January 30, 2011

66) SV Angel & Y-Combinator

危 wēi  danger

Y-Combinator, a startup bootcamp of sorts, provides seed money (generally less than $20k), advice, and connections to startups.  It has grown rapidly since its launch in 2005 and has had some high profile wins, including Posterous.

But the news this weekend that SV Angel and Yuri Milner are offering every Y-Combinator startup $150,000 in convertible debt, with no cap and no discount is still surprising.  Convertible debt is a common tool for early stage investment because it allows deferral of tough valuation decisions but investors usually include clauses to ‘sweeten’ the fact that they are investing earlier, for example a discount on equity at later stages and a cap on the valuation of their equity.  In this case there are no such clauses – there is no discount or ceiling whatsoever.

SV Angel is offering all 40 startups in this 3 month Y-Combinator cycle a free $150k loan.  Why would an investment firm ever offer such a large investment to 40 startups, some of which it presumably knows nothing of, with no preferential terms for investing earlier?  Surely this is investor suicide?

机 jī opportunity

The more I’ve thought about it the more smart I think SV Angel is being: this deal is all about access.  Paul Graham, the founder of Y-Combinator has always said “This is a hits driven business”, and SV Angel’s offer gives it access to the ‘hits’.

Counter-intuitively, the generous terms really help with this.  If the firm was offering onerous conditions surely only the least promising startups would accept the investment and the ‘hits’ would slip through the net, a sort of negative selection bias.  However, under these terms I imagine all the startups will take the investment.

So, this offer effectively becomes a broad bet on Y Combinator startups, and a means by which to access the ‘hits’ (and potentially invest in them in subsequent rounds).

When Y-Combinator launched in 2005 it invested in 8 startups, in the current cycle there are 40 – this growth rate and the high profile ‘hits’ to date , including Scribd, reddit, Justin.tv, Dropbox and Posterous make this a smart bet.  The offer may even improve the outcomes for Y-Combinator startups if it enables them to focus on the important stuff, like finding a business model, rather than worrying about fundraising.

How About…

  • Remembering to look for the hidden cost of driving a hard bargain – are you creating a negative selection bias?

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Techcrunch article here

October 11, 2010

62) diaspora* and Kickstarter

危 wēi  danger

Four students at New York University’s Courant Institute of Mathematical Sciences listened to a lecture on cloud computing and privacy and began to worry about relinquishing ownership of their data to Facebook and other social networks.  They believed that they should retain all of their personal data, after all once you give up control initially you effectively lose the option to regain control over it permanently.   The students believed that they could build a distributed social networking service to overcome this which they called diaspora*. Users would set up their own server (or “seed”) to host content; seeds would then interact to share status updates, photographs and other social data.  The team wanted to test whether anyone else shared its concerns and to raise $10k seed capital to build the product.  Surely the inexperienced team would struggle to get the idea off the ground without giving up huge amounts of equity?  And how would they test demand more broadly than just in their close social groups?

机 jī opportunity

Instead of testing the idea with potential users in face to face discussions and tapping into angel funding the team decided to place a request for funding on Kickstarter, a platform that enables crowd-funding of creative projects.  The team set their goal at $10k, recorded a video outlining why the project was important to them and explained what donors would receive in exchange for any backing.  For example, those that pledged $25 or more would receive “a CD, note, a bunch of cool diaspora stickers, and an awesome diaspora t-shirt!”.  As with all Kickstarter projects no equity was offered in exchange for funding (conveniently reducing the need for financial regulation of the Kickstarter platform) and the project had to be fully funded before its time expired or no money changes hands. diaspora* was fully funded within 12 days and within a few weeks the team had received pledges of over $200,000 from over 6500 backers.

Here’s the Kickstarter widget for the Diaspora project:

The team had proven that their product had appeal and had raised 20 times the capital they had aimed for without giving up a single percent of equity. diaspora* is now in build: a developer preview was released on the 15 September 2010 and a consumer alpha is planned for October 2010.

This approach is developing into a business model itself – just look at American Idol or X-Factor (read more in my article here).

How About…

  • Crowd-funding new ideas – testing demand and perhaps eliminating the need to give up equity?

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October 4, 2010

61) Amazon Prime

危 wēi  danger

Retailer loyalty programmes fall in and out of fashion.  Their supporters describe increased customer stickiness (particularly for retailers that become known for value in price-sensitive markets), increased average spend per customer and valuable data aggregation for market research on shopping habits.  Tesco clearly believes in these benefits as it relaunched its Clubcard last summer, leading to an increase in scheme members to 15 million.  However, the schemes are expensive to launch and run: Clubcard’s relaunch cost c£150m.  In addition, as referenced in this Marketing Magazine blog, Tesco is quite unique: it sees data frequently and across many items, is able to change its offer using that data and can sell the data to its suppliers, turning a cost-centre to a revenue centre.  Given the high costs and uncertainty of benefits Amazon would surely be crazy to launch a loyalty programme open to everyone in a similar way?

机 jī opportunity

Maybe not.  Keith Melker, my friend from HBS, recently brought to my attention a slightly counter-intuitive trend in the introduction of ‘paid’ loyalty programmes in the US, and helped me understand why they’re often smarter than they appear.

Amazon Prime, launched in 2005 is one such example in which members enjoy unlimited free shipping with no minimum purchase amount.  But, instead of giving membership away free Amazon charges $79 per year.

Superficially you might expect this to be taken up solely by Amazon’s most frequent customers and that the programme would be loss-making because those customers place frequent orders (which Amazon would have to foot the shipping bill for).  But that assumes that customers don’t change their behaviour as a result of being a Prime member and a quick scan of various blog posts suggests that they do.  In fact anecdotal evidence suggests that Amazon’s customers go from about $160/yr to $600/yr after they buy Prime.  It appears that once customers pay for Prime they begin to order more (perhaps because they feel that they’re beating the system).  So, assuming the combination of the Prime charge and the increase in margin per member is greater than the value lost through free shipping it’s a business masterstroke.  Had Amazon given it away free the uptake might have been greater and the behaviour change might not have been as dramatic: that could have been hugely expensive.

How About…

  • Re-examining loyalty programmes – perhaps deliberately offering it to a select group (rather than everyone)?
  • Or even charging for it if it might drive positive behaviour change?

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