Skype Introduces API

Skype strikes again. They have introduced an API for developers that will allow software and web sites to offer integrated Skype functionality (free long distance calling to other Skype users). It’s free for non-commercial applications; there will be some licensing fees for commercial uses.

Skype has had 33 million downloads and has served 2.4 billion minutes of free voice calls so far. Momentum is gaining. Allowing other developers to integrate this tool into games, web sites, call centers, etc, will greatly increase the Skype footprint.

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Before Meeting with a Venture Capitalist . . .

. . . I recommend reading two books that reveal the inner workings of venture funds:

Another one I purchased but haven’t read yet is Breakfast at Buck’s, a book by Jamis Macniven, owner of Buck’s Pancake House in Woodside, California. This restaurant is perhaps the #1 lunch/meeting spot in the world for venture capitalists.

I think it is important to understand the mindset of venture capitalists and the intense pressure that they operate under to perform for their limited investors. I think it’s also instructive to understand their selection criteria for even looking at a deal in the first place, and a bit about how competitive they are with other VCs, and sometimes how they do admittedly have a herd mentality.

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Perpetual Philanthropists

Yesterday I lectured at a Brigham Young University course titled “Spiritual Issues in Management”. This course is taught by the incredibly talented Yvette Arts and provides 2 religion class credits and 1 business credit. I wonder if any other university offers a course such as this.

I was asked to address the topic of ethics and wealth. I discussed my own experiences in entrepreneurship and raising venture capital and the challenge of overcoming negative feelings against others when the company I founded ended up being controlled by others.

The key for me was reading in the New Testament one morning where the Apostle Paul said (speaking of his very successful missionary labors), “I planted, Apollos watered, but God gave the increase; therefore, he that planted is not anything and he that watered is not anything, but God that gave the increase.” (This is my paraphrase)

When it struck me everything we do that prospers is only as a result of God’s gifts to us, and that we should take no credit, I was humbled and immediately freed of my negative emotions about people whom I earlier thought were taking away from me the company that “I had founded.” (Whenever those negative feelings creep back I force myself to think of the powerful spiritual experience I had when God said to me, through his Word, that I am not anything.)

Since then, I have carefully watched how some entrepreneurs and inventors and innovators do give God all the credit. Being freed from the “I built this company and I deserve the most money for doing so” attitude is a wonderful thing. If we give God the credit, and the glory, then whatever we end up with (in terms of material things) is satisfying and full of gratitude. If we end up with nothing, then we can say as Job did, “The Lord giveth and the Lord taketh away: blessed be the name of the Lord.”

I intended to spend most of my lecture talking about my philanthropic heroes, but I had to rush through them in just a few minutes.

My philanthropic heroes are those who give gifts that are perpetual–gifts that bless the world forever. Namely,

  • Sir Thomas Bodley, who donated money for the original library at Oxford, now the world-renowned Bodleian Library. King James I quipped once that his name should have been Godly and not Bodley.
  • James Smithson, who never set foot in the U.S. but donated the 100,000 pounds to endow what became the Smithsonian Institution
  • Leland and Jane Stanford, who built and endowed Stanford University
  • Pierre Omidyar, founder of eBay, who in 2002 publicly said he would give away 99% of his wealth over the next 20 years, much of it to the Omidyar Foundation.
  • The LDS Church recently instituted the Perpetual Education Fund, patterned after the 19th century Perpetual Emigrating Fund which helped tens of thousands of impoverished immigrants come from England and Scandinavia to Utah, to start a new life. (One of the immigrants was 14-year old David Eccles, whose family borrowed 70 pounds, and settled in Utah. Within a few decades, David became Utah’s first multi-millionaire. At the time of his death, David Eccles owned 27 businesses and was worth between $10-20 million. There are now a half dozen foundations named after Eccles family members whose total assets exceed, I believe, $1 billion.)The Perpetual Education Fund has already provided loans to about 15,000 students, who on average raise their income levels by 4 times. After repaying their loans, the funds are available to more students. Since education is the key to opportunity in life, this program is centered directly on the thing that has the greatest potential to change and bless the world–increasing human capital.

I can’t fail to mention the Gates Foundation, which I believe has $17 billion in funds and will perpetually bless humankind; or Mohammed Yunus, founder of the Grameen Bank and micro-credit lending pioneer which has lifted millions of people from poverty since the 1970s.

There are many, many others, including the Academy for Creating Enterprise (founded by Steve Gibson) which operates presently in the Philippines and has helped more than 600 people learn how to start their own business.

In our own way, small or large, each person has the opportunity to endow a fund or donate to a program (such as PEF) or give a gift to bless our future posterity or the world at large. It might be writing a book containing life lessons and experiences that generations to come will treasure. It might be volunteering or teaching and changing but one life. Everyone can choose to leave a legacy that will be perpetual and thus be immortalized.

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Help Earn Money to Buy a Horse

A great email from one of my readers:

Since you are such an proponent of Internet entreprenuerism, I thought you might enjoy seeing what my 8 year daughter has pulled off for about $50. Take a look at

http://horseshues.com

And no, she isn’t looking for investment capital 😉 She is raising�money to buy a horse. She sold enough in the first week to pay back all the start up capital we fronted her, and show a profit. I’m now fairly certain she will have the money for a horse several years before I was really planning on owning one.

No other point to this email. I read you regularly and thought you might want to say something about the micro end of the Internet scene. For every Google there are probably a thousand people like my daughter�finding creative ways to use the Internet for goals a little short of world domination!

Everyone please visit www.horseshues.com and help an 8-year old girl earn enough money to buy a horse. I love it–the spirit of entrepreneurship is alive and well, even among the very young.

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Reading List for Internet Execs

I’m halfway done re-reading Permission Marketing by Seth Godin, the classic text (written in 1999) for internet marketers. This time, in good Tim Sanders fashion, I’m marking the book up like crazy and making it mine. Permission Marketing was very influential at MyFamily.com/Ancestry.com. Problem was, whenever I read a key book, I’d give my copy away and never see it again. When you haven’t pick up a book for 5 years, you forget all the details and just have some general notions about what you should be doing. I love getting back into the details of how internet-based permission marketing is revolutionizing advertising and will eventually overthrow the Interruption Marketing that was used to build all the great brands of the past. Godin spent millions of dollars on wasteful television advertising back when that was the only way to reach mass markets. But he has spent much of the last decade pioneering the use of the internet in marketing, and he shares his learning freely.

I have a recommending reading list for entrepreneurs, but I need to update it.

Books are so underrated. As Tim Sanders says in Love is the Killer App, 80% of your reading time should be spent with books.

I’m thinking of creating a curriculum for employees of Infobase Ventures companies, a reading list, as it were, for every major position in the company. There are a handful of books that I hope all our CEOs read, including The Art of the Start, Good to Great, First Break All the Rules, and Game of Work. I can think of a dozen critical readings (including MarketingSherpa summit transcripts) for all marketing employees.

Phil Windley (BYU CS Professor) told me the other day that when he mentors a graduate student in the lab, he provides him/her with all kinds of reading materials as part of the learning process. But once someone has a job, how much is invested in their ongoing training? Steve Jurvetson (my favorite VC) says we should embrace lifelong learning–how many companies help employees do this?

I think most companies neglect the development of intellectual capital among their employees.

Google may come closest. By requiring all employees to spend 20% of their time on a pet project (while Larry and Sergey keep a list of the top 100 most promising projects in the company) I think Google will unlock the creativity and promote the ongoing learning (we learn more when we’re applying what we learn, rather than just talking about it) of thousands of bright employees. This culture of learning and experimenting at Google will go far towards making the company one of the most valuable companies in the world.

In addition to a reading list of core books and documents, each position in a company should have its own set of keywords for Google News Alerts as well, so that key employees can stay up with the latest news on competitors, new technologies, marketing trends, etc.

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MyFamily.com Hiring International Managers

Google Alerts notified me over the weekend that MyFamily.com has 20 job openings right now including a few international positions. A VP International with 12-15 years international experience is sought to help the company expand into Europe, Asia, and Latin America. The company currently has 1200 employees.

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Finders Keepers, Founders Weepers

I have heard that Ray Noorda (Novell fame) used to say, “Finders Keepers, Founders Weepers” to indicate that most of the time inventors and entrepreneurs don’t end up with much. Business savvy investors and later stage business managers can often clean up for themselves, leaving entrepreneurs with nothing but the pride of knowing what they started.

It appears that this has happened yet again, in a fairly high profile case. Gary Rivlin, NY Times writer, discusses how 4 of the 5 founders of Epinions made nothing in the recent IPO of Shopping.com. (Shopping.com was formed last year with the merger of Epinions and DealTime.com).

Rivlin’s article says:

Before the offering, Epinions had two classes of shares: common stock, which was granted to the founders and employees, and preferred shares, which were given to investors. Their preferred shares in Epinions entitled the financiers to be reimbursed the $45 million they had invested before anyone else was compensated.

Today, the Epinions portion of Shopping.com is worth hundreds of millions, but at the time of the DealTime merger, Epinions was valued at roughly $30 million, which rendered all common shares worthless.

“The question we’re asking,” said one former Epinions employee who asked not to be identified and who plans to be part of the lawsuit, “is how this company supposedly worth only $30 million was suddenly worth $300 million only 18 months later.”

When entrepreneurs and employees and early angel investors get common shares, and venture capital firms get preferred shares, there are many scenarios under which the VCs take all–even in the case of a successful outcome like Shopping.com.

The problem is that VCs typically end up controlling the board of directors. This gives them control over the timing of a liquidity event, and whether the company will choose to pursue an initial public offering (IPO) or be acquired.

If preferred shareholders control the board, they therefore have the power to crush the common shareholders by triggering a liquidation event at any time. If the valuation at that point is not higher than the Liquidation Preference, then the common shareholders get nothing.

For any number of reasons, a board of directors may decide to take an action (such as deciding to sell or merge the company) which is considered a liquidation. The valuation of the company at that moment determines whether common shareholders end up with anything at all.

For me, the trouble begins with the word “liquidation.”

Venture capital documents define what qualifies as a liquidation event. According to Term Sheets and Valuations, a typical liquidation clause looks like this:

“a merger, acquisition, or sale of substantially all of the assets of the Company in which the shareholders of the Company do not own a majority of the outstanding shares of the surviving corporation shall be deemed to be a liquidation.”

Because Epinions was valued at only $30 million when the DealTime merger occured, and the preferreds held $45 million in preferences, the Epinions preferred shareholders ended up with 100% of the value of Epinions. The common shareholders got nothing.

I bet the preferred shareholders controlled the board of directors when this merger occured.

This terrible outcome for Epinions founders brings back a lot of memories for me. A similar scenario almost occured at MyFamily.com. Fortunately, we barely escaped this fate. Our common shareholders experienced a serious but not a complete devaluation.

Here’s how our story played out.

From 1998 to 2000, MyFamily.com raised funding rounds of $12 million, $30 million, $33 million from venture capital firms at increasing valuations. So we had liquidation preferences equalling $75 million.

Back in the day when our valuations were in the hundreds of millions of dollars, no one seemed too worried about “liquidation preferences.”

I moved to Silicon Valley to open our west coast office and help us move towards an IPO.

The cost of living in the Valley was (and is still) outrageous, and I was running up a serious personal debt. But I had no fear of that debt because of my stake in MyFamily.com. I could always ease my mind about the debt by doing some simple math: “I own X percent of MyFamily.com which will eventually translate into X million dollars–even if the company is only valued at say $100 million.”

Little did I know how wrong that mental math was.

For us, the problem began after the stock market decline of April 2000. By late fall, we were in need of additional cash, but our management didn’t want to do a “down round.” To avoid raising money at a lower valuation than before, our CEO worked out an acquisition of ThirdAge Media, a San Francisco-based company that had some cash and was looking for a business model that worked. (Advertising models were really being hammered back then.)

The merger was quickly approved by our board. Only afterwards did one of our largest common shareholders give me a real education.

He explained to me that ThirdAge carried into the deal another $70 million in liquidation preferences–bringing our total to $145 million.

He explained to me that if the company were sold tomorrow for anything less than $145 million, that the preferreds would take all and the common stock would be worthless.

All of a sudden my mental math (“I own X percent of a company worth at least $100 million”) was meaningless.

For the first time I understood that all the common shares might be worth zero.

As I naive entrepreneur in my first venture-backed company I had always assumed that the term liquidation meant “fire-sale.”

The only time I had seen that term used was in connection to a “going out of business sale” by local mattress and furniture companies. I actually thought liquidation preferences meant that if we went out of business, the VCs would end up with whatever assets the company had to help pay back their investment. That was only fair.

This had never bothered me at all. We were not going to fail. Our core subscription business was always strong, so a liquidation would never occur. I thought we would either be acquired for a huge sum of money or have an IPO, in which case preferred shares would convert to common shares.

A liquidity event, yes; a liquidation event, no way.

I didn’t understand the meaning of the word.

I did not realize then that a merger or sale of the company, even at a decent valuation, could trigger a liquidation event, give the preferred shareholders their investment back, and render common shares completely worthless.

Within six weeks of learning this tough lesson, I moved back to Utah, dramatically cut my cost of living, and did everything I could to help the company raise a final round of funding and get to profitability.

Fortunately, in conjunction with our Series E round of funding, our CEO persuaded the preferred shareholders that to keep the company alive (to retain management and employees and to attract new investment) all preferred shares from earlier rounds needed to convert to common shares. A ratio was negotiated and the conversion occured.

Now, the only preferred shares in the company are from the Series E round.

I relate this story for one reason only: to educate other entrepreneurs about a key clause in venture capital term sheets–liquidation preferences. Never do a deal unless you understand all the terms.

I strongly recommend the excellent book Term Sheets and Valuations, written by a VC to help educate entrepreneurs about clauses in venture deals. You should also talk with legal and financial advisors with recent experience.

I wish VC deals could be more balanced and not so investor favorable. I have only one reason to hope that they will: I recently heard of a venture deal where the venture fund took common shares in a company that is profitable and very promising.

Now that, in my book, is fair. I wish all venture fundings were this fair and balanced.

Now I don’t want to be misunderstood. I am not against venture capital.

I am against entrepreneurs seeking venture capital without understanding the terms and risks–which I think few do.

I also think few entrepreneurs and inventors realize that most of them won’t end up with nearly the payoff that some of the more business savvy investors and late stage business managers achieve.

If you want to mentally prepare yourself for the potential disappointment of building something great and seeing most (if not all) of the financial rewards being taken by others, I suggest you read the concluding chapter of Crossing the Chasm, the classic high-tech marketing book by Geoffrey Moore.

Moore talks about the difference between pioneers and settlers.

Pioneers are entrepreneurs, technologists and salespeople who create a business out of nothing and in a state of early stage chaos build a promising venture. Companies cannot be created and built without pioneers.

But at a certain stage, when high tech companies are trying to “cross the chasm” from an early adopter to a mass market, with all the standardization of processes and all the pragmatism that this entails, the pioneers are no longer needed. In fact, they can become a liability.

What is needed in the “post-chasm” stage are settlers who are willing to systematize the business processes and build a stable and predictably profitable company.

I re-read Moore’s book a couple of years ago after the common share devaluation experience. I felt much better after realizing how critical the settlers are in building a sustainable enterprise (like how Dell CEO Kevin Rollins put so many systems in place at Dell, taking it from a $2 billion to a $50 billion company along the way). I almost felt that Moore was claiming that settlers roles are in fact more valuable than pioneers and that if everyone went into a business understanding this fact, that much disappointment would be avoided down the road.

Perhaps all entrepreneurs should entertain this humbling thought, that you are not the most important person in your company, even if you created it.

You need settlers to take you to the next level. And they should be generously rewarded for doing so.

If you think you’ve been ripped off by investors or settlers, my advice is to get over it, move on with your life. Do you want to end up like the Wright brothers, involved in lawsuit after lawsuit while others are taking your ideas to the next level? Just start over, do it again. After all, you’re a pioneer.

(Note: The Wright brothers won their patent lawsuit in 1914, but it was a hollow victory since Wilbur had died of typhoid fever 2 years earlier and Orville had spent so much time in court that others had leapfroged his invention and taken aeronautics to entirely new heights…pun intended.)

(Thanks to John Richards for sending me the NY Times story.)

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