Venture capital in China

I recently caught up with my friend Derek Sulger, founder of Linktone (Nasdaq: LTON) and current founder and CFO of Smartpay, a Paypal-like play in China (I really like what Derek is doing with this one-no credit in China, use the mobile phones for debiting from bank accounts).  Derek and I are college friends and we certainly have come a long way from college when he finds my email on Google under a heading "Geeking out with Ed Sim" (thanks to Jeff Clavier for this one!) because his mobile device with all of his data on it is cracked on his flight from China.  That being said, we had a great chat on VC in China and opportunities he sees there.

First, from his perspective, he would rather pick one or two ventures at a time then spread out investments VC style.  If you think about it, there have only been around 7 or 8 internet-type companies that have gone public in China since the last bubble in the US (Linktone is one of those) when the Sina.coms were out in the market.  Given that, he would rather pick a couple sure bets and really work with them cradle to grave.  It is also tough to have any real governance and control of an investment by just sitting on a board in China, especially if you are monitoring a deal from thousands of miles away.  Secondly, he said it is tough to find good, experienced talent.  That is one of his gaiting factors in ramping up his ventures.  Finally, from an investment perspective, he would rather go consumer than enterprise.  His first business was a systems integration play which spawned Linktone and Smartpay.  He said it was difficult because the private companies you are selling to are really quasi-government agencies.  It is tough to get paid and very tough to protect your intellectual property.  At least on the consumer side, if you price your product or service appropriately, you can build a real PAYING user base and protect yourself from competitive threats with your base of subscribers.  Look at the history of China going from Boeing to the automakers like GM which did joint ventures with companies in China only to have their IP recreated and used against them.  I am sure GM could have protected themselves by charging less for their Buicks!

So there you have it from an experienced entrepreneur in China.  His thoughts make a ton of sense.

Welcome GreenPlum and Bizgres

I have looked at a number of open source projects over the last year and mostly agree with Bill Burnham’s comments that many of these open source plays are "marketing gimmics for startup companies."  Many of these companies are trying to start a new project from scratch, hoping to build a community brick by brick.  In addition, without the ability to create a community, it is hard to build a real sustainable revenue model.  Finally, open source does not matter if there is no customer need for the solution.  That being said, I am quite excited about the relaunch of one of my portfolio companies, GreenPlum, which is bringing the power of open source to enterprise business intelligence.  (Stop reading if you are not interested in a pitch for a portfolio company)

Quite simply, Greenplum is using an open source database optimized with supercomputing architecture to bring terabyte scale datawarehousing to enterprises.  Leveraging this architecture, Greenplum will be able to offer significant price performance benefits over existing BIG IRON solutions.  In addition, Greenplum is working with Josh Berkus and the PostgreSQL community to launch a new project, Bizgres, whose goal is to build a complete database system for BI exclusively from free software.  From a business perspective, what I like about our strategy is that we are building off an already existing and strong community of PostgreSQL developers.  Secondly, rather than pursue a broad platform play for all databases, we are focusing on a large but focused market in BI.  We believe this is a great way for open source to enter the enterprise as the market is riddled with expensive solutions, BI is a top 3 initiative in most enterprises, data is growing like a weed in most places, and because we are not asking CIOs to bet their transaction systems on open source.  Finally, our revenue model is not based fully on a support/service play.  The open source DeepGreen product will target small-medium sized businesses or anyone with data marts and reporting apps in the 10-300 gigabyte range.  GreenPlum will sell licenses for any company that wants to to deploy the DeepGreen MPP product to scale to multi-terabyte environments.  While it is yet another spin on open source, I am quite excited about what GreenPlum is doing and truly hope that by leveraging the success of PostgreSQL, staying focused on a targeted market, and employing a dual license model that the company will be able to rise above the noise.  As I have mentioned in a previous post, one of the clear benefits of open source, especially if you leverage an existing community, is to reduce the friction in the sales and marketing process.

Working with partners

I can’t tell you how many early stage companies I talk to tout their great list of partners.  I always step back in amazement at how a small company can support more than one, really large partner in the beginning.  In fact, I remember being in a meeting with a strategic partner once and having them tell me that we would break if they put their resources behind our product.  You have to realize there are 2 kinds of partners – technology partners and real partners.  In my mind, if you and your partner are not generating revenue for each other than it isn’t a real partnership but rather just a Barney press release.  Yeah, you know the "I love you, you love me" kind of partnership that sucks precious resources from a startup and yields no value and no customers.

So how do you make a real partnership work?  In theory, it is very simple but requires a ton of hard work.  Here are a few rules I like to use when working with partners. 

Rule #1 – Don’t rely on corporate; engage at the field level. 
Many early stage companies try to create partnerships from the top down without recognizing that the real action is in the field.  If you can bring your potential partner customers and lots of customers, you will get attention and be in a much better position to negotiate a real partnership.

Rule #2 – Focus, narrowly focus your opportunities.
Many of your potential partners are huge enterprises, and it is easy for a small company to get lost in the shuffle.  Try choosing a group in the large organization (it depends on how the company is organized) where you can effect a real P&L and create a strong value proposition.  In some companies that might mean focusing on a vertical like energy or financial services while in other companies it may mean picking a specific function like business intelligence or compliance.  Either way focus on groups where you can make a real impact. 

Rule #3 – Your partner’s sales force needs to get comped
Once you are able to demonstrate a handful of customer wins, it is time to get a deal done.  No matter what kind of deal it is, make sure that your partner’s sales force is comped for selling your product.  If there is no comp for the sales force, your product will not move in a highly leveraged way.

Rule #4 – Dedicate the proper amount of resources to make the partnership successful.
Once again, lots of companies think that once you sign a deal the hard work is done.  On the contrary, this is just the beginning.  You need to treat your partner like your largest customer and provide the same amount of focus on your partner as you do your customers.  You will have to develop a joint business plan together, figure out the proper sales strategy, put together compelling joint collateral and presentations, offer sales and SE training to your partners and their resellers, and finally get your customer support ready.  In addition, make one person responsible for making the partnership work.

Rule #5 – Don’t get sucked into your partner’s black hole.
Be careful of developing custom software for your partner or making too many proprietary tweaks beyond the necessary integration.  I have seen early stage companies too often bend over backwards without thinking about the real benefits of all of your partner’s requests.  As an early stage company you have to walk a fine line between leveraging partners for sales but also not becoming so glued to the partner that you alienate other potential channels.  As I have said in previous posts, it is ok to say no to some requests especially if you can demonstrate why it will not help generate more sales for both comapnies.  Either way, your partner will respect you and know that you are not a pushover.

As you can see, it is quite hard to support more than one partner for an early stage company. 

Go early, go late, or go home

After having returned from vacation last week, I had the chance to reflect on the current venture and investing market.  Yes, one of the big challenges is that there is still way too much money sloshing around in alternative assets.  As I think about how to make money in this competitive environment and where to make new investments, I keep coming back to the thought that there is still opportunity very early or very late in a company’s life cycle.  On the late side, the tech sector is clearly maturing, growth is slowing, and forward P/E ratios relative to the S&P are pretty equal or even less indicating strong value.  Combine this relative value with the fact that many tech companies, particularly large software companies, derive 50-70% of their revenue from annual recurring maintenance and you have an opportunity to buy out many of these businesses due to their predictable cash flow.  I see this as a trend that will only accelerate in the next few years as you have venture funds, LBO shops, and even hedge funds get into the tech buyout action.  Witness the recent Sungard deal and others.  If the private investors are willing and able to pay $11.3b for a company then no public software company is sacred.  This includes companies like Siebel and BMC who both recently missed their earnings targets.  There is plenty of value left in these software companies that the public does not see, and therefore plenty of money to be made by smart investors.

On the early side, I continue to believe there is much innovation to be done.  As the VC funds get larger and larger, they are under increasing pressure to put more dollars to work in every deal.  Therefore, it remains quite difficult for the larger funds to dole out money in $2-4 million chunks, and the valuations are quite attractive at this stage.  As a fund, we typically like to lead or co-lead the first institutional round (post-angel) where the company has a strong entrepreneur, innovative technology, and a handful of customers to prove the market need.  Where I do not want to be is in a Series B or Series C round in a "hot, momentum" company.  I have had a number of these companies come through my door, and I keep asking myself how a company which is only a feature of a much larger offering will create a significant return for the fund after having raised too much cash at too high a price.  When I see "hot" companies with revenue less than $5mm raise capital at $50mm pre-money valuations, I start getting worried, and it further reinforces my thinking on where to make good investments.

In the end, making good investments is predicated on taking advantage of inefficiencies in the market.  As we look at every new deal, we always revert back to the lesson that Warren Buffet’s mom gave him, "Buy low and sell high."  This includes investing on both sides of the barbell, very early with innovative technology in new markets and very late with established, out-of-favor software companies throwing off good cash flow.  Considering that I am an early stage VC, I will have to play the later part of the barbell with personal investments in the public markets.