Jason sent me a quote that was on the first slide of a 409A presentation from one of the major law firms we work with.

“409A is the tax law that ate the world.  Every day we discover another 12 issues.”
—– Senior US Treasury Department Tax Official, March 13, 2006

Maybe Jack Bauer will start paying attention to 409A in tonight’s episode of 24.

The rumors about someone buying JBoss have been bouncing around for weeks.  As I was working on a presentation titled Commercializing Open Source for Eric von Hippel’s Democratizing Innovation conference this week, I went to Red Hat’s page to pick up their logo and saw that they announced the acquisition of JBoss this morning.

This is a huge success for everyone involved, especially Marc Fleury (JBoss CEO and founder) and the primary investors – Accel, Intel, and Matrix.  JBoss only did one disclosed round of financing for $10 million about two years ago.  Red Hat acquired them for $350 million with an additional $70 million earn out.  This is about 10% of Red Hat’s market cap.

Oracle should have stretched a little harder for this one.

Check Point and Sourcefire announced the cancellation of their deal on Thursday.  This was a very nice deal for Sourcefire and its investors, as Check Point was paying $225 million for the company.  Sourcefire had raised a total of about $33 million so the early investors, including Sierra Ventures, probably made about 15x, NEA which was a round 2 investor probably made about 10x, and Sequoia – which was a round 3 investor, probably made about 3x.

As I sit here pondering this on a Saturday morning, I’m baffled, appalled, and offended by our government’s actions in killing this deal.  I remember having similar reactions when the government was investigating the $5.5 billion acquisition of Verio (a Colorado-based ISP / hosting company) by NTT in 2000.  While I wasn’t an investor in Verio, I knew many of the people there, including several of the key investors, and couldn’t fathom why our government would get in the way of the deal. Thankfully, the Clinton administration finally greenlighted the deal and one of the huge pre-bubble crash Colorado deals got done – just in time.

I’m baffled because of the open source aspect of the situation. Sourcefire’s core products are built on top of Snort, which was created by Sourcefire’s founder Martin Roesch.  While Sourcefire has undoubtably created a significant amount of proprietary (i.e. non-open-source) code in their products, Snort is still an extremely popular and growing open source product and community.  Dear Mr. Government – this means that anyone – including the really bad nasties – can download Snort and take a look at it.  While they can’t take a look at Sourcefire’s products, as long as Sourcefire has any meaningful Snort-based code as part of their system, the thing you proport to be concerned about is irrelevant.

I’m appalled because it makes no sense to me that the US government would stand in the way of the acquisition of a US security software company by an Israeli software company.  Check Point is a well-known, publicly traded (on NASDAQ) and broadly deployed “international company” – they have a huge US presence, employ large numbers of US citizens, and – well – operate in the global software / IT marketplace.  Check Point was funded in the mid 1990’s by two prominent US VC firms – Venrock and USVP (in fact, Ray Rothrock of Venrock and Irwin Federman of USVP still sit on Check Point’s board.)  This type of protectionism is just gross to me and is potentially damaging to the venture business as foreign companies (such as those in Israel, China, and India) are natural buyers of many US-based startups, including those that have significant business with the US government.  If an Israeli-based company can’t buy a US-based security startup, why would the US government let a China-based company do this?  As a VC or an entrepreneur, if you take this out to it’s logical conclusion, you get unhappy really fast.

I’m offended because – as a jewish American and an investor in high tech companies – the notion that our government is willing to block the sale of an entrepreneurial company to an Israeli company because the Israeli company is a threat to US security makes me want to vomit.  This is the same government that recently decided to share civilian nuclear technology with India.  Now, I’m not tied up in the politics of it all, nor do I want to be, but when I step back and look at it from an entrepreneurial perspective, and think about all of the Israeli security technologies that have made their way into US products (and – in a number of cases – become meaningful US-based companies), I just feel like someone in Washington needs a major history lesson.

While Check Point and Sourcefire have put a good face on the situation, I’ve got to believe there are some very unhappy people in Maryland and on Sand Hill Road today.

This week has already been active for new startups in Colorado.  On Monday, the news broke that my friends Don Springer and Tim Wolters had closed on a $2.6 million financing led by Appian Ventures for their new company, Collective Intellect.  Tim has blogged some about the fundraising process from an entrepreneur’s perspective – good stuff.

Yesterday, my friends Paul Berberian and Karl Maier announced that they’d raised $19.3 million for their new company, Market Force Information.  This equity piece was $11.3 million and was led by Centennial Ventures with participation from Boulder Ventures and Vista Ventures; the debt piece was $8 million from Hercules Technology Growth Capital.  Market Force also announced that they have acquired their first company, Atlanta-based Shop’n Chek, one of the largest mystery shopping companies in the country.

Paul was one of the first entrepreneurs I go to know when I moved to Colorado.  We met at the first YEO Colorado meeting in 1996 at the Boulderado and he helped me start up the YEO Colorado chapter.  I funded – with Centennial – Paul’s second company Raindance, which he co-founded with Jim Lejeal and Todd Vernon.  Raindance went public in 2000 and was recently acquired by West Corp. 

I met Karl Maier through my very close friend and attorney Mike Platt at Cooley Godward a couple of years ago.  Mike and Karl are best friends and Karl has worked closed with Centennial on a number of their companies, including Vector, VIA Net.Works, and Cordillera.  Karl is well known throughout this area as an extremely strong operating exec.

I watched Paul and Karl as they got to know each other over the past year and developed the idea of transforming the established (and technology unaware) “mystery shopping business.”  They learned this business extremely well, determined that there was a huge opportunity to apply technology to it, and decided to acquire a number of mystery shopping companies, consolidating what is currently a very fragmented industry, applying contemporary technology, and building the dominant company providing “store-level, customer experience information for retailers, restaurants, consumer packaged goods companies and the financial and hospitality communities.”

Cool vision.  They’ve taken the first big step by closing both the financing and their first acquisition.  Market Force is now a 130 person company with real operations and a market leader.  It’s a nice new company on the Boulder scene, funded by a strong syndicate of Colorado investors.  Congrats to all.

Yesterday, I wrote a high level summary of this year’s Venture Capital in the Rockies conference.  I thought I’d give the local press one more day to see if anyone was going to write something substantive about some of the companies presenting.  I haven’t seen anything, so here are my thoughts on the companies I saw. 

24 companies presented in two tracks so the most I could see was 12.  I had a couple of conference calls during the day so I only managed to see 7 of them: Collective Intellect, Confio Software, HomeSphere, Solidware Technologies, iPosi, CreekPath Systems, and XAware.  The only company on this list that I directly have an investment in is Collective Intellect, although I have indirect investments (through VC funds that I’m an LP in) in XAware as well as Collective Intellect.  I’ve listed the companies in rank order starting with the one that I thought was most interesting / did the best job.

Collective Intellect: I backed the founders – Don Springer and Tim Wolters – in their previous company (Dante Group – acquired in 2003 by WebMethods.)  Don and Tim are super second time entrepreneurs, and the way they’ve started up Collective Intellect shows.  Their tag line is “filtering new media for the securities industry” – they are using a bunch of hard core computer science to analyze new media content (blogs, chat rooms, discussion forums) for public market fund traders, analysts, portfolio managers, and quants (i.e. the dudes at hedge funds.)  The intersection of new media, heavy computer science, and the massive hedge fund dollars sounds like a good place to hunt.  Don did a great presentation and announced their round of funding led by Appian Ventures.

Confio Software: I met the CEO and primary backer of Confio – Charlie Sanders – about 18 months ago when he first got involved with Confio and its cofounder Matt Larson.  Charlie’s an impressive guy having been a senior exec at Seagate (and previously Conner Peripherals.)  It sounds like 2005 was a very good year for them as they landed 40 new customers, although reading between the lines it appeared that one or two customers accounted for about 50% of their revenue.  Confio’s market – IT performance management – is a crowded one, but they appear to be doing some unique stuff around digging into the Oracle database layer to look for root cause defects (ah – “root cause” – the holy grail of all APM companies.)  Charlie a super salesman and is determined to scale the business up nicely on modest capital.  He’s off to a good start.

XAware: Tim Harvey, the new CEO of XAware, did a super job of presenting after a mere three weeks on the job.  I generally like XAware – it’s in a market segment (SOA middleware) that I like, understand, and have made some money in.  However, I don’t understand their approach to the business.  While they generated a respectable $3m of revenue last year, it appears that most of it came from financial services customers.  Consequently, I don’t understand why they present themselves as a horizontal SOA middleware provider when they could be kicking ass in the deep pocketed financial services vertical.

HomeSphere: I’ve got to hand it to James Waldrop and his team – they raised money in 2000/2001, survived their market falling apart, focused on growing slower but getting profitable, and have accomplished that.  They now have a respectable $10m business that sells two things: (1) manufacturer incentive and rebate service for through group buying (80%) and (2) construction management software (20%).  While #1 is a solid growth business (and HomeSphere has likely gotten to an interesting critical mass), #2 looks like a flat to declining business.  As a result, HomeSphere is looking to raise $10m to roll out three new lines of business (none of which I can remember a few days later.)  I don’t understand why they’d do this – if I was on their board I’d say “no more money – stay profitable – grow aggressively in segment #1.”

Solidware Technologies: Sue Kunz, the CEO of Solidware, is a firecracker.  I’ve known her and her gang for about a year and watched them do unnatural acts (ah – the joys of entrepreneurship) to get their “Splat Software” up and running.  Splat is an SQA product (software quality assurance) that helps identify software defects through visual analysis of the source code.  I declined to invest last year as I’ve already got an investment in a somewhat competitive company (Klocwork), but I’ve tried to be helpful and encouraging to Sue and her team because I like their style.  I only caught the tail end of Sue’s presentation so I don’t know how she did, but she handled the Q&A nicely.

iPosi: I don’t get iPosi.  They presented a vision for a set of E911 products based on GSM-based location combined with IP geolocation (they are talking to one of my companies – Quova – about working together.)  I listened to the presentation and really didn’t understand either (a) what exactly they were going to do or (b) how they were going to do it.  My brain was working hard when I saw their revenue slide – immediately afterwards my nose started bleeding and I started fantasizing about steep upward sloping exponential curves.  I know – and like – a few of the people involved – I’m sure I’m missing something obvious.

CreekPath Systems: I remember looking at Creekpath in 2000 when it was originally spun off from Exabyte.  I was pretty excited about funding it until one of my partners vomited all over the floor after meeting with the team.  As a result I passed – am I’m glad I did.  They’ve been through a lot of ups and downs and retooled their leadership team – again – last year.  Creekpath is a good example of the endlessly elusive storage success animal (hardware or software) that tantalizes, but eludes, the Colorado VC.  Maybe this will be the one, but as many have gone before them, they have a long road ahead of them.  I keep hearing that none of the storage vendors have this, but then I think about EMC’s software group and just shake my head.

Oh, and Seth and Chris assured me that the skiing on Wednesday was outstanding and the skiing on Friday was social (e.g. not much fresh powder, but lots of friends hanging around, blue skies, and 60 degrees.)

I received the following question last week. It’s a good one – very chewy – and my answer is given from my frame of reference (e.g. a managing partner in a large VC fund).  Consequently, I’m not sure that my answer is either generally correct or abstractable to all situations. How’s that for a hedge? The question is:

Do you agree or disagree with the following scenario as a firm basis for Web 2.0 ventures: Raise $2 to $6 million to be spent over a two to three year period, with an exit of a $20 to $50 million sale to one of the GEMAYANI’s. Would you adjust those numbers significantly, as a general thesis? Is such a venture model an attractive VC proposition, by definition, or maybe merely acceptable in the absence of a more traditional, larger-scale exit (say, raising $4 to $16 million with a $80 to $300 million exit after 4 to 7 years)? What model has the most appeal to you these days? Ultimately, it’s a question of what entrepreneurs should be shooting for. Implicit here is the question of whether Web 2.0 is a short-term window which may close in less than two to three years.

Let’s assume an median case where the $2m – $6m raised gets 50% of the company. In this situation, the VC firm gets half of the exit, which would result in a 5x return in the best success case and a 1.5x return in the worst success case. Of course, both of these assume the exit will occur – this only happens a small percentage of the time, so you have to risk adjust these numbers down by this amount (say 1 in 100 success case, although I’d assert given the number of startups in this domain, it’s probably 1 in 1000 right now.)  So – while the “invest $2m – $6m and return $20m – $50m is a reasonable thesis”, it’s missing the “how many times does this actually happen” multiplier.

While the exit numbers are ok, they aren’t going to move the meter on most VC funds with > $100m under management. While VCs need these kind of exits, they are typically looking for are both higher multiples and higher absolute returns, especially when you take into consideration the discount associated with the probability of success.  So – investing in this general thesis is limiting in a way that won’t be attractive for many VCs.

Now there’s been plenty of blogosphere chatter about how the VC business needs to be revolutionized, how new fund types that are motivated to invest in these outcomes should appear, and how “Advisory Capital” should play a role in all of this. All that is fine – but the second question that’s asked is the really interesting one.  What model has the most appeal to you these days? Ultimately, it’s a question of what entrepreneurs should be shooting for. Implicit here is the question of whether Web 2.0 is a short-term window which may close in less than two to three years.

I’ve always invested with the idea that I should be trying to build significant companies, rather than invest for a quick flip.  Occasionally I end up with a quick flip (and I’m always happy), but – if I see an opportunity to create something large, I’d rather go down that path.  Of course, everything is circumstantial – there is often great fit with an acquirer early in the life of a company and – when this is the case – it’s often in the best interest of all parties (entrepreneurs, buyer, VC’s, employees) sell the company and for the VC to move on (remember – a VC has a limited number of things that he can handle at any given time.)

So – the invest for a quick but modest return doesn’t appeal to me as an investment thesis.  However, I’m sure it appeals to plenty of other folks, including some VCs.  Subsequently, the real answer (from the entrepreneurs frame of reference) is to understand the investor you are working with, what his underlying economic motivation actually is, and ensure that you (the entrepreneur) are aligned before you take the investment.

As to whether Web 2.0 is a short-term window which may close in less than two to three years, I have no idea.  Ask me again in three years.  However, I expect that in three years there will still be an opportunity to create great Internet-related companies.

For the last 23 years, the Venture Capital in the Rockies conference has been the signature fund-raising conference in the Rocky Mountain region.  A full day of presentations from companies looking for venture capital (with the presenters mostly in suits – a rarity in this part of the country) followed by a day of legendary skiing (and – while I don’t ski – this year was phenomenal) makes for a great conference.  320 attended this year – 100 were investors including a number from out of state.

It was fun to look through the list of presenters since 1996 and see the following companies that I’ve been involved in:

1996: Mercury Mail – IPO as Exactis

1998: Email Publishing – acquired by MessageMedia
          Vstream – IPO as Raindance

1999: Service Metrics – acquired by Exodus
          Tellsoft – unsuccessful

2000: Finali – acquired by Convergys
          Service Magic – acquired by IAC

2001: Deuxo – unsuccessful
          Latis – now StillSecure – current portfolio company
          Prosavvy – acquired by eWork

2002: Dante Group – acquired by webMethods
          Npulse (Xaffire) – acquired by Quest
          Wideforce – unsuccessful

2003: F4 Technologies – now Rally Software
          Finali (again) – acquired by Convergys
          Newmerix – current portfolio company

2005: Oxlo – current portfolio company
          Rally (again) – current portfolio company

It was also interesting to see all the companies I haven’t invested in over the years that presented at this conference that have either been successful (oops – missed that one) or unsuccessful (sorry – but I’m glad I didn’t invest.)

Chris Onan from Appian Ventures did an awesome job hosting the conference this year.  He followed a tough act from Chris Wand of Mobius Venture Capital who hosted the preceding two years – and did great.  Maybe they should rename the conference “Venture Capital in the Rockies: By Chris.”

All the local papers have now written up their piece on the conference at this point.  The Boulder Daily Camera had a light weight piece on the conference in general.  The Rocky Mountain News ran two pieces – one that highlighted David Moll – CEO of Webroot (and the article said that he didn’t stay long because he had more important things to do – ouch) and one that announced ITU Ventures new $120 million fund.  The article in the Denver Post was the most substantive, actually highlighting several companies including Collective Intellect, Accucode, and Groople.

Given the lack of actual focus on the companies, I’ll write up a separate post talking about the ones I saw at the conference, offering feedback and (hopefully) constructive advice.

Jeff Bussgang – a GP at IDG Ventures in Boston – has a good post up on the dynamics – from both an entrepreneurs perspective and a VC perspective – on syndicating deals.

The following question appeared in my inbox the other day.  “As you mention in this blog VCs never sign NDAs. Maybe you can also tell me why actually not? If I follow your blog does it mean that in most cases they simply want to check the startup out?”

For starters, I’ll restate the assertion.  Most VC’s don’t sign non-disclosure agreements.  Guy Kawasaki had a good comment on it in his Venture Capitalist Wishlist post.

“Before you even start addressing the hard stuff, never ask a venture capitalist to sign a non-disclosure agreement (NDA). They never do. This is because at any given moment, they are looking at three or four similar deals. They’re not about to create legal issues because they sign a NDA and then fund another, similar company–thereby making the paranoid entrepreneur believe the venture capitalist stole his idea. If you even ask them to sign one, you might as well tattoo “I’m clueless!” on your forehead.”

That basically says it all.  I’d add a few things:

1. Even if I was inclined to sign an NDA, I’d have to go through the process of reading it and deciding if it had any problems (many of them do – they are usually overreaching for the information being disclosed), dealing with my lawyer to change it, and you dealing with (and spending time with your lawyer) to accept or reject my requests.  In some cases, I’d probably spend more time dealing with the NDA then with the entrepreneur and his idea.  How stupid.
2. I’d have to keep track of all the NDA’s I signed.  It’s “yet another legal document” in the pantheon of documents we have to keep track of.  Hmmm – maybe we should consider funding a startup to automate the creation and tracking of NDA’s.  Nah.
3. In 20 years of high tech (as an entrepreneur, angel investor, and VC), I’ve never been involved in a situation where an NDA is enforced except in an M&A context.  It’s simply a waste of paper and time for anything but M&A.

There is one type of NDA that I’ll sign.  Some large companies – for some reason – want to show you stuff, but then don’t want you to tell anyone about it “until they are ready.”  I can usually deal with this as it’s not worth the ensuing arguement.  However, I don’t need to sign an NDA for this – all they have to do is ask me to keep my trap shut “until they are ready.”

As an entrepreneur, don’t think of this as “arrogance”, think of it as “practicality.”  Your friend the VC is actually trying to save you time and money.  If you think you have something super secret that no one else should know, just don’t tell me about it.  Oh – and check your assumption in that case – especially since the value is in creating the thing, not simply having the idea.