Uncrunched

I have a few thoughts on this Y Combinator/Google Ventures mess.

Background:

The original post is at Business Insider and includes a leaked email from Y Combinator founder Paul Graham. The email:

If you’re talking to Google Ventures you may be part of a pattern. The pattern is: you’ve already raised some money at a cap of $x. Then GV says they’re interested and wants to invest at a cap of $x/2.

If this happens to you in isolation, you worry “Oh dear, maybe my cap is too high.” But in fact for some bizarre reason this is just their standard m.o.

What do you do in response? Just focus on other investors instead. Maybe you’ll find enough from other sources that you can blow off GV. Or maybe you won’t, and you’ll need that offer to fall back upon. Either way it’s better to wait.

Graham commented and clarified on this on a Hacker News thread:

Just so everyone understands, I was not saying that Google Ventures is a bad investor and should be avoided. If we thought that, the email would have been a lot shorter. I was just talking about a structural problem that happens when you’ve already raised some money on a convertible note with a valuation cap, and an investor offers to invest at a lower cap.

That sort of offer puts founders in a bind, because if you take it (a) it can anger the earlier investors, and (b) perhaps worse, it can, like a “down round” give investors the impression that your prospects are getting worse.

My overall advice about fundraising is to do breadth-first search weighted by expected value. I.e. talk to every investor who’s interested but focus on the most promising ones. This is one of many situations whose solution follows from that rule. An investor offering you money on worse terms is at least offering you money, which is better than nothing. But all other things being equal, the expected value of such an investor is lower than that of one willing to invest on the same terms as your existing investors, so you have any of the latter you should focus on them.

My thoughts:

1. My first reaction to the message is that Google has done absolutely nothing wrong. It is absolutely fine for a venture firm to offer whatever they want to a startup, and it’s absolutely fine for the startup to not accept that offer and move on. It’s easy to read Graham’s message as bullying. A sort of “don’t piss us off or we’ll blackball you” type thing.

2. However, the actual message in the email isn’t all that bad (more on that below). What’s awful is that it looks like a public takedown with the leak. Most people don’t really parse the language or read Graham’s clarification. They just see “Y Combinator Is Publicly Trashing Google Ventures.”

3. I think Graham’s choice of language in a couple of sentences is way too strong. Like suggesting Google Ventures has a “standard m.o” of lowball offers. I’ve seen no evidence of this from Google Ventures.

4. To sum up the first three points above, the only real problem with this email is that it became public and looks like bullying. You have to remember, though, that Graham is probably horrified this was made public.

5. An aside – Most stuff like this from Y Combinator doesn’t leak. The fact that this did leak is the most interesting part of all this for me. It may be because there are so many companies coming out of YC now that there isn’t the same sense of loyalty to the program. Or it may be a sign of stress because some of the startups may be finding it much more difficult to raise funding than previous classes.

6. Another aside – Most of these YC companies are being started by extremely green entrepreneurs who have never raised money from investors, or even had any real business experience. They’ve also seen an extremely loose venture capital world over the last few years and may have unrealistic expectations on just how hard it is to do all this stuff. A “setback” like a low offer may make them feel like they’re being mistreated and it’s natural that they’d complain to their support group (YC and their fellow startups) about it. Graham has a big job mentoring these entrepreneurs and he’s shown over time to be pretty balanced with his advice.

7. Graham has sent us (CrunchFund) private feedback at least twice in the past. We appreciated the feedback (he didn’t have to take the time to communicate), we responded, and everyone moves on.

8. I don’t fully agree with Graham that it is a disaster for startups to accept money at one valuation cap and then accept money at a lower cap. But he’s right that investors can get extremely pissed off about it.

The two times we’ve seen this happen (where we offered less than the previous cap and our offer was accepted) the company amended the previous agreements to give those investors the same deal we got.

9. The VentureBeat article today that suggests the reason Graham wrote this email is because Google Ventures is now a full on competitor to Y Combinator (“Google Ventures has perhaps become more of a competitor to Y Combinator than an asset”) is just pure nonsense.

The email is clearly nothing more than Graham trying to mentor and advise his startups. I know him well, and like most successful people he doesn’t worry much at all about his competitors (even if Google Ventures was a competitor, which it really isn’t).

That article also shows a fundamental misunderstanding of how these financings work on a mechanical level. For example, the statement “In debt financing, most rounds have multiple caps” is just wrong. Many startups raise multiple “financings” over time with different, usually increasing, valuation caps. But in a single financing? No, that’s quite rare.

There are other errors in the article as well but I won’t take the time to list them here. Just imagine if I wrote an article on fashion or particle physics or something that I know nothing about and my research consisted entirely of reading Wikipedia for a few minutes. There’s be a lot of words there maybe, but anyone with real knowledge of the subject would know I was full of shit.

I also think VentureBeat should fully disclose any other issues they have that might be affecting their judgement about Y Combinator, but I’ll leave it at that.

10. In the end the startups are the ones who will take a hit on all this. If a venture fund has to make a choice between walking away from a deal or making a lower offer than other investors, they’ll almost certainly walk away rather than take the risk of a public lashing like this. I’m sorry about that. I’m certain it’s the absolute last thing Graham wanted to happen.

I remember having a Habitrail and a couple of hamsters when I was a kid. It was cool because no matter where those Hamsters wandered off to (and I had quite the maze) I could watch their every move.

Suddenly we’re all the hamsters in the Habitrail.

The U.S. Constitution has no express right to privacy, but the issue was brought up repeatedly in the Bill of Rights.

We don’t have a right to privacy in the U.S. But the basic agreement with government has always been that the police can’t just do whatever they like, they have to have probable cause and get a warrant from the judicial branch before they start shredding privacy.

There are lots of notable exceptions, like sobriety checkpoints, that allow police to sidestep the judicial process. But generally speaking as long as you avoid driving drunk (or perhaps being an Asian American during World War II), you could have a reasonable expectation of privacy, or something like it, as an American.

Those days are long gone. Today we all carry finely tuned location tracking devices in our pockets and purses nearly all of the time.

We carry these devices voluntarily, even though we know that the government can access that location data at any time and without a warrant. And then use that data as evidence against us to convict us of crimes.

If I could somehow explain all this to our founding fathers, I imagine them doing a double take and sputtering something along the lines of “say what now?”

But that’s today’s reality.

It really is happening right now. If you’re a criminal there’s good chance your cell phone company is handing over all your location data.

This is such an efficient system the police aren’t even bothering with their own GPS tracking devices any more.

You might be saying to yourself “I’m not a criminal, so I’m fine. Who cares if the police are tracking my every move. I have nothing to hide.”

I’d say “Ok. I hope that you aren’t dating or married to a police officer or federal employee who might get jealous and start to track you. Or that you aren’t friends with the wife of a police officer who might start tracking you, too.” Because, damn, being a police officer today means you’re just a phone call away from being able to track anyone in the country for any reason.

And wait for the day a decade from now when someone is convicted of a crime based on nothing but implied guilt from turning off their phone or leaving it at home.

After a couple of years of this the police won’t just be happy they can track anyone – they’ll start to really think that they have the absolute right to track everyone.

And therefore anyone who isn’t carrying their phone with them, or turns it off, must certainly be doing something illegal and trying to hide what they’re really up to.

There are juries that will convict on this kind of circumstantial evidence. Maybe even you would.

Personally I don’t want to live in that kind of America. Because I’m not a hamster, and America isn’t supposed to be a Habitrail.

The last line of defense against the government is our Supreme Court. They’re the line in the sand. And they’re completely complacent about all of this.

Update: Google continues to do what our judicial branch will not.

Sarah Lacy wrote about acqui-hires this weekend on Pando Daily. She got some things wrong.

The main problem is her argument doesn’t work on its face. The logic breaks.

She says that all the interested parties love acqui-hires – entrepreneurs get an easy out, buyers get engineers, and investors get a free pass.

But she also says acqui-hires have to stop. In the world she’s describing, which is a three party circle jerk, I don’t see where the pressure would come from to stop them.

In reality investors don’t like acqui-hires at all. An acqui-hire is marked down as a “fail” in the books. In almost every case we’d much rather have the entrepreneur keep fighting for a win even at very long odds.

That being said, we don’t complain about them or try to stop them. But some investors do and will. That’s why there has been academic and legal interest in finding ways to plan ahead for acqui-hires in financing documents.

The idea would be to make them less attractive to entrepreneurs, or at least to give investors a bigger piece of the pie when they happen.

As investors, we never see an aqui-hire as something like getting our money back when we buy a lottery ticket. Like I said above, it’s just a loss. If every company we invested in did an acqui-hire our fund would perform terribly and we wouldn’t be doing this for very long.

Sometimes a company is just done and an acqui-hire is the best solution for them. But most of the time companies still have a fighting chance, and an acqui-hire is just the easy way out.

The article that needs to be written is how many entrepreneurs today expect an automatic Hollywood ending to their startup. No one is preparing them for the extremely hard times ahead, and they seem to be going in blind.

Nick O’Neill also has a good rebuttal.

My credit card won’t die.

On August 1 I cancelled a Chase credit card. I cancelled it because I couldn’t get rid of fraudulent recurring charges by contacting the merchant.

A few months ago I had tried asking for a new card with a new number, in the past that always worked to clear out all the BS recurring charges (gym memberships, etc.). The charges blasted right through that new card.

I wrote the blog post because I was surprised in the change in the law that allows credit card banks to continue to push recurring merchant charges even after a card had been claimed lost or stolen.

But it turns out it’s even worse than that. Yesterday I received a bill for that cancelled credit card. The account was closed, said the bill, but there was a new charge for $40.

Say what?

I called Chase. They told me that even though I had cancelled the card merchants could continue to bill me.

Basically, any merchant that had a recurring billing relationship with me can keep billing that card even though it is a closed account. All I can do is pay the charges or go through the dispute resolution procedure.

This raises an interesting philosophical question – How does Chase manage to continue to accept charges on my behalf when we’ve ended the contractual relationship? Can an account really be called “closed” when people can still run charges through it?

That’s something I’m going to explore by actually reading my credit card agreement. Shudder.

The merchant won’t deal with me because they don’t want to deal with me. My bank won’t stop them.

My only recourse is to go through the full dispute process and all the paperwork it entails.

The guy from Chase was interesting. He said that this was really necessary because so many people defraud merchants by getting out of recurring charges.

Err, ok.

I really don’t think I’m going to be giving out my credit card so freely in the future.

If you haven’t updated Facebook on your iPhone yet, do it now.

I was skeptical this morning when I saw the news that the the company was releasing a “faster” iOS app. Like all of you I’ve sort of forgotten that Facebook even had a mobile version, because trying to access the mobile site or app just put my iPhone at extreme risk of being thrown through the nearest window. I’m not exaggerating, it was awful and you know all know it. I often said it was the company’s Achilles Heel, and a self inflicted one at that.

Well, they’ve ditched HTML 5 and went native.

I’m not going to go into the philosophical issues around the decision. The only real point is, this new version performs.

So far I haven’t seen any lags or screen locks (which were constant on the old version). Pictures and text are loading snappy and everything seems to be, in general, staggeringly better all around.

This is a big, big deal for Facebook. They really nailed this. Well done.

Facebook is back in the mobile game.

More at TechCrunch.

Obama campaign to start accepting text message donations

Like a lot of people, particularly in the bay area, I’m pretty libertarian. I tend to like Republicans on fiscal issues and Democrats on rights issues.

As a libertarian I don’t think that redistribution programs as a rule help society or even the individuals receiving the redistributions. And the staggering, country-busting expense of them isn’t pretty, either.

I could go into why, but it would just be a long debate with some of you (ostensibly about economics but really just about politics) and I’ve seen that movie before. My point is, if I was forced to pick one of the two big political parties based on my beliefs it would have been Republicans in the past, because I don’t like large welfare and other spending programs.

In the past I’ve said that if the democrats could just take an econ 101 course they’d be perfect. And if the republicans could just stay out of our bedrooms, they’d be perfect.

One issue that has always made me very uneasy about voting for any republican, though, are gay and womens’ rights.

The libertarian in me really comes screaming to the surface in these situations. The only really emotional issue debates I’ve had with people over the last several years have been about gay rights in particular. It just really makes me angry that someone feels so superior as to tell other people who they can and cannot love.

Trust me, I think lots of liberals also have ridiculously superior attitudes, too, and they piss me off all the time.

But I think my struggle is over now. I’m going to have a blanket policy of not voting for any Republican from now on, unless they are publicly pro-choice and very libertarian in their human rights beliefs in general.

Why? This Todd Akin asshole. It’s just way too over the top to even think about letting it go.

I was talking about this with a friend this last week. The republicans have thrown away generation after generation of new voters with their absurd infatuation with controlling our personal beliefs, what we can do with our body, and who we can love.

I think I’d actually be more willing to stomach the financial armageddon that the liberals are walking us into than have to continue to see elected officials lecture women about rape and gays about love.

Which is too bad. Just a week ago I was toying with the idea of voting for the Romney/Ryan ticket. But that’s absolutely not going to happen now. I may not vote for Obama because I think he’s the worst president we’ve had since Carter. But I’m certainly not voting Republican.

It’s time for the republicans to give up on the oldest generation of voters, and the religious nuts. It’s time for them to focus on the next 50 years. There are millions of voters that would embrace them, if only they could stop the hate. I’d be first in line.

Comments should be fun.

Went to Detroit this week. It’s a lot nicer there (at least in the burbs where I was) than I thought it would be.

I flew Delta because it was the only nonstop flight option from Seattle. I bought a first class ticket, just like the last time I flew Delta.

A lot of you know my feelings on Delta, if not you can read them right here.

It’s my absolute last choice when flying. I can’t think of another business where everyone is so damned surly all the time, practically snarling at you from the first interaction at checkin all the way until you land.

I was joking with someone earlier this week about just how bad it was, saying my interactions with flight attendants basically came down to “hey asshole, you want any food?” An exaggeration, obviously. But it really does feel that way on Delta most of the time.

Anyway, today when I got to the airport the first class check-in area was pretty deserted and there were three Delta people behind computers to check people in. Doing absolutely nothing.

I stood at the front of the line area, the only person around. None of the three people were helping anyone. None made eye contact with me or asked me to walk up to them.

I asked one of them in general if they were open and if I could approach. Something like “Hi, can I check in with you?” She was about 15 feet away from me

She said “I need a couple of minutes.”

I stood there. No problem. Lots of time. A little while later she said “I can help you once you have your boarding pass and ID.”

This was from 15 feet away, and she didn’t invite me to the counter and it was sort of clear that I wasn’t to approach the counter until I had those items.

It was a little absurd, having a loud conversation from 15 feet away. And I was confused because all I wanted from her was my boarding pass.

I said “I thought I was supposed to get my boarding pass from you.”

She said “what?”

I said “I thought you were supposed to give me my boarding pass. If I already have a boarding pass what is it you do for me?”

She said “what?”

I said “it’s a little awkward talking from this far away. Can I come over to you?” Still in a good mood, finding this sort of fun and funny.

She said “Sir, I can help you once you have your boarding pass. Please stop yelling.”

Flashback to that hilarious scene from Anger Management.

So at this point I’m at the front of the check-in line at Delta. The woman who’s job it is to check me in has told me I cannot approach her area until I have my boarding pass. And we are having this absurd catch-22 conversation that neither of us can really hear because I can’t go close enough.

Okey Dokey.

Eventually I went to the computer area and got my boarding pass. Didn’t go back to her.

This all goes back to my old post where I talk about how Delta employees seem to hate their jobs so much that it’s almost impossible for them to be nice to customers.

This whole situation was mostly just funny and sort or surreal and wasn’t that big of a deal.

But it does remind me of one thing about business. There are so many self destructive businesses out there that sometimes you only have to actually be normal to have a competitive edge.

When I fly Virgin they’re usually pretty competent. But really it’s the vast difference between Virgin and Delta/United/American. The old airlines are so bad, and Virgin is so normal, that it seems like I’m being treated like a king.

When really all that’s happening is I’m allowed to walk up to them and get my boarding pass.

Klout has been one of my go to punchlines for some time now. For example – in May I wrote a post titled “My Detailed Thoughts On Klout” that contained a single word in the post itself: “Why?”

The problem I had with Klout was that it was just another meaningless social game to play. People were wrecking their heads trying to game it and get their score up higher.

To keep his [Klout] score up, Lee tweets up to 45 times a day—an average of one every 32 minutes. “People like food porn,” he notes, “so I try to post a lot of pictures of things I eat.” Lee once took a vacation during which he had no access to the Internet. This made him uncomfortable. “I was worried that brands couldn’t get in touch with me. It’s easy for them to forget about you. And I knew my Klout score would go down if I stopped tweeting for too long.”

That’s just pathetic. And then having companies focus their marketing attention on these people. Lee got an Audi A8 for a few days. More:

Matt Thomson, Klout’s VP of platform, says that a number of major companies—airlines, big-box retailers, hospitality brands—are discussing how best to use Klout scores. Soon, he predicts, people with formidable Klout will board planes earlier, get free access to VIP airport lounges, stay in better hotel rooms, and receive deep discounts from retail stores and flash-sale outlets. “We say to brands that these are the people they should pay attention to most,” Thomson says. “How they want to do it is up to them.”

So my “Why?” post was just that – this wasn’t something I had a big problem with, it just seemed kind of stupid.

Not long after that Chi-Hua Chien from Kleiner Perkins contacted me and convinced me to give the company another look. Yes, the current product was a bit cheesy he admitted. But that was all going to change in the very near future, he said. MG Siegler and I soon sat down with CEO Joe Fernandez at the companies offices in San Francisco, saw the product vision and met some of the people who work at the company.

And Chi-Hua was right. I’ve changed my mind. So much so that CrunchFund has now invested in Klout, and we’re big believers in what they’re doing.

They’ve relaunched the product and a lot of the tricks that people used to game the system are gone. And better, Justin Bieber is no longer considered the most influential person in the world on Klout.

Klout will have a constant, ongoing battle in fighting gaming. But that’s ok. Google is in a constant fight defending the integrity of PageRank, too. And yet we find it interesting. Klout is very much like a PageRank for people and things. And it can be much more useful than just helping companies hand out perks.

First, there’s a lot of data being collected and processed by Klout. A staggering amount of data about people and things from a wide variety of social services. No one else is doing this. The end Klout scores are just the tip of the iceberg, so to speak, on what this company can eventually do with all that data.

Second, Klout’s head is in the right place. Here’s a snippet from an email exchange I had with Fernandez not long after my “Why?” post:

In the end, my goal is to build a product that goes beyond the gimmicks and drives real value for everyone. I believe that every person who creates content online has influence to some group of people and on some topic. Everyone also wants to feel listened to and interesting and I think we can do this in a way that empowers people to become better, more effective, online citizens.

That’s what I really like about the company’s goals. It isn’t to get people like Lee to spend all day tweeting to try to drive his score up. It’s to showcase what’s interesting about people, and help them “feel listened to.”

Klout’s goals are sort of the opposite of what I first presumed. They’re encouraging constructive online behavior, and they’re gathering and processing tons and tons of data along the way.

That’s why I like Klout so much. And why CrunchFund recently invested.

In April I wrote about the tons of (private, never public) grumbling by investors over “acqui-hires.”

In many cases investors feel cheated when entrepreneurs take millions off the table in a small acquisition and investors get little or nothing back.

To be clear, we take the opposite position at CrunchFund.

But the lawyers and the VCs are definitely trying to figure out ways to protect themselves in these deals.

And a newly published academic paper by UNC law professors John Coyle and Gregg Polsky digs deeply into the topic. You can download and read it here.

Dan Primack also has a good summary.

The paper references my earlier post:

Michael Arrington recently suggested that, in response to this situation, counsel for investors will develop legal innovations to address this deficiency. Specifically, he suggested thatinvestors’ counsel develop new contractual provisions that deal specifically with the prospect of a future acqui-hire. In this Section, we propose several possible innovations along these lines.

It also includes information from a lot of anonymous interviews with entrepreneurs, buyers, investors and counsel.

What’s most interesting about the paper for me – these guys, outsiders, really get the whole psychology of Silicon Valley and the multi-stage game that’s going on.

Everyone’s concerned with long term reputation and that leads to non-legal pressure to act in certain ways by all parties involved.

The only thing I think the authors missed is that there’s also reputational pressure on buyers as well. These buyers rely heavily on investors to get deals done and if they push too hard, investors tend to get pretty angry over the long run.

Anyway, this is an area of deal culture that is highly volatile right now, and the psychology at work is fascinating. This last long quote really gets to the fundamental forces that drive Silicon Valley:

Whether an entrepreneur will be able to raise funds for a new venture will depend, at least in part, on his relationship with the investors who had funded his last venture. “When you start a company,” we were told, “the first place you look is to the people who funded you the last time.” Even if these previous investors decline to invest, their opinions will still affect the ability of the venture to obtain funding. In Silicon Valley, previous investors often vouch for an entrepreneur and also provide leads and recommendations for funding when they are unwilling or unable to invest themselves.

Entrepreneurs who aspire someday to start another venture will therefore desire to remain on good terms with their previous investors. In game theoretic terms, the relationship between the entrepreneur and the investing community in Silicon Valley is a multi-stage game where the optimal strategy may not be to maximize one’s winnings in the first round of the game. A desire on the part of the entrepreneur to maintain his reputation, we were told repeatedly, can and does serve to check his incentive to extract everything he can from the current venture. This may explain theprevalence of the acqui-hire structure, in which part of a portion of the compensation package is effectively deflected to the investors, as contrasted with the defection model, in which the newly- hired engineer keeps everything.

The power of reputation as a check on entrepreneurial opportunism appears to vary with the prominence of the investor in the original venture. If the investor is Sequoia Capital—perhaps the best-known venture capital firm in Silicon Valley—then we were told that the entrepreneur will go to great lengths to end the current venture on good terms. In the acqui-hiring context, this would mean making sure that Sequoia received a payout from the buyer large enough for Sequoia to feel as though it had been treated fairly. If, on the other hand, the investor is a small-time angel investor, then the entrepreneur will be less concerned about leaving on good terms. Such an angel investor might be unable to finance any future ventures and, moreover, would be a small enough player that any negative assessment would not generate traction in the Silicon Valley investor community.123 Between these two extremes—Sequoia and the novice angel—there is obviously a wide range. In all cases, however, it seems that entrepreneurs try to figure out, as one interviewee put it, “the lowest amount that can be paid to investors so that they don’t squawk.”

It’s all game theory.