So what would just right liquidity look like?  Can you have your cake (all the typically enormous strategic advantages that accrue to a private company) and eat it too (the advantages of being listed, afforded by having a periodic mark-to-market and the ability to use your equity as a real currency)?  I think you (mostly) can and am very encouraged to see this sweet spot slowly emerging and gaining traction outside of a handful of what previously would have been considered exceptions to the rule.  In my opinion, the answer (as I have mentioned before) lies in further developing secondary markets in private company equity.

The two most successful companies I have had the privilege of investing in – Markit and Betfair – despite being multi-billion dollar companies and market leaders, are still today private companies and have provided liquidity to investors, management and employee shareholders (in different ways) which has gone a long way to allowing them to remain private and reap the associated benefits.  The flexibility of Facebook’s management to run their company for the long term optimal outcome has I suspect been a direct function of the liquidity that secondary investments (from DST) and a relatively active secondary market in Facebook shares on platforms like Second Market and SharesPost have provided to early investors and employees.  And it’s not just about cashing out – at least half the value of these secondary markets comes from providing a credible mark-to-market and the reasonable expectation that – if needed – an investor could access liquidity.  Perhaps paradoxically, with these two factors in hand, more often than not, investors will actually have a higher propensity to hold on too their investment, not lower.

Another benefit of secondary markets would be to improve the health of the overall venture investment ecosystem which while evolving in fits and starts, most recently with the rise and rise of “super-angels” and “seed funds” still mostly remains in the eyes of this industry outsider, static and prone to herding around the notion that one-size-fits-all in terms of capital structure and financing paradigms is somehow optimal and should not be questioned.  In particular, I fail to understand why the received wisdom of the venture capital community seems firmly stuck on the concept of “nobody exits until everybody exits”.  It’s a dumb concept and worse, quite frankly is at odds with the interests of the various investors and stakeholders in a private company,  including later stage investors (aka mainstream venture capital funds.)  I believe much of the angst surrounding seed stage investing and (traditional) venture capital investing, arises as a result of a dysfunctional transition mechanism. (ie There isn’t really one.)

What I would like to see – and quite frankly have never heard a good counter-argument against – is a more dynamic and flexible financing chain, one that pragmatically combines both primary and secondary elements.  Practically speaking, what would this mean?  At its simplest, it would mean that at any given funding round, the possibility of existing investors exiting part or all of their holding is considered objectively and without undue emotion.  Having participated in many such transitions in companies going from “seed” funding to “series A”, or “series A” to “series B”, etc. the relationship between existing shareholders and the new shareholders is far to often one of conflict – to the extent that this is often seen as just the normal way of things – when there is no reason that this ever need be the case.  Venture capital firms often talk of “needing” to invest a minimum amount of capital and/or “needing” to own a certain minimum stake in the companies they invest in.  While I think the case is sometimes overstated, if you understand the dynamics of their business model, their attitude is easily understandable and basically rational.  And yet, I have never yet seen a venture capital fund offer to buy-out the early stage investors in whole or in part when more often than not this would be an ideal outcome for everyone:

• the company:  not needing to raise more new capital than strictly necessary
• the early stage investors: (whether professional angels or seed funds or friends and family) allowing them to reduce risk, recycle capital and retain focus on the market segment (early stage) they know best and which corresponds to their capital base
• the venture capital funds:  allowing them to simplify the capital structure, deploy more capital and ease negotiations

If this became the norm, I think it would drive a massive downstream benefit which would be to create a more dynamic, focused and intelligent early stage investment paradigm as investors in this ecosystem niche could really focus on funding two types of companies:

• companies that have a plausible case to become successful but modestly sized businesses worth $10-40 million; and
• companies that have a plausible case to become “VC fundable” where the goal is to exit in a series A or series B at $10-40 million

This would considerably improve both the availability but also the quality of early-stage capital as the risk / return dynamics would become much less random and the impact and velocity of the best investors in this space would increase considerably, providing more, cheaper and easier access to capital to entrepreneurs while at the same time providing a fantastic “farm-system” of talent and corporate development to later stage VC’s, perhaps even allowing (the best amongst) them to deploy their hundreds of millions or billions of capital efficiently as their ecological niche becomes better defined. I am absolutely convinced that this paradigm would create a much healthier, more vibrant capital market for innovation and disruption, improving returns for everyone in the ecosystem.

What I am not saying is that buying out seed investors would be appropriate in every situation.  Nor that all seed investors would always be happy to sell all or even part of any individual investment.  Nor that later stage investors should always look to buy out early stage investors.  What I am saying is that this discussion should always be a part of the financing tool-kit, this option should always be on the table, and dismissed only when and where it is objectively inappropriate.  Let’s get rid of the dogma and let markets work.  Liquidity:  not too much, not too little, let’s get it right!

Related articles by Zemanta

• The Illiquidity Premium (avc.com)
• Beware the Spectacular B-Round Valuation (kellblog.com)
• A Second Market Is Emerging (avc.com)

To be able to succeed (in providing meaningful, affordable, services) in such challenging environments to my mind offers great insights into how improvements can be made to how services are designed and sold in any environment – including the developed and wealthy western markets. A variation on the New York, NY theme of – ‘if you can make it here, you can make it anywhere’…

And so this post: “…and you will hear our voices” from Teddy Ruge really resonates:

So what does this really mean for us as an ever-increasing population empowered by the social media stage? It means we have the responsibility to start speaking up for our continent. We have right to say enough is enough with the hand outs, enough with the aid mentality, enough with the top-down solutions, and enough with being ignored on the global stage. Our voices count, and it would be good to partner with us—to have a conversation with us first—before any projects are started.

I would go further and say it would be insane not to partner with the people that are “at the coal face”. That not only would this reduce the number of mistakes, failures and unintended consequences but that the opportunity for learning and cross-fertilization of ideas, business models and innovations is so rich that to ignore it would simply be foolish. Social media is giving a voice to ideas from everywhere, anywhere, with the best ideas emerging naturally based on their intrinsic worth and evolutionary strength (and not because of where or by whom they were ‘invented’.) So for talented, ambitious people everywhere the cry is no longer “Go west young man!” but “Go south, go east, go north, go west – go into the global social ecosphere and connect with the current of humanity.” Open. Not closed.

Related articles by Zemanta

• Global Youth: Africa is the Future (debaird.net)
• African Broadband Market Size to Triple by 2015, Mobile Broadband to Dominate, According to AfricaNext Investment Research (prweb.com)
• India’s Mela Economy…Have we recognized Africa’s equivalents? (africaunchained.blogspot.com)

There’s nothing more valuable than an unmet need that is just becoming fixable. If you find something broken that you can fix for a lot of people, you’ve found a gold mine. As with an actual gold mine, you still have to work hard to get the gold out of it. But at least you know where the seam is, and that’s the hard part. - Paul Graham

In the latest of his series of great essays, Paul Graham makes the obvious – but all too often overlooked – point that one of the best ways to create value is by working to “fix things that seem broken.” He also highlights the fact that sometimes it pays to step back from your daily environment to get a clear picture of what is broken:

You may need to stand outside yourself a bit to see brokenness, because you tend to get used to it and take it for granted. You can be sure it’s there, though. There are always great ideas sitting right under our noses.

At the end of 2006, after a long, successful, and mostly exciting and enjoyable career in capital markets I took that step outside. And my suspicions became convictions. Finance seemed broken to me. And it bugged me. It still bugs me. It bugs me when super smart people (who aren’t financial or market professionals) resign themselves to accept crappy advice and ill-suited products and services when it comes to their finances. It bugs me that so many bright, energetic, ambitious people working within the financial services sector continue to be trapped in the status quo of 20th (even 19th) century business models, their talents misdirected when the alternative is so much more appealing.

And so I thought I should try to fix it. Not all of it. Not all at once. But more than just a single facet. I haven’t got it all figured out yet, but I think I’m headed in the right direction and most importantly I’ve learned more – about the industry, about people, about building value and about myself – in the past 3 years than in the 10 before combined. I’ve never worked harder and I’ve never had more fun. And I’ve met some pretty amazing people too.

A few days ago, Fred Wilson commenting on the (ridiculous) inclusion of venture capital in the financial stabiliy bill wrote this:

The only systemic risk the VC business is creating for the financial system is attempting to put the current one out of business by financing entrepreneurs with new ideas for banking, brokerage, insurance, and other financial services. I’m not joking about this. I believe entrepreneurs will use technology to reinvent the way financial services are provided to consumers this decade.

“Using technology to reinvent the way financial services are provided to consumers this decade.” Nice. In fact that is our elevator pitch. I just hope Fred doesn’t mind if we use it.

Related articles by Zemanta

• Venture Capital Creating Systemic Risk??? (myventurepad.com)

RabbitMQ was born of a JV between CohesiveFT (my partner Amy sits on their Board) and L-Shift and was spun out as an independent entity under Alexis’ leadership about a year ago. The mixed feelings I alluded to above are only because we were quite excited by the prospect of helping Rabbit grow as a standalone business, given their already excellent market share, the existing and extremely fast growing market for their product (messaging), the already strong brand and market adoption of RabbitMQ and a number of successful open-source business model pioneers and exits to emulate. As we did not have the capital required to make this happen we could not put a credible alternative on the table. To be fair, there were always a lot of moving parts and there is no guarantee that we could have put a better, workable deal forward and clearly joining the VMWare family is an awesome opportunity for the company and the team.

In any event, I’m really excited and happy for them and proud to be associated with them, even if only in a small way. Here’s to hoping this is a homerun deal for VMWare! (And yes having “Rabbit” in your name is one of our investment criterea…)

Related articles by Zemanta

• SpringSource Acquires UK-based Open Source Company Rabbit Technologies (techcrunch.com)
• SpringSource Buys Startup to Scale Messaging in the Cloud (gigaom.com)
• RabbitFX: simple, transparent and secure. (parkparadigm.com)
• Venture innovation. (parkparadigm.com)
• Can big companies adapt? (parkparadigm.com)

But why am I explaining this here? And no, it is not to generate an outpouring of sympathy (which however I must acknowledge as very nice as I have been fortunate enough to have been reminded of over the past week.) No, there are effectively two distinct reasons I thought it would be worth telling this story.

The first is from a strictly practical standpoint: to get the word out to all the people I “work with” on a day-to-day basis without needing to write dozens or hundreds of emails (never much fun at the best of times but even less appealing with one-hand…) I suspect not all the people that I’d like to have this information are readers, and clearly for many of you this is probably unnecessary information, but while clearly not perfect, the broadcast mechanism of a blog I felt was the best option available to me. So for those of you waiting for an email or call to be returned, or an appointment to be confirmed, now you know what has happened and I would ask your indulgence and patience. If you have heard nothing back from me in the next few days or so, or if it is more urgent than that, please follow-up with a nudge. Otherwise, give me a couple weeks and I’m sure I can get back on top of things (at least as much as I ever do!)

The second reason is hopefully more interesting to a wider audience and is about addressing one of the risks that seems to me to be less discussed in the vibrant “start-up commons” that many other issues venture entrepreneurs and investors face. This is the risk to founders health from exogenous, unanticipated events.

In particular, I’m interested in risks not readily addressable by traditional key-man life insurance. This of course is a standard requirement when raising outside investment and insofar as it protects investor capital (if not their opportunity cost) from the worst-case result of a catastrophic injury or death of one or more of the founders (ie winding up of company), it probably doesn’t help in the more probable situation of a significant productivity loss due to severe illness or accidental injury. Thinking through our portfolio of early stage companies, I dare say none of them has thought much about this except for one, and if I am honest, this was only because we had to manage just such a risk in the early days of the company (which I’m happy to report was successfully done, helped of course by the individual’s recovery proceeding as expected.) If you are a start-up founder or investor, have you given this much thought? If so what sort of solutions or contingencies have you put in place to mitigate this risk? Are any insurance companies writing policies that pay out (to companies, quickly) in the case of non-critical short term health issues with key personnel? If so is the pricing reasonable?

I’ve obviously had a few days and a good reason to think about this, and just to be clear, have been considering the question in the first instance from the point of view of a founder. (For while we are also investors, my company is in fact a start-up and I am reliant upon it for my livelihood.) And in terms of protecting my family, I have life insurance, but this accident underlined that in the event I were temporarily incapacitated and unable to work, mitigating the financial risk arising is potentially much more problematic, and that this is a problem (most acutely) faced by start-ups and small businesses. Indeed, were I still working for an established (big) company or organization, I have a very nice letter from my doctor stating I cannot work for the next 4 weeks and so I would sit at home collecting my salary and healing. But even more importantly, the business of the company would go on (even if I were Steve Jobs); and while (one would hope that!) some opportunity cost would be incurred, the larger and more established the company or organization, the more marginal it would be. ie The problem (for founders and their investors) isn’t insuring the loss of a month’s salary/revenues/burn per se (which is I’m sure a tractable actuarial problem.) Rather, it is insuring the opportunity loss of a month of foregone productivity or progress. And because the “value” of this lost opportunity is subject to so many internal, external and temporal/situational variables unique to each founder/company pair, I suspect this is probably an uninsurable risk, at least in the sense of financial insurance. Indeed, I think the solution to mitigating this risk if one exists lies more in ‘operational engineering” admitting that in some cases even this will be impossible.

And so my (highly tentative) conclusions are that:

• founders should probably think about a “Plan B” to manage their personal risk (eg this could be cash savings, support from family, returning to traditional employment, etc.)
• investors need to consider the value of portfolio diversification in this context and perhaps, insofar as possible, think about what critical skills may be replaceable on a temporary basis should a founder be incapacitated for a few weeks or months and ideally build a network of people who have or have access to these skill sets; my thinking here is not to suggest that founders are replaceable but that it may in some cases be possible to soften the impact should the unexpected happen.

I would be very interested in the community’s thoughts on this and in particular whether they think it is a risk that can and should be acknowledged and managed in early-stage (and/or later-stage) companies, or if on the contrary they believe this is an intractable risk and so just needs to be “accepted” without wasting any time, energy or money trying to manage it.

So having spent 90 minutes on this post (sooo slow…) I better get down to work, and so while I’ve a dozen posts up my sling, I probably won’t be back here for a week or so as I work my way through a daunting (but mostly exciting) to do list. Oh, and for the next few weeks at least, you can just call me Lefty.

The recent sensation caused by an ex-Microsoft insider’s NYT op-ed is just one more example of this seemingly inevitible ‘circle of (corporate) life.’:

Microsoft’s huge profits — $6.7 billion for the past quarter — come almost entirely from Windows and Office programs first developed decades ago. Like G.M. with its trucks and S.U.V.’s, Microsoft can’t count on these venerable products to sustain it forever. Perhaps worst of all, Microsoft is no longer considered the cool or cutting-edge place to work. There has been a steady exit of its best and brightest.

What happened? Unlike other companies, Microsoft never developed a true system for innovation. Some of my former colleagues argue that it actually developed a system to thwart innovation. Despite having one of the largest and best corporate laboratories in the world, and the luxury of not one but three chief technology officers, the company routinely manages to frustrate the efforts of its visionary thinkers.

Much has been written on how large companies can or cannot innovate, and Clayton Christensen’s “The Innovator’s Dilemma” is probably the primary reference with respect to modern management thinking on the subject.

Innovation is a new way of doing something or “new stuff that is made useful”

I’ve of course added my two cents to this discussion, with my thoughts on the subject drawing on my personal experiences (and those of friends and colleagues) of having tried (very hard) to sponsor a pro-active approach to disruptive innovation in a very large company. For those of you not familiar with my hypothesis on the question, I’ll save you the trouble of digging through my blog, it boils down to the complex weave of organizational and personal dynamics that unavoidably emerge when you assemble large groups of people in one organization:

1. Loss aversion dominates: most people (and sub-groups) fear loss much more than they enjoy gain. This is why the status quo is so closely guarded (at any level of resolution, from the individual through to the overall company.)
2. Dancing with the one that brought you: at any level of seniority, it is likely that the person in charge got to be that person in charge by being particularly skillful or adept at navigating the existing business and/or organizational model. It’s like the America’s Cup: the winner sets the rules (and has no incentive to adopt “new rules” for which they are probably less well adapted.

In fact, Machievelli eloquently summed it up 500 years ago:

It must be remembered that there is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than the creation of a new system. For the initator has the enmity of all who would profit by the preservation of the old institutions and merely lukewarm defenders of those who would gain by the new ones.

These principles form the core of the corporate immune system which considers any disruptive innovation as a threatening virus. So what is a big company to do? Should they accept the inevitability of decline (hopefully slow, profitable and graceful) or can they postpone or avoid this fate?

In some (most?) cases, I would suggest that they accept decline but this does not mean giving up. On the contrary it means aggresively (and even creatively managing the exisiting assets to create as much value as possible as the business model and or product ‘runs off’. This indeed was my prescription for Microsoft when I wrote two years ago that they should break-up the company and re-jig the capital structure, running the Windows/Office businesses for cash (with a debt financed balance sheet) and let a thousand new baby Microsofts bloom. A conventional view would see this as a failure of management and/or ambition. Obviously I think this attitude is ass backward: running the core products for cash while releasing enormous amounts of human and financial capital, which in turn could be used to create hundreds of new companies could – using any metric you like – only be considered a triumphant success. But convention, inertia and ego means that this path to success is rarely if ever taken by the leaders of market giants. Just in the last couple weeks the idea that Google might becoming the ‘next Microsoft’ has gained currency (at least in the valley.) I asked this same question (in May 2008:)

I know it has been asked a million times before but is Google the next Microsoft? (At least from a financial point of view…) At the start of 1996, MSFT traded at c. $6/share. Four years later they peaked at almost $60/share. GOOG IPO’ed at c. $85/share in 2004, and just over three years later peaked at over $700/share. Both moves of approximately 10x. Since 2000, MSFT has been more or less range bound at around $30/share, despite continuing to grow it’s top and bottom lines and produce prodigious amounts of cash. I’m not suggesting history will repeat itself exactly – perhaps we have not yet seen the peak in GOOG’s share price (sell at $850?), and I’m certain they will continue to grow their top and bottom lines and produce prodigious amounts of cast in the next 5-10 years. But…will the stock eventually settle at around $500 – 600/share…? Is it conceivable that Google, like Microsoft before it, will become the place where good companies are bought only to disappear?

However, like with human life, I think there are probably a number of recipes to extend the natural corporate life (and the quality of those extra years) and to leave a more valuable legacy when and if the company ultimately disappears. Starting with investing some of their excess capital in the innovation ecosystem that surrounds them. As I have found however, this idea is anathema to most large companies. And with some reason. The history of ‘corporate venturing’ is indeed (as Azeem Ahzar eloquently writes) riddled with failure. My view is that this is because it is exceeding hard to do this in house: the corporate antibodies as described above will almost always do their job and sabotage any in-house venture program. And yet just investing as an LP in an outside venture fund – even if one that happens to focus on markets relevant to the company – is an understandably unsatisfactory and probably equally ineffective alternative.

But we think there is a third way: a focused, strategic innovation program run independently from, but in close collaboration with the company. Maybe we can help your company. You know where to find us: where innovation grows.

Related articles by Zemanta

• MSFT: An Organizational Culture that Squelches Innovation? (seekingalpha.com)
• Eye on Microsoft: Signs of Game Over (boycottnovell.com)
• Google Does Not Have Innovator’s Dilemma (cloudave.com)
• Business Model Innovation: the major contributions of Øystein Fjeldstad (johngaynardcreativity.blogspot.com)
• Why Do We Care about Disruption? (blogs.hbr.org)
• Reminder From The Innovator’s Dilemma: Markets Change Whether You Like It Or Not (innovationtoronto.com)
• Solving For Impossible: The Four Quadrants of Innovation (siliconangle.net)

Which brings me to an idea I’ve been toying with for the past several months. I’ve been contemplating publishing a virtual portfolio of venture and private equity investments – ie the investments we would likely have made (and would make) had we the capital available. A sort of an analogous take on Covestor or Marketocracy but for private investments.* There are however a number of reasons I have not taken the plunge. Perhaps most obviously is the issue of proprietary knowledge. After all, the heart of the value proposition we make to prospective investors is that we have a unique and robust investment thesis and that based on this foundation, we have identified (and will continue to identify) exciting young companies who are naturally adapted to grow and prosper in the coming years. If we tell everyone who these companies are, why would anyone need to pay us a fee? Why wouldn’t they just invest directly. Or more likely, why wouldn’t competing investors just ‘free-ride’ on our research and analysis, using our list as a filter or more? And what if the companies we listed failed (see below)? What benefit would there be to publishing such a list?

Further, there are a number of structural factors at work that mean that the ‘Covestor’ metaphor is imperfect at best and fundamentally inappropriate at worst. Investing in private companies involves a number of challenges that are different/additional to those faced by a public company investor. A number of these factors are interrelated but for the sake of clarity I’ll try to enumerate a few:

• deep information deficit: for most of the companies that would appear on such a list, our information is significantly limited, especially with respect to financial aspects (budgets, sales, valuation, etc.) As a practical matter it is usually not possible to obtain this level of detailed information unless one is actively engaged with the company in view of a potential investment. Obviously it would be completely disingenuous for us to misrepresent our capacity and intentions simply in order to be able to put our slide-rule over the financial model. Further, without the potential pay-off of being able to follow through and invest in companies that pass due diligence and valuation muster, quite frankly we don’t have the luxury of doing such a deep analysis even if the company was happy to provide us the data.
• price (valuation): while perhaps less important (within reason of course) the earlier you are in the life-cycle of a company, it is obviously a key input that is quite often unavailable. To be fair, one could possibly – at least for the purposes of such a list – assume that if respected investors participated in a given financing round that we would have been ok with the pricing too.
• value enhancement: call it hubris if you like, but one of the key inputs in our investment process is understanding to what extent our participation as an investor can help reduce risk and accelerate success. Elements of this analysis can be done from ‘outside’ but without a deeper understanding of the business and in particular a personal relationship with the management team, it is hard to properly assess what value, if any, we can bring to the table. Some companies that look great to us from afar might just not be a good fit.
• managing destiny: (a variation/specific case of the point above) particularly for seed and very early stage companies, one of the biggest risks they face is securing follow-on finance. In this context, a theoretical investment and a real investment are fundamentally different: there are many ways a company can fail. Failure is failure of course but I suspect there is a risk that some of the companies on our wish list might indeed fail to raise follow-on capital, whereas had we invested for real, we would be prepared to follow-on in most cases, mitigating if not eliminating this risk. Of course it’s probably impossible – even ex-post – to definitely identify companies whose failure was ultimately unavoidable (market driven) from those whose failure was only due to a financing gap.

The case for publishing such a list – assuming you can overcome some of the structural limitations outlined above – really boils down to building reputation and trust, both with potential investors and existing and aspiring entrepreneurs in particular and within the wider venture capital / private equity ecosystem in general. Part of me also likes to think that there is less risk, in terms of ‘giving away’ intellectual property, than would be the case for say a hedge fund manager focused on public equities: anyone can buy a public security, the same is not true of private companies. Wanting to invest is not sufficient to allow one to invest. Further, let’s be realistic: for better or worse, I’m not Warren Buffett or John Doerr or anyone really…will the fact that I say AMEE is a must own company really make a difference to anyone? More importantly (to me!), will it make it more or less likely that I will be able to use my skills to make a living identifying and investing in great young companies?

Basically the only potential downside to publishing a virtual or ‘wish-list’ portfolio I can see is the fact that one would have to assume that any nuance and qualifying information attached to such a list would ultimately get lost and that for better or worse, the companies would be inextricably linked to me without qualification. I was thinking that a list constructed as ‘Probables’ and ‘Possibles’ might just allow some useful qualification without diluting the impact. And yet, I hesitate. And I’m not sure why. So I thought I’d ask you.

1. Why should I not publish such a list?
2. What (if any) qualifications should I include, were I to publish such a list?
3. Why don’t other investors publish lists of deals they would like to or would have liked to have done? (before outcome is known of course!) (Or if any do, please tell me who/where.)

* Is there a business idea in here somewhere? Sort of a Covestor meets seedcamp for aspiring new private equity managers? A set of tools and a community to help LPs identify new talent and spread their investments in this asset class more widely (and intelligently) without the limitations of the existing fund of funds business model…

Related articles by Zemanta

• The Great VC Ice Age is Thawing (for now) – Part 1 of 3 (cloudave.com)
• Another Start-up Wants to Democratize Investing (bits.blogs.nytimes.com)
• Covestor issues open invitation to enable anyone to become a portfolio manager * (covestor.com)
• Being friendly has become a competitive advantage in VC (cdixon.org)
• Another two-sided market. (parkparadigm.com)

And I am certain there is more to come. Their primary constraint has and will likely continue to be the physical/logistical limitations of growing as fast as they have but each year they only improve and in terms of acquisitions the company they most remind me of (in terms of disciplined and deliberate execution) is Cisco. Besides, General Atlantic doesn’t invest in companies where they don’t think they can make 20-30% annual returns or more.

And yet many (most) people in the ’start-up’/'tech’ scene whether in the UK or the US have never (or only vaguely) heard of Markit. (For example, I counted only about 50 or so tweets referencing the announcement today, less than for any TechCrunch launching start-up…) Why is that? Obviously I can’t say for sure but (in no particular order) would guess the explanation perhaps lies in the following:

• not venture capital funded; funding initially came from it’s cornerstone customers, the investment banks, and then later from some very smart hedge funds
• focused on the wholesale financial services industry (and not on consumer or media or other mass markets)
• key products and services (and associated economics) unknown to those outside finance and even worse generally considered ‘boring’
• management team laser focused on execution, not PR (although to be fair they had this luxury not needing to sell to the mass market)
• and so folks like TechCrunch and VentureBeat don’t know or write about them (aka “if a startup isn’t listed in CrunchBase does it really exist?” syndrome)

Indeed for me, Markit is a poster child for the cognitive, cultural and expertise chasm that exists between ‘Wall Street’ and ‘the Valley’ (or the ‘City’ and the ‘Roundabout’ to use the less good UK-centric metaphor.) They might as well be on different planets. Indeed bridging this divide is at the core of what we set out to do at Nauiokas Park and was the driver that led Paul Kedrosky and Tim O’Reilly to launch the Money:Tech conference in 2008 (which sadly didn’t survive the financial crisis and quite frankly was met by a deafening indifference by the vast majority of the Wall Street side of the equation.)

And yet, the opportunities available to those who can successful bridge this gap are enormous. Well, anyway that’s what we think. And the crisis in venture capital ostensibly caused by too much capital? I’m going to disagree with Paul and Fred and suggest it’s not too much money overall; rather it’s too much money concentrated with too few investors, focused on too few sectors, who end up all chasing the same deals. So to the LPs out there my message would be: don’t shrink the pool, enlarge the opportunity space. Oh, and try to make sure you’ve got exposure to the next Markit Group.

Related articles by Zemanta

• Through the Looking Glass, Midterm Report (parkparadigm.com)
• Another two-sided market. (parkparadigm.com)
• Fixing finance, part 326. (parkparadigm.com)

(December 2015:) …The global securities and investment banking groups that dominated the market in the last century are now extinct. In their place we have an intelligent galaxy of new specialist advisory, investment management, algorithmic software and consulting firms networked with a universe of powerful transaction facilitation exchanges. Banks now exist only as giant regulated pools of capital.

Following the sweeping banking reforms proposed last week by President Obama, and the fact that we are now halfway to this hypothetical future, I thought it might be worth doing a quick mark-to-market of how my ideas have lined up with reality.

Oracle

• stock exchange consolidation and emergence of new exchange venues (A-) pretty close both in outcomes and timing – the major stock exchanges have been merging a-go-go while at the same time new trading venues have proliferated, and exchange (or quasi-exchange) trading of new asset classes continues to develop strongly.
• sports/outcome trading in US legitimized (B-) my narrative had this happening in February 2010, not there yet but Congressman Frank’s bill might open the doors later this year and the trend seems to be on the right track and will probably be signed into law by Obama (!); as an aside was way early on a Betfair IPO…
• giant bank mergers followed by break-up of vertically integrated universal banks, with Goldman Sachs leading the way (A) we have seen the big get mostly even bigger (RBS/ABN, BoA/ML, Barclays/Lehman…and while JPMorgan didn’t buy MS, they did get Bear Stearns and WaMu); GS hasn’t yet broken itself into three as predicted but I’m still confident it will lead the way when/if industry structure changes, and more generally the trend of regulatory thinking across the globe is definitely a trailing wind for the kind of change I envisioned. The 2010-2012 timeframe for the re-organization of global banks is probably a bit early but plausibility has certainly gone up (from near zero) significantly since I wrote this.
• more (and more) algorithmic / automated intermediation of markets (A-) this was obliquely referenced in my article but was really at the heart of the idea that this fictional ‘AmazonBay’ platform would end up dominating this aspect of markets; clearly the market is heading this way – in fact it may seem obvious now but most people did not fully understand this even as little as five years ago.
• Amazon anything (B+) The jury is probably still out on this one, but in my view it is looking increasingly likely that Amazon.com will become a giant of the next economic paradigm; whether or not they use their vast intellectual and technological resources to participate more directly in the financial services arena is not yet clear, but I can tell you the only ‘big company’ job I would not hesitate for two minutes to accept if it were offered would be CEO or CSO of Amazon Financial Services (AFS) Jeff are you listening?

(Note: Remember I used real company names mainly to add vividness to the ideas underlying the narrative. The key concept I wanted to convey with this GS break-up vignette was that the vertically integrated model would decompose under the light of new technology and regulations into a (technology-centric) Sales & Trading component, a more focused, relationship driven Advisory component (cf. the emerging proliferation of pure advisory ’boutiques’) and independent, conflict-free Asset Management businesses (cf. the secular growth of hedge funds and Barclays sale of BGI, etc.))

(February 2009:) …Reacting to new competition, Goldman Sachs becomes the first major investment bank to break itself up. Securities and distribution are sold to Ebay Financial Markets, while the remaining activities are split into two new companies: GS Advisory Services and GS Capital management…

Charlatan

• eBay anything (D) Despite the fact that the actual companies cited are more symbolic than literal, the choice of eBay to represent the cutting edge of online, data-driven, algorithmic marketplaces was simply awful. To the extent that it risks distracting the viewer from the key, underlying messages. It is now entirely implausible and so instead of bridging the cognitive gap, the inclusion of eBay simply extends it. Thank goodness this is somewhat mitigated by my inclusion of Amazon.com (see above) as the other new markets avatar but they come late to the narrative…
• sports trading developing as an asset class (C+) this clearly hasn’t happened, although there are one or two small funds and firms offering managed accounts; and a vibrant ecosystem of professional traders and the associated software has emerged around the Betfair and other exchange platforms. In my defense, I picked sports as just a provocative and emotionally attractive example of the idea that – enabled by technology – a vast array of new tradable markets in goods but also outcomes, would emerge. Work in progress.
• credit crunch and asset bubbles (D) although the overall purpose of the piece was to provoke thinking on the sustainability of existing business models in financial services in the face of radically shifting underlying technological, economic and demographic trends, I failed to include a thread touching on the possibility of catastrophic systemic discontinuities arising as a result of the prevailing market structure and business models. It’s a significant ommission, especially as at the time of writing this I was in the process of exiting my former responsibilities as a senior executive in the credit business due in part to my increasing discomfort with the sustainability and prudence of the risk pricing in that market.

All in all, I would give myself a mid-term grade of B+/A- with room both to improve and to slip back. Mostly on the right track, especially with respect to big themes but perhaps a bit optimistic in terms of some of the timelines. What do you think? Better? Worse? To be fair, the correct measuring stick is not so much whether or not I was right or wrong, even in terms of ‘macro’ predictions but whether or not this article and video helped catalyze serious discussion, debate and thought about the potential for disruptive and non-linear change in the financial services industry. Alas I have no idea how one could even attempt to measure that, but any thoughts or anecdotes you might have with respect to this would of course be appreciated.

Through the Looking Glass (2005)

Related articles by Zemanta

• How Obama’s new Wall Street proposals will – and should – punish Goldman Sachs. (slate.com)
• Goldman’s Escape Route Might Be the Private Road: David Reilly (businessweek.com)
• Wall Street, break up and go private (money.cnn.com)
• Goldman and JPMorgan — The Two Winners When The Rest of America is Losing (tpmcafe.talkingpointsmemo.com)
• One day… (parkparadigm.com)

1. I would set upon transforming the company into a retail financial services powerhouse, focusing in particular on developing markets like India and Brazil; and
2. I would buy Skype.

I don’t have time to articulate the whole thesis here (and besides, if they want the whole thesis they can hire me!) There are some hints in my Platforms, markets and bytes presentation.

The Economist has a good summary of the fix they find themselves in. I think they are at risk of becoming the new Microsoft, in that they buy all sorts of neat, smart start-ups (including a minority investment in Obopay), only to then kill them. According to the Economist, they are trying to adapt and having some success especially in markets like India:

All this will no doubt help Nokia come up with better, if not magic, products. The firm may even reach its goal of 300m users by the end of 2011 because its efforts are not aimed just at rich countries, but at fast-growing emerging economies where Nokia is still king of the hill, such as India. There, services such as Nokia Money, a mobile-payment system, and Life Tools, which supplies farmers with prices and other information, fulfil real needs, says John Delaney of IDC, another market-research firm.

Which only strengthens my view that their path to salvation lies in (yet another) complete re-invention, this time to a 21st century, sixth paradigm, retail financial services platform (built on a mobile substrate.) They might even want to keep (at least some of) their handset engineering know-how: it might come in handy for building handsets that are particularly well adapted to mobile financial services.

In any event, if Nokia want their share price to go up, they better hurry up and change their frame of reference. I mean really, who would you rather compete with? Apple? Google?

Or Citigroup?

Related articles by Zemanta

• CES 2010: Nokia issues $1 million challenge to developers (v3.co.uk)
• Nokia unveils new mobile financial service (news.cnet.com)
• Nokia Launches Life Tools, Commodity Prices From 291 Local Markets To Be Made Available (contentsutra.com)
• NovaBanca. (parkparadigm.com)