04 August 2014

The Bankruptcy Boon

The US bankruptcy process is amazing. When a large mismanaged company goes under, it is a boon for many parties. Consultants and attorneys bill four figures an hour, opportunistic investors prey on the carcass, all in the vein of cashing in on a distressed situation. Despite all the excess, however, the process does work in many instances. The high priced consultants are often able to make the structural changes required to create a sustainable business. Is it the process in play, or should we hire these experts on the front end in the business building game? More importantly, while it may work on the large business side, why isn’t there a similar process for small business?

The GM bankruptcy is a classic example. They needed over $30B in debtor financing just to navigate through the process. Like most in similar situations, they hired high priced advisors to lead them through the intricacies of the bankruptcy code (including a $16M a month contract to a single firm). I never understood why maneuvering through the process is so complex, but it is extremely lucrative for the few that are versed in it. As the city of Detroit was paying lawyers millions of dollars a month during its bankruptcy, their citizens would wait more than 30 minutes in response to a 911 emergency call due to lack of funding. Is there really no other way?

Sure it is easy to fault the winners in the process; but there is something to be said for how often the trustees are able to turn these companies around so quickly. Generally speaking, there are large fundamental issues that need to be resolved in a short time window. These turnaround specialists cut costs, prioritize payments, cut deals with debtors, and divest assets in such a manner that oftentimes entities thrive post-bankruptcy. Certainly leveraging the benefits of the process helps (ie. cramming down creditors), but there have been some impressive successes. Most of the airlines, for example, have all gone through the process; now just this week they announced record profits and huge stock buybacks. Six Flags, Trump, and many other household names are also in this group.

And what do small companies do that can’t afford $1000 lawyers? The law of small numbers works against them as they don’t have access to bankruptcy financing or experts to navigate through the process. When a small entrepreneur over-leverages the company, he or she loses all personal assets. When private equity pays too much for TXU Energy, they get most of their money back. Small companies generally don’t get a second chance like the big boys do and are usually forced to liquidate. It’s a complicated process for small business owners and creditors aren't as willing to work with entrepreneurs as they are in bigger deals.

So perhaps there is an opportunity for the experts to move downstream into the SMB market. Or maybe small business owners should look to take a page out of the GM bankruptcy playbook. It would seem reasonable that at least in the instances in which struggling entrepreneurs could be helped, they should. One idea is an SBA loan restructuring program for those that are behind; perhaps banks can have more flexibility to convert the loans to equity or higher interest loans. There could also be programs to incent creditors to give businesses some more time. While bankruptcy is never good situation to be in, it would be great to afford small businesses similar support that big businesses have during this dire time.

20 May 2014

The Disruption of the Disruptors

I am like no other pundit waiting for the shoe to drop. Like the late 1990s. For yet another cloud storage company to shelf its IPO (sorry Box). Frothy valuations based on solely on a disruptive story are already becoming harder to come by. I wonder what will happen to the struggling ones that have already raised cash under lofty expectations; how will they handle the fallout? Now that a fresh batch of funding is no longer in the cards (at least not at current valuations), how will the newly minted blue chips change themselves amidst new market conditions?

I was the first to surprised to read that Square might be on the block due to cash flow issues. Mobile commerce has already hit mainstream and certainly the leader in the payments space should be minting money like its predecessor Paypal, right? But Square is struggling. They lost $100M in 2013 and faces a business model that doesn't scale well to profit (~20% gross margins after processing fees). Paypal was not forced to sell to Ebay in the 2000's, but does Square need a lifeline? No question it can raise fresh money if it has to, but probably not at the clip its existing investors would seek. As a standalone concern, it will likely face layoffs, cash conservation, and significant pressure towards monetization. These are not concepts that are in the Jack Dorsey DNA.

Reinvention is nothing new for tech firms of the past, but it will require a significant mindshift for the next generation of startups. IBM has gone through many periods of peaks and troughs and transformation throughout its long history. Amazon has experienced the same. However these companies had a culture of top grazing and restructuring. For the foosball playing startups with lofty aspirations, making money was never on top of the list. The last time around, the playbook was to hire MBA’s and black belts to “babysit” the business-lite founders. Does that logic still apply? I'm a bit skeptical in any approach that jeapordizes the culture of a promising startup, but perhaps a fresh mix of skill sets can bring new approaches to the problems. Maybe rightsizing will be modernized into a cool buzzword like "uncrowding" that the newbies can huddle around.

To be sure, Snapchat is no eToys. The companies of today are generally in a much better position than the late 1990s. Companies like Twitter have large cash warchests to buffer downturns. There are more fundamentals and less extraneous cash backing today's startups than two decades ago (remember price to eyeballs?). But the shakeout will be swift and painful. Once hot SaaS companies like Bazaarvoice and Fireeye, for example, have seen their valuations drop by more than half and face employee exodus and liquidity concerns shortly after their IPOs.

Lofty expectations have an ugly downside. As the second internet bull run comes to an end, the high flying startups that sought out to change the world will have to start with themselves. As external financing slows, these companies will have to become profitable and change their business models in order to keep their independence (with the exception of the fortunate Google and Apple acqui-hires). Cash flow forecasts and customer acquisition will take precedence over iterative coding and disruptive mentalities. This hard reality is not only necessary for saving face or generating returns for investors, but also for survival in itself. Expect the early signs of consolidation, bankruptcies, and growing impatience from their backers to continue. But then again, aren't we just getting started with virtual reality and 3D printing?

01 March 2014

A New Perspective on Net Neutrality

Net neutrality seems to have lost its momentum. Little by little (as evidenced by the latest federal court ruling), the reality of an unfiltered internet seems more and more remote. Once thought of as a sacrosanct protection from traffic prioritization by internet providers, the practicality of a usage based pricing model seems no longer out of the question. On the one hand, we shouldn’t give infrastructure incumbents free reign to charge whatever they want for internet traffic, but we can’t also expect the Napsters of the world to get a free pass given the network buildout costs. Despite the pendulum shift, it’s still a controversial and important issue; after 20 years of debate, where should society end up on net neutrality?

In the early days of broadband, pro-net neutrality was an easy position to have (see my perspective from four years ago). During those times, options such as DSL relied heavily on existing copper wire infrastructure to provide internet access. These legacy networks were owned by a single entity in each market (the Ma bell spinouts) and it was precisely because the government mandated that incumbents grant access to competitors is why early adoption flourished. A bustling industry of CLECs, ISP's and others that leased lines brought innovation to century old networks. As a result, email, AOL, and the web was brought to the masses. Internet based startups such as Google came to prominence. But more importantly, it permanently changed the way we live.

The world has significantly changed since the dial up days. The copper infrastructure was insufficient. Despite billions of investment into equipment and fiber cables to build the next generation of networks, supply cannot keep up with consumer demand. Distrubuted content is the new normal as a streamed Netflix video is as common as checking email. The strains on internet networks are real. Why shouldn’t infrastructure companies like AT&T and Comcast be able to charge more for increased usage? It also seems to make sense for bandwidth-intensive content companies that demand more of them to bear some of the burden. Further, our current fixed price arrangement in which all consumers pay the same inherently charges everyone equally rather than specifically to those that use more bandwidth. And perhaps by allowing content providers to subsidize some of the network costs (like in television), consumers might even see better rates. If providers were able to better match revenue to actual costs, we may benefit from a more efficient pricing scheme.

The problem is that the internet toll takers are the same companies that are the gatekeepers to the internet. And much like the older days, there isn’t much competition at a local level. A typical consumer may still only have one or two choices of providers at their home or business. Not only that, the bad actors that we knew from the monopoly days are the same ones that are making the investments and gating the entrance onto the superhighway. Should we trust AT&T and Comcast to do the right thing? Given history, it's a hard pill to swallow. And on the other side, content providers are starting to get bigger as well. As evidenced this week by Netflix's access deal with Comcast, well capitalized content companies can afford to "pay to play". Google, Facebook, and the like, despite their net neutrality advocacy (which seems to have subsided throughout the years), can afford to make sure their needs are met. But what about the next round of startups, how will they fare? Who will make sure those without deep pockets have fair access to consumers?

Are there lessons to be learned from the AOL days? Perhaps a middle ground solution could force the current infrastructure players to lease access to their networks much like the ILECs did. What if the likes of AT&T and Comcast could begin to charge content providers but in return were mandated to lease a portion of their networks to competitive access providers? New competition could bring new models and innovation much like the CLECs of the past. Perhaps AT&T could realize a utility type return on this leasing arrangement while at the same time promoting choice. This is probably an oversimplification of the issue, but this type of solution would not only keep the network companies' power at bay, but also help them monetize their networks better.

As an early net neutrality supporter, it would be hard for me to say that the incumbent telco and cable providers should have an unencumbered right to filter traffic, charge discriminately, and leverage their unique market position. We’ve seen that movie before. On the other hand, free market and changing times should also be factored into the equation. As we lean on the private sector to lay down the cash to buildout networks, we can’t expect them to work solely on altruistic motives. It also still remains to be seen how new technologies and innovations can change the paradigm; Google is building fiber networks, mobile infrastructure is becoming more prevalent, and even satellite talk is back. Consumers deserve unfettered access to any content they want. But as I have wrote throughout the years, the days of free are over. We all have to bite the bullet at some point.

12 January 2014

The Real Reason Big Businesses Fail

Inspired by holiday reading, i've decided to address a complex issue in a relatively short script (in the vein of Malcom Gladwell's latest opus). For leaders at large conglomerates, the risk of failure should turn heads. Only one of the original 12 Dow members still remain as does only a handful of the initial Dow 30 from 1928. And these were the best of the best. While there have been numerous explanations ranging from poor management execution to the Innovator's dilemma to explain this phenomenon, there is one simple commonality amongst all the companies gone bad. They stopped selling stuff that people wanted.

Blockbuster missed on mail order. Yahoo missed search. The list goes on across industries around the globe. These companies were acting complacently as new competitors were ramping up. But even had the incumbents acted flawlessly, they probably wouldn't have succeeded. Sure Yahoo had a chance to buy Google early on; but it was so focused on advertising that the company missed the fact that search mattered more. Someone with that insight would probably have outseated them anyway. There have been countless case studies on Blockbuster's miscues, but the bottom line was that its bricks and mortar offering failed to meet new customer demands. Its' half baked home DVD offering was too little too late compared with Netflix's execution. When a company is generating signficant cash, it is difficult for them to have enough foresight to recognize their offerings will soon become outdated.

Sometimes overall shifts in consumer demand dooms companies. Coke and Phillip Morris have a real problem as overall consumption of their products continue to slide. Price increases and international expansion can only mask this reality for so long. Incumbents also often miss subtelties of the markets they dominate. In the early 1990s, Walmart took a huge cut of the grocery market as its competitors relied on a loss leader strategy that consumers ultimately shunned. Today, Tesla is on the brink of taking material share from its rivals who have sat on high fuel efficiency technology for years. They didn't think people wanted it.

Large companies that use its position of power to stimulate market demand are the ones that succeed in the long-run. People did not know what they wanted out of portable stereos or smartphones until Apple educated them. IBM's customer-centric approach has helped it seemlessly moved from hardware, software to services (and also remain on the Dow from the original 30). IBM is spending a significant effort today teaching its customers how to implement Watson-based big data analytics to drive their businesses forward (albeit with only modest success so far). Facebook is doing a similar thing for clients who are new to social advertising.

The numerous texts designed to help corporations build their organizations are helpful playbooks. However, the fundamental problem that companies face as they grow is that they shift focus inwardly instead of on its customers. Things like stock price, hiearchy, and motivation saddle companies and mask the importance of the one thing that matters most. If companies simply keep up with consumer demand, everything else usually will fall into place. Successful new entrants are often singularly focused on what customers really want. With business cycles increasingly shortening, market share shifts are occuring more frequently and more rapidly. Successful organizations that fail often do so by not keeping up with consumers' tastes as internal deficiencies are usually symptomatic of them missing this critical point.

25 November 2013

Should we Crowdfund?

Angel List is one of the hottest capital sources around today. The benefits of crowdfunding sites like it are many - they offer a wide number of startups access to funds, gives small investors opportunities previously not available to them, and adds transparancy throughout the process. I am one of the biggest proponents of democratizing closed networks (Venture Capital is certainly on the list), but I can't help but wonder if the timing of the JOBS act could not be worse. Loosening regulations in a time of frothy valuations, high risk, and oversupply of undeployed capital reminds me of the Clinton-era push to make home financing more widely available. Will crowdfunding leave common investors in financial straits like those that were affected by the housing bust?

For one, early stage investing is hard. Even the experts get it wrong. According to some recent articles I read from Fortune's Dan Primack, almost 2/3 of tech Angel investors lost money and some 40% of early stage VC investments end up worthless. And remember - these are the professionals. Despite their expertise, exhaustive diligence, and access to exclusive deals, they still bet wrong more times than they do right. In fact, because of this difficulty, VC firms have systematically been shifting focus to later stage companies over the past few years. If the pros are moving away from this asset class, how do we expect individuals to fare better ? In the VC world, only 10-20% need to succeed for them to generate their required returns; there's not quite the same risk tolerance for Joe the Plumber who is investing his retirement funds.

Also, for the few that haven't noticed, we are in the midst of a capital bubble. Outsized pre-revenue valuations are back (really Snapchat, $3B wasn't enough?) as is hot public markets fueling a pace of IPO filings that hasn't been seen since the dot-com days. Large investors like corporations and private equity groups have never been flushed with more cash. Smaller companies have more choices as new angel groups, accelerators, and incubators compete fiercely for them. And if that isn't enough, the Fed continues to crank money into the system ensuring the record low interest rates remain. We are in an unusual environment in which capital is aplenty; if there was a shortfall in the market, it certainly isn't now.

On the other hand, before crowdfunding, a typical entrepreneur had very places to go. Local banks were out of the question given the risk. VC's and Angels were almost impossible to connect with. Friends and family, which is the typical route, is limited and sometimes complicated. As social, sharing, and mobile drive rapid efficiency in communication, it's only natural that those benefits extend to the investing world. Kiva brought microfinance to the masses helping millions of entrepreneurs; so why shouldn't Angel List do the same in the for-profit world? The notion of the Facebook next door that can't get funded should not be a reality nowadays.

In some ways, democratizing capital should level the playing field for entrepreneurs that aren't tied exclusive clubs like the Silicon Valley network or NY elite. But on the other hand, the landmines of early stage investing may not be well understood by smaller investors. I personally think the pros of crowdfunding outweigh the cons, but i hope the timing of its incubation during the capital boom doesn't shorten its life cycle. Buyer beware - just because your teenage kid is allowed to take the keys to the car doesn't mean you should give them to him.

18 October 2013

Can Startups beat the Lobbyists ?

What the ongoing circus in our nation's capital shows us is that special interests and lobbyists still rule the day. As upstarts bring new business models in to change broken industries, they face significant hurdles by incumbents and artificial forces trying to protect existing turf. Broken laws, deep pocketed industry leaders, and politicians are at play against the upstarts - Can they ultimately survive the long and expensive battle they will endure?

Uber has faced the threat of a ban in almost every market it has entered. A hodgepodge of federal and state lawsuits as well as motions by taxi and limo lobby have essentially tried to shut them down (even the ultracool city of Austin tried to pass an ordinance during SxSW). Why are they trying to protect the revenue of the taxi oligopoly if there are cheaper, more effective alternatives? Let's not be naive to think this resistance is with consumer protection in mind - just look at who is funding the legislation. AirBnB faces similar challenges as it faces threats from hotels, realtors, and taxing authorities. The city of New York, for example, has recently requested their entire database in order to vet out long-term housing hosts. I understand the need to collect taxes if appropriate - but let's not try to save Marriott from individuals renting out their rooms.

Many incumbents try to hide behind ill-conceived laws that they try to uphold. Tesla, which has brought a step change of innovation into a slow moving industry, is surprisingly facing resistance in its market rollout. The culprit is outdated state franchise laws that mandate cars be sold through franchisees. While originally designed to protect small business franchise owners, the laws seem ridiculous nowadays. Imagine if we were forced to buy diapers or a stereo from a certified outlet? A question to the states - have you heard of ecommerce?

To be sure, bizarre regulations are nothing new. Southwest Airlines has faced an incredibly long road to unwind the "Wright" amendment which limited its flights out of Dallas. The law, designed to protect American Airlines and DFW Airport, failed to do so. American still went bankrupt while Southwest thrived since it was passed. In hindsight, the city bet on the wrong horse. Consumers have realized low fares because of Southwest(try pricing non-SW city pairs if you don't believe me) and the company is the only one in the industry to refrain from layoffs, even post 9/11. As Southwest finally can count down the days until the Wright amendment elapses, I commend its patience and high road tactics by keeping its headquarters in Dallas.

So are the new entrants winning so far? Despite some early wins, the road will be long and bumpy. While AirBnB initially won a ruling in New York, the city is going aggressively after them to collect forgone occupancy taxes. Uber seems to continue to operate in most of the markets they want, despite the political noise. The good news, particularly in the new sharing economy, is that the fight has become increasingly more public as the newbies take it to the streets (virtually). They have smartly created online petitions and other consumer-driven campaigns to forward their cause. It also helps that some of the startups are backed by huge valuations that can arm them for the legal hurdles. If the rhetoric from Uber's CEO and others is any indication, these startups will not shy away from battle anytime soon.

Artificial barriers to entry fail to protect the companies they are supposed to and usually hurt consumers in the long-run. Given the accelerating rate of change and strength of market forces, they tend to be speed bumps for entrepreneurs trying to gain market share. But as Washington shows us loud and clear is that lobbying and inertia are here to stay. Let's hope that market-based concerns such as a mobile taxi app can force trasparency and efficiencies within the system. Unfortunately, elections do not change the game - and it's a game that needs a significant makeover if the US wants to stay the center of technological and business advancement.

03 October 2013

Can JVs work for small business?

Generally speaking, joint ventures have a finite shelf life. There are numerous examples of JV's winding down, such as Verizon's recent acquisition of Vodafone's wireless stake. Bringing two parties together with different capabilities seems to make sense on paper, but more often than not, most large ones end in failure, dispute, or a partner buyout. With a similar thesis in mind, are small businesses bound to a similar fate when attempting joint ventures? Or are entrepreneurial companies more adept in successfully navigating partnerships better than big conglomerates?

First off, small businesses have much more to lose than larger concerns. When big companies do it, they generally have limited options for that particular business. For example, an oil & gas company cannot enter a middle east country without some sort of government or local JV. In other instances, JV businesses are non-core or underperforming which makes the risk less. For smaller companies, the stakes are much greater. They don't have idle cash or business lines to throw into the mix. It's usually the entire business that would be impacted by the potential partnership. So the bar is much higher to engage in one.

A traditional JV, which may involve a merger with a similarly situated company, is hard to pull off. The required exchange of information to consummate a deal is often difficult as head to head competitors will be relunctant to disclose business secrets. And even if a deal can be completed, the operational risks are great. Cultural division, power struggle, or misalignment of goals are often hard to overcome. While there are things you can do on the front end to stave off potential conflict, the odds of a successful merger are long.

Partnering with a large industry player might be a way to mitigate some of this risk. Large companies can often provide the most sought after benefits for a small business (such as capital and distribution) with potentially less conflict of interest. They often have different goals than a small business, so the risk for overlap is less. Large suppliers, for example, are often good choices for product companies.

The downside, however, is that the terms of a proposed JV might be very expensive. If they feel they have bargaining power, they may try to extract more equity or better terms than you are willing to offer. Further, large companies tend to overestimate the amount of support they can provide as part of the JV; these companies have numerous priorities that fluctuate and can't make critical decisions as quickly as the business may require. On the other hand, if you offer something they really want (such as a new product line or channel), they will be much more willing to give you a greater piece of the pie.

Financial sponsors are another potential avenue. From a JV perspective, examples are very rare. Financial investors generally want control (or a path to control) or have too large investment hurdle rates for it to make sense to engage in a partnership. There are less synergies compared with industry players and can generally help only on the growth capital or leveraging their vast network. While possible, a financial based JV would need to have a limited scope and finite timeframe.

The irony is that despite the long odds for a successful joint venture, many businesses small and large continue to attempt them. The upside could potentially be great, especially for entrepreneurial concerns that are at an inflection point in their business. I think that more established companies may be a better fit as a JV partner, but taking control around the governance and commercial terms is paramount in the discussions. In addition to JVs, other options such as joint cooperatives may yield some results without giving up any control. In the end, it's important to keep an open mind about them but certainly tread carfefully.