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March 31, 2005

History is written by the winners

This is a bit outdated but still worth noting.  On March 11th, Marketwatch had an article on Vani Kola and Certus.  Now Vani is a terrific entreprenuer and I respect her immensely.  She has done a great job in running both Rightworks and Certus and is a strong positive role model for women entreprenuers.  However this article gets the facts wrong and I am sure its partially the reporter's fault.  Full disclosure: my firm is an investor in OpenPages which is a competitor to Certus. Here is an excerpt from the article:

In 2001, a few months after selling her first company, RightWorks -- her first start-up -- for about $667 million, the now 40-year-old Kola started thinking about her next venture. At about that time, scandals at Enron and elsewhere started making headlines.

"The more I was looking at the news and reading what was going on, my view was that there would be a backlash and management would be held to a different grade of responsibility than hitherto," Kola said in an interview at Certus' offices near San Jose, Calif. The privately-held company has about 50 U.S. employees and 40 in India.

Kola started developing a product designed for companies eager to set themselves apart by raising the bar on corporate governance.

"I thought there would be a ... new standard because there was so much loss of life," Kola said, speaking metaphorically about the toll corporate scandals took on investors' confidence, and pension plans.

In 2002, the federal government gave Kola's idea a hefty boost in the form of the Sarbanes-Oxley Act and its requirement that companies faster and more accurately report their financial condition -- and any possible risks to their bottom line.

The way this article makes it out to be - Vani left Rightworks and had this insight around corporate governance and decided to start Certus.  Great story but alas not the complete truth.  Vani started nth Orbit (the old name of Certus) right after Rightworks.  Thanks to the Internet archive wayback machine, here is what the main page looked like on May 19th 2001:

nthOrbit is a well-funded startup focused on developing real-time, supply-chain software so companies can collaborate and quickly respond to market fluctuations.

We are backed by Sequoia Capital, one of Silicon Valley’s top venture-capital firms, are led by a seasoned management team with deep supply chain experience, and have a strong network of industry partners and advisors.

Another snap shot from October 21st 2001:

Do you experience

 

  • Less than stellar on-time delivery to your customers
  • Constant requests for Purchase Price Variance
  • Premium charges to expedite delivery
  • Excess inventory from your suppliers?
  • Weeks rather than days for response to schedule changes?
  • Surprise shortages from your suppliers?
  • Too much time spent managing the supply chain?


nthOrbit has a solution.
  Efficient, responsive production networks for the manufacturing enterprise

You get the picture.  Not exactly focused on corporate governance, are they?  You can see the complete evolution at the wayback site

Every company goes through ups and downs and if anything, we should congratulate Vani on how she has successfully evolved Nth Orbit into Certus.  However its misleading to distort history.  Its particularly ironic since she is trying to improve corporate governance.

 

Posted by Venky Ganesan at 12:05 PM in Current Affairs | Permalink | Comments (6) | TrackBack

March 22, 2005

Time for some alma mater pride

Given that Chari and I were both fortunate enough to attend Caltech, I am going to give into some alma mater pride and do some boasting.  The Patent office recently issued a press release on the 10 universities receiving the most number of patents.  Here is the table:

                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
          PRELIMINARY LIST OF TOP PATENTING U.S. UNIVERSITIES
          Calendar Year 2004
         
         
                Rank in 2004*
Number of                 Patents in 2004*
U.S. University*                
(Rank
                in 2003)
(Number of                 Patents in 2003)
1
424
University of California
(1)
(439)
2
135
California Institute of Technology
(2)
(139)
3
132
Massachusetts Institute of Technology
(3)
(127)
4
101
University of Texas
(4)
(96)
5
94
Johns Hopkins University
(7)
(70)
6
75
Stanford University
(5)
(85)
7
67
University of Michigan
(8)
(63)
8
64
University of Wisconsin
(6)
(84)
9
58
University of Illinois
(20)
(39)
10
52
Columbia University
(9)
(61)

Sure the UC system got 5 times more patents than Caltech but consider this Caltech has a total of 2000 students (800 undergrads, 1200 grad students) and probably 600 faculty members.  Its the smallest institution on this list by far - the first year freshman class at Berkeley alone is bigger than all of Caltech combined.  For Caltech to punch so much above its weight class is downright amazing.  Quality always trumps quantity. 

Posted by Venky Ganesan at 11:41 AM in Current Affairs | Permalink | Comments (0) | TrackBack

March 19, 2005

Talk radio

Read David Foster Wallace's entertaining dissection of the talk radio industry in the Atlantic on my plane ride back from Atlanta yesterday. Some excerpts:

Whatever the social effects of talk radio or the partisan agendas of certain hosts, it is a fallacy that political talk radio is motivated by ideology. It is not. Political talk radio is a business, and it is motivated by revenue. The conservativeness that dominates today's AM airwaves does so because it generates high Arbitron ratings, high ad rates, and maximum profits.

Radio has become a more lucrative business than most people know. Throughout most of the past decade, the industry's revenues have increased by more than 10% a year. The average cash-flow margin for major radio companies is 40 percent, compared with more like 15 percent for large TV networks; and the mean price paid for a radio station has gone from eight to more than thirteen times cash flow.

Also, here is an interesting story about a rather clever show:

... the Phil Hendrie Show which is actually a cruel and complicated kind of meta-talk radio. What happens every night on this program is that Phil Hendrie brings on some wildly offensive guest - a man who's leaving his wife because she's had a mastectomy, a Little League coach who advocates corporal punishment of players, etc. - and first-time or casual listeners will call in and argue with the guests and (not surprisingly) get very angry and upset. Except the whole thing's a put-on. The guests are fake, their different voices done by Hendrie with the aid of mike-processing and a first-rate board  op, and the show's real entertainment is the callers, who don't know it's all a gag - Hendrie's real auidience, which is in on the joke, enjoys hearing these callers get more and more outraged and sputtery as the "guests" yank their chain.

Later on in the piece, Wallace goes on to speculate that perhaps the callers are also fakes conjured up by Hendrie and his crew, so that the "initiates" are also the butt of the joke. Rather funny.

Also learnt about Arbitron which is something like Nielsen ratings for radio. It is referred to as "Arbitraryon" by insiders because "it is 100 percent diary-based, and diary surveys are notoriously iffy, since a lot of subjects neglect to fill out their diaries in real time (especially when they're listening as they drive), tending instead to wait till the night before they're due and theen trying to do them from memory." Leading, no doubt, to inaccurate ratings numbers that are fed to gullible advertisers.

Posted by Narasimha Chari at 01:10 PM in communications, Current Affairs, technology | Permalink | Comments (2) | TrackBack

March 17, 2005

An Unified Theory of VC Suckage

Ah, Eu Tu Paul!!! First Joel Spolsky wrote about fixing venture capital and now Paul Graham offers his unified theory of VC suckage.  First a few caveats and disclaimers (I am a cowardly, sneaky VC after all ;-))

  1. I enjoy Paul Graham's writings very much.  He is eloquent, insightful and logical and I aspire to write that way
  2. I do not aspire to defend VC's.  Like everything else, there are good people and bad people, good Germans and bad Germans, and good VC's and bad VC's.

However I disagree with the argument that the structure of venture capital make VC's behave as they do.  Paul is kindly proposing that its the system that makes us the cowardly, deceitful, beasts we are:

I used to take it for granted that VCs were like this. Complaining  that VCs were jerks used to seem as naive to me as complaining that users didn't read the reference manual.  Of course VCs were jerks. How could it be otherwise?  But I realize now that they're not intrinsically jerks.  VCs are  like car salesmen or petty bureaucrats: the nature of their work turns them into jerks.

The nature of their work that Paul is referring to is the "fund structure" that VC's use:

The problem with VC funds is that they're funds.  Like the managers of mutual funds or hedge funds, VCs get paid a percentage of the money they manage.  Usually about 2% a year.  So they want the fund to be huge: hundreds of millions of dollars, if possible. But that means each partner ends up being responsible for investing a lot of money.  And since one person can only manage so many deals, each deal has to be for multiple millions of dollars.

This turns out to explain nearly all the characteristics of VCs that founders hate.

The system or the "fund structure" does not make people behave in a particular way, their arrogance, lack of skills or poor behavior is the cause. 

Let us consider the things that Paul feels VC's do that founders hate:

. . . VCs take so agonizingly long to make up their minds, and why their due diligence feels like a body cavity search. [2] With so much at stake, they have to be paranoid.

It explains why they steal your ideas. . .

. . . It explains why VCs tend to interfere in the companies they invest in.  They want to be on your board not just so that they can advise you, but so that they can watch you.  Often they even install a new CEO . . .  With so much at stake, VCs can't resist micromanaging you.

. . .VCs don't invest $x million because that's the amount you need, but because that's the amount the structure of their business requires them to invest.

. . . And of course giant investments mean giant valuations.  They have to, or there's not enough stock left to keep the founders interested. . .  You're rolling the dice again, whether you like it or not.

. . . Add up all the evidence of VCs' behavior, and the resulting personality is not attractive.  In fact, it's the classic villain: alternately cowardly, greedy, sneaky, and overbearing

Let us analyze the fund structure first.  The economics of venture capital are that most VC's get 2% management fee and a 20% carry on the funds they manage (some top tier firms get more carry but for the most part the management fee is the same).  The average venture fund these days is $300 Million so the venture capital firm gets $6 Million a year for 10 years in management fees = $60 Million.  This is a lot of money for sure but remember this has to pay for salaries, office, travel, due diligence, administrative staff, accounting, etc.  And most importantly the *FEES* have to be paid back to the limited partners.  The "carry" is only calculated on top of the $300 Million so the venture firm only starts getting carry after the fees are paid back.

Now let us look at the carried interest part of the economics -  if the venture firm triples the fund i.e. make $300 million worth $900 Million than the partners in the firm will make $900 - $300 = $600 * 20% = $120 Million.  This is even more money and you only have to pay "capital gains" tax on it versus the "income tax" you have to pay for the fees -  VC's are greedy bastards what do you think they will look to maximize?  Also institutional venture capital is about raising multiple funds and the way to raise future funds is to have stellar returns on the current funds.  So even if VC's were optimizing to manage big funds the only way they can do it is to get good returns on the money they are investing.  Ultimately you can only remain in the venture capital business if you have strong track records.

So the incentives of the system are set up for VC's to raise the *RIGHT* amount of money that allows them to maximize the "return" on the fund.  Now does that mean that every VC is doing the right thing - absolutely not!! Some firms especially those who are not focused on the long term have indeed focused on maximizing management fees rather than multiples.  However there are also some top tier firms who don't get a flat management fee but rather get a  budget based management fee depending on their expenses.

Now let us look back at some of Paul's other points:

a. VC's taking a long time to make a decision:  If a VC does not know the space, she is going to take  a long time to make a decision.  Trust me if you are starting another search company and you show up at  Mike Moritz or John Doerr's door, they will make a decision in less than 2 weeks.  However if you showed up at Mike's door with a biotech deal, he is not going to make a quick decision since he does not know that space well.  Diligence is a function of how well a VC knows an area and less of how much money he is going to invest.

b. VC's stealing ideas:  I am sure some VC's do steal ideas but for the most part this does not happen.  First of all ideas are dime a dozen - its the execution that matters and Paul himself wrote about that in his essays about doing a startup.  Also if your idea is so simple that all it takes is for me to know it to duplicate it then you don't really have a valuable business anyway.  The real issue is that ideas are not independent things that exists all on their own.  Every idea builds upon something else and therefore the lineage of ideas undermines sole ownership of any idea.  Malcolm Gladwell wrote this brilliant article about plagiarism that is worth reading.  I think the whole idea stealing concern is over blown.

c. VC's micromanaging: I think if you look at the history of the most successful venture backed companies - Amazon, Cisco, eBay,  Google, Oracle, Microsoft, Sun, Yahoo, etc. - they have all had the founders at the helm and the venture guys on those deals have not micromanaged them.  Good VC's get the value of not standing in the way.  Bad VC's don't.

d. VC's invest not what you need but what they want - again if a VC wants you to take more money that you need then she is a bad VC and you should find a different one.  This is not a function of the system but rather you are dealing with someone who does not understand venture capital.  The best venture capital returns have come from very small investments - Microsoft raised $1 Million in venture capital, Cisco raised $2 Million, etc.  Vinod Khosla has a great presentation on how his most successful deals have been ones in which he put a small amount of money first. 

This blog has turned out to be much longer than I first intended.  My overall point is that Paul does a good job of raising some valid issues with VC's but its not the system that's at fault, its the incompetence of the VC's in question.  Like everything else, there are good VC's and bad VC's - just try to find the good ones if you need money.

Posted by Venky Ganesan at 05:56 PM in ventures | Permalink | Comments (9) | TrackBack

March 16, 2005

National Planning Scenarios

A DHS document titled 'National Planning Scenarios' has apparently been inadvertently leaked (executive summary available here, but I've not been able to find the full report yet). The document reportedly contains a prioritized list of threats and is intended to guide investment in terror deterrence and mitigation programs. Scenarios developed include blowing up a chlorine tank in a metro area as well as terrorist deployment of a nuclear weapon. This sort of risk management approach makes a lot of sense and is long overdue.

By identifying possible attacks and specifying what government agencies should do to prevent, respond to and recover from them, Homeland Security is trying for the first time to define what "prepared" means, officials said.

The goal of the document's planners was not to identify every type of possible terrorist attack. It does not include an airplane hijacking, for example, because "there are well developed and tested response plans" for such an incident. Planners included the threats they considered the most plausible or devastating, and that represented a range of the calamities that communities might need to prepare for, said Marc Short, a department spokesman. "Each scenario generally reflects suspected terrorist capabilities and known tradecraft," the document says.

The article also quotes Michael Chertoff, the new secretary of homeland security, who makes a lot of sense:

Michael Chertoff, the new secretary of homeland security, has made it clear that this risk-based planning will be a central theme of his tenure, saying that the nation must do a better job of identifying the greatest threats and then move aggressively to deal with them.

"There's risk everywhere; risk is a part of life," Mr. Chertoff said in testimony before the Senate last week. "I think one thing I've tried to be clear in saying is we will not eliminate every risk."

It seems like this might also bring some sanity to the homeland security spending allocation process:

To prioritize spending nationwide, communities or regions will be ranked by population, population density and an inventory of critical infrastructure in the region.

The communities in the first tier, the largest jurisdictions with the highest-value targets, will be expected to prepare more comprehensively than other communities, so they would be eligible for more federal money.

"We can't spend equal amounts of money everywhere," said Mr. Mayer, of the Homeland Security Department.

Posted by Narasimha Chari at 11:38 PM in Current Affairs, security, Terrorism | Permalink | Comments (1) | TrackBack

Secrecy and security

Bruce Shneier points to interesting testimony from the Director of the National Security Archive regarding rising levels of secrecy within the government, using the war on terror as a justification. The testimony highlights the observation that secrecy often doesn't contribute to security (a point that Shneier has made elsewhere)

The lesson of 9/11 is that we are losing protection by too much secrecy. The risk is that by keeping information secret, we make ourselves vulnerable. The risk is that when we keep our vulnerabilities secret, we avoid fixing them. In an open society, it is only by exposure that problems get fixed. In a distributed information networked world, secrecy creates risk -- risk of inefficiency, ignorance, inaction, as in 9/11. As the saying goes in the computer security world, when the bug is secret, then only the vendor and the hacker know -- and the larger community can neither protect itself nor offer fixes.

The testimony offers some great examples of instances where exposing secrets actually contributed to averting attacks or catching criminals and argues that one of the lessons of 9/11 was the need for greater openness, rather than increased secrecy:

The number one lesson of 9/11 is that the "relevant players" include the public, front and center. As the staff director of the Congressional Joint Inquiry on 9/11 found, "The record suggests that, prior to September 11th, the U.S. intelligence and law enforcement communities were fighting a war against terrorism largely without the benefit of what some would call their most potent weapon in that effort: an alert and informed American public. One need look no further for proof of the latter point than the heroics of the passengers on Flight 93 or the quick action of the flight attendant who identified shoe bomber Richard Reid." After all, the only part of our national security apparatus that actually prevented casualties on 9/11 was the citizenry - those brave passengers on Flight 93 who figured out what was going on before the Pentagon or the CIA did, and brought their plane down before it could take out the White House or the Capitol.

Look at the case of the Unabomber, the Harvard-educated terrorist who blew up random scientists with letter bombs. Years of secret investigation turned up nothing but rambling screeds against modernity and the machine, and only after the madman threatened more violence unless his words were published, did the FBI relent and give the crank letter file to the newspapers. The Washington Post and the New York Times went in together on a special section to carry the 35,000 words in 1995, but the key paper was the Chicago Tribune, read at the breakfast table in a Chicago suburb by the bomber's brother, who said, sounds like crazy Ted, guess I'd better call the cops.

How did we catch the Washington sniper? The police had been chasing a white van for weeks with no luck, and finally changed the description to a blue sedan based on an eyewitness report. They refused to give out the license plate number (because the sniper would then change the plates, of course); but finally an unnamed police official took it upon herself to leak the license number at midnight, local radio and TV picked it up, and a trucker was listening who saw a blue sedan in a rest area in western Maryland. He checked the plate number, and bingo, within three hours of the leak they arrested the sniper. Openness empowers citizens.

Posted by Narasimha Chari at 09:00 PM in Current Affairs, security, Terrorism | Permalink | Comments (4) | TrackBack

False positives in radiation detection

Bruce Shneier picks up on this article quoting Robert Bonner (Commisioner of Customs and Border Protection) on radiation detection equipment beginning to be installed in ports:

Robert Bonner, commissioner of U.S. Customs and Border Protection, told a Senate subcommittee on homeland security that since the first such devices were installed in May 2000, they had picked up over 10,000 radiation hits in vehicles or cargo shipments entering the country. All proved harmless.

As an example of how the system was working, Bonner said on Jan. 26, 2005, a machines got a hit from a South Korean vessel at the Los Angeles seaport. The radiation turned out to be emanating from the ship's fire extinguishing system and was no threat to safety.

I tracked down Bonner's testimony which has this to say:

Our investment in WMD Detection technology is paying off as demonstrated by the following recent event. On January 26, 2005, at the Los Angeles seaport a PRD activated in proximity to a vessel from Kwan Yang, South Korea. A search of the vessel revealed that the source of the radiation was located in the ship’s engine room. Subsequent screening with a Radiation Isotope Identifier and analysis by CBP Laboratory and Scientific Services Personnel stationed at the NTC revealed that the material was Cobalt 60, a material used in industrial and medical applications. Following coordination with the Science and Technology Directorate’s Secondary Reachback Program, scientists were dispatched from the Department of Energy Radiation Assistance Program and it was confirmed that the radiation levels posed no threat to safety and that it was emanating from a gauge in the ship’s fire extinguishing system. Although this alarm proved to be benign, the event demonstrates CBP’s improving ability to detect sources of radiation in conveyances arriving at our borders and quickly take appropriate action to resolve any potential threats. Indeed, since CBP installed the first RPMs in May 2002, we have resolved over 10,000 radiation hits of vehicles or cargo shipments crossing our borders.

Shneier is rightfully amazed that the large number of false positives generated by the system are actually cited as an example of how well the system is working. I remember coming across this article and registering a similar reaction: high numbers of false positives should not be used as evidence for a system that is functioning well.

False positives in radiation detection can occur due to a variety of causes including (1) fluctuations in the natural radioactive background, (2) presence of other radioactive isotopes whose radiation cannot be distinguished from that being detected, (3) equipment malfunction. A good system design should seek to minimize the frequency of false positives, since they impose a cost: each positive needs to be investigated and the total cost of dealing with false positives is the frequency of false positives times the average cost of conducting an inspection. There are ways to reduce the false positive rate including adequate link budget in the detector system design so that the radiation signature can be effectively discriminated from the background as well as use of detectors with sufficient resolution to be able to distinguish between, say, Cobalt-60 and highly-enriched uranium (HEU).

How well is the system actually working? We need to look at the number of false positives (10,000 in this case) as a fraction of the system throughput (number of containers inspected). We also need to look at the number of false negatives: cases where the detection system failed to recognize radioactive materials. Both false positives and false negatives should be minimized and either category of error represents a failing of the system.

Posted by Narasimha Chari at 07:47 PM in Current Affairs, RF, Science, security, Terrorism | Permalink | Comments (58) | TrackBack

March 01, 2005

Age Old Questions

Some age old questions remain not yet answered:

  • Which came first - the chicken or the egg?
  • Is light a wave or a particle?

In that vein, the big question in Venture Capital is always

  • Markets versus Team i.e. do you bet on big markets or bet on great teams

Clearly its best to bet on both but often you need to make that trade off and different firms have had different philosophies on that.  Arthur Rock was known for his focus on great teams.  He wrote a $250,000 check to Robert Noyce and Gordon Moore to form Intel on his pure conviction on the strength of the people.  Don Valentine is famous for betting on big markets even if the team is less than stellar.  Warren Buffet (one of my personal heroes) has this great line about teams and market:

When a management team with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact

My friend, Robin Bordoli, of Mobius has this great piece on the way he looks at deals and market spaces.  I take a slightly different approach to Robin.  While markets clearly matter and I agree that  M&A is going to drive most of the exits for VC's, if I had to tradeoff the two, I would go with the great team.  The rationale for my preference is driven by the following:

  1. I am a young VC who is looking to partner with great people for the next 30 years so the more great people I partner with today, the better the leverage over my planned time line ( assuming my partners actually let me stay in this business for that long ;-))
  2. Great people attract other great people so again over my planned time line I will be able to fund the alumni of my hopefully successful companies (the number of semiconductor companies founded by alumni of Fairchild or software companies founded by alumni of Oracle/Siebel are astounding)
  3. Great people can usually figure out to make at least a single/double out of a bad market
  4. People are a little easier to judge than market (this is a marginal point since both is equally hard)
  5. Markets can change but people normally don't

So that's my answer and I am sticking to it ;-) ;-)

Posted by Venky Ganesan at 04:28 PM in ventures | Permalink | Comments (32) | TrackBack