EarlyStageVC

Two Crunchie Nominees -- Very Cool!

As the Web 2.0 has become enamored with all things social media, I have increasingly lost interest in investing in the next Facebook clone.  So imagine my surprise this morning as I saw the Crunchies nominees.  My companies, Radar Networks (a.k.a. Twine) and Riya.com (a.k.a Like) are two of the five companies nominated in the category of Best technology / innovation / achievement. 

A few years ago when I decided to return to Web investing, I made a decision that I would invest in companies that had real technological advantage.  This is more capital intensive than lots of web investments and has a longer gestation, but I figured it would pay off in differentiation and, hopefully, a better user experience. 

These companies are not without their challenges.  The change at Riya as is moved from photo classification to e-commerce has been well chronicled by Munjal.  I am happy to say that the business is doing extremely well.  The daily graphs I get on CTRs, Revenue, and Revenue/Visit  all been consistently up and to the right on a monthly basis, all year long.  Congratulations Team -- a better user experience is paying off, literally.

Twine is the still gated-beta application from Radar Networks.  I have been using Twine for about 2 months now.   I can say the promise of better information management by the use of semantics is definitely there. We still have a long way to go.  The platform is very fast and very reliable, now we are tuning features to improve the workflow. Being a gated app, I doubt we have chance to  win the Crunchie Award at Twine, even if every beta user voted.  I guess it truly is "just an honor to be nominated."

There is no guarantee that this technology-focused investment strategy will really pay off in great venture returns.  That remains to be seen. But this is still nice.

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Well, earthmine won.

Measuring Success

My previous post was a semi-theoretical statement about how to view the need to fund the continuous experimentation of consumer services.  Last week I was on a panel at Pillsbury Winthrop regarding Web 2.0.   Continuing my point about the need for continuous iteration, I made the point that it is absolutely essential to instrument your business to learn the fine grain details of what is really driving your business. 

I thought I'd share with you just a hint of what I mean.  Each day I, and every other Board member at Riya, get an email containing over 50 operating metrics of Like.com.   Some of them are obvious, like Daily Uniques, Number of Clicks, etc.  Others are not so obvious, and reflect our daily success at coaxing users to help us build the business.  Each of these metrics ties to decisions the team is making about traffic sourcing, user experience, product features, products being compared etc.

One of the cooler things in the daily stats are the SKU analyses we see.  Among all the other stats, we get to see the daily zeigeist of fashion and what's selling.  We literally get pictures with associated links for the top selling SKUs.  My last mail with the SKU report had the following products as top sellers:

About a month ago I actually bought a pair of "Von Zipper" sunglasses that came to me in my daily traffic report.  (Invest $5.5M you still pay retail!)

This fanatacism about continuous measurement and transparent communication is not something the Board imposed, nor even asked for.  I remember this was the thing that most impressed me about Munjal the first time I met him five years ago. Then he whipped out an excel spreadsheet with every operating parameter of his prior business and showed me how he and the team were moving up, one day at a time.

There are a lot of ways to grow the top line.  You can spend your way to revenue (and oblivion) - the strategy formerly known as "get big, fast."  There is only one way to grow the bottom line - make the business algebra actually work. Today Riya is using the organic traffic to see how changes improve monetization, repeat usage, etc. The business is in "fine-tune" mode.  Every change improves the lifetime value of every user and the marginal profit contribution of every dollar to be spent on marketing.  We haven't poured gasoline in the engine to accelerate the traffic.  We are tuning the user experience as measured by the economics of the business.  Of all the graphs and images I get every day, this one is the best because it shows our users are voting with their mice.  What's not to Like? 

When you can measure what you are speaking about, and express it in numbers, you know something about it; but when you cannot measure it, when you cannot express it in numbers, your knowledge is of a meager and unsatisfactory kind: it may be the beginning of knowledge, but you have scarcely, in your thoughts, advanced to the state of science
- Lord Kelvin

...and these days, consumer internet is definitely a science.

Fail Fast, Fail Often

There was an article last week in the Wall Street Journal talking about an apparent change in the entrepreneurship/VC funding model.  Riya, Meebo, and others were cited as poster children for the new restraint.  The core idea was that entrepreneurs are taking advantage of the availability of capital to fund for long periods, often several years, rather than the traditional 12-18 months.  So why does this make sense? Why raise a bucket of money when a thimbleful will do?

The classic venture model has been to fund to milestones 12-18 months out.  In consumer web services, there are only two meaningful milestones --  (1) are you getting a lot of users and (2) have you figured out how to make money?  We use other metrics in other sectors (like management, product, etc.)  as proxies for real economic progress.  We also use them because (we believe) they would have residual value in an asset sale or merger. 

None of this is true in consumer web services. You're either hot or not. Second place generally sucks.

The problem is that it is hard for entrepreneurs and VCs to know a priori if something is going to be a hit. The only way to know is to try, and trying takes time and money.  So here's the real rationale for what it makes sense for these companies to raise "a lot of money" and not blow it.  They have to run lots of experiments.

By now we are all well-acquainted with the observation that software is cheaper than ever to produce.  But that is only half the story.  The other half is that it takes several iterations -- several trials -- to hit it big.   

Imagine you have a low-burn consumer internet company and you think you can do your next build for $2M (offshore, open source, etc.)  Imagine further that there is a 1 in 20 chance that you could be the next [insert fantasy outcome here]. Angels are lining up with $2M in hand.  VCs are waving $5-20M checks at you.  Everyone says this is a $10M pre-money company and you own 50% today.

Assume you have a 5% chance of Being Big on the $2M raise, and a 95% chance of nothing.  The chance of Being Big if you raise $4M is 9.75% (1-.95*.95).  This is because you can iterate twice at 5% probability each.  The chance of Being Big after raising $20M is 40.1%.

Of course, each $2M has a dilution to you as the Founder. As the graph below illustrates for this hypothetical example, the risk-adjusted ownership (diluted ownership x probability of success) increases as you raise more money.  (This conclusion is not universally true in all situations.)   

The key to this thinking is to resist the temptation to spend like a lottery winner. Raising the big VC round isn't winning the lottery; it is the purchase of a deck of weekly lottery tickets. 

This is how Munjal Shah described the move to Riya 2.0 in the WSJ article.  It was the realization that the first experiment, while a success by many measures, wasn't enough of a success relative to other options.

The larger-than-expected VC rounds in consumer internet deals are perfectly rational outcomes, for the entrepreneurs who understand the trials of consumer marketing.  Failure is baked into the calculus of the opportunity.  The key is to fail fast.  Set metrics ahead of time and be decisive. Because time is money -- literally.

Entrepreneurs who practice this discipline are just doing what VCs do every day.  Venture Capital is a hits business, too.  Companies often fail.  Time is money here, too.  Failure is part of the process.  We, too, are looking to fail fast and expect to fail often.  That's why funds are getting bigger, too.

Critical Strategic Questions for Riya

As many of you know by now, Munjal Shah is the CEO of Riya.  Riya's been an interesting illustration of the use of transparency to enhance visibility.  Munjal continues his series on the metamorphosis of the business.  He got a little "ink love" on the topic from the Wall Street Journal last week by Becky Buckman in her article about the Web advertising market.  Here he talks about the Board meeting we had a few months ago in which we basically said "Yeah, you're right. Go for it."   

What Munjal doesn't mention in this write-up is that he didn't just announce this proposed change at the Board meeting.  The Board meeting was an in-depth review of the thoughts he had shared in conversations he had with each of us the two weeks preceding the meeting.  By the time of the meeting we were all (1) aware of the issues and (2) aware of his proposal.  Consequently, we came prepared with a few focused questions, not off-the-cuff reactions.   More importantly, we came prepared to make a decision.   

Three hours later we emerged, united in our go forward plan.

This is the back story about how to lead a process of change -- board level or any other team.  Bring everyone  with you along  the way. Don't think you have to have the "complete answer" before you engage others who are critical to your success.  Leadership isn't about having all the right answers.  It more about having all the  right questions.

Riya - Phase 2

About 8 weeks ago Riya launched its open beta.  By any usage metric this has been a success.  We enjoyed the Techcrunch Effect with 1M image uploads in the first 24 hours.  Thanks, Mike. Once past the pent up demand, we have continued to grow nicely, passing 7M images last week.  Yesterday we had a board meeting to officially chronicle the progress and approve Riya Phase 2.

When we first conceived of Riya (by the way, we officially changed the company name from Ojos to Riya today) we were torn between the twin objectives of sharing photos and finding photos.   Since then, it has become clear that there are literally 100’s of ways to share, but precious few methods of searching for them.  Text search engines like G***** and Y****!  (I  don’t want to give them more brand awareness, lest you have not heard of them  ;-),  really aren’t very effective for finding photos. 

As a board member, I get an automated report every morning from Riya that shows the number of daily users, images, faces recognized, etc.  Each morning has been a re-affirmation that we are on to something very big.  We now have a very powerful team. Over 30% of the Company is in Research, as distinct from Engineering. (I have never had a software company with this level of investment in basic research from the beginning.)  We already may have the largest Machine Vision team in the world. We have over a dozen PhDs in Computer Science.  As a consequence, the Company is now entering into Phase 2 – Rapid Innovation.  Phase 1 was about building the platform and the user base.  With 7m+ images and 5M+ faces detected, and a full infrastructure for rapid development, deployment, and iteration, Riya is now about doing what consumer Internet companies have to do to succeed  – experiment – testing  new innovations with real user behavioral feedback.  One consequence is our IP attorneys are getting a big payday as we patent the innovations in image search that this team is inventing.

Phase 1 exceeded my initial expectations, but has raised my expectations for Phase 2 and beyond.  Munjal and the team are clearly veering into Photo Search to complement and partner with the 100s of photo sharing sites out there.  The PhotoWeb is very real and there is no effective way to navigate through it.  If we are successful, all the sites with photos (stock, personal, amateur photography, etc.) should benefit by being easier to search.   If navigation is easier, monetization will naturally follow for them and for us.  A photo is worth a 1000 words.  So a photo site is worth …