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My Job As A Pre-Launch Startup CEO Was To Buy Sandwiches

May 31st, 2011. Published under My Recent Reads. No Comments.

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Seth Sternberg is the CEO and Co-founder of Meebo. He previously worked in M&A at IBM.

I love talking to aspiring entrepreneurs—I do it once a week at minimum.

I often get asked “what’s the role of a startup CEO?” Sometimes people are curious about the pre-launch “CEO” and ask if a startup really needs one. If that CEO isn’t an engineer, what do they do anyhow? Other times people wonder what I do today as CEO of a 180 person company. In this post I’ll cover the pre-launch role, and in a follow-up, I’ll get into the role post-launch.

So what does the CEO, who at the beginning is really the general business person, do at a pre-launch startup?

Let’s go back to the beginning of Meebo, circa April, 2005.

Co-founders Sandy Jen, Elaine Wherry and I met every Wednesday night and all day every Sunday in an effort to get Meebo off the ground. We’d never meet in my apartment—it was always either at Sandy’s or Elaine’s. Why? Because they had the better computers and the faster internet connections. Frankly, that’s pretty emblematic of one’s role as the “business person” pre-launch. I’ve touched upon this topic before in a Founder Stories interview with Chris Dixon (embedded below), but it is worth elaborating on.

For most consumer internet products, there’s not a whole lot the business person can really do pre-launch. All of the company’s value will come when the team builds and launches a product, so that should be the primary focus. There aren’t any partnerships to be struck yet, as the product has yet to build any credibility in the market. There aren’t any folks to interview, as you can’t afford to hire a full team, and you’re wasting your time looking for pre-launch financing—a controversial statement these days, I know, but that’s a topic for another post. So what can you do if the most important thing is simply to minimize all distractions in the pursuit of getting the product launched?

Buy sandwiches.

Well, really, the business person’s job, until the last 2-3 weeks before launch, is to be supportive.

When we got together on Sundays, I really couldn’t contribute very much real work. I could make the sandwich runs to the Andronico’s down the street (I still have the “buy 10, get the 11th free card” in my wallet). I could also take care of the mundane tasks like buying the domain name and paying the server bills. Heck, I could even suggest “that button might look better over there.” But that was about it. I was the support.

I began to wonder, “Should I even be here?” Frankly, it didn’t feel very good to sit there and watch Elaine and Sandy working away while I did comparatively little. I could just as well have been playing Frisbee.

When I wondered that aloud, the feedback from Elaine and Sandy was pretty clear: if you’re going to be part of this team, then we want you here.

We were all equals with our own skills that we each brought to the table. My presence, at some level, was moral support. At another level, it contributed to the team bonding that you need pre-launch. Post-launch, things will tend to get crazy, fast, so pre-built trust is critical. At the end of the day, it’s the team that really makes the startup. Strong teams—as Sandy is quick to point out—survive multiple ideas.

Let’s fast-forward to the 2-3 weeks pre-launch, however, where the business person begins to get a job.

First, go and line up the right law firm to get incorporated.

The standard deal, at least at the time, was $20K in legal fees deferred until you raise your series A. I don’t think much has changed. Make sure you get advice on which firm and partner to work with—the way your company gets incorporated can save you a lot of pain down the road. (Watch a relevant chat between Chris Dixon and Erick Schonfeld here). Do not work with a firm inexperienced in setting up startups. Rather, work with Fenwick, Wilson Sonsini, OMM, Gundersen, Orrick, and the like. And even in those firms, ensure you’re working with the folks who have startup creation experience—all partners are not created equal.

Second, figure out your launch strategy.

Do you want to line up a bunch of friends to test your product before launch? Do it. Then corral all of their feedback and help prioritize it for your co-founders. Do you need to find a couple of folks who can introduce you to a blogger or two to write about your launch? Find them and go pre-brief those bloggers. Make sure you also line up your friends to give you some social media mojo—get them to Facebook and Tweet your launch.

Third, find a good mentor or two.

It’s important to find someone who is passionate about what you’re up to and who genuinely wants to work with you and your team to help you create an awesome product. Someone who is perhaps 2-4 years ahead of the process from where you sit, who has seen good and bad, and who can guide you toward good choices and help you avoid potentially painful early mistakes. Ironic, but when you have the least experience is also when you make a bunch of choices on how you set up your company—choices which will potentially burn you or save you years down the road.

In a future post, I’ll get into the business person’s role post-launch. But before we end, one more thing: do you even need a business person pre-launch since they do seemingly so little?

The answer is yes, for three basic reasons.

First, post-launch, the business person’s job becomes very important. You want them there for their actual work product (beyond their amazing ability to remember your sandwich order) post-launch. You don’t want to go through the pain of finding this person post-launch when things get nutty. Rather, you want them lined up and ready to go from the start.

Second, just like it’s unbelievably hard to find great engineers, it’s also unbelievably hard to find great business people. Just like a bad engineering co-founder can help ruin a company and a good one can help make a company, the same goes for business folks. Once you find a great engineering co-founder, hold onto them as tight as you can. And once you find a great business co-founder, do the same.

Third, team bonding is really important. The more time you have to do this, the better. I’ve argued that there’s nothing more important in getting a company off the ground than finding and putting together the ultimate founding team. This bonding is super critical in the early days because you will likely spend years together. It’s hard to explain ust how important it is that you understand and trust each other, implicitly. The sooner you get together as a unit, the better off you all will be.

Photo credit: Flickr/FotoosVanRobin

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21 Books Every Entrepreneur Should Read

May 31st, 2011. Published under My Recent Reads. No Comments.

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beach reading book

Summer is here, and even dire workaholics should take a few hours to relax. Read one of the following books and you’ll become a better entrepreneur while you’re at it.

We asked small business leaders and VCs to name books that anyone starting a business or even thinking about it should read.

Over the past two years, these were some of the best recommendations we heard.

Click here to see the reading list >

What books have influenced your career? Add them in the comments below.

“The Fountainhead” by Ayn Rand

Charlie O’Donnell: “I don’t know any book that sums up the entrepreneurial passion and spirit better than The Fountainhead by Ayn Rand:  'The question isn't who is going to let me; it's who is going to stop me.'"

Charlie is a principal at First Round Capital.

“Out of the Crisis” by W. Edwards Deming

Roger Ehrenberg: “Big or small, this book focuses the entrepreneur/manager on respecting employees, focusing on process, and insisting on the collection and analysis of data. The development of metrics to manage the business is critical for the start-up founder.”

Roger is Managing Partner of IA Capital Partners, LLC.

“Extreme Programming Explained” by Kent Beck

Babak Nivi: “Revelatory. Develop your product like this book tells you to, unless you know better (e.g. you have experience building operating systems, space shuttles, Googles.) Buy the first edition.”

Nivi is a founder of Venture Hacks.

See the rest of the story at Business Insider

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Multiverse = Many Worlds, Say Physicists

May 26th, 2011. Published under My Recent Reads. No Comments.

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Via The Physics arXiv Blog (MIT Technology Review) -

The many worlds interpretation of quantum mechanics is the idea that all possible alternate histories of the universe actually exist. At every point in time, the universe splits into a multitude of existences in which every possible outcome of each quantum process actually happens.

So in this universe you are sitting in front of your computer reading this story, in another you are reading a different story, in yet another you are about to be run over by a truck. In many, you don’t exist at all.

This implies that there are an infinite number of universes, or at least a very large number of them.

That’s weird but it is a small price to pay, say quantum physicists, for the sanity the many worlds interpretation brings to the otherwise crazy notion of quantum mechanics. The reason many physicists love the many worlds idea is that it explains away all the strange paradoxes of quantum mechanics.


Let’s put the many world interpretation aside for a moment and look at another strange idea in modern physics. This is the idea that our universe was born along with a large, possibly infinite, number of other universes. So our cosmos is just one tiny corner of a much larger multiverse.

Today, Leonard Susskind at Stanford University in Palo Alto and Raphael Bousso at the University of California, Berkeley, put forward the idea that the multiverse and the many worlds interpretation of quantum mechanics are formally equivalent.

But there is a caveat. The equivalence only holds if both quantum mechanics and the multiverse take special forms.


At one time, such an idea would have been heresy. But in theory, it could be done if an observer could perform an infinite number of experiments and observe the outcome of them all.

But that’s impossible, right? Nobody can do an infinite number of experiments. Relativity places an important practical limit on this because some experiments would fall outside the causal horizon of others. And that would mean that they couldn’t all be observed.

But Susskind and Bousso say there is a special formulation of the universe in which this is possible. This is known as the supersymmetric multiverse with vanishing cosmological constant.

If the universe takes this form, then it is possible to carry out an infinite number of experiments within the causal horizon of each other.

Now here’s the key point: this is exactly what happens in the many worlds interpretation. At each instant in time, an infinite (or very large) number of experiments take place within the causal horizon of each other. As observers, we are capable of seeing the outcome of any of these experiments but we actually follow only one.

Bousso and Susskind argue that since the many worlds interpretation is possible only in their supersymmetric multiverse, they must be equivalent. “We argue that the global multiverse is a representation of the many-worlds in a single geometry,” they say.

They call this new idea the multiverse interpretation of quantum mechanics.


But what this idea lacks is a testable prediction that would help physicists distinguish it experimentally from other theories of the universe. And without this crucial element, the multiverse interpretation of quantum mechanics is little more than philosophy.

That may not worry too many physicists, since few of the other interpretations of quantum mechanics have testable predictions either (that’s why they’re called interpretations).

Still, what this new approach does have is a satisfying simplicity– it’s neat and elegant that the many worlds and the multiverse are equivalent. William of Ockham would certainly be pleased and no doubt, many modern physicists will be too.

There’s a Secret Patriot Act, Senator Says

May 26th, 2011. Published under My Recent Reads. No Comments.

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There’s a huge “gap between what the public thinks the Patriot Act says and what the American government secretly thinks the law says,” according to Sen. Ron Wyden (D-Oregon). The gap is so big, in fact, that it amounts to entirely different, and secret, law.

Financing Options For Startups

May 24th, 2011. Published under My Recent Reads. No Comments.

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I got a bunch of great suggestions in my kickoff post on this topic last week. Based on that feedback, the series is going to look like this:

1) Friends and Family

2) Contests/Prizes/Accelerator Programs

3) Government Grants

4) Customer Financing

5) Vendor Financing

6) Convertible Debt

7) Preferred Stock

8) Venture Debt

9) Capital Equipment Loans & Leases

10) Bridge Loans

11) Working Capital Financing

This list is roughly in chronological order of how a small company might avail itself of the various financing options, but there are always exceptions. Starting a company is more art than science.

I want to do each financing option as its own dedicated post so I’m not going to start today. I will start next week with friends and family.

If you are looking for some meaty MBA Monday reading this week, I point you to Brad Feld and Jason Mendelson’s awesome venture capital term sheet series, which is required reading for anyone seeking to raise venture capital.

Following the White Rabbit: Software Attacks Against Intel VT-d

May 15th, 2011. Published under My Recent Reads. No Comments.

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Today we publish a new paper which is a result of our several month long in-depth evaluation of Intel VT-d technology. To quote the abstract:

We discuss three software attacks that might allow for escaping from a VT-d-protected driver domain in a virtualization system. We then focus on one of those attacks, and demonstrate practical and reliable code execution exploit against a Xen system. Finally, we discuss how new hardware from Intel offers a potential for protection against our attacks in the form of Interrupt Remapping (for client systems available only on the very latest Sandy Bridge processors). But we also discuss how this protection could be circumvented on a Xen system under certain circumstances…

I think the attack is likely the most complex and surprising out of all the things we have presented so far. Parts of it are even funny (if you share our weird sense of humor), such as the use of ICMP ping to generate MSIs. The paper also covers the vendors’ response. You can download the paper here.

This Is The Best Blog Post We’ve Ever Read By An Entrepreneur

May 14th, 2011. Published under My Recent Reads. No Comments.

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ben pieratt svpply

Ben Pieratt is the founder and CEO of Svpply, a social shopping startup in New York City, and he wrote the best blog post we think we’ve ever read from a startup CEO.

The title gives the tone of the post: “I have no idea what I’m doing.”

Pieratt writes about the fact that he’s a graphic designer by training, and that all of the business-y aspects of running a startup, recruiting, etc. are hard and scary. That things don’t happen how or as fast as they should. That even when it’s not his fault that things go wrong, it’s still his fault because the buck stops with him.

The world of startup entrepreneurship can be pretty macho, with plenty of onanistic self-congratulation about how awesome it is to be an entrepreneur. Your writer has started several companies, and the fact of the matter is that it’s lonely, terrifying and not glamorous at all. Most of the time, you really have no idea what you’re doing. Being public and upfront about it shows amazing humility and strength of character, two qualities that almost always go together.

Congratulations, Ben Pieratt.

Here’s how it starts:

I am the CEO of Svpply, Inc., a social shopping S-Corp operating out of New York City. My company has been the recipient of over half-a-million in investor dollars, for the stated purpose of building an unknown, 3,000-member web service into a cultural phenomenon, and I truly have very little understanding of what I am doing.

Click here to read the whole thing →

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Beating Up on Android: Practical Android Attacks

May 12th, 2011. Published under My Recent Reads. No Comments.

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In this talk Massimialiano Oldani and Bas Alberts exploit the Android Attack Surface. This talk will demonstrate the various ways Android devices may be compromised both remotely and locally. Furthermore, it will explore many of the interesting things a remote attacker can do once they have established access to your Android device.


This presentation was presented @ Immunity Inc.’s Infilrate 2011 conference by two senior researchers for Immunity, Inc.

Google lobbies Nevada to be first state for self-driving cars

May 12th, 2011. Published under My Recent Reads. No Comments.

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Google hasn’t given up on its sci-fi ambitions to make self-driving cars a reality. The company is now lobbying Nevada to be the first state to legally allow self-driving cars on public roads, the New York Times reports.

We’re still far from seeing the self-driving cars widely deployed across the country, but landing Nevada’s approval could get the cars up and running in Las Vegas within a few years. Eventually, the cars could perform automated deliveries and serve as self-driving taxis in Vegas, policy analysts say.

The news comes about eight months after Google first announced the technology, which at the time seemed to have come straight out of an Isaac Asimov novel. And in addition to announcing it had developed self-driving cars that actually worked, Google also dropped a bombshell saying the cars had covered 140,000 miles of driving in California with occasional human control. Seven cars drove over 1,000 miles without any human intervention at all.

Google hired Las Vegas-based lobbyist David Goldwater to promote two bills that would legalize self-driving cars. One bill is an amendment to a current electric-vehicle bill that would allow licensing and testing of autonomous vehicles, while the other would allow texting while riding behind the driver’s seat of a self-driving car.

Thus far, Google has been testing the cars with a person in the driver seat (to take over in case the system fails) and passenger seat (to monitor the system). If the legislation is passed and Google’s technology reaches a point where it can be reliably deployed, the cars would be able to drive completely on their own.

Sebastian Thrun, the director of the Stanford Artificial Intelligence Laboratory and co-inventor of Google’s Street View service, previously said that the company’s goal is to prevent traffic accidents, give people more free time, and reduce carbon emissions by changing the way people use their cars.

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Half In / Half Out

May 6th, 2011. Published under My Recent Reads. No Comments.

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Recently I met a great entrepreneur working in a hot space. Like many entrepreneurs he’s bootstrapping his company by running a services business on the side. Today, I passed on that opportunity. Why?

- Does not yet have a clear vision and direction

- Not working on it full time

These points are completely related BTW. If his team was full time on this they might be much closer to having clarity around the problem, value proposition and ultimate vision. But they’re not there yet. And while investors can contribute to that vision and I certainly have some ideas, the vision has to come from the company.

Speed is so important to building value. Repeat founder Mike Cassidy who has built and very successfully sold multiple companies says speed is the ultimate strategy. Everything else being equal if I’m looking at two companies going after the same space at the same stage, I’ll back the one that’s moving fastest. Hard to do that when you’re part time.

I am very sympathetic to the need to put food on the table. I get it. But, if you’re going after a big opportunity, one that needs outside investment capital and is capable of delivering the returns that capital needs, then you can’t be half in / half out. You just can’t. If the opportunity is a good one then it’s guaranteed that other teams are working on it full time. And as an investor if I really want to be in that space, I’ll go and find those other companies.

The worst is people who come and pitch and idea they will start after they quit their jobs (after they get funded). Those conversations are very short.

If you want to raise outside $ and even if you don’t but you want to build a leader in your market you need to be all in. Technology and markets move too fast. The barriers to launching companies are almost non-existent. Speed really is the ultimate strategy. So, if you’re going to launch a company find a way to do it full time.

A Syrian Man-In-The-Middle Attack against Facebook

May 5th, 2011. Published under My Recent Reads. No Comments.

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UPDATE: If you are in Syria and your browser shows you this certificate warning on Facebook, it is not safe to login to Facebook. You may wish to use Tor to connect to Facebook, or use proxies outside of Syria.

Yesterday we learned of reports that the Syrian Telecom Ministry had launched a man-in-the-middle attack against the HTTPS version of the Facebook site. The attack is ongoing and has been seen by users of multiple Syrian ISPs. We cannot confirm the identity of the perpetrators.

The attack is not extremely sophisticated: the certificate is invalid in user’s browsers, and raises a security warning. Unfortunately, because users see these warnings for many operational reasons that are not actual man-in-the-middle attacks, they have often learned to click through them reflexively. In this instance, doing so would allow the attackers access to and control of their Facebook account. The security warning is users’ only line of defense.

EFF is very interested in collecting TLS/SSL certificates. Our SSL Observatory project has collected millions of them by scanning the public Internet. Thanks to the assistance of a Syrian citizen named Mohammad, we can also provide a copy of the fake Syrian Facebook certificate. Interested readers can find a copy in human readable and PEM encoded form.1

This is very much an amateur attempt at attacking Facebook’s HTTPS site. The certificate was not signed by a Certificate Authority that was trusted by users’ web browsers. Unfortunately, Certificate Authorities are under the direct or indirect control of numerous governments, and many governments therefore have the capability to perform versions of this attack that do not raise any errors or warnings.

  1. 1. Mohammad’s machine resolved the domain to, and the domain to These addresses appear legitimate to us, so the attack was probably implemented with routers or proxies rather than DNS tampering.

Robots Evolve Altruism, Just as Biology Predicts

May 5th, 2011. Published under My Recent Reads. No Comments.

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Robots in a Swiss laboratory have evolved to help each other, just as predicted by a classic analysis of how self-sacrifice might emerge in the biological world.

10 Best Practices For Raising A VC Round

May 5th, 2011. Published under My Recent Reads. No Comments.

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Having raised a number of VC rounds personally and observed many more as an investor or friend, I’ve come to think there are a set of dominant best practices that entrepreneurs should follow.

1. Valuation: Come up with what minimum valuation you’d be happy with but never share that number with any investor.  If the number is too low, you’ve set a low ceiling. If your number is too high, you scare people off. Just like on eBay, you only get to your desired price by starting lower and getting a competitive process going. When people ask about price, simply tell them your last round post-money valuation and talk about the progress you’ve made since then.

2. Never tell VCs the names of other VCs that are interested. Reasons: 1) if you are overplaying your hand that could send a negative signal.  Most VCs know each other and talk all the time. 2) it is possible they’ll get together and offer a two-handed deal in which case you have less competition.

3. I think the optimal number of VCs to talk to seriously is about 5.  That is usually enough to get a sense of market but not so much that you get overwhelmed.  You should pick these VCs carefully – this is where trusted, experienced advisors are critical.

4. If there is a VC you really like, have a “buy it now price” and if they hit that valuation (and other terms are clean) do the deal.  Otherwise, say you’d like to “run a process” and include them in it.

5. Try to set timelines that are definite enough that investors feel some pressure to move but not so definite that you look dumb if you don’t have a term sheet by then.  (Investors have an incentive to wait – “to flip another card over” as they say – whereas entrepreneurs want to get the financing over with asap). Depending on where you are in the process, say things like “we’d like to wrap this up in the next few weeks.”

6. Once you start pitching, the clock starts ticking on your deal looking “tired.”  I’d say from your first VC meeting you have about a month before this risk kicks in.  You could have a great company but if investors get a sense that other investors have passed, they assume something is wrong with your company and/or they can wait around and invest later at their leisure.

7. The earlier stage your company is the more you should weight quality of investors vs valuation. For a Series A, you are truly partnering with the VCs.  You should consider taking a lower valuation from a top tier firm over a non top tier firm (but probably any discount over 20% is too much). If you are doing a post-profitable “momentum round” I’d just optimize for valuation and deal terms.

8. Term sheets:  talk about terms in detail over the phone.  Only accept a term sheet once you have decided that if it matches what was described you are prepared to sign it.  After sending a term sheet VCs get worried you’ll shop it and usually want it signed in 24 hours.

9. Get to know the VCs. Talk to their other portfolio companies, read their blogs, call references, etc.  You will be in business with this person for (hopefully) a long time.

10. Timing. While it’s ideal to raise money once you hit the milestones you set out initially, you also need to be opportunistic.  Right now, for example, seems to be a really good time to raise a VC round.  You could make a ton of progress over the next 6 months but the market could tank and end up in a worse place than you would be today.


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Megatrend Crosscurrents

May 4th, 2011. Published under My Recent Reads. No Comments.

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It is an exciting time to be an entrpreneur and an investor in tech startups. The history of tech investing is a series of waves or megatrends that come one after another. Mainframes to minicomputers to PCs to client server to Internet, for example. But right now we are in the midst of a number of these megatrends all happening at the same time. There are at least four big ones going on at the same time:

- Mobile – yesterday I wrote that at least 16% of the visits to this blog are coming from mobile devices and that number is up from essentially zero six quarters ago

- Social – Facebook will have 1bn users in the next year or so

- Cloud – A third of Netflix’ new subscribers are opting for the streaming only plan

- Global – companies like Skype, Facebook, Twitter, Google see upwards of 80% of their users from outside the US and these numbers are growing faster than ever

Each one of these megatrends would be an investable wave on its own. But we are in an environment when all four are crashing on the shore ata the same time. Twitter, for example, is mobile and social and global. It is the world in your pocket. And it is changing the world too.

All of this is happening in the context of a very frothy investment climate. Investors are acutely aware that this is a time of great opportunity in tech investing. Capital has come gushing into the venture capital and startup sector. Maybe it is appropriate given all the opportunity. Or maybe it is irrational exuberance. But as my friend Tom Evslin says, “nothing great has ever been built without irrational exuberance.”

Investing in the midst of these megatrend crosscurrents is both exciting and challenging. And I certainly wouldn’t want it any other way.

Why now is the “second golden age” for VC tech investing, says new report

May 3rd, 2011. Published under My Recent Reads. No Comments.

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A new report issued today by venture capital company Clearstone Venture Partners on how well the venture capital community is doing says that VCs who put their money into technology startups now will get the best return on their money since the boomtimes of the dotcom era last decade.

Titled “The State of Venture Capital in America,” the report says that because conditions have improved considerably due to a shakeout in the number of VC players involved in the tech sector, there’s been a reduction in capital allocated, making the money VCs do invest count even more.

It concluded that the top three reasons for superior performance returning to the venture capital asset class are: a scarcity of capital leading to better returns to those who are investing; far higher valuations being awarded to successful companies at their IPOs; and the rising importance of businesses going global sooner in their life cycle.

The significant decline in VC funding raised since the dot-com bubble burst — only $12 billion in 2010, versus more than $80 billion in 2000, and $37 billion in 2007 — has combined with a high uptick in money pouring into clean technology deals, which made up 17 percent of venture investments in 2010, to create ideal conditions for investing.

These factors and a sluggish IPO market could lead to a second “Golden Age” of tech investing on the part of venture capitalists, said the report.

“While the asset class has been largely abandoned by institutional investors, this disinterest will paradoxically lead to superior returns in the future,” William Quigley, managing partner at the Menlo Park, Calif.-based outfit and author of the report told VentureBeat.

That makes it a prime environment for investors looking to find bargains at the seed stage level and large payouts when popular companies such as Zynga, Facebook and Twitter do go public.

“Investors in the hot start-up companies of today, Facebook, Groupon, Zynga [etc.] will do fantastically well,” said Quigley who has seen a number of his early-stage investments go public, including,, Emusic and PeopleSupport.

However, he warned that because most of the new Silicon Valley companies already have an existing product and gone global, public shareholders in these company will be taking on substantially more risk this time than they did versus their investments in the leaders from the last tech cycle.

“The iconic companies of the dot com and telecom bubble, such as, eBay and Juniper Networks were priced at very attractive valuations when they were offered to public shareholders  Amazon went public at less than 1 times forward 12 month revenues,” he said.  “I don’t see the same fantastic opportunity for IPO investors this time around.”

“The newest crop of high-profile IPOs will be fully priced, with all of the risk that implies for public investors,” he added.

The report also said that taking a data-driven prospective, conditions today in the private and public capital markets bode well for superior performance and a to return to the venture capital asset class this decade.

“Specifically, the rewards accruing to private investors in the leading tech companies of today far exceed what private investors used to earn from their investment in the best companies of previous tech cycles,” it said.

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Ordinary Income vs Capital Gains

May 2nd, 2011. Published under My Recent Reads. No Comments.

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I’m wandering a bit on MBA Mondays right now. I don’t have a strong view of where to take this thing next. So I’m just going to post about stuff I think people should understand until I find the next vein we can mine for a while.

Today, I’d like to talk about ordinary income vs capital gains. This is not tax advice. I am not a tax lawyer or a tax accountant. I hope both tax lawyers and tax accountants show up in the comments as this is important and complicated stuff.

When you think about the various ways you can make money, two ways predominate. You can provide services to others and get paid for those services. That is ordinary income. And you can invest in something; shares of stock, a building, a domain, and then sell it later for more. That is a capital gain.

The distinction is important, at least in the US, because these two kinds of income are taxed differently. Ordinary income is taxed at the full federal, state, and local tax rates. We live in NYC and according to our accountants, we pay a marginal fully loaded tax rate of 47.62%. That means we keep about half of the ordinary income the Gotham Gal and I generate.

Capital Gains are broken down into short term (less than one year) and long term (more than one year). Short term capital gains are taxed at ordinary income rates but long term capital gains are taxed at a much lower rate. According to our accountants, we pay a fully loaded tax rate of 27.62% on long term capital gains. That means we keep about 3/4 of the long term capital gains the Gotham Gal and I generate. That’s a big difference.

It gets more complicated when you have ordinary losses and capital losses because you need to understand when and how losses and gains offset each other. The rules are complicated and ever changing and I’ve learned to consult my tax accountants whenever stuff like this turns up.

But the important point of this post and the one I want to bring home is not all wealth producing activity is treated equally in the eyes of the government. There is a strong bias to capital gains. I agree with that bias, not surprisingly, because I think we should have an incentive to recycle capital instead of putting it under a mattress.

If you think about wealth creation in the context of ordinary income vs capital gains, you’ll quickly come to the conclusion that you can build wealth a lot more quickly with capital gains than you can with ordinary income because the tax load is so much lower. This is one of the many reasons I encourage people to think of entrepreneurship as a career. If you are a founder of a startup, your founders stock will qualify for long term capital gains if you structure it correctly when you set up the company. And when you go to the pay window (to borrrow one of my favorite JLM phrases), you will be sharing a lot less with the government and keeping a lot more.