Thinking About Thinking

The Law of Large Numbers

Posted in Venture Capital by larrycheng on November 9, 2009

There have been a number of great venture-backed acquisitions recently, and does a great job outlining the Top 10 acquisitions that have closed this year.  Here they are:

  1. Zappos ($847M)
  2. CoreValve ($700M)
  3. Pure Digital ($590M)
  4. Visiogen ($400M)
  5. SpringSource ($362M)
  6. BBN Technologies ($350M)
  7. Evalve ($320M)
  8. Ablation Frontiers ($225M)
  9. Mint Software ($170M)
  10. PayCycle ($170M)

Let me revise the list to add in a few more things.  The list below includes deals that have been announced and not closed (AdMob, Playfish, RueLaLa).  It also gives 100% credit for all earnouts ($300M+).  And, it gives credit to Zappos for Amazon’s stock appreciation (an additional $300M+).  Let’s consider this the fully loaded list.  Here’s how the top 10 will look:

  1. Zappos ($1,200M)
  2. AdMob ($750M)
  3. CoreValve ($700M)
  4. Pure Digital ($590M)
  5. Playfish ($400M)
  6. Visiogen ($400M)
  7. SpringSource ($362M)
  8. BBN Technologies ($350M)
  9. RueLaLa ($350M)
  10. Evalve ($320M)

In aggregate, this is a whopping $5.4 billion in exit proceeds when you take the top 10 acquisitions this year.  Most of these companies probably took investments from venture funds from the 2002–2006 vintage, when a typical large VC fund might be $750M.  Now let’s say this fictional $750M venture fund invested in all of these companies – yes, one VC firm investing in every top 10 acquisition in 2009.  And, let’s go further and say this VC firm got a very healthy 20% ownership in every single company.  Since I’m being so generous, let me do one thing that is not so generous, which is presume these exits represent all the exits in the fund.  Here’s what you’d get with some basic math:

That would lead to $1,084 million in gross proceeds back to this fictional large VC firm.  Now let’s net out 2% fees over 10 years (to keep numbers simple) – that leads to $934 million of net proceeds.  That’s a 1.25x net cash on cash multiple after getting the top 10 acquisitions in 2009. 

Now, let’s presume a fictional small $100M VC firm made a bunch of bets and owned 20% of AdMob.  And, let’s say they lost money on everything else in their portfolio.  That would be a $150M gross return and $130M net of fees.  That’s a 1.3x net cash on cash multiple from one great exit.  

The fictional small VC firm made a better cash on cash return for its LPs through one winner, than the large VC firm could accomplish by getting all top 10 winners.  That’s the law of large numbers in effect. 

Are You A Founder, CEO, or Entrepreneur?

Posted in Venture Capital by larrycheng on November 6, 2009

This post is for all of you out there who are both founder and CEO of your company.  My simple question is this: which “title” resonates most with you – founder, CEO, or entrepreneur?  Clearly, they’re all true, but let’s set aside the option to say all three.  I am asking the unfair question of which one title best represents you and are you the most proud of being called?  I’m also not asking which title should be on your business card, rather I’m asking how you view yourself.  Which title best represents you?

Let’s look at these three statements:

  • I am a founder.
  • I am a CEO.
  • I am an entrepreneur.

If you could introduce yourself as only one, which one would you choose and why?  And, if there’s one that is better than these three, I’m all ears.

[UPDATE: I happened to be talking to a friend today who was the founder and CEO of a prior company – so I mentioned this post.  He thought about it and talked about the experience of bringing in a CEO to run his company.  He said he had no problems giving up the CEO role.  But, the CEO had requested to also be titled one of the co-founders of the company.  And, that he found violently objectionable.  Maybe that’s another way to look at the question.]

Thinking About Thinking: Most Popular Blog Posts – November 2009

Posted in Uncategorized by larrycheng on November 4, 2009

I’m coming up on the six month anniversary of this blog, Thinking About Thinking.  I’ve written 54 posts in that time, so about 2 per week.  This blog was named after my favorite class in college – which was a multidisciplinary class on philosophy, science, and law.  In that vein, I wanted this blog to be “one serving VC, one serving technology, and 3 servings of other stuff of varying degrees of randomness and interest”.  Out of sheer curiosity (which is the genesis of most everything on this blog), I decided to look at my top 15 posts (by # of views) to see whether that ratio had held true.  Here it goes:

  1. Global VC Blog Directory (16,349)
  2. Where In the World Is Eduardo Saverin? (7,362)
  3. The Most Expensive Commercial Real Estate In The World Is A Place For Computers, Not People (4,667)
  4. Missionary CEOs v. Mercenary CEOs (2,096)
  5. How Can We Double Down? (1,345)
  6. It’s Hard To Get The News From The News (1,181)
  7. Relative Value v. Absolute Value (958)
  8. Harvard Business School Is Taking Over Boston VCs – For Better or Worse? (954)
  9. College Optional (945)
  10. What If The Federal Government Was An Average Household (798)
  11. Cortera: Turning The Business Credit Rating Industry Upside Down (725)
  12. The Learning Test (709)
  13. 4 Questions and 4 Pressure Tests To Decipher A VC’s Interest In Your Company (673)
  14. The Categories of Risk In the VC Brain (660)
  15. How To Easily Subscribe to VC Blogs (548)

It looks like the real ratio is more like 3 servings VC/tech and 2 servings other stuff.  Still enough variety to keep things interesting.  Thanks for reading everyone. 

What Option Grants Tell Us About The US Dollar

Posted in Economy, Venture Capital by larrycheng on November 3, 2009

Let’s start with the obvious.  When you receive an option grant in a private company, you are told a number of options.  The absolute number of options you receive is not as relevant as the percentage of the company it represents.  Your option grant is the numerator, but the denominator is key.  The denominator is the total number of shares outstanding in the company.  Obviously, if you are granted 10,000 options and there are 1,000,000 shares outstanding, you have been granted 1% of the company.  You are probably a direct report to the CEO.  If you are granted 10,000 options and there are 100,000,000 shares outstanding, you have been granted .01% of the company.  You are probably in an entry level role of some capacity.  It’s the percentage that counts. 

The more a company raises money by issuing more shares, the larger the denominator grows, and the lower your percentage gets presuming your option grant does not change.   It’s basic math: if the numerator stays constant, and the denominator keeps getting bigger, the resulting percentage keeps declining.  This effect is called dilution – which is never a positive word in our world.  No shareholder wants to be diluted.   For the readers of this blog, I suspect this principal is relatively obvious since many of you have worked within or around private companies.  OK, enough with the obvious. 

This very same principal applies to the value of currency which is why it surprises me when people are nervous, they decide to keep their money in cash (US Dollar).  In the world of currency, your numerator is the amount of US Dollars you have in the bank.  People feel safe because they have $x in the bank.  That’s the equivalent of people feeling properly compensated because they have 10,000 options.  It’s an incomplete equation.  You need to know the denominator.  In the case of the US Dollar, the denominator is the money supply.  The money supply is the “total amount of money available in an economy at a particular point in time.”  Just like in the option example, if you have a certain amount of cash in the bank, but the government keeps “printing money” to expand the money supply, your percentage of the money supply is declining.  It’s the currency form of dilution.  And here’s what’s happened to the US money supply:


If I told you you could hold a fixed number of options in one of two companies: (A) a company that had to raise a ton more money and issue a ton more stock to do so, or (B) a company that is profitable and has to raise no more capital and therefore issue no more shares – all other things being equal, you’d take Option B every single time.  You’d take it because your ownership in the company would not be diluted.  But, why is the answer less obvious in currencies, when the principal is largely the same?  The US government is printing money and is the national equivalent of Option A.  It would seem more logical to look for the national equivalent of Option B and keep your money invested in that currency. 

Now there are lots of exogenous factors.  You can’t discount the fact that the US still has the strongest military on the planet.  And you certainly can’t discount enough the fact that I’m no economist and am probably missing many obvious points.  And, certainly, do not take this as investment advice.  This is just an exercise in thinking aloud which is what this blog is about.

Tagged with: , ,

What If The Federal Government Was An Average Household?

Posted in Economy, Pop Culture by larrycheng on October 31, 2009

I’m not an economist.  So, it’s hard to make sense of the trillions of dollars that are thrown around when it comes to the federal deficit and national debt.  So, I thought I’d just normalize the federal income statement and debt statistics against a typical household since it makes more intuitive sense to me.  Here we go:

Federal Government (2009 Fiscal Year)

  • Income (Receipts): $2,104,613,000,000
  • Expenses (Outlays): $3,521,734,000,000
  • Surplus/(Deficit):  ($1,417,121,000,000)
  • National Debt:  $11,874,664,000,000

Now we take that data and normalize it against a household with $50,000 in income (which is the US median HH income):

  • Income: $50,000
  • Expenses: $83,667
  • Deficit: ($33,667)
  • Debt: $282,110

Now normalized against a household with $100,000 in income:

  • Income: $100,000
  • Expenses: $167,334
  • Deficit: ($67,334)
  • Debt: $564,221

Now normalized against a household with $250,000 in income (top ~2%):

  • Income: $250,000
  • Expenses: $418,335
  • Deficit: ($168,335)
  • Debt: $1,410,552

Looking at it this way, I have a couple of intuitive observations.  The $100k household is spending $14,000 per month.  Let’s just say they have $4,000/month in mortgage/auto interest expense.  That means the husband and wife are each running up $5,000 per month – each – on their credit cards if they charge everything.  That’s an average of $167 charged per day per person on their credit cards.  That’s hefty spending especially if you presume only modest savings which is probably a fair assumption given our near negative historical savings rates.

Prior to doing this analysis, I thought the normalized debt number would be outrageous.  It’s probably ~2x what it should be.  A $100k household through most mortgage calculators can probably afford a $300k-$350k mortgage.  So, $564k in debt for a $100k household is clearly too high, but not by several orders of magnitude which is what I though it would be.  Anyways, food for thought…

Are VCs Lemmings?

Posted in Venture Capital by larrycheng on October 28, 2009

Many in the entrepreneurial ecosystem (VCs included) have used the phrase, “VCs are all lemmings.”  Is this true?  Is it not?  Before answering that question, let us take a look at the lemming migration across the Norwegian coast.  How can you compare a VC to a lemming, without detailed knowledge of lemming migratory patterns?  Here’s a transcript from a video – best to start the video at 1:14 while reading the transcript [with VC translation – tongue firmly planted in cheek]:

“The second thing lemmings [VCs] do is reproduce.  As more and more individuals [VCs] are born, the food and water supply [good deals] begins to diminish.  Every three to four years, the populations in some localities grow to great densities [Silicon Valley, India, China].  In response to this overcrowding, lemmings exhibit a very specialized behavior [reinvention].  Individuals begin to migrate away from the centers of dense population [to other centers of dense population – cleantech, web 2.0, etc.].  They group together and move in detectable waves across the countryside [cleantech forums, web 2.0 forums, etc.].  Whatever barriers block their passage [absence of business models], they tend to crowd in increasing numbers until a sort of panic reaction drives them over the obstacles [capital market ponzi schemes].  The migration impulse [fear their track record will be exposed] affects each individual driving them to keep moving [doing new deals].  If a stream or river interrupts their path [no exit market], they swim across [bridge financings].  Many die during migration – perishing by predation, starvation or accident.  Occasionally, some reach the ocean [a new firm] and plunge in [break out a new checkbook].  Once again, they begin swimming [doing new deals].  They act under the same impulse [trying to get a winner] that forces them to cross smaller bodies of water.  Swimming until exhausted, all of them drown.  Through this migration and mass drowning, the number of lemmings is checked.  Scientists do not yet completely understand how this behavior has continued over the centuries when so many of the emigrating lemmings die.”

All in good fun :).

Tags: ,

The Grassroots Deli Economic Forecast

Posted in Economy, Pop Culture by larrycheng on October 20, 2009

When the market crashed over a year ago, I got pretty motivated to stay on top of global macroeconomic research.  So, I started reading about 7 different sources of economic forecasts and analysis.  As the year has progressed, I have narrowed in on a couple that I think are keepers.  My two favorites are The High Tech Strategist by Fred Hickey and some of the commentary of Jurrien Timmer who runs the Fidelity Dynamic Strategies Fund.  But, neither of them has replaced my true source of grassroots economic information, from appropriately named, Grassroots Deli.

Grassroots Deli is a hole in the wall deli across the street from my office on 183 Devonshire Street in Boston’s financial district.  They have great homemade muffins in the morning and a mean turkey platter for lunch.  The owner mans the register and she remembers everyone’s name and usual order.  It’s a little bit like Cheers – where everyone knows your name.  (BTW, this is for another blog post, but I think she’s cracked the code on customer retention in the restaurant business – good food and remember the customer’s name.)

Every once in awhile, I ask her how business is which is my gauge for the health of the economy.  Here are some tidbits of what she’s said over the past:

  • Summer 2008: She was feeling the effects of the vacancy level at 1 Federal Street.  She commented that the money managers spend a lot more money on lunch than the lawyers do – and it’s the money managers who left the building.  I guess money managers are OK paying $10+ for lunch which is important in her business.  She was also feeling the pain of the high oil prices which led to fuel surcharges tacked on by her food suppliers.
  • Fall/Winter 2008: Feeling the sting of many layoffs around the downtown – deer in headlights.  Even more infuriating was the continued oil surcharge from food suppliers despite oil falling from $100/barrel to $35/barrel.
  • Summer 2009: Business demand is still well below average, but what’s hurting her business is the price of sugar.  Sugar had climbed from $0.12/pound to $0.18/pound inside of a year.  Climbing commodity prices across the board are hurting her margins since she can’t raise her prices.  Profits are being squeezed at the cost of goods line – business is tough.

I got my latest update today:

  • Fall 2009:  Hopes of a pick-up in business after Labor Day have now faded.  Business is still very slow.  She said her paper supplier who has been working the Boston and Cape Cod region for 38 years said his business in Cape Cod fell by more than $1 million year over year.  It’s at it’s worst point in 38 years.

Well, the food is great at Grassroots Deli, but business is still challenging.  Her business is probably a microcosm of many different businesses as she is doing a great job servicing her customers but there are things out of her control.  Her little business illustrates the fundamental and wide-ranging impact of things like commercial vacancy rates, rising commodity prices, and high unemployment.  I’m definitely rooting for a better forecast next time.  Official Grassroots Deli Economic Forecast: not out of the woods yet.

Harvard Business School Is Taking Over Boston VCs – For Better Or Worse?

Posted in Venture Capital by larrycheng on October 18, 2009

Take a look at the middle tier of most Boston VCs – and what will you find in abundance?  Harvard Business School (HBS) grads.  Here’s a smattering of folks you can find with HBS degrees, including two of our own:

  • Rob Go, Spark Capital
  • Jon Lim, Polaris Venture Partners
  • Ryan Woodley, Polaris Venture Partners
  • Irena Goldberg, Highland Capital
  • Amanda Herson, Highland Consumer Fund
  • Jesse Feldman, Battery Ventures
  • Dayna Grayson, North Bridge Venture Partners
  • Cali Tran, North Bridge Venture Partners
  • Matt Witheiler, Flybridge Capital Partners
  • Geraldine Alias, Fidelity Ventures
  • Sean Cantwell, Fidelity Ventures
  • And on and on….

Now let’s look at the graduate school education some of the more established VCs in Boston:

  • Todd Dagres, Spark Capital – MBA, Boston University
  • Scott Tobin, Battery Ventures – no MBA
  • Dave Tabors, Battery Ventures – no MBA
  • Rob Soni, Matrix Partners – no MBA
  • Bob Davis, Highland Capital – MBA, Babson College
  • Dan Nova, Highland Capital – MBA, Harvard Business School
  • Dave Barrett, Polaris Venture Partners – no MBA
  • Joel Cutler, General Catalyst – JD, Boston College
  • John Simon, General Catalyst – MA, Oxford University
  • David Fialkow, General Catalyst – JD, Boston College
  • Mike Zak, CRV – MBA, Harvard Business School
  • Anne Mitchell, Fidelity Ventures – no MBA

Over the last 10 years, venture capital has become a more mature industry (meaning more job opportunities) and a highly desired career path for business school grads.  When I joined the venture industry in 1998, there were probably <10 non-partner positions in the Boston VC community altogether.  Nowadays, it’s not uncommon to find individual firms with 5–10+ non-partner positions.  Back in 1998, the typical HBS grad probably wanted to do investment banking or consulting.  These days – it’s hedge funds and private equity (VC & LBO).  Put that altogether, and it makes logical sense that HBS grads are far more prevalent in the Boston VC community than they were 10 or 20 years ago.  It’s the end result of every Boston VC firm that has a job opening going to HBS and aiming to hire the best of the best.

But, what does this mean for how the Boston VC culture will change over the next 10 years as opposed to where it came from the past 10–20 years?  What does it mean if a preponderance of Boston VCs all have the same educational training?  My guess is that both generations will find their own success, but perhaps their success will be for different reasons.  Perhaps the “HBS Generation” will succeed due to pure analytical horsepower and smarts.  Perhaps the present/past generation found success due more to creativity and courage.  It’s hard and ultimately unfair to generalize, but I have to think that things will change – maybe not better or worse – just different.

How Language And Math Intersect: Chinese v. English

Posted in Pop Culture by larrycheng on October 7, 2009

Following my 1+1= post, here’s another post about numbers.  But, this post is less about numbers and more about the words used to articulate those numbers.  Below, you will see a comparison of the actual words used to say the numbers represented on the left.  The first set of words is the number represented in the English language, and the second set of words is the number represented in the literal English translation of the Chinese language. So the sequence is (#, English, Chinese).  Here we go:   

  • 1: one, one
  • 2: two, two
  • 3: three, three
  • 4: four, four
  • 5: five, five
  • 6: six, six
  • 7: seven, seven
  • 8: eight, eight
  • 9: nine, nine
  • 10: ten, ten

Nothing earth shattering here.  When you count from 1–10 in English and Chinese, ten unique words emerge representing the most basic of numbers.  But, from 11–20, the languages diverge (#, English, Chinese):

  • 11: eleven, ten one
  • 12: twelve, ten two
  • 13: thirteen, ten three
  • 14: fourteen, ten four
  • 15: fifteen, ten five
  • 16: sixteen, ten six
  • 17: seventeen, ten seven
  • 18: eighteen, ten eight
  • 19: nineteen, ten nine
  • 20: twenty, two ten

In the English language, to count from 11–20, you need to learn ten new words.  So, to count from 1–20 in English, 20 unique words need to be learned.  In the Chinese language, to count from 11–20, no new words are introduced.  Chinese language reincorporates the same words used for 1–10, to cover all the numbers from 11–20.  If you can count from 1–10 in Chinese, you can count to 20 by default.  What if you expand it to 100 (#, English, Chinese)?

  • 30: thirty, three ten
  • 40: forty, four ten
  • 50: fifty, five ten
  • 60: sixty, six ten
  • 70: seventy, seven ten
  • 80: eighty, eight ten
  • 90: ninety, nine ten
  • 100: one hundred, one hundred

In the English language, to count from 21–100, eight new words are introduced (thirty, forty, fifty…hundred.).  In the Chinese language, to count from 21–100, only one new word is introduced: hundred.  No new words are introduced to count from 11–99 in Chinese.  Therefore, to count from 1–100 in English, you need to learn 28 words.  To count from 1–100 in Chinese, you only need to learn 11 words.  It’s a profound difference and impacts learning. 

Watch kids learn to count in Chinese.  After a child learns to count from 1–10 in Chinese, it’s seamless to watch them count from 11–99 – it happens in a snap.  Why?  Because they don’t have to learn a single new word to count from 11–99.  By learning to count from 1–10, they have learned everything they need to count from 1–99. 

Watch a child learn to count in English.  What happens after they learn 1–10?  They get confused, because it’s ten new words to count from 11–20.  And what happens after they count to 20?  It’s a quick hop and skip to 26, 27, 28, 29….  But then they often get stuck at each ten segment for the very simple reason that it’s a new word – thirty, fourty, fifty, etc. 

Some researchers hypothesize that one possible reason some Asian cultures show proficiency in math at an early age ironically has nothing to do with math – it has to do with language.  It is easier to learn to count in Chinese than it is in English because it requires learning fewer words.  While numbers are the building blocks of math, maybe language plays an unspoken role in making math easier. 

The Unofficial Cool Parent Test

Posted in Philosophy, Technology by larrycheng on October 5, 2009

Are you a cool parent?  It all depends on whether or not and under what circumstances your teen has “friended” you on Facebook.  The following ranking is principally based on real experiences of parents I know.  Here we go from the most cool (1) to the clearly not cool (10): 

  1. Your teen sought you out and invited you to be their friend on Facebook.  Kudos to you, you’re cool.  You’re in the top 10%. 
  2. You signed up with Facebook and invited your teen to friend you.  After 6–12 months, your invitation was accepted without any intervention from you.  Congratulations!  It took awhile, but look at it this way – after extensive diligence, you have passed the cool threshold.  Congrats. 
  3. You invited your teen to friend you on Facebook.  You have been accepted – but the content on the page looks thin.  You have been accepted with limited information access – real friends have full access.  Look at the bright side, at least your child doesn’t mind his/her friends knowing that you exist.  You’re not explicitly cool, but you’re not a total embarrassment either. 
  4. You have not been friended by your teen, but they have friended a close friend of yours.  They know that your friend will probably let you check in online every once in awhile through their account.  Your kid thinks you’re cool enough for some access, but he/she’s not ready to go public with that sentiment.  Ask your friend why he/she is cooler than you. 
  5. After the 6–12 month wait, you coerce your child through a mix of threats and gifts (like a car) to accept your invitation.  Your invitation gets accepted with your child under extreme domestic pressure.  Not cool – stop taking parenting tips from 24
  6. Your invitation to your teen to friend you on Facebook has been flat out declined.  It’s got to sting, but look at the bright side – at least he/she was honest with you. 
  7. You invited your teen to friend you.  You have heard no response.  You keep waiting.  No response.  6–12 months have passed – you’re afraid to bring it up. Your invitation may have been “ignored” by your teen – which is the polite way of saying “No Way!”.  Look at it this way, at least your kid cares about your feelings enough to not neg you outright. 
  8. You have no idea what Facebook is.  Not cool, but there could be worse. 
  9. Your teen friended you on Facebook, and the very same day you clicked to every friend they have, looked at every friend’s links, pictures, videos, etc.  Not cool – that is parental stalking.  You give parents a bad name.  Beware of the next one:
  10. You were friended by your teen, but you have been subsequently defriended.  Ouch, you screwed up somewhere along the way.