new iMessage product. Apple built the product, so no doubt it will be freakin’ awesome. I’m sure I will personally use it as we own 2 Macs, 2 iPads, 3 iPods and 2 iPhones. Yes, we’re a fanfamily. The New York Times came out with their list of companies impacted by Apple’s new releases and all of the major group messaging companies were on the list of companies in need of checking their shorts.

The major players are GroupMe, Kik and TextPlus (I’m an investor). Actually, I wouldn’t consider all of them “group messaging” companies but ever since SxSW that seems to be what the press wants to talk about.

Let’s look at some simple facts:

• Apple will let you communicate seamlessly with all of your other friends using Apple devices. That’s a lot of people.
• But the much larger market for smartphones will be non-Apple and all of the app-to-app messaging companies allow you to communicate with a much broader set of smart phones. iMessage will not. At least not initially. It does for the Apple world what BBM was for the RIM world.
• And beyond app-to-app messaging some of the products will allow you to also send SMS messages to the 10′s of millions of people who don’t yet have any smart phones at all.
• Many of the services are moving toward providing you phone numbers, voicemail and eventually free phone calls
• Some services like Tango already do video calls. This is already better than what Apple’s Facetime provides out-of-the-box.
• Beyond that I see the market bifurcating into “utility players” that provide iMessage-like services on a cross-platform basis and those that evolve into either mobile, social networks or mobile, social games companies. iMessage will not quickly follow either route.

BBM will have another major push and we expect an inevitable Google rebuttal to iMessage. Purely being “group messaging” will be stuck in the cracks of the giants. Group messaging isn’t a market, it’s a feature.

Are the companies competing in this sector shitting their pants? Hardly. They’re focused. They know their purpose. They know where they’re going. It will be differentiated. It will be hard for the largest players to compete with their vision. If they don’t get there one day it will be their lack of execution.

Bit.ly – Remember when Twitter announced that they would be embedding their own URL shortening and the Bit.ly obituaries were written in the first 24 hours? As far as I can tell Bit.ly is still around. In fact, they continue to be the dominant URL shortner and provide a plethora of analytics data to go with it. Next market moves? I dunno. But dead? Hardly. I still use them nearly every day.

Boxee – I remember talking with Avner Ronen before the announcement of the new Apple TV last year and just as Google TV was ramping up their marketing messages. Boxee had gone from marketing darling to dead man walking in the press in a matter of months. Avner was so calm. He pointed out that Apple would build a closed system that would appeal to part of the market. Ultimately a small percentage of his total opportunity. Boxee was about being open. It was about freeing up content to be displayed on big screens regardless of the source or content type. Where Apple would veer toward control, Boxee would bend toward open.

And whenever you see closed systems all of the major players not invited inside the velvet rope will search for technology partners. The enemy of my enemy is my friend. So every OEM not included in the Apple TV universe now knows they’re on notice to innovate. And no TV manufacturer with a brain doesn’t see that Apple will likely one day have its own Internet TV that will be scooped up by adoring fans like me. They already have beautiful monitors that are practically TVs. So hardware players need some software friends. Boxee might just be what the doctor ordered.

And GoogleTV? Yeah, that would slow down his discussions with OEMs whom he hoped would be building on the Boxee software stack more quickly, but he said to me,

“Mark, we’re not looking to build a quick flip. We have a long-term vision that video content will be widely available whether you produced it and it sits on your computer, whether it’s the sports you love but is currently only available on a content bundle or whether it’s long-tail content that appeals to large audiences of people who currently can’t get it over the Internet. And we’ll build the best discovery engine to find the best content.”

Will he get there? I’m not sure I’d easily bet against Avner. He really does have a great vision in a market that will undoubted be disrupted. But his story doesn’t map to an easy headline. Let’s see if he can put up the numbers over the next 3-5 years.

Summary
It’s not a sufficient strategy to think you’re going to win because you’re competing with big, dumb companies. They’re usually much smarter than you think. But they’re not nimble. They can’t take as many risks. They can’t iterate as quickly. They can’t easily have a focused set of marketing messages and a user experience that will have clarity of purpose for users.

You must figure out how you deliver real differentiation. What you’ll stand for, be known for. You have to have a core. You can’t let the market machinations and press proclamations worry you. The big guys can’t crush you as easily as others think. Be a cockroach. Be indestructible. And remember that competing with the big boys is not for wimps. Fight hard. No cry babies. The big boys will do what the big boys will do. And if you raise VC make sure your backers have a long-term vision and the internal fortitude to last the periods where it seems that the big boys will eat your lunch.

And if there are no big boys—you’re probably in the wrong market.

Good luck.

Image courtesy of Fotolia via @ryanborn

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

I have conversations with entrepreneurs and other VCs on a daily basis about fund raising, the prices of deals, how much companies should raise, etc. I’ve stopped talking about this as much publicly because it’s such a heated, emotional topic where the points-of-view are strictly subjective and for which the answers will only be revealed in the future.

I’ve decided to take all of my private points-of-view on the topic and make them public in a keynote speech at the Founder Showcase in San Francisco on June 15th.

I thought I’d post on one of the topics beforehand. It’s the one bit of advice I find myself giving to entrepreneurs most frequently these days, “raise money at the top end of normal.”

Huh?

Here’s what I mean. There is an inherent value that any company has. On a public stock market that is the value that investors place on future free cash flows of the business discounted to today’s date to account for the time value of money. The more mature the company and industry, the easier it is to predict its future. When investors are feeling confident about the future they tend to bid up the value of public companies due to an increased perception that the future cash generated by the company will appreciate. The price of public stocks change instantly in reaction to news that is perceived to affect the future value of that company.

Every day shareholders vote on the value of the company by buying or selling shares. There is no price movement without one person agreeing to sell the stock and another agreeing to buy it. Stocks that have a lot of people trading are said to have a lot of liquidity, which basically means it’s really easy to get into (buy) or get out of (sell) the stock.

Private markets for stocks are the opposite. They are pretty illiquid. If you invested in the first angel round of a startup company it is usually very hard to sell your stock—usually for many years if ever at all. So how exactly are prices determined?

There is no great science to it. The earlier you invest the higher the chances the company won’t work out and thus you pay a lower price than later-stage investors. As an investor you’re trying to pay the appropriate price for your perceived risks of the company succeeding and protect yourself in the event that it isn’t quite as valuable as you had hoped. As the risks below get eliminated the higher the valuation investors are prepared to pay.

Over time some “norms” have emerged in pricing based on investors risk / return profile.  The obvious thing that investors think about is making a financial return on the investment they made in your company. Early-stage investors in technology startups are only looking for growth-oriented companies that can achieve an “exit” someday—either via selling your company to a larger company or via an IPO. The former is much more likely than the latter. So investors have to have some general sense of what companies that are similar to yours ultimately sell for in the private marketplace via an M&A transaction and they have to have some sense of valuations on public stock markets to be able to back into what their potential returns on your investment might be in the event of an IPO.

For example: If you were to invest $41 million into a company (and one could assume that you owned between 33-50%) then the company is worth $82-123 million at funding. As an early stage investor you’re often planning around 10x your investment at the time you write your first check so in this case you’d be going into your investment expecting an exit of $800 – $1.2 billion. Then you can do a little bit of research and find out that very few companies ever achieve this valuation in a trade sale so you’re clearly gunning for an IPO. You’re unlikely to want to make this sort of investment with the product or the market not yet validated. The risk wouldn’t be appropriate.

Ah, but you say that for a normal-sized angel check or A round check one shouldn’t worry about the ultimate exit because he or she is getting in really early and at a cheap enough price so who cares whether one pays $5 million pre-money or $15 million pre-money—you just have to make sure you back really big companies. Well, obviously if you knew that in advance it would be big, of course that would be true. But the reality is that you’re faced with two problems: 1) the earlier the stage the riskier and thus more write-offs so you need to have enough ownership percentage in your winners to make up for the losers and 2) the earlier stage your check the more likely the company will need many more funding rounds behind you and thus you face dilution.

So rounds tend to be “range bound” where prices at the top end of the valuation spectrum often being done in boom markets (i.e. 2007, 2011) and for the hottest of companies test the top end of the range, and in bad markets for fund raising (2003, 2008) test the bottom end of the range.

There is no such thing as a uniform price. It is highly dependent upon many factors: experience of the team, type of opportunity (a big biotech or semi-conductor A round is likely to look different from an Internet A round), geography, etc. So the ranges you would expect can be highly imprecise. But to help with the explanation I’d like to put down some markers of typical Internet pre-money valuations done in major US markets (San Fran, NY, LA, etc.) while acknowledging that San Fran deals are often higher valuations due to increased competition amongst investors.

There is no value judgment in my putting up these numbers nor am I negotiating with anybody. I’m just pointing out my gut feel for approximate ranges of deals that I’ve seen with Silicon Valley having the highest valuations, NY / LA / Boston / Boulder / Seattle having valuations in a slightly lower range but comparable and sometimes significantly lower prices in markets that don’t have a healthy venture market. These are not scientific, just anecdotal and just trying to provide some transparency for entrepreneurs on what I’ve seen in the market. And of course there are always outliers.

Prices have definitely gone up in 2011 as depicted in the anecdotal chart below. Again, prices are expressed as pre-money valuations.

For me I think that investors have got to accept the new reality in pricing if they want to remain competitive in markets like we’re seeing now. As ever, prices are still determined by: quality of team, quality of product / market and competitiveness of the deal.

So when I advise entrepreneurs on fund raising I often say that it’s OK to try and shoot for the “top end of normal” for the market conditions. So in 2011 as a startup company if you can generate lots of demand you can definitely raise an A round of capital (say $3 million) at a $7 or 8 million pre-money valuation or slightly higher whereas just two years ago you would have struggled. That’s fine. That’s the deal you get when you’re raising in a good market for startup financing.

What I caution entrepreneurs from doing is raising money at significantly ABOVE market valuations. I’m a VC so I have an obvious bias. But that’s not where this is coming from. I’ve been preaching the “don’t get ahead of your inherent valuation” message for nearly 10 years. I raised my A round at a $31.5 million post-money valuation with no revenue. It was early 2000. That was market. I saw this kind of pricing when I first entered the VC market in 2007. We had companies pitching us that had almost no revenue at all and they were raising $10-15 million in capital at a $40-50 million pre-money valuation. I should also point out that while they had built their products they had limited market traction.

We passed on all of these deals and often tried to discuss the possibility of more modest amounts of capital raised and at more realistic prices. It’s hard to stop a train. One company which was raising at $40 million pre-money wrote a comment about me in a public forum saying something along the lines of “Mark worked really hard to understand our business and was very detail-oriented. But he and his firm were just too cheap on valuation.” Fair enough. But he sold within 3 years for not a huge price after having raised more than $20 million. Another firm we saw tried to raise $15 million at a $60 million pre-money with similar metrics. They did an inside round, spent a bunch of money and then went through a fire sale of the business less than 2 years later.

Here’s the problem. If you haven’t figured out product / market fit and therefore still have a highly risky business you run great risks for getting too far ahead of yourself on valuation. If you raise at a $40 million pre-money on what would in normal times have been a $15 million valuation you’re fawked if the market corrects and you need another round. To any prospective investor you look like you’ve failed even before your first pitch. Even if you have an interesting story to tell, most investors won’t want to go through the brain damage of doing a “down round,” which creates tension between them and early investors.

Finally, even if they could bring themselves to offer you a major down round, the more sophisticated investors know it’s fool’s gold. They get a cheaper price, they wipe out much founder stock value and they reissue you new options. You’ll take the money—what choice do you have? But 6 months later you’re not working past 10pm. 1 year in you stop catching early morning flights. Within 2 years your evenings & weekends are spent planning your next business. And the CEO they would hire to come in and run the business when you go would always be a mercenary.

So my advice: go ahead and ask for a valuation that 2 years ago wouldn’t have been likely. Use competition to make sure you get a fair price. Raise a slightly higher round than you would have previously but keep some amount as a strategic reserve. Make sure that when you need to raise your next round of funding that you are able to show an uptick in valuation that is important for new investor confidence and to maintain great relations with your early investors.

Increase price. But unless you’re already a well-known technology heavyweight be careful about raising above the range of prices that are normal for a bull market. If you’re hot, don’t raise above normal. Raise at the top end of normal.

Other topics I’m going to cover at the Founder Showcase on June 15th:

• Why I believe convertible debt with no cap is wrong for your investors
• Why convertible debt WITH a cap is wrong for you
• How much money should you raise?
• When should you start talking with investors?
• Why you shouldn’t stack too many brand names into a round
• Are we in a bubble?
• and more.

Hope to see you there.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

I have often said that what separates real entrepreneurs from pundits and bystanders is a bias towards getting things done versus over analyzing things. My credo has always been JFDI.

It’s the hardest thing to teach people who come out of big companies, out of conservative jobs. At the big consulting firms, investment banks and established large technology companies we’re taught to produce long reports, make sure that every document is perfect quality and that every possible bit of diligence has been done. Good enough isn’t.

And so things operate on a CYA basis.

That doesn’t work in a startup.

There’s a certain cadence that you can feel when you spend time hanging any well-run startup company. The management team has to have a bias toward making decisions. They know that a 70% accurate decision made quickly and based on sound principles is better than a 90% decision made after careful consideration.

The startup entrepreneur knows that they’re going to be wrong often. They’re flexible and willing to admit when they’re wrong. They don’t create a culture of punishment for mistakes. They live be the credo that if you’re never making mistakes you’re not trying hard enough.

In my mind the sign of a great entrepreneur is the one that spots the 30% scenario quickly and adjusts but doesn’t get gun shy about rapid decision-making in the future.

In fact, analysis paralysis drives me fucking bonkers. It is not uncommon in a meeting for me to say, “There are three choices: A, B, C. My gut tells me that we ought to do B. But let’s decide as a group. I don’t care if my view isn’t selected. Let’s make a decision and move on.”

Many people find this uncomfortable. The world is filled with people who don’t like having to put their neck on the line and say what they think. I don’t really care if I’m wrong as long as I’m not dogmatic if evidence later shows we need to change course.

So that was a long walk into the topic of recruiting. But given that I believe the success of startups is almost entirely correlated with having extra-ordinary talent, the ability to source, select and inspire new staff to join is one of the greatest early tests of entrepreneurs.

There is an old management adage that says, “Hire slowly, fire fast.” The idea has become conventional wisdom. It says that you need to take due care in selecting team members. It also says that you need to act quickly when your instinct says somebody isn’t working out.

Only half of this adage is accurate for startups.

Hire Slowly?
This is the bit I have a problem with. I don’t think that recruiting is any different than any other decision process in a company. You’re never really going to know how somebody is going to perform in the role, how good of a cultural fit he or she is going to be and how motivated they’re going to become until they’re on the inside.

I’m not arguing that no screening is required. There are obvious questions you have give staff to get a gut feel on cultural fit, intelligence, aptitude and the like.

But here’s the thing. I see many teams that feel the need to interview another 3 candidates just to be sure. They suffer the decision on the way in. They over think the decision framework.

I come from the “Blink” school of recruiting and decision-making. If you haven’t read it, you should. As humans most of us are inherently good at reading people and our innate instincts for “fit” are much better than our ability to analyze humans on a spreadsheet.

I also subscribe to the views that you should always be recruiting (ABR) and when great people pop up you hire them and then find a way to make the role fit. I’d much rather have the super bright, super ambitious, great cultural fit in my business now than look for the “perfect” person who’s done this job before and maybe find them in 3 months. 3 months is a lifetime in a startup.

If you haven’t read it I’ve written before on these topics:
1. Attitude over Aptitude
2. Only Hire A+ People
3. Hiring at a Startup

And just as my gut feel about the likely success of startups is often determined by looking at their velocity of product development and market progress of their product, so too is recruiting a factor in my assessment.

Great leaders and great teams have the ability to find potential staff, evaluate their fit, inspire them to join and onboard them. They have good recruiting velocity.

Any team that I work with that struggles to hire people quickly knows that I’m likely frustrated because I have many other companies that I work with that aren’t so slow.

And when we didn’t ship product on time, didn’t get the biz dev deals we wanted competed, didn’t get our market messages out and the founder says, “sorry, I had too many other priorities – like fund raising” they know it will fall on deaf ears with me. Time spent onboarding new talented team members always yields more productivity than doing everything yourself.

“But we don’t have budget!”

Great entrepreneurs find a way. Recruiting cadence matters.

Fire Fast?
I’ve written in the past about changing jobs too frequently and I received a lot of blow-back from technical people who said, “I had asshole CEOs. When we hit a bump in the road he was very quick to slash-and-burn.”

I was trying to argue that it’s OK to change jobs a few times when you’re young and that “things happen” but that if things happened 5-6 times there is probably a pattern that isn’t completely the fault of some asshole boss.

But people don’t like to hear about firing or job cuts, so I was flamed.

So I have been reluctant to weigh in again on the topic publicly. Brad Feld and I were discussing the topic at lunch at the most excellent Glue Conference this week in Boulder.

He encouraged me to write this post and after smoking me out on Twitter I had no choice. Outed.

So here goes.

I have never regretted firing anybody. Not once.

I have on many occasions regretted not firing somebody quickly enough.

I don’t take any pride in letting somebody go. I recognize that it affects somebody economically, can affect somebody’s personal life and is one big blow to the ego. But if you’re afraid of firing people you shouldn’t be an entrepreneur. No startup company has any spare capacity for dead weight.

I’ve made every excuse to myself in the past, “I can’t fire him now, he owns the customer relationships and it’s a crucial point in our sales process.” Or, “I haven’t given him a long-enough chance to prove himself – let me see how he develops” or even, “it will have a big impact on morale because she is well liked. I can’t afford that right now.”

I’ve heard VCs use similar rationale, “We knew the CEO wasn’t working out but we couldn’t fire him because it would have made it too hard to get a fund raising round done” only to later regret not moving more quickly and reacting to the obvious discontent of the rest of the startup team.

I’ve lived through every excuse. And for every firing procrastination I’ve made, one month afterwards I’ve always felt the exact same way, “Why didn’t I do this three months early?”

Trust me: if you know, you know. If you know, do it now. Things don’t get better. Your “Blink” instincts are right. You won’t patch things up. Delaying the inevitable is not going to make things smoother with your investors, biz dev partners, customers or employees.

There is only one answer: fire fast.

Firing somebody is no different than the other 10,000 decisions you need to make in your company to survive. You free up much needed budget. You free up the org chart to bring in new blood. Almost universally your staff will come out of the wood-works and say, “thank you, he needed to go.”

When people aren’t pulling their weight other members who are know it. And they’re grateful to work in an organization where they’re valued and slackers aren’t.

When you have to fire somebody, don’t pussyfoot about. Don’t make up fake excuses about why they’re going or try to pretend it’s a redundancy or something. Tell them specifically what isn’t working. Don’t be mean for the sake of it. Give them suggestions of how they might think about the situation differently at the next company. Give them honest and constructive feedback.

If the sacking is legitimate, chances are they knew in their gut it wasn’t working and will appreciate the candor.

Obviously make sure that you’re following a legal process. In the US and UK if the termination comes reasonably quickly you’re almost always OK but please double-check with your legal advisors.

To be clear – I’m not advocating creating a slash-and-burn employee culture where there is a constant revolving door. I do believe that you set the tone in your company that you as a founder work your arse off and expect it of others. You make sure people know it’s a meritocracy and the best staff will rise to the top. Age and experience are irrelevant. Good people get ahead, bad people get asked to leave.

So there you have it. Most companies hire slowly and fire slowly – the exact opposite of best practice for startups.

Pick up your recruiting cadence. Take a risk on people who you think will be a good fit. Don’t look for perfect resumes. Take some chances. Trust your gut feel. And when you got it wrong you move on. You’ll recover.

Move fast. Don’t delay the inevitable. Check your legal framework. Get your papers in order. Treat people with respect and professionalism. Be open and productive. But honest with them about their shortcomings or why they aren’t working culturally. But fire them quickly.

Flame away.

Image courtesy of Joeff via Flickr.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at his Startup Blog, BothSidesoftheTable.

I’ve been thinking a lot lately about the proliferation of startups in the past 2 years. It seems almost incomprehensible that only 2.5 years ago we read the “RIP Good Times” presentation from Sequoia.

But what does this all mean? Are we headed for a long era of innovation in which startups are the new norm? Are we seeing a time in which pre-revenue companies are more valuable than our offline institutional brands? As with the late 90′s the answer is “Yes. And no.”

Yes, there is unprecedented innovation. I’ve never seen anything like it in my career. The era of cheap cloud computing plus open-source software plus digital natives unleashed upon society is creating some truly amazing products that will challenge the way we do business and the way we live our lives. I don’t believe it’s hyperbole to say that Twitter and Facebook are truly transformative at a societal level, for example.

No. It’s not all sunshine and candy canes. We are building a lot of stuff now that has no longevity. In a way, startups have become kind of like the video game industry. New stuff gets created, it’s fun to play with and talk about. You want to use it because your friends are doing it and you want to find out what it’s all about. You want to see what’s new. You want the dopamine rush.

You play with it for a few weeks or months. Then you stop. You stop because it was game like. Temporal. Non valuable. Not really helping you do something better. Not improving your life or business.

Not solving a real problem.

And so it occurs to me that many startups in the consumer world are now truly hits driven like video games or movies. They get marketed as such. We compare user numbers like box office receipts. Some become true breakouts that can be built into a franchise even though they started as just a game, like Angry Birds. They had the magic formula. Others like Words with Friends solve deeper problems than games, like meeting new people or curing loneliness.

The challenge that many startups face today is: Are you really providing enough value? Will you get the TechCrunch bump, the tier-1 VC anointment, followed by great PR firm support and then the NY Times or WSJ story that follows? Will that be enough or will high churn rates creep in, new toys be introduced into the market, new time sucks pulling user attention away?  This year’s Tamagotchi?

If you’re building a startup today I would encourage you to think harder about how you’re going to win the battle for share of mind. That’s much tougher than getting people to play with your hot product for 6 months. To do so you must truly provide value that changes the way that end-consumers do something in their lives that will persist.

My example du jour is LinkedIn.

Why had it endured though market machinations and become this year’s darling IPO? I can’t comment on its stock price – I’m not a public market analyst. But the obvious value to LinkedIn is that it is the dominant online resume of our generation. They got us to fill out the details of where we worked in the past and the network effect compels us to keep it updated.

The second obvious value driver is that it was one of our first true “social graphs.” I often argue that this has greatly weakened because everybody I know accepts LinkedIn requests from strangers so it’s not really a true barometer of our graph anymore but enough of the remnants are accurate enough that value persists. So resume + directionally-correct social graph = goldmine for recruiting, networking and marketing.

It doesn’t strike me as a “social network” in the way we’ve come to define them. But its focus on solving a real-world problem makes it uniquely valuable to most other social graphs.

So as I get around the country speaking at college campuses in 2010 & 2011, I have been preaching the same theme. If you want to build enduring companies that weather both the tech market acceleration and the inevitable tech market correction as companies like LinkedIn have done, you need to ask yourself if you’re solving a real problem for users that will persist when hotness wears off.

That might be in online resumes. It might be in online game platforms solving the problem of entertaining people. It might be online videos targeting a niche audience. It might be a way to diet online or a way to manage your online scheduling / appointments. Or like a company I spoke to today, SportsForce, that is helping high-school athletes better prepare to get picked up by college sports teams. That’s a problem in need of a solution – I’m sure. Or the way Uber is shaking up the cozy, static world of taxi transportation.

Not every problem has to be a huge VC-fundable business.

But what I do see in the market in 2011 is way too many “me too” solutions where a bunch of founders have brainstormed a way to do a better Groupon, a better Gilt Groupe, a better Twitter or a better Quora. When pressed, not enough of these entrepreneurs can answer questions about why users would still be using this product in 5 years, about why their product is going to solve a consumer or business problem that isn’t being solved today. They pitch me features, not value.

I play with features. I’m a tech junkie as much as the next guy. But next month I’m on to the next one.

I would encourage you to think bigger. The market is over-weight in companies trying to solve problems for bars & restaurants. Sure, that’s a fine category. I have no problem with it. But what about education? Healthcare information? Energy? Housing? Auto? Financial Services? There are so many big inefficiencies in this country that need tackling. I feel quite comfortable that our bars & restaurant industry will be just fine.

When you solve a real problem you’ll win the true battle. The battle for share of mind. Challenge yourself to think harder.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at Bothsidesofthetable

I’m in Seattle this week.

People keep asking me if I’ve “seen anything interesting.” Of course I have. I’m an entrepreneur at heart so I’m always inspired when I hear stories about innovation.

I really liked BigDoor, MediaPiston, OpsCode, BuddyTV, SEOMoz and much more. Can’t list them all.

But I’m not here trolling for deals. I’m here to build long-term, stable relationships that I hope will pay off over a decade, not a week.  I’m looking to turn dots into lines over time.

I’m inspired by the enthusiasm of the young, emerging startup ecosystem that is here. It has all of the components for success: a steady inflow of smart, CS graduates from UW who prefer to stay local if they could, a smattering of local VCs & angels, some “patron” companies like Microsoft and Amazon who provide new talent as well as the opportunity for company-defining partnerships and it has “elder statesmen” like Bill Gates and Jeff Bezos.

The ingredients are all here. Seattle should be the envy of any non-Silicon-Valley tech community in the country. Great lifestyle, great cost of living, motivated people and only the crap weather on the negative side. They have their successes; yet somehow all of the neurons don’t yet seem to be firing as powerfully as they need to be.

As I gear up to give a keynote at the annual Seattle 2.0 awards dinner on Thursday night I started to reflect on what it would take to “change the trajectory” for Seattle or for any regional market, really. It really wouldn’t take much to turn a great technology ecosystem into a truly electric one.

And I think about the “Seattle issue” as a metaphor for startups and business in general. I’ve always been a big believer that just a couple of key individuals make all of the difference in a company’s success. It’s why my investment philosophy is called, “the entrepreneur thesis.”

I was meeting with a first-time CEO of a very promising young startup recently and offering my advice on what his priorities should be. He listed all of the product releases that were upcoming, the customers that were in the pipeline and where he saw his competition moving. I gave him the same advice I give nearly all over-worked, control-freak, do-everything-yourself startup founders:

“Your number one priority isn’t any of these things. Your highest priority right now is hiring the 1 or 2 people that are going to join your company and make a difference. There’s you and your killer CTO co-founder. But who else is going to get out there and close your big biz dev deals with you? Who’s going to help you with improving your marketing / positioning to become a clear platform category leader like Twilio?

Are you going to do all of this? Evidence over the past year would suggest otherwise. You have too much on your plate.

A few key people really can make a huge difference.”

Him:

“I know, I know. I will start recruiting soon. But I need to get our next release out the door. I need to take some VC meetings. I just don’t have enough time to focus on it right now. It will be a bit easier when we have a little more progress to show.”

Me:

“Bullshit. It never gets easier. There are always the next 20 tasks. The reason you’re not getting to the next level is that you’re not prioritizing the precise thing that could take you to the next level. I would say recruiting at least one superstar would be your priorities 1,2 & 3.”

I don’t care if you’re a 10-person organization, a 1,000 person organization or a multinational corporation – often it is the few key players that change the dimensions. Imagine Apple without Steve Jobs. Or less obvious, imagine Facebook without Sheryl Sandberg.

So entrepreneurs need to think the same way some VCs do – because markets change, competition changes, innovation & technology cycles move so fast that only by having a few truly outstanding leaders in your company can you sustain any sort of advantage.

And that is precisely my thoughts for Seattle and what I plan to deliver on Thursday night: Which few key community leaders are going to step up and get those neurons properly firing and connected?

My recipe for Seattle or your community:

1. Community Leaders + Organizers
You need a good mixture of both.

Look at what Brad Feld has done for Boulder. I know it’s not single-handed as he has both fantastic partners at Foundry Group and many other community leaders. But he has helped put Boulder on the consciousness of so many young, aspiring entrepreneurs in search of somewhere other than the San Francisco Bay Area to work & live. It is possible and he’s showing people that.

David Cohen deserves much credit for building TechStars into an internationally recognized brand name for innovation. If you can attract people to Boulder for a session to be part of the magical mix of people at TechStars then some will naturally stay put afterward.  But it did take Brad as a public spokesman, consummate networker and successful VC to help create legitimacy to let David’s ideas flourish.

It takes both to build a community. The business leaders need to do their parts. The people with the time, energy & creativity to build organizations like TechStars need to bring their ideas to fruition.

I see this emerging in Seattle and the passion of “a few key individuals” who can help shift the game. Chris Devore & Andy Sack have created Founder’s Coop with the goal of funding, incubating & launching more early-stage ventures in Seattle. If you could convince a few young “wantrepreneurs” that there is a community that can support them & a safe landing if they’re not immediately successful you might have your next Amazon in the works. It’s a very cool vibe at Founder’s Coop. These two guys are part of the recipe for Seattle’s growth.

2. Passionate Entrepreneurs & Ambassadors
Stating the obvious but you can’t will a region into success. You need to have passionate tech entrepreneurs who want to build businesses locally. They have the same trade-off decisions that you do about packing up and moving to Silicon Valley vs. staying and building locally. The answer seems obvious (to move) but it’s not. When you account for competition for talent, the difficulty of retention, the cost of living and the difficulty of rising above the noise – there are many advantages of staying put. The advantages of moving are more obvious.

So you need Dave Schappell who is building an interesting business in Seattle called TeachStreet, a local-community initiative to connect teachers & students. Dave is ex-Amazon and is a tireless advocate for the Seattle community. He’s been steadily emailing me for the past 18 months with ideas for local entrepreneurs I “have to meet” and has been egging me on to spend more time in Seattle. He’s why I came this week.

He helped me organize a set of meetings with high-potential individuals and a dinner where we all debating how to increase entrepreneurial velocity. I re-connected with Andy Liu the founder & CEO of BuddyTV – the largest destination for social TV enthusiasts on the web. When I saw what BuddyTV is working on and how long they’ve been the market (since 2005) I realized that this has huge potential to help disrupt the television market. They haven’t launched their next gen product – watch this space. No Dave S. = no knowledge of what BuddyTV is up to for me.

Every community needs their “ambassadors” who build relationships with leaders from other communities, who convince these people to come visit the community, who help organize events with local teams to get the cross-city interactions and who create awareness for the local talent.

Dave is a potential key ingredient in the recipe for Seattle’s success.

3. Patron Companies
Seattle has something that many communities don’t have. It’s what I call “patron companies” and the local giants are Microsoft & Amazon. When you think about the success that is Silicon Valley, the unfair advantage is not just the huge amounts of available venture capital. When you start a company in the Bay Area you can often get your first biz dev deal done with Google, Facebook, Salesforce.com, eBay, Yahoo! or the countless other successful startup firms.

A key deal not only helps you raise venture capital but it can help attract employees, garner press attention, help with product focus & importantly drive customer adoption and/or revenue.

In Los Angeles we don’t have “patron technology companies” that are big enough to matter – we’re still hoping to see them emerge. But every time I talk with senior executives a the big studios or talent agencies I tell the same story,

“You know that your industry is being disrupted. What industry isn’t these days. You can be part of the creative destruction. You can help local entrepreneurs get their first deal done and the innovation ought to benefit you.

Sure, it might mean some of your employees or colleagues go to join the barbarians at the gate, but would you rather that innovation happen in your home town where you can play to your strengths or do you want your entire future industry to shift to Silicon Valley?”

This message is surprisingly well received. People do want to help. They just need a few key individuals who are willing to go out on a limb, take some actions and make things happen for them. They need somebody bending their ears. They can then direct staff, allocate budgets, talk to the press, connect you with politicians and attend events. A few key people really can make a difference.

And that is what is most disappointing about the feedback I’m getting about Seattle. It has the dual technology patrons and yet the consistent story I get is that they’re not actively out embracing the startup community, helping local successes emerge, getting comfortable with the symbiotic benefits of some employees going to startups that innovate at a different pace and then buying up local teams, talent & IP. They’re doing stuff – just not enough.

Seattle has its patrons. The neurons aren’t connecting to the startups. Somebody needs to make this happen.

4. Elder Statesmen
This is where I think the action on connecting neurons has to come from. Jeff Bezos (and executive team) have to recognize that it’s in their best interest to see the community thrive and the benefits to Amazon (not to mention Seattle) are far greater than any negatives of employee flow. Steve Ballmer, Bill Gates and other senior teams from Microsoft need to want to promote local startups. These kinds of connections seldom emerge from middle management who view the immediate threats more than the long-run benefits.

But Jeff, Bill, Steve and well as Howard Schultz, the executive team at CostCo, etc. are not likely to spearhead this movement. They’re too busy running their companies and literally changing the world. Who from Seattle has their ears? Who can get help get access to their capital? Who can get them to communicate the bigger picture message top-down to their teams to embrace the startup community and unleash local partnerships?

Without this – it’s a totally wasted patronage. Who will step up the way that Steve Case (founder of AOL) has done with Startup America to promote this initiative to politicians, business leaders and the press. Actually, who will get Steve Case to spend time in Seattle helping communicate the message to local leaders? It’s clear that America has a vested interest in promoting entrepreneurship in many regions in the country to stimulate innovation & job creation.

Who will be those key leaders who will step up and make a difference?

5. Playing to Your Advantages
Every region has its advantages and while not limiting innovation to local themes it seems to make sense to at least consider local advantages. It’s no big surprise that I spend a larger portion of my time in LA working on: disruption of television, performance-based marketing, games & mobile. We have unique skills, teams, experience and regional assets that give us a better chance of success than other regions.

In no expert in Seattle but when I look around I see: enterprise software (Microsoft), the market leader in cloud services (Amazon AWS), games (Xbox), some of the most innovative retailers in the country (CostCo, Starbucks, REI) and what is left of Boeing (HQ moved to Chicago). I’m sure there’s much more.

I’m not sure it makes too much sense to have check-in applications for restaurants here. That seems likely to be dominated by a more urban startup from NYC or from San Francisco. But who know? I’m just saying’ … what local assets do you have that load dice in your favor?

6. Marketing Muscle
It’s great to see an initiative like Seattle 2.0 because every community needs its local tech press to report on companies and run conference. Consider just how much exposure the Austin community gets every year due to SXSW. It’s awesome.

I’ve often talked about the NY advantage of having the NY Times, WSJ, Silicon Alley Insider, New York Magazine and even the editor of TechCrunch based there. Not to mention every major agency, many PR firms, etc. There is no question NY startups get disproportionate press.  That’s natural. Not to mention they have the highest profile VC / blogger Fred Wilson of AVC.

It was great to hear that in Seattle John Cook and company are solving this at GeekWire.  Every region needs its local media & events. In LA we have SoCalTech, for which I am grateful. It’s an awesome source of regional news. I’d LOVE to see it become more of a national vehicle. How do we make that happen?

I’m now getting about 400,000 views / month at BothSidesoftheTable. I don’t write about LA but I write from LA. It’s important. A few key people can really make a huge difference.

7. Local Angel Community / Recycled Capital
Fred Wilson wrote an eloquent piece on his blog about “recycling capital,” which every regional community should read. The magic that is Silicon Valley is that every tech entrepreneur who has made a bit of money chooses to “recycle” it by investing back into the startup community. There is a long tradition of these and it’s what formed the original angel network groups.

As I look at LA I see a lot of this reinvestment going on. There are great entrepreneurs like Evan Rifkin, Tom McInerney, Paige Craig, Diego Berdakin, Brett Brewer, Kamran Pourzanjani, Jarl Mohn and many, many more who have done several local Los Angeles tech investments. There are several “club deals” where you see the same sets of people “passing the hat” around on deals.

I know from all of my private conversation that they aren’t seeing this as a “get rich quick scheme” – they’re giving back to the community. And the truth is that they know $25-50k from them on a deal that they can help influence returns on is a lot better than handing it over to a money manager who is parking your cash in a vehicle you don’t understand.

I have done the same. I had the good fortune of doing one small deal that returned 6x in a year. So it was newfound capital I wasn’t expecting. I plowed it back into 9 deals. I prefer not to do any angel investments because I focus on my VC funds but it was gratifying to write some small checks to support local teams.

I know there’s tons of money in Seattle. Perhaps somebody needs to organize it a bit better to go into more angel deals. I know that Founder’s Coop has a fund as does TechStars Seattle. That’s one model. Perhaps some experienced tech entrepreneurs could formalize more of the Amazon / Microsoft money into a higher velocity of angel deals.

8. Venture Capital
And of course you need a mature venture capital industry. There are several local firms in Seattle like Madrona, Maveron, Ignition and others. But the consistent message I heard was “there’s not enough.” That’s why more VCs ought to be spending time in Seattle. It’s similar to LA in that there are a highly motivated cadre of tech savvy entrepreneurs wanting to create companies and a lack of funding. I’d bet if one is disciplined about investing here you’d see significantly better pricing than chasing deals in the overly competitive Bay Area corridors.

It’s not an either / or but both / and. But as I look at the GRP Partners returns we’ve made a lot of money investing in companies in New York, Chicago, Baltimore, Las Vegas, Arizona and Seattle. We won’t rush into the market but we’re very open to finding teams with the ambition to build big businesses. We know it can be done.

9. Foreign Direct Investment (FDI)
The other message I delivered to the room of entrepreneurs & investors at dinner the other night was that you need to think about equity from outside the region the same way that countries think about foreign direct investment. The inflow of capital can be transformative.

But what is often not talked about is that those investments lead to 8-10 board meetings every year of which it would be hoped that the “outside the region” VC would attend 6-8 of them in person. I think a series of brand ambassadors should find out when these VCs will be in town and organize evening events for them the night before so they don’t do a fly-in, fly-out visit.

Imagine if the ambassadors from Seattle organized a dinner with 8 entrepreneurs, the CTO of Amazon, the head of Xbox and the head of marketing for Starbucks. You mean to tell me that the VC wouldn’t fly in early for that?

With VC FDI the community gets more than money. They get time, commitment & attention. One deal begets more deals. If you’re already on a plane to Seattle 8 times a year picking up a second investment there is trivial. Get them over that first hurdle.

10. Time
And finally, it’s clear that to really build a regional community you need time. LA and Seattle are in the second (or third) major wave of technology innovation. We have all of the 2nd-time entrepreneurs from Overture, CitySearch, MySpace, etc. on to their next companies and that produced Demand Media, a public company who even with a slight recent reduction in share price is still trading at $1.3 billion.

Over the past 15 years Seattle has built one of the most interesting technology companies in the world. I’m still amazed at how forward thinking Amazon has been in cloud services – years ahead of Google, Salesforce.com, IBM, HP, Oracle or the countless other companies that should have been strong in this space.

It’s a shame that hasn’t translated into more local break-out successes, but if a few key people really wanted to put in the effort to make it happen I’m confident that Seattle could be a major force in the decade to come. That will be “the decade of the cloud” where it really starts to become a truly connect resource that continues to accelerate innovation.

Who’s in?

Top photo courtesy of Fotolia

Editor’s Note: This is a guest post by Mark Suster (@msuster) a VC at GRP Partners. He blogs at BothSidesoftheTable.

Banner Ads. They first started in 1994 and are therefore almost as old as the Web itself. They were very effective back then, with the original ad garnering a 78% click-through rate (CTR)!  I guess from there we had nowhere to go but down.

Nowadays banner ads get on average 0.2% CTR meaning for every 1,000 ads that are served up only 2 people click on them. And as Jon Steinberg of Buzzfeed points out, the CTRs for social media banner ads are just 0.08%.

Holy Shiitake!

Despite its creation more than 15 years ago, banner ads have been surprisingly resilient despite their lack of efficacy. In the IAB study that revealed the graph above, brand advertisers indicated that their number one objective in online advertising was “creating awareness” followed by “creating purchase intent” or “likelihood to recommend” the product. Yet these seem to be the least effective attributes of banner advertising.

The fundamental problem with banner ads is a condition called “banner blindness” meaning that our eyes are really quickly trained to look at what is most relevant on the page – the content we want to see. Check out this chart from eye-tracking research conducted by the usability guru Jakob Nielsen published in this piece. It shows that our eyes are trained to focus on the text, not the ads.

I’m sure it probably resonants with how most of you read the web.

So I’ve spent the last few years checking out companies that are trying to solve for this problem. The global advertising market is estimated at around $475 billion / year with only 12% of this online and measurable. (some data sources have this estimate much higher.) We believe that the structural industry changes will continue to create big opportunities for technology firms that enable the changes in media consumption for television, radio, inbound calls, online & social media. We are investing heavily in these changes.

One company that I previously wrote about trying to change this industry is, Solve Media, (I am not an investor) has created an interesting ad unit designed to drive up brand “engagement” and recall. The idea is that if I can serve you an ad for a function that you already need to perform on the web anyways – a captcha – with a brand message I can drive recall. And market research seems to confirm this.

You’ll see a clear problem here. Traditional banner ads only drive 16% brand recall and almost ZERO message recall. So it’s hard to argue that brands shouldn’t worry about CTR rates when it doesn’t seem that banners are very effective for branded advertising or awareness either.

It’s no big surprise that the overwhelming majority of online spend has therefore been “direct response” advertisements (trying to elicit an action) rather than branded advertising as pointed out in this good summary by Jeremy Liew.

So people will spend money online to get you to sign up for credit cards or Netflix but not to change your laundry detergent. I decided to look up one branded company in the chocolate segment to get a sense for the magnitude of spend online. Hershey’s chocolates spends about $365 million in advertising per year. Just $460,000 of this is spend on online display ads (0.1% for those without a calculator handy).

The reality is that advertising has got to become more integrated with content in order to drive efficacy. I know that any time ads are mentioned it makes the blood boil on any self respecting technologist the same way it did when HotWire ran their first ad in 1994 and the way it made Google’s blood boil when Overture launched the sponsored search category.

Ask anybody if they like product placements in movies or TV and they’ll resoundingly tell you “no” but marketers know better, which is why the celebrity endorsement industry is a $50 billion industry.

But even for the consumer reality sets in. Firstly, we care more about getting cheap or free high-quality media than we do about whether we see ads. Give people massive price increases on most media and they’ll abandon it. So how people behave and what they verbally say they stand for are often at odds.

Integrated Advertising

I believe that “integrated advertising” is one of the more effective types of advertising out there. You have to find a way to get your audience to actually “engage” with the content in the way that Solve Media is doing, in the way that in-game advertising works for video games or the way that celebrity endorsements work.

It’s why I still believe passionate in companies like Adly (I’m an investor) who have created ways for celebrities to integrate endorsements “in stream” in a Twitter feed. Yes. Oh, sacred cow. In the stream. Integrated with where our eyes & attention are. I advocated strongly for this 18 months ago and my belief system is as ardent as it was back then. If you’re interested here is my case.

But the simple facts are:

• Our attention is all in the stream. As evidenced by the eye-tracking studies – they will remain in the stream.
• We know that celebrity endorsement works. It has for decades. Celebrities care about their personal brands so will naturally rebuff requests to sponsor inauthentic products.
• The beauty of social media is that consumers can vote with their “unfollow button” so it has a natural self-correcting mechanism. If you get economic value out of having followers you don’t want to lose them over one ad.
• Sure, there needs to be ad disclosure. And naturally we have built in quality controls like: frequency capping, automated measurement so we can pull ads that people respond poorly to, A/B testing tools, data analysis to tell celebrities & brands which products will resonate, etc.

But I can tell you as my firm invested in Overture who created the category of pay-per-search that Google perfected – our company underwent three years of ridicule in Silicon Valley until people looked at the performance data and realized that efficacy matters.

The technology blogs will be aflutter with continued criticisms of in-stream ads while mainstream consumers continue to click on links provided by the celebrities they respect and will buy products accordingly. We already have the data that proves it.

In Image Ads

Another areas that I’ve been really focused on over the past 2 years is “in-image ads” as another form of integrated media. When you think about the eye-tracking we know that people care about the story and the images. And it is already an accepted fact that in many cases the ads & images are blended as any lady who reads Cosmo or Vogue will tell you. The big splashy image ads is part of their reading experience.

So we put our money where our mouth was an invested in the largest in-image advertiser on the web, GumGum, whose network now reached over 100 million monthly uniques with 3 billion ad-compliant images, delivering an average CTR of 0.4% (2x industry average for banners). The eyes are in the image. We believe this is why Google Ventures invested in Pixazza.

As you can see from this image, the ad is unobtrusive and potentially valuable to the reader. The ad unit is served up based on algorithms that determine what is actually in the image and also for whether an ad placement would impair the image. We could even target ads better based on who the end consumer was.

What else is out there in the field of integrated advertising?

Vibrant Media & Kontera have both built large and fast-growing businesses around text-based advertising and there are new entrants doing it in new ways like SkimLinks. Vibrant has a reach of 250 million uniques, making in the 12th largest ad-focused property online and has 3rd-party verified studies suggesting up to 50% increase in brand lift following their in-text ads (I’m not an investor in any of these companies). Text is shown to deliver higher CTRs than banners. Text is what we’re reading. It’s integrated.

There is a whole industry being spawned in the Internet video world and especially in the integration of devices (second screen TVs) and the TV experience. Some of the interactive experiences I’ve seen in recent demos are simply mind boggling and are starting to form new opinions in my head about how we will consume big screen TV in the future (I’ll save that for a future post).

The games industry has massively changed over the past several years to more of an integrated advertising / purchasing media with the growth of virtual goods and ads. An obvious example of integrated media would be the new Rio Angry Birds version. It’s actually very cool. There are increasingly incentivized offers to get more powerful swords & shields in battle games. This has proved far more effective than small crappy banners at the bottom of each screen.

There will always be a tension between advertising wanting to reach audiences through whatever means they can to capture their attention and help them discover new products and consumers who claim a strong preference for ad-free products. Yet the other tension between ad-free products that cost more versus ad-supported models have a clear winner: ads. On products where I’ve seen data the “ad free” versions have converted at 4-6% of the user base at maximum.

So the future of helping make the ad industry more measurable (and more online) I believe will be one of helping make ads both authentic & integrated. Trying to relegate ads to the least intrusive real estate of our computers is missing the point. Advertisers pay for efficacy.

If not, we’d be telling advertisers to just leave all of their branded advertising spend on traditional television in the future. And to stick with their old adage, “Half the money I spend on advertising is wasted. The problem is, I don’t know which half.”

Editor’s Note: This is a guest post by Mark Suster (@msuster) a VC at GRP Partners. He blogs at BothSidesoftheTable

There’s a line of thinking in Silicon Valley that you should build product businesses rather than services businesses. This thinking is largely driven by the venture capital industry (and subsequently Wall Street) who are in search of high margin, highly scalable businesses.

It’s nearly impossible to get a services company financed by VCs. You’re a small fish.

So pervasive has this thinking become that on several occasions startup companies with profitable & fast growing tech services businesses have come to me wanting to change their companies to product businesses or to create “spin outs.”

A great recent example of this was a successful group of entrepreneurs who had created a company that will do $10-12 million in revenue at their system integration business in 2011 ($5 million in 2010, $2-3 million in 2009). They feel very confident they can hit $18 – 20 million in 2012.

They have created two internal technology “products” and wanted to figure out how they could turn their services business into a product business that could be financed. This team is talented. They wanted advice. And probably some money.

I gave them advice I don’t think they were expecting from a VC,

“Don’t raise venture capital for this business. Ever. And stop effing around trying to create a product company.”

It is advice I give entrepreneurs often as I have written here on why most businesses should never raise VC.

Why Shouldn’t Most Services Businesses Raise VC?

Well, let’s look at this exact situation:

• I don’t have access to their actual financial statements but let me make some reasonable assumptions. It would not be a big stretch to image a well run service business like this making 15-25% net profit margins. Early in a services business there are usually no profits as the company reinvests in hiring people to grow, but by $20 million in sales the company should at least be pulling in 10% profits (if not more) depending on how much is reinvested.
• So assume that in 2012 the company would do $20 million in sales and $2 million in profits (10%) and 2013 they would do sales of $25 million and $4 million in profit (16% net margin) and then slow growth in 2014 to $30 million and $6 million in profit (20% profit). That is $12 million in profits over 3 years.
• The founders could reinvest this in growth (0% tax, focus on future equity growth) or take the profits of $12 million and divide amongst the founding partners. Assuming there are 3 founders and they own an equal amount (33%) then they’ve just taken $4 million each in profits and note that this is at a qualified dividend tax rate (currently 15%) versus an income tax rate (35%). True, the 15% rates will likely go up in the future, but I doubt they will approach the income tax percentage level.
• The thing is – even if your services business is a smaller scale than this – you have complete control over the decisions about where to take the business. There is no shame in making a few million dollars in profit and paying yourself dividends while still owning a large percentage (if not all) of your business. It’s how things are done across the country outside of Silicon Valley.
• The minute you raise VC you have one option – grow & try to become big. No VC is interested in dividends – they want growth. That’s the right answer for VCs.  It may be the right answer for you. But it might not.
• Trying to turn a successful services business into a product business is getting the cart before the horse. If you really want to do a product business then hire a professional manager for your services company, quit that job and focus 100% on your product company.

Why Build a Services Business in the First Place?
There are at least two types of tech services businesses in my mind:

1. Service as a bridge to a product business - One of the best ways for young startups to finance their business without any dilution is what I call “customer financing,” which is mostly only possible in businesses that target businesses rather than consumers. Customer financing often comes in the form of your company agreeing to build a product with a “sponsor” customer or two and helping them with the rollout / implementation. Often in this strategy you end up giving them the product for free and bill them only services fees. You own the IP you create.

The benefits for the customer are: a mostly custom-built product addressing one of their internal needs, the focus of a very talented young startup focusing on their business need & free product – potentially for life.

The benefits for you are even more clear: you get to build a product raising significantly less external money (if any at all) and therefore no dilution, you get a customer who will help you figure out the real requirements for your business and you have your first real reference client lined up, which should help with future funding and with future sales.

If you set out to build this kind of business you just need to be sure you don’t become a permanent consulting business by default. The “customer-financed” type of tech service business is never frowned upon by VCs – unless you’ve been doing it for 2-3 years with no product business to show for it, by which point they assume you’re the second type of services business.

2. Services for services sake - The type of business that is generally shunned in Silicon Valley is the “pure services” business like consulting, system integration, value-added resellers (VARs), customer support businesses, outsourcing companies, etc.  I have already outlined some of the economic reasons these can be good businesses as well as the one of the most important – retaining full control in you business.

But the broader reason that I often suggest to entrepreneurs is that they’re much easier to build than product businesses even though they’ll never become Google, Twitter or Facebook. Trust me – it is far easier to persuade a business to pay you for your services (a concept they readily understand) than it is to persuade them to buy a totally new product concept and pay for that product.

“How much is that software really worth? Who else is using it? How much did they pay? Wait, I’m only paying “X” for my Salesforce.com licenses – and you want me to pay “Y” for your product? Who are your competitors – how much do they charge?”

I could go on-and-on with all of the sales-blocking messages you will hear when you try to charge for a product. I’ll repeat: everybody understands paying for services. It’s pure irony. At my first company we would have a product sale of $80,000 where the customer would grind us to get the fee down to $70,000 but would readily pay $25,000 extra for “implementation & post-sales support.”

We were building a VC backed software business so I had to focus on the product business. But this lesson in business was never lost on me. And some of my former teammates are now building really awesome services businesses in the exact same field and they own 100% of their companies.

Even tech blogs know this. You struggle to get advertisers to pay your CPM rates and get your page clicks up in a business where you become a near commodity to every other website out there. Yet you can run a conference and mint money. If it’s well run, people readily pay for conferences and sponsors readily pay to become platinum, gold or silver sponsors. Tech blogs can theoretically scale, tech conferences are pure service businesses.

But How Do Service Businesses Grow?
I’m not saying the scaling a services business is easy – it’s not. One big challenge is how to grow the company. You end up needing to add staff and take on more risk without knowing what your future demand will be. There are a couple of ways to think about this growth.

1. Start with a network of independent contractors (1099′s)- When you’re a young company with 3-4 people and you land work that requires 7-8 it can be daunting. You don’t necessarily want to take on the extra employees and risks. I recommend that you establish a network of contractors who want to do similar work to you but don’t know how to sell projects or to build a company. They’ll be glad for the occasional extra work.

2. Vendor financing – When you start to win business – let’s say as an implementation arm for tech / business products or as an ad sales team for large tech / media businesses – you can often get financed in a small way by your vendors who are all to happy to have a bigger ecosystem of implementation houses. They won’t do this before you prove yourself but once you hit a minimum scale this is always an option.

3. Angel financing – just because VCs won’t back this kind of business doesn’t mean angels won’t. If you can show a few million in sales and the ability to return dividends in the near-term there are always smart businesses professionals who will consider financing this. What are there other choices these days – money in a bank at 0.5% interest?

4. Bank financing – OK, so this isn’t immediately likely to come from Wells Fargo, but there are tech banks like Silicon Valley Bank or Square1 Bank that are in the business of financing startups. If you can show regular cashflow and are willing to put your profits into their bank you can often fund expansion this way.

Final message on financing – just be careful not to let your fixed costs get too high as a young services business. In a booming tech market like 2011 it’s easy to think your business will always expand. The problem with service businesses is that when the economy turns revenue & profits take a really big and quick hit. Those companies that have a largely variable cost base and make the tough decisions survive for the next boom.

Why Shouldn’t Service Businesses Become Product Businesses?
If you build a true “technology services for services sake” business at some point you’ll likely build technology products as part of your projects where you either own the IP or you own in jointly with your customer or business partner.

This is where many service businesses make mistakes and go pear shaped. They get “product business envy” because they read too much TechCrunch about their product brethren raising money at crazy valuations and getting sold at even crazier ones. So they set out to build a product business within a services company.

A few problems arise. Firstly, they don’t realize how hard product businesses are. They mistake their successes in selling services as a competency in selling products. This is a huge mistake. Secondly, they often ramp up their cost base to accommodate these costs, which when a down market hits they are more effed than those that stay focused. Finally, the focus on the product (envy) means that they take their eye off of their core business, which is services. So the core business suffers.

I saw this first hand. My first career was at Andersen Consulting (one of the largest services businesses in the world). We built a hugely successful global services business yet we never got over our product envy from watching our tech clients. So we created internal software projects and all of the internal consultants on those projects became blowhards who thought they knew how to create software product businesses.

We stunk at every product we ever created. We had no sense for gathering real customer requirements. We over-spec’d products. We built for our over-intellectual selves. I can’t think of any great software tools ever created internally by Andersen Consulting. We were a great services business. Period.

What Should Services Businesses do with Their Product Businesses?
So back to my advice to the company I recently spoke to about spinning out their tech business or raising VC. My advice wasn’t to shut down all product / IP initiatives but rather to be clear on their purpose and how to monetize them.

1. Products as a service sales machine – My dear friend Franck Meudec in Paris knows this best. He has built some internal technology products to support his services business. They are “loss leaders” for his core business. Instead of going in and trying to hold the line on how much to charge for these products he can tell customers, “Sure, we’ll give you our planning software at cost if you decide to work with us.”

His business is booming. These products help him win his core sales. He is not confused about which is the horse & which is the cart. He is building a services business. Instead of owning 1% in options to join a startup tech company he created his own tech services business. He is the majority owner. Higher risk, higher reward than joining as a junior employee somewhere else.

2. Products as a key differentiator – Another important reason for having internal IP in your services business is as a key differentiator against other services businesses. If a customer is faced with two equal choices for companies who can implement Salesforce.com – how do they choose one other than references & price? Imagine if you had built a few modules on top of Salesforce.com that made that product more effective? Even if you didn’t charge for these it would sure increase your sales hit rate.

Tech services business in booming markets are mostly about how fast you can sell, implement, manage quality, hire and sell some more. In a down market IP can become a huge differentiator.

3. Products as a gross margin bump - Finally, it should be said that in a services business often your implementation rate becomes a commodity relative to others in the market. If you can make an extra 10% on each sale by selling your “add on” products that are at 90% gross margins not only will you increase your win rates but you’ll also add valuable profits to your bottom line.

In summary: I’m not advocating that companies are crazy to try and be product companies. In fact, that’s all that I fund as a VC. But I don’t want the narrow world of venture-backed companies and the trade rags that report on them to dissuade the overwhelming masses of potential entrepreneurs from building meaningful businesses that are both fun and economically rewarding.

Photo courtesy of Fotolia - check ‘em out. Thanks to Ryan Born.

Editor’s Note: This is a guest post by Mark Suster (@msuster) a VC at GRP Partners. He blogs at BothSidesoftheTable

I’m a very big proponent of the “lean startup movement” as espoused by Steve Blank & Eric Ries. The part of the movement that resonates the most with me (in my words) is that entrepreneurs should keep their capital expenditures really low while they’re experimenting with their product and determining whether there is a large market for what they do.

In the initial phases of any new market you’re developing a product (hopefully with a minimal set of features), getting feedback from customers, refining your product based on user feedback and then re-launching your product. Rinse & repeat. Nobody really knows whether or not the idea is yet going to be big, so I believe in not over capitalizing too early. This benefits you, the entrepreneur. It’s the whole basis of my investment philosophy, which I call “The Entrepreneur Thesis.”

I believe that over capitalizing companies too early often favors the VC. It takes options off of the table. It produces only one kind of outcome. It drives perverse incentives.  If you’re creating truly innovative products, you often have no idea whether the proverbial dog will eat the dog food. You have a hunch. Testing is what helps determine whether you’re really on to something.

In the late 90′s I saw a dangerous trend creeping into the startup world, which was that companies were suddenly raising huge amounts of money too early in their existence. It seemed to be purely speculative. It’s not clear that there was big customer demand for some of these products yet entrepreneurs were egged on by VCs to “take the money” and try and push the market. I was a victim of this kind of thinking. “If my competitors have raised $40 million then I need to in order to keep up.” This is total bullshit.

Here’s what those VCs (and us entrepreneurs, myself included) didn’t understand: 9 women can’t make a baby in a month.

Markets develop for a complex set of factors that are often beyond all of our control. It is often the fortuitous mixture of new technologies, customer awareness and then acceptance of the technology and then the slow adoption into our daily lives that leads to markets exploding.

Often the timing of this is luck. And one of my favorite sayings is that “being too early in a market is the same thing as being wrong.” Throwing more money to speed up market adoption very seldom produces results. Yet it tempts us all. And it seems to be creeping back into startup culture of late in a worrying way. Great product ideas (and even potentially great companies) are being thrust at us in an attempt to go more quickly.  I recently read this anecdote in the press (I won’t mention the company name because I actually really love the concept, but it’s not too hard to figure out). Talking about whether to raise more money or not, their VC allegedly said to them:

“If you had more capital, could you get to the future faster?  Will (many more) millions help you get five years into one?”

9 women. Baby. Month. You can’t get 5 years into one. That’s falling prey to the “mythical man month” line of thinking.

Over funding often produces bad behavior in early-stage companies. You hire people too fast, you over build your products, you try to force market adoption and you do PR blitzes before your product is really ready for prime time. And having too much money certainly raises board expectations that you will do big things quickly. No board is going to give you $25 million up front and then expect your year-one staff expenditures to be $2 million.

I would argue that the father of the lean startup movement might actually be Bill Gross as he talked about in this interview I did with him on “why your company needs to be 10x better than your competitors to win” in your market. And I believe that strength of the Y Combinator movement in America has been exactly this: take incredibly talented technologist who have a passion for an idea, let them launch it and let’s see what they produce and what the market reaction to this product will be. It’s interesting to me that two of the most talented tech leaders of our era – Bill Gross & Paul Graham – have both opted for a model of incubation to encourage young tech entrepreneurs to build disruptive businesses.

The moment that you have a product that seems to satisfy the needs of a large enough market you enter what startup people like to call “product / market fit” characterized by the rapid acceleration of customer demand and therefore adoption. This is the so-called “tipping point.”  It is at this point that your startup needs to consider “going fat.” In fact, not going fat at this stage can also cause problems. Once you’ve woken up the sleeping lions (e.g. Facebook, Google) to a large market opportunity then you had better have enough resources to compete.

Some of the best new companies of the past several years seem to stay lean until they figure out their product / market fit. Twitter took a few years until people (or the company) really understood how to use it effectively. I’d hate to see what Twitter would have become if they had started with $50 million. Quora is one of the better designed new products of the past few years in my opinion. And they seem to have been going really slow in building out the team and you certainly don’t see a ton of too-early PR blitzes from them.

Those of us that espouse “lean startups” often do so from personal experience. We made mistakes ourselves that proved to us that you can’t make markets move faster than they inherently want to just by throwing more resources at them. Those of us that are willing to admit that we fawked things up in the first dot-com explosion and learned from our mistakes have the battle wounds to make more pragmatic decisions in 2011. It is encapsulated in one of my favorite quotes that I first heard from Bruce Dunlevie of Benchmark Captial,

“Good judgment comes from experience, but experience comes from bad judgment”

I loved the quote so much I wrote an entire blog post on the topic. That’s why when you hear Steve Blank talk about lean startups you can hear his experiences ooze out of him in real-life examples of 8 startups. He knows that in the earliest phases of your businesses you’re trying to discover whether there is actually a large market for your product. If you’re a startup or product person and haven’t read his book Four Steps to Epiphany please do.

And let’s be clear. “9 women behavior” is not restricted to just fund raising. We technology leaders also make this mistake. I certainly did in my first company. I continually felt the market pressure to get new product releases out the door. I had my sales teams telling me we needed certain features to be competitive. I had my dev team asking for us to work through new architectural components to improve performance. I had my operations team telling me it was too hard for them to run analytics unless we built in our new BI platform.

It was so tempting for me to throw extra resources at our technology debt for a couple of quarters. And that’s exactly what I did. Our lead architect argued against it. He said that they were in a tight, small, very productive team and if we left them alone he felt they could be incredibly productive. As we added more resources we added more strain on his high-calibre core team. They had to spend time training our new resources, reviewing code, refactoring where mistakes were made, attending meetings, etc.  He argued that in some cases less was more.

What did he know? He was tech. I was management. He didn’t feel my pressures on sales, marketing and ops. I had built computer systems before. I had been part of large, multidisciplinary teams. So I added a third-party developer in Bulgaria to increase output on one of our products. I added a dev team in India to spearhead new initiatives and design our future UI. The former was outsourced, the latter was our own team.

In the end, of course, our productivity actually suffered. It is he who first taught me this lesson. It was Ryan Lissack, now senior director in tech at Salesforce.com. He understood “the mythical man month” long before I did.  The beauty of working with uber talented teams is that no matter how experienced you are as a leader you’re always learning from your team if you’re willing to listen. Eventually I did. And ever since then I have been reluctant to over-resource tech projects. Ever since then I have been in favor of smaller teams focused on core tasks. I have been in favor of lean development.

I hope this phase of the economy – the 9 Women phase – doesn’t last too long. And I hope that entrepreneurs will have the confidence to resist VCs who are pressuring them to over-fund too early. I know how it feels when the “siren calls” of money. It’s tempting. Just know how the end game often plays out …

** Image courtesy of Fotolia. Check ‘em out.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at Bothsidesofthetable

Blogs. We all read them to get a sense of what is going on in the world, peeling back layers of the old world in which media was too scripted.

By definition, if you are reading this you read blogs. But should you actually write one if you’re a startup, an industry figure (lawyer, banker) or VC? Absolutely.

This is a post to help you figure out why you should write and what you should talk about.

1. Why
If you care about accessing customers, reaching an audience, communicating your vision, influencing people in your industry, marketing your services or just plain engaging in a dialog with others in your industry a blog is a great way to achieve this.

People often ask me why I started blogging. It really started simply enough. I was meeting regularly with entrepreneurs and offering (for better or for worse) advice on how to run a startup and how to raise venture capital from my experience in doing so at two companies. I was having the same conversations over-and-over again (JFDI, Don’t Roll Out the Red Carpet when Employees are on the Way Out the Door, Don’t Drink Your Own Kool Aid, etc) and I figured I might as well just write them up and make them available for future people who might be interested. I never really expected a big audience or ever thought about it.

I had been reading Brad Feld’s blog & Fred Wilson’s blog for a couple of years and found them very helpful to my thinking so I honestly just thought I was giving back to the community.

The results have been both unexpected and astounding. Within 2 years I was getting 400,000 views / month and had been voted the 2nd most respected VC in the country by an independent survey of entrepreneurs, The Funded and sentiment analysis. I know that I have not yet earned these kudos based on investment returns (although my partners have. GRP Partners last fund is the single best performing VC fund in the US (prequin data) for its vintage year). But it speaks volumes to what people want from our industry:

• transparency
• accessibility
• authenticity
• thought leadership
• advice

2. What

You wouldn’t. You shouldn’t.

Not only would it be less authentic but if you’re a startup it’s not immediately clear that other startup CEOs are your target market. They’re mine because I’m a VC. I care about having a steady stream of talented startup people who want to raise money thinking that they should talk to me in addition to the top others whom they’re targeting.

3. Where

You need a blog. Duh. If you’re a company and if hanging it off of your company website makes sense for the link traffic – go for it. If you’re head of marketing at a company and keeping a more generalized blog (in addition to your company blog) so that you can influence brands & agencies – it can be separate.

I chose for my blog to be independent of my firm, GRP Partners.  The reason is that I wanted to be free to say what I was thinking independently of my partners. My views don’t always represent theirs and vice-versa even though we’re pretty like-minded (we’ve worked together for 10+ years).  I chose a title that represented a brand that I wanted to emphasize – Both Sides of the Table. I chose it because I thought it would represent who I am – mostly an entrepreneur but somebody with investment chops. I wanted to differentiate.

So. People keep asking me, “why would you write on TechCrunch?” I guess I would have thought it was obvious. Apparently not. People say, “aren’t you driving traffic away from your own blog?”

Facts:

• I don’t really care about total page views or uniques other than as a measure of whether I’m improving. I don’t sell ads.
• I DO care about “share of mind,” which means that I want fish in the pond where the people whom I want to speak with hang out. I know a certain number hit my blog. But I’m not so arrogant (or successful) as to think they come all the time. So I take my show on the road. If I can write about a topic for which I’m passionate about and double or triple the number of people who read it – that’s gold dust. That’s why I never stopped anybody from taking my feed and republishing.
• As it happens, since I began writing at TechCrunch my viewership has continued to go up, not down. I always publish on my own blog the day after it runs on TC. I want the historical post there. A large number of readers on my site get it from Feedburner or newsletter feed.
• I also get a lot of inbound links from writing here. I try to make any inbound links to my blog authentic to the story. But each story has driven 1,000′s of views.
• The majority of my traffic still comes from Twitter. TC posts = more Twitter followers = more conversion when I do write on my own blog = more Feedburner / newsletter subs = more traffic. It’s an ecosystem. Simple.

So once you have a blog, a voice and a small following – don’t be shy about writing some guest posts for target blogs. Remember – for you that’s likely not TC – it’s the place your community hangs out.

4. How

Be authentic. Don’t try to sound too smart or too funny.  Just be yourself.  People will see who you are in your words.  If you try to make everything too perfect you’ll never hit publish.  If you try to sound too intelligent you’ll likely be boring as shit.  Most blogs are.  I hate reading blow hards who try to sound like they’re smarter than the rest of us. Be open and transparent.  Get inside your reader’s minds.  Try to think about what they would want to know from you.  In fact, ask them!

Don’t be offensive – it’s never worth it to offend great masses of people.  But that doesn’t mean sitting on the fence.  I have a point of view and I’m sure sometimes it rankles.  But I try to be respectful about it.  Sitting on the fence on all issues is also pretty boring.  And don’t blog drunk.  Or at least don’t hit publish Mostly, have fun.  If you can’t do that you won’t last very long.

How do I get started? First, you’ll need a platform.  I use WordPress.  Some people swear by SquareSpace. There are the new tools like Tumblr and Posterous.  I’ve played with both and they’re pretty cool. They’re more light weight and easier to use. Importantly, they’re more social. It’s much easier to build an audience in social blogging platforms the way you do in Twitter or Facebook.  T

hen  you need to decide whether to use the “hosted” version or the “installed” version.  At least that’s true in WordPress.  The advantage of the hosted version is that it’s easier to get started.  The disadvantage is that you can’t install a lot of additional tools that use Javascript. I started with the hosted version and then migrated to an installed version so I could use Google Analytics and some other products.

You then need a URL.  It’s true you can be something like msuster.typepad.com but that’s kind of lame so I wouldn’t recommend it.  Just get a real URL.  I think it’s important to think about what image you want to portray when you pick your URL name.  It doesn’t need to be short.  You’re not trying to build a consumer website.  My website is a pretty long URL but people manage to find it.  Much of my traffic is through referring websites and/or social media. Some search. What are YOU trying to convey?  What will be your unique positioning?  Don’t just write a carbon copy of what somebody else is doing.  That’s boring.

So I wrote a post, now what? Don’t blow your load on your first post.  Slice it up enough to do many posts.  I think most blogs are between 600-1000 words / post.  Once you’re written a few posts don’t try to make the flood gates open at once.  Slowly build your audience.  Make it organic.  If you write good content and consistently you’ll build an audience over time.

The number one thing that kills 95% of blogs is that they do 5 or 6 posts in rapid succession and then peter out. It’s lame to go to a blog where this happens. And then 8 months later they do the obligatory post saying, “OK, I’m going to be more committed to blogging now!” and then another 4 months go by. If you’re really not going to write that often at least don’t put dates on your posts.

But if you write good stuff, but in an effort and keep going – it’s a marathon – you will see results over time.

How do I build an audience? If you build it, will they come? No. A blog post is just like a product. First it needs to be good. And then you need to market it. It doesn’t just happen. You should be subtle about how you market it, but market it nonetheless. If you’re too squeamish to ask for help in promoting it or to do so yourself then you’ll never build an audience (you’ll also likely not make it as an entrepreneur. Sorry. But that’s true.)

The obvious starting point is to email a few friends and let them know you have a new blog.  Don’t be overbearing – just an email saying, “wanted to let you know about my new blog.”  I also recommend you put a link to it under your email signature (in a color other than black).  You also should have it be what your Twitter bio links to.

Every time I write a post I send it out on Twitter.  I try to send out the Twitter link when more people are online.  Over time I’ve found out that I get better clicks at 8.30-9.30am Mon-Fri so that’s when I Tweet a lot of my stuff.  I’ll frequently send two Tweets – East Coast & West Coast. If you want to know why I’ve outlined it here.  Not everybody sees the first one.  Social media is ephemeral.

Because I’ve built my Twitter following slowly but steadily and authentically over time I get very high click-through rates (and thus a high Klout score – currently 74). I get about 4% CTR (click-through rate) on every Tweet in the AM) and it’s actually higher because if I assume only 33% of my followers on online the CTR is closer to 12%.  Interestingly if I had sent one Tweet at 5.30am (to get East Coast time) and another at 8.30am I get 4% CTR both times. So it’s hard to argue you shouldn’t Tweet twice if you have a geographically distributed following.

How do I know my stats? I use awe.sm (disclosure, I’m an investor) which is the best tool I know of for tracking: each individual share behavior (it creates unique URLs for each Tweet) plus it also separates out Tweets from Facebook shares, from “Retweets” that come from somebody clicking on my blog, etc. It also tracks who Tweeted the link so you will know who your most influential social followers are.

Make sure your blog has Tweetmeme or similar to make it easier for readers to Retweet.  Also, make sure to sign up with Feedburner.  That way people who want to get your blog by RSS and/or email can do so. Make sure your blog also has a Follow Me on Twitter button so people who find you can easily follow you.

5. When

People often ask how I blog so much and don’t think they can do it themselves. If you write about something for which you’re both knowledgeable and passionate I’ll bet you can pump out more than you think.

I usually blog at 10pm or on airplane flights. I never blog at work. Like you, I don’t have the time. I have board meetings, company pitches, internal partner meetings, etc. Hell, I often can’t even get to email during the day. So it comes out of TV time, which means I’m not missing anything. Occasionally if I really want to blog and I have a date or too much work I just set my alarm for 5.30am. Yup. It’s not that hard if you make a commitment to it.

What would it mean to you and your business if you could: increase your inbound traffic, enhance your company & personal brand, meet new influential people who suddenly know who you are. If you want these things they are available to you for the cost of some time & effort.

If you plan out what you want to write about in advance (create topics then to headings to structure your article. You’ll notice on this one I started with mine … Why, What, Where, How and then I later added When & What Next) then it’s really about writing.  Structure helps enormously.  If you need some help with the creative process read this.

I write for about 45 minutes to an hour in the first pass.  I usually then re-read, edit, spell check and add links.  This usually takes another 20-30 minutes.  I then always add an image.  I think this is a nice touch.  Just staring at text is a bit boring and I find that the image can add humor and/or drive people in.

6. What Next?

Then there’s comments.  You HAVE TO respond to comments.  Do yourself a favor and install Disqus. It makes a huge difference in driving a comment community.  If you want the details on why I covered it here.

First, it’s the most fun part of blogging.  It’s addicting like Twitter.  It’s where you exchange ideas with other people.  It’s where your community gets to know you.  It’s where you build loyalty and relationships.  I have met many people in person who were first commenters on my blog.  I find it frustrating if I leave comments on somebody’s blog and they never respond.  If somebody found your blog and took the time to comment then they’re like a customer who should be cherished. Responses to them are like customer retention. It’s also where you’ll learn. People will tell you when you’re full of shit.

Appendix: Traffic Hacks:

• Commenting on other blogs – you need to comment on other people’s blogs.  First, it is a place where your comment will often link back to your blog where it can drive traffic.  Occasionally, and not overtly, and only if relevant you can provide a comment with a link back to an article in your blog.  Don’t do this often, don’t be blatant and make sure it’s relevant.
• Linking to other blogs – For example, many people know that I love VentureHacks because it’s a great resource for entrepreneurs and I think that Babak Nivi is a star.  Notice I’ve linked to his website.  If he tracks his blog (which I’m sure he does) he’ll see this link.  If he has a Google Alert on his name (everyone does) then he’ll also get that.  Don’t be over the top gushing and creepy.  Be subtle.  Don’t overtly tell everyone you link to, “I linked to you, check out my article!”  Assume that over time if you write compelling content they’ll eventually check you out.
• Covering relevant people in your blog in an authentic way – If your blog covers topics in your industry it’s likely that you’ll be able to write about some people and companies that you want to be aware of your blog.  Don’t Tweet @ them telling them you covered them. Don’t email them saying you covered them. Just talk about their company. If you write good articles over time and do this often enough people will notice.
• Tweet support - What I did in the early days was to enlist Tweet support.  I would occasionally ask people that I was close with to retweet my posts.  I tried to mix it up in order to not ask the same people often.  I would send out emails with the Tweet text already written so that they just had to cut-and-paste.  As my blog started getting authentic traffic I stopped asking for this help very often.
• Guest authoring – Once you have a bit of credibility as a writer a great strategy to drive traffic is to write guest posts for relevant bloggers in your sphere of influence.   If you run BakeSpace and blog about food why not contact some of the local food blogs and see whether you could submit guest articles.  Most people are delighted to have the free content.  In return all you ask for are links back to your blog and to your Twitter account.  Slowly and surely these will add users, of which some will come back on a regular basis.

Editor’s Note: This is a guest post by Mark Suster (@msuster), a 2x entrepreneur, now VC at GRP Partners. Read more about Suster at Bothsidesofthetable

Startups. We know the mantra: Team matters. Is this philosophy exaggerated? Overrated? Cliché? No. Team is the only thing that matters.

Whatever you’re working on now, the half-life of innovation is so rapid now that your product will soon be out-of-date. Your existence is irrelevant unless you continue rapid innovation.

Your ability to keep up is dependent on having a great team of differing skills. Individuals don’t build great companies, teams do.

The nature of the Internet and global knowledge is such that even if you’ve stumbled on to a super interesting area of innovation there will be many teams tackling the same problem at exactly the same time.  If you develop something novel that catches a spark you’ll have the world gunning for you over night. In this globally connected world product leads disappear in nano-seconds.

The company with the best team on the field will win. The team which hires the most talented people, channels them in the most productive configuration and gets the most output from their unique capabilities.

So how exactly do you assemble such a team?

1. Only hire A players
There’s an old saying, “A players beget A players. B players beget C players.” Why? Well, A players are discerning and tend to only want to join somewhere where they perceive other A players are. B players tend to have slightly more self-confidence issues so they tend to hire people slightly worse than themselves – thus C teams.

Is this a universal truism? Of course not. But it is general pattern matching. And it’s why VCs tend to look for uber-talented founding teams. We know that if you start with ho-hum founders you’d less likely to assemble a world-class team.

So if you’re trying to scale your team be focused on quality. Don’t sacrifice. Don’t hire too quickly just because you raised money or because you feel pressure to make things happen. The minute you compromise on quality you’ve already begun the descent.

Aim high.

2. Find people to “punch above their weight class”
I wrote an entire blog post about this in the past highlighting my belief that you should hire people who “punch above their weight class.” But what does that actually mean?

It means that many management teams I know feel the need to hire people who have “done it before” and frankly many VCs encourage this. It’s a mistake. When you hire somebody too early who has already “done it” you often find somebody that is less motivated in tough times, less willing to be scrappy (as many startups need to be), more “needy” and less mentally flexible / willing to change their way of thinking.

Importantly, you also find people who are too quick to undermine the authority of the founders. They “know more.” You don’t want sycophants - don’t get me wrong – you want people who challenge your thinking and a meritocracy of ideas. But you don’t want team members who openly question your judgment, your authority. At least not publicly.

So what do it mean to “punch above one’s weight class?” It’s a boxing analogy. It means a welter weight who wants to fight in the heavy-weight category. It means a “young Turk” who has something to prove. It means somebody who held the director of sales in their last company but in this company wants to be VP. Their last company said, “you don’t have enough years of experience.”

You said, “Eff experience. I want to know whether you can deliver. If you can, you’re golden. You’ll go a long way. If you can’t – you’re toast. Are you up for it?” It’s Tristan Walker of FourSquare. They hired him when he was an MBA. He had no right asking for a senior biz dev role at one of the hottest companies in the US. But he was ready to punch above his weight class. And he pushed for it.

And heavy-weight he has become. He is out innovating people with 10 years’ his experience. He is hungry. He is an A player. His innovation and execution are proving his worth.

3. ABR: Always be recruiting
In the entire time I was an entrepreneur I think I never really stopped recruiting.

In my busiest days I was still taking early-morning coffees or end-of-day beers to meet as many people as I could. Sunday mornings often became recruiting coffee sessions.

One of the “tells” for me of a management team that will not be extra-ordinarily successful is that they’re not always recruiting. I’ve seen it before – I send a talented member to a team and they say to me, “we don’t really have a role for that person.”

Really? I always have a role for talented people. I may not have a BUDGET for talented peole – but I always have a role for them. What role? Who the F knows. But let me at least have a coffee and feel out their enthusiasm, talent and ambitions.

I might choose to do an upgrade on my existing team. I might be grooming them for when I have more money or more revenue. I might not be able to persuade them now but I want them to know my company so that when I’m ready to step on the game I have a list of A players I want.

Sure, the challenges to me are obvious:
• How can I afford them?
• How do I motivate them?
• If I bring them on board now, how do I not reduce the motivation from those that I have already hired?
• Should I upgrade existing staff or hire them laterally?
• Can I persuade them to join when they have other choices?

If you’re not dedicating a large chunk of time to continually “recruiting” then you’re high. Or maybe you’re “low” – as in “not likely to succeed.”

Remember. Always be recruiting. ABR.

4. Don’t worry about exact “roles”
I think the most limiting factor that stops startups from recruiting is the “we don’t have an open spec” or “we already have somebody doing that role” excuse. Don’t let that be you. Your team can always make room for David Beckham. Lebron James. Keith Rabois. Sheryl Sandberg.

Get out there and find them. Ask others for intros to their talented friends. Meet talented people and sell them the vision. Get them exited about what you’re doing. Be relentless.

If they’re amazing, then be radical. Give them controls that they don’t have in their current company. Allocate them enough options to salivate. Convince them that even if they stay only a year they’d learn great stuff that would be valid for the rest of their future. You might several meetings to bag top prospects. But if you never start you’ll certainly never hire them.

5. Attitude over Aptitude

If you’re doing a great job at continually recruiting and if you have a company ready to hire several people, at some point when you have enough of a pipeline of talented people you need a way to separate them. I have a long-standing mantra, “attitude over aptitude.” This is assuming a raw minimum of MIPS in the candidate. They need to be seriously smart / talented in their field to make the minimum grade.

But within this “minimum acceptable talent level” you still have a wide variance of “employee types.” Let’s be honest – some uber talented people are PITAs. I never hire them. One bad apple spoils things for everybody.

You don’t see it coming. You figure, “sure, they’re a pain but they produce such high quality work I’m willing to put up with them.” Don’t. The last thing you need is some rat bastard fomenting trouble.

They’re the ones who are talking pop at cocktail parties when they’ve had one too many. They’re having private lunches with other employees talking about how they’ve lost faith in your vision.

When you hit internal moments of doubt you need the team members who say, “Guys, we can do this! We’re up against the ropes but we’re not down. Let’s dig in.” You need team members who do that when you’re NOT there.

If you have a trade-off between somebody who is more talented but a “bad seed” versus somebody who is very talented (but perhaps less so) who is a motivator – I’d hire the latter any day of the week.

Choose attitude over aptitude.

6. Culture matters
Along the same lines as aptitude I would say that “company culture” matters. Know what your principles are. Know the kind of people you want. Know what makes a member of your team. What traits are important to you? What values to you want to embody?

Try to set out guidelines for hiring. Try to live them yourself or people will see through it.  As times get tough you’ll value this culture. Even in uber successful times where you’re hiring like mad you’ll want to know what somebody who embodies your culture is like.

The best book I ever read on this topic was Delivering Happiness by Tony Hsieh (founder of Zappos). It’s a must read and has great advice on building a company culture.

7. Don’t over-sell
Finally, I always tell management teams not to “over sell” and I never do so myself.

I don’t mean you shouldn’t sell hard on the virtues of your company and why you’re the next Google – you should. If for nothing else you want all of the talented people you interview to spread the gospel whether they join or not.

What I’m talking about is this – if somebody is thinking about joining but you can tell they’re not convinced don’t cross the line to get them to join. What does this mean?

It means don’t tell them that they’re stake will make them $20 million if you’re not convinced it will. Don’t promise them that their role will be much bigger than you’re planning. Don’t promise revenue or growth faster than you know you can achieve.

Sell hard, sure. But don’t over sell.

Why? Because if somebody is not convinced in their own mind and you arm-twist them to join they’re bound to be unhappy and eventually leave. I’ve seen it a loads of times. You promise the world. You don’t deliver. They are frustrated. They feel duped. They express this to others. Now you have more than one problem.

And it’s never a good thing when a high-profile hire quits unexpectedly. It causes otherwise happy people to second-guess things.

So sell, by all means. But don’t over sell. Don’t promise unrealistic things. Don’t over promise.

So that’s it.

So go and schedule your next coffee meetings. Increase your number of interviews. ABR.