I had an awesome day on Saturday. I spent the weekend with my fraternity at MIT (the Lambda Phi Chapter of Alpha Delta Phi) on an undergraduate retreat called ADPrentice (be patient, you’ll get it in a minute). I co-sponsored this with two of my frat brothers – Sameer Gandhi (a partner at Sequioa Capital) and Mark Siegel (a partner at Menlo Ventures).
As I look back 20 years later, our fraternity generated a number of very significant entrepreneurs in a short period of time (the graduating classes from 1984 to 1990). Several companies that effectively started in the house (at 351 Mass Ave in Cambridge) included my first company (Feld Technologies – co-founded by me ‘87 and Dave Jilk ‘84), Art Technology Group (started by Joe Chung and Jeet Singh ‘85), iRobot (started by Colin Angle ‘89). Sameer Gandhi ‘87 and Mark Siegel ‘90 are prominent VCs. Ross Ortega ‘87 has started several companies. And – while the 1984 to 1990 period was rich with entrepreneurship, it didn’t stop there – Pehr Anderson (I think originally ‘96) dropped out to start NBX which was acquired by 3Com in 1999 (Pehr eventually got his degree).
This activity all happened well before the Internet bubble. MIT has always been a huge generator of entrepreneurial activity and the fraternity system / independent living groups (FSILG) at MIT – which used to be critical to the Institute as there wasn’t enough dorm space to house all the students – was a uniquely vibrant source of entrepreneurial activity. In recent years, MIT has shifted emphasis away from FSILG as they’ve built more dorm capacity, been concerned about liability issues associated with the FSILG system, and generally wanted more control over the behavior and experience of the undergraduate community.
Last year, Sameer, Mark, and I decided to contribute a modest amount of money to the chapter. Since Lambda Phi is chartered as a “literary society”, we were determined to do something intellectual as part of our gift. We wanted to impact the house in a meaningful way, especially since all three of us had been disengaged for some time. It took a while before several of the alumni and undergraduates engaged and during this process we started to learn about the challenge that our fraternity – and others at MIT – are having with the new rules and constraints that MIT has imposed on FSILG. I won’t go into them here, but we were surprised and as a result more motivated to try something different to get the undergraduates excited and reconnected to several of us.
A team of folks – led by Manish, Ruben, and Zach – put together an incredible event. We spent Saturday at MIT’s Endicott House – MIT’s fantastic off campus retreat facility – and had an Apprentice-like day (now you get it: ADP + Apprentice = ADPrentice). This acted as the “fall retreat” – most fraternities have something similar where all the undergraduates go away for a weekend and do something together. Usually (at least 20 years ago when I was in college), the retreat devolved into a drunken bash that – while it included some “activities” – was primarily social, often a lot of fun, but rarely intellectual.
ADPrentice had three discrete challenges:
In between challenges, Mark, Sameer, and I gave the following lectures.
During the day, Mark, Sameer, and I observed the teams and scored them on each challenge. At the end of the day, we totaled up the scores and picked the winner. We awarded the first place team with $1,000 – second and third received $500 each.
I was completely blown away by the quality of work these guys did. Remember – we are talking about undergraduates with no real work experience (albeit they are MIT undergrads). The quality of what they did was unbelievable and reminded me how incredible MIT is at teaching people to think.
As the day wore on, we were worried that the energy level would start to wane. The opposite happened – folks became more engaged, the competition became more intense, and the level of conversation increased. Now – this is a Saturday – these guys didn’t go to sleep early Friday night (well – some of them didn’t bother going to sleep since they had to be ready to leave at 8am) – but they just powered through. Awesome.
Sameer, Mark, and I had plenty of time to talk about entrepreneurship. One of the things this day reminded us of was the incredible raw material that exists in the US. While there is endless talk about China and India – and undoubtably the US is no longer undeniably at the top of the heap in the innovation game – we shouldn’t forget the quality and potential of the kids currently in our top tier schools in the US. In addition, as a guy approaching 40, it’s just a blast to hang out with 20 year olds, remember what it was like to be 20, and participate in influencing these guys’ lives, even if only a little bit.
Jason and I have engaged in a little foreplay with you in our Letter of Intent series. While you might think the length of time that has passed since my last post is excessive, it’s often the length of time that passes between the first overture and an actual LOI (although there are plenty of situations where the buyer and the seller hook up after 24 hours, just like in real life.)
As with other “transactions”, there’s a time to get hot and heavy. In most deals, there are two primary thing that the buyer should have on his mind – price and structure. Since the first question anyone involved in a deal typically asks is “what is the price?” we’ll start there.
Unlike in a venture financing where price is usually pretty straightforward to understand, figuring out what the “price” is in a merger situation can be more difficult. While there is usually some number floated in early discussions (e.g. “$150 million”), this isn’t really the actual price since there are a lot of factors that can (and generally will) effect the final price of a deal by the time the negotiations are finished and the deal is closed. It’s usually a safe bet to assume that the “easy to read number” on the first page of the LOI is the best case scenario purchase price. Following is an example of what you might see in a typical LOI.
Purchase Price / Consideration: $100 million of cash will be paid at closing; $15 million of which will be subject to the terms of the escrow provisions described in paragraph 3 of this Letter of Intent. Working capital of at least $1 million shall be delivered at closing. $40 million of cash will be subject to an earnout and $10 million of cash will be part of a management retention pool. Buyer will not assume outstanding options to purchase Company Common Stock, and any options to purchase shares of Company Common Stock not exercised prior to the Closing will be terminated as of the Closing. Warrants to purchase shares of Company capital stock not exercised prior to the Closing will be terminated as of the Closing.
Hmm – I thought this was a $150 million dollar deal? What does the $15 million escrow mean? The escrow (also known as a “holdback”) is money that the buyer is going to hang on to for some period of time to satisfy any “issues” that come up post financing that are not disclosed in the purchase agreement. In some LOIs we’ve seen extensive details, in so much as each provision of the escrow is spelled out, including the percentage of the holdback(s), length of time, and carve outs to the indemnity agreement. In other cases, there is mention that “standard escrow and indemnity terms shall apply.” We’ll discuss specific escrow language later (e.g. you’ll have to wait until “paragraph 3”), but it’s safe to say two things: first, there is no such thing as “standard” language and second, whatever the escrow arrangement is, it will decrease the actual purchase price should any claim be brought under it. So clearly the amount and terms of the escrow / indemnity provisions are very important.
Well – that working capital thing shouldn’t be a big deal, should it? True – but it’s $1 million. Many young companies – while operating businesses – end up with negative working capital at closing (working capital is current assets minus current liabilities) due to debt, deferred revenue, warranty reserves, inventory carry costs, and expenses and fees associated with the deal. As a result, these working capital adjustments directly decrease the purchase price in the event upon closing (or other pre-determined date after the closing) that the seller’s working capital is less than an agreed upon amount. Assume that unless it is a “slam dunk” situation where the company has clearly complied with this requirement, the determination will be a battle that can have a real impact on the purchase price. In some cases, this can act in the seller’s favor to increase the value of the deal if they have more working capital on the balance sheet than the buyer requires – often the seller has to jump through some hoops to make this happen.
While earn outs sound like a mechanism to increase price, in our experience, they really are tool that allows the acquirer to under pay at time of closing and only pay “true” value if certain hurdles are met in the future. In our example, the acquirer suggested that they were willing to pay $150 million, but they are only really paying $100 million with $40 million of the deal subject to an earnout. We’ll cover earnouts separately, as there are a lot of permutations, especially if the seller is receiving stock (instead of cash) as their consideration
In our example, the buyer has explicitly carved out $10 million for a management retention pool. This has become very common as buyers wants to make sure that management has a clear and direct future financial incentive. In this case, it’s explicitly built into the purchase price (e.g. $150 million) – we’ve found that buyers tend to be split between building it in and putting it on top of the purchase price. In either case, it is effectively part of the deal consideration, but is at risk since it’ll typically be paid out over several years to the members of management that continue their role at the acquirer – if someone leaves, that portion of the management retention tends to vanish into the same place lost socks in the dryer go.
Finally, there’s a bunch of words in our example about the buyer not assuming stock options and warrants. We’ll explain this in more detail later, but, like the working capital clause, can affect the overall value of the deal based on what people are expecting to receive.
Clive Thompson has an outstanding article in today’s New York Times called Meet The Life Hackers. He describes the problem that affects so many people today – the complete overload of digital information and interruptions that makes it difficult to get immersed in any project for an extended period of time.
Rather than simply describe the problem (which is where so many articles like this end), Thompson frames the issue as one that has been popularly called the need for “continuous partial attention” (coined by Linda Stone in 1997). He then goes on to describe great research by Mary Czerwinski and Eric Horvitz that directly address this issue.
I’ve ranted in the past about how stupid my computer is. We’re going to see a dramatic transformation in the way our computers “help us” over the next 20 years as more of this research begins to be embedded in the core technology that powers our “personal computing infrastructure” (pci). In the same way that information systems and computer technologies have increasingly developed layers of abstraction, I predict we’ll start to see a similar abstraction layer between us and the rest of the universe that is trying to communicate with us digitally. Instead of forcing us to be the ultimate router and arbiter of the priority of information (and interruption), our pci will learn how we work, gradually augment how information gets to us, and ultimately automate much of the information flow and our response.
We’re already seeing this in some very simple applications. An extremely useful example is the automated elimination of spam. Now – if we could turn these same spam elimination systems – which work automatically in the background (e.g. I use Postini and spam simply disappears – I never think about it anymore) – into “email prioritization systems” (e.g. spam has priority=null, email from Amy or my mother has priority=immediate, email from my partners has priority=high) where the priorities are automatically tuned by my pci based on my behavior things become more interesting. Finally – add one more layer of abstraction – my pci knows when I am ready to received different priorities and presents them to me only when I’m ready (e.g. I always get interrupted by Amy or my mom, I sometimes get interrupted by my partners depending on the thing I’m working on, but it always comes at the top of the queue, etc.) – and you’re really getting into an interesting zone. Of course, delivering it one time on the appropriate device (computer, cell phone, television, carrier pigeon) in the right location is a key part of this.
Once you extend this construct to all digital communication and interaction, you start to get some interesting things happening. Which – of course – is only the beginning of the real transformation. It’s going to take a while, but the way we do things today – and the way our pci works – sucks.
Today must be my day to catch up on “friends blogging.” I was at Microsoft earlier this week for my three times a year “Microsoft Emerging Business Team (EBT) technical advisory meeting (my co-conspirators were Scott Maxwell – Insight, Chris Pacitti – Austin Ventures, and Vladimir Jacimovic – NEA). We had a great (and very fun) meeting.
If you are running a startup company that uses any Microsoft technology, you should know about EBT and the other Microsoft programs for early stage companies such as Empower and the Microsoft Partner Programs. In addition, several of the EBT members are now blogging regularly, including Cliff Reeves, Don Dodge, and Sam Ramji.
While the irony that they are all using Typepad is not lost on me (or them), their blogs are outstanding resources to get insight into how Microsoft thinks about partners, how EBT works, and other things these guys are thinking about. All of them are well worth the time if you touch the Microsoft ecosystem in any way.
Peter Rip (Leapfrog Ventures managing director) – who has just started his blog – has yet another warning on “problematic behavior” that is emerging around the Web 2.0 frenzy and is likely to cause plenty of unhappiness. He takes in on from both a VC – but more importantly – entrepreneur point of view. I haven’t seen Peter in a long time, but remember him fondly and expect his blog to be on the must read list if you are interested in what VCs think.
My long time friend Alan Shimel, Chief Strategy Officer at StillSecure, has started a blog.
I first met Alan in NY when I was co-chairman of Sage Networks. We had started to acquire web hosting companies in 1997 and Alan’s was one of the first that we talked to. At the time, he and his partners were running a very rapidly growing shared web hosting company. We had our first meeting at a GE office in Manhattan that I was camping in that day – me in my long hair and jeans; Alan is a lime green jacket (looking like he’d rather be wearing jeans). We connected immediately and were able to put together a deal quickly.
We then proceeded to go through plenty of ups and downs, but became good friends in the process. When Raj Bhargava started StillSecure, he recruited Alan to join him – it’s been great to work with Alan again.
Alan has been spending a lot of time thinking about open source, especially in the context of security software and some of the actions of several of the companies that have been formed around popular open source projects. Among other things he’s got a strong and well reasoned point of view that’s worth listening to. Of course, if you are interested in security software, Alan is a great guy to talk to about it.
I was at a company the other day that I’m considering investing in. They walked me through their v2 web design and we did a detailed review of it. While it’s much improved over v1, there were still plenty of things that could be improved. One of the people in the meeting suggested everyone review the list of Top Ten Web Design Mistakes of 2005.
In addition I’d recommend everyone click through the following links and look carefully at the page design.
Forget about the content – just concentrate on the design. Is that [blue black green] thing the Google standard, Yahoo standard, or Microsoft standard? Given that this is what people look at 90% of the time they search, why would you present search results in a different way?
And – in case you are wondering – there are great examples of Flash. Take a look at this IKEA site (thanks Eric D) – make sure you pan left and right. When Amy and I bought our house in Alaska, we went online and bought an entire house full of furniture at JCPenney.com in an afternoon. Unfortunately, the didn’t have a “buy a house full of furniture button” at the time – if they had, our online experience would have been that much easier.
I got a Verizon BroadBand Access card (formerly known as “EVDO”) 12 days ago. I’ve been on the road non-stop since then. I can’t imagine life without it. As I sit in the Seattle airport waiting for the redeye to Boston, I haven’t had to sign up for Internet, struggle with any weird logins, wander to another part of the terminal to try to get T-mobile, or anything else. It’s flawless – fast – totally effective – and trivial to deal with. I’ve already saved the monthly subscription fee ($60) through not having to pay $10 / night for Internet access in my hotel rooms and I’ve managed to squeeze in some online time at random spots waiting for things (e.g. the 15 minutes I had to wait for a cab at Microsoft today).
Now, if I could just get my bluetooth headset to work with my laptop and Skype I’d be in geek heaven.
Kevin Maney at USA Today was in fine form yesterday with his article titled “Tech People Appear Hyped About Their Industry Again.” It’s worth a read if you are struggling with whether it’s Web 2.0 or Bubble 2.0.