The Growing Ponzi Scheme in Venture Capital

May 24th, 2011 by Jay Levy View Comments

A Ponzi Scheme is unfolding right in front of our eyes. Chances are nobody will wind up sharing a cell with Bernie, but it could ultimately crush the growth of the venture and startup industry.

Here’s why it happens: insider pricing rounds, when financing is led by existing investors, creates a natural conflict of interest; as many times, it’s in the insiders’ best interest to inflate the values. The inflated values allow the investors to show paper gains to their LP’s on their existing investment, which makes their LP’s happy, thereby making the GP happy. This also makes the founders happy as it’s generally easier to raise money from existing investors, and most entrepreneurs feel a higher valuation is better, something I’ll dive into in a future post.

The sham is being perpetrated by existing investors who price follow on rounds. To make things worse, since angels are so eager to invest right now, they are essentially ‘validating’ the high valuation.

Below is a realistic example of how the scheme works:

The Setup

A startup raises a $500k seed round on a $2m pre-money followed by a $1m round.

The Analysis

The table below shows the outcomes of raising $1m on $5m pre-money valuation and a $10m pre-money valuation

The Result

The example shows that the fund has an incentive to go with the higher valuation, as the net result of the value of the full investment is 50% higher. Further, while not shown above the value of their 1st investment is 100% higher by increasing the pre-money from $5m to $10m.

Unfortunately, this situation is happening pretty regularly right now, and in the long term will prove to be detrimental to founders, vc’s and angels.

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Would You Do Me A Favor?

May 5th, 2011 by Jay Levy View Comments

We live and work in an extremely “networked” world, which has altered how we interact with people personally and professionally.  As a result, our ability to ask for help as well as receive requests has beensignificantly leveraged due to our accessibility with many people.

Think about how often you or someone else has asked for a favor in the past day, week or month? These favors include:

  • Can you help spread the word by sharing this link or retweeting this message for me?
  • Can you recommend a subject matter expert to help me solve a problem?
  • Can you introduce me to someone in your professional network?
  • Can you help me fill or find a job?

How have you asked (or been asked) a favor? Probably one of the two ways mentioned below:

  • Some people make these requests one-to-one: face to face, via a phone call or by email. While the chances of fulfillment are high due to the personal nature of the interaction, it’s not the most efficient process.
  • Some people make those requests on a one-to-many basis: on Facebook, LinkedIn, Twitter and other social sites. That’s also good, because those networks are force multipliers, which spread messages faster and reach more people. On the other hand, this method is impersonal, so fewer people (per capita) are likely to fulfill that request.

Neither method of requesting or answering a favor works perfectly well. There has to be a compromise between the two systems. These requests can be made more efficiently, powerfully and still maintain a level of intimacy. The bridge is Favo.rs .

Favo.rs is the newest addition to Zelkova’s portfolio and is not another social network. It works in conjunction with existing networks allowing professionals to broadcast and fulfill each other’s help requests. Requests can be as simple as a retweet, or as important as an intro. And each time a request is granted, Favo.rs records the exchange enabling both parties to constantly see how they are building and exchanging social capital with each other.

Most significantly, however, Favo.rs facilitates building relationships between professionals who are unfamiliar with each other. I’ll use myself as an example. As an early stage VC, I have a constant stream of help requests from people I don’t know, or don’t know well. While I always try to be as helpful as possible, I also have to establish a filter for who gets priority and who doesn’t. Usually, this filter is based on a rough mental calculation of my relationship with the person who made the request, but if I don’t have any connection to the person, I am stuck.

Favo.rs eliminates being “stuck” because you don’t know how to proceed with someone you lack a relationship with. Once you join the Favo.rs beta, you’ll be able to follow my public requests and myself. I might ask you and my other followers to tweet and share this blog post, or I might ask someone to refer an expert who can help one of Zelkova’s portfolio companies. Every time you fulfill those requests for me, you’re building social capital with me. And when you have a request for me, I’ll be able to see that you’ve helped me in the past and deserve higher priority. Pretty simple, huh?

I’m really excited for Favo.rs. not only because I think it’s a great company, but also because I think it’s going to help us all be more effective at helping each other. I hope you’ll join me by signing up for early access to the Favo.rs beta now.

PS: Favo.rs will be opening up its beta in just a couple of weeks. If you signup by May 10th, you’ll get a priority invite code so you can check it out early.

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Capital Deployed by Month

May 4th, 2011 by Jay Levy View Comments

In our ongoing effort to provide more transparency in the investing process, I’ve charted an analysis of our dollars deployed per month over the course of a few years.

% of Dollars Deployed by Month

As you see there are peaks and valleys in the deployment of capital and I account the cyclical nature of this to a few things:

  • As a small team we typically can only handle so much at once, so when we’re in the process of closing several deals it reduces our time to look at new deals, which creates the pattern.
  • The lift in November and December is due to the use of ‘year-end’ as a catalyst to close deals. Specifically in 2010, there was uncertainty as to whether the tax benefits for investing would be extended, so there was a rush to close any deals in the pipeline.

As a company looking for investments, the chart’s peaks and valleys represent opportune times to pitch. Since it generally takes us between 30-60 days to close a deal, the best period to pitch would be during the valleys, typically January, April, June and October as we are most likely to have the bandwidth to provide the needed attention.

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Social Media and the Internet, What’s the Difference?

May 3rd, 2011 by Caroline Scheinfeld View Comments

Last week I attended a webinar on How to Drive Marketing and Business Strategy With Social Intelligence, hosted by Zach Hofter-Shall of Forrester and Melyssa Plunkett-Gomez. Zach’s presentation covered an overview of social intelligence, challenges of social media and in-house verse outsourcing listening platforms and Melyssa discussed how social intelligence is a massively underutilized opportunity for brands. Melyssa works at Crimson Hexagon, a Zelkova Portfolio Company, which is a leading social intelligence business powered by patent-pending technology developed at Harvard University.

One of Zach’s main discussions revolved around how when properly implemented, social intelligence (as defined by finding information online and well, doing something with it) has the power to drive a company’s marketing and business strategies. While many believe social media is made up of different social networks, Zach disagrees, claiming the internet is becoming increasingly social in nature and social media is a bit of everything online. To understand his claim, let’s use his example of The New York Times homepage it’s not just an online version of the publication, but rather a hub of articles, blogs, comments and other interactive components that make it social, yet it isn’t viewed as a traditional social media (such as Facebook or Twitter). This brings up the conversation of whether we can ever be passive readers online, or if we automatically become participants engaging with one another as soon as we open the browser?

There are different levels of internet users which Zach describes in the form of a ladder: the most influential group are the creators who sit at the top rung followed by the conversationalists, critics, collectors, joiners, spectators and finally, the inactive. Zach predicts the inactive category will eventually become obsolete because going online will assume interactions with others in some capacity.

Deciphering the data from users engagement online can be an exceptionally valuable for brands, as long as companies are able to determine which information is useful. In conjunction with the internet becoming intrinsically social, the data derived from social media will increase, making listening platforms even more imperative. To understand the relationship of social media information and listening platforms, compare it to garbage and garbage trucks: with less inactive users and more engagement online, the amount of information available to companies will become overwhelmingly large, resulting in a huge pile of garbage. While there will be valuable data, most will be useless, and it’s up to the listening platforms (the garbage trucks) to help weed out the trash. Brands need to decide the most fitting method of gathering and applying data to their business strategies now before the info becomes even more vast.

Zach’s Recommendations

Step 1: Internal Resources
- Evaluate

- Determine capabilities

Step 2: Listening Platform Data
- Evaluate the data process from the listening platforms

- If use listening platform services, evaluate them

Step 3: In-house or outsource listening
- Either way, partner with a listening platform

Step 4: Assign leadership responsibilities

Step 5: Define data distribution channels

Step 6: Prepare for Action

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Social News, The Shared Web Way

April 28th, 2011 by Jay Levy View Comments

Recently, a team of entrepreneurs I am working with (The Shared Web) reminded me of a post, (http://cdixon.org/2010/07/22/graphs/), by Chris Dixon where he discusses different types of graphs and how his product Hunch is trying to create the interest graph. Hunch is doing this by discerning user’s interests based on their answers to playful questions. Hunch illustrates that users are more interested in making decisions such as what movie to see or book to read based on the suggestions of people with similar interests, whether or not they are your friends. Dixon’s believes that Twitter’s innovation was to create asymmetric relationships where you can “follow” people (of interest to you) and obtain what they broadcast.

The Shared Web (TSW) takes the concept mentioned above and applies it to show users content categorized in topics that they’re interested in curated by people they trust. The Shared Web is a social news product – think of a Hacker News for every topic or a social Reddit. Users follow topics and TSW shows them content in the areas of interest by people who have similar taste. To do this, The Shared Web pulls content from users’ social networks (starting with Twitter) and from content shared on TSW. The product promises the following:

1. That users will stay informed. i.e. they wont miss the big stories of the day (i.e. you won’t overlook things or miss them because you didn’t log on to Twitter at the right time)

2. Users will able to discover content they are interested in but wouldn’t have found otherwise.

3. Users can quickly engage around content that they find interesting by thanking the person who posted it, reposting it to their own network or having a conversation about it.

They are building the interest graph by looking at what topics each individual sbuscribes to and who they trust (endorse) in these different categories. If a service or set of services succeeds in mapping out this graph, they can use that information to help people relevant information that is important to them and customize their experience in different avenues. There are numerous opportunities to monetize the data, which is quite exciting to us!

They have an interesting strategy that is two fold:

1. They pull content from Twitter and rerank it based on how relevant it is to you (by looking at topics it belongs to) and the number of people that have retweeted it + other heuristics in their secret sauce.

2. They let people share on their own network with the underlying assumption that there are many things that people see everyday that they don’t share because there isn’t a dedicated place to do that without flooding your audience. Think of articles on Cassandra, a key value store database, or startups that you find, or the myriad of blogs posts that you see over the course of a day. A key differentiator to all the social news readers currently out there, is that they let you share knowing you wont flood your audience because they have subscribed to the topics they care about.

The Shared Web is a curated experience of content on the web, you subscribe to topics you are interested in and in return you don’t miss the big stories and discover content that you wouldn’t have otherwise found. The mixture of curation and serendipitous discovery as opposed to search is very exciting. It’s a way of creating that  ’AHA’ moment where you think WOW I would have never found that if it wasn’t for this product. It is a very satisfying, addictive experience. Sharing is the new search and they believe that if you can share better you’ll share more.

Here is an exclusive link that lets you get onto their site – which is still in early beta – to get a sneak peak on what they are working on (link expires soon):

http://thesw.com/hR5kYq

There are really innovative features on the way and your feedback can help inform what they do next, so I would love to hear your thoughts once you try it out. Get onto to the beta quick, the link expires in a few days.

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About Jay Levy

Jay Levy

Jay Levy is a co-founder and principal of Zelkova Ventures. Jay focuses most of his time in working with the current portfolio company and looking at new investments in the software-as-a-service, internet media and green tech space. More »

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