VC investors take different approaches to finding new investments.  I tend to think of it as a continuum with purely thematic investing at one end and a purely opportunistic approach at the other.

Thematic investing is where VCs research a macro trend or specific market, form a thesis around why this trend/market will serve as a good basis for building great startups, and then pursue as many exceptional investments in this theme as appropriate for the VC’s strategy.  IMO Bessemer is perhaps the most emblematic firm of thematic investing… all the investment professionals in the firm from senior partners to more junior staff team up in small groups to construct “roadmaps” of the themes in which they intend to pursue investments, which are then articulated more broadly within the firm.  While these roadmaps are used as guides rather than bright line rules, my experience suggests Bessemer tends to be fairly disciplined about this process and will pass on opportunities that might be compelling but are clearly outside the roadmaps they’ve constructed.  Other notable examples of highly thematic investors include Foundry (current themes here) and IA Ventures‘ overall focus on big data.

Opportunistic VC investors focus less on developing very specific theses and more on cultivating a deep, rich network around the entire firm.  Sometimes “opportunism” is used pejoratively but that’s not the case here… it’s not that these investors don’t have a clearly articulated strategy or will simply invest in any company that walks in the door. Rather these firms know that there are countless bright, hard-working entrepreneurs out there thinking 24/7 about the next big thing and so they remain open to these innovative ideas even if the firm hasn’t previously formed a specific investment thesis about that space.  Also really great opportunistic VCs are highly intentional about how they build their sourcing network and brand.  Two firms I respect in this regard are Greylock and Andreesen Horowitz.

It’s my experience there are relatively few absolute truths in venture investing… there are incredibly successful investors that pursue a purely opportunistic approach as well as ones that are thematic in nature.  There’s also plenty of examples of both who’ve been wildly unsuccessful.  So there’s no right answer about which approach is better.

At NextView we’ve intentionally taken an approach which combines both thematic and opportunistic investing for a couple reasons:

1) Our Overall Strategy is Highly Focused - We’re a dedicated seed VC fund, so we invest in startups exclusively at the seed stage.  We also invest only in software & internet enabled businesses.  And we invest in US-based startups,  primarily on the US east coast though we’ll consider other parts of country on a selective basis (roughly 15-20% of our portfolio is in the SF Bay area).  So NextView’s strategy already excludes large portions of the VC landscape in terms of stage, sector (no cleanteach, life sciences, IT hardware or semiconductors, etc), and to some extent geography.  This enables us to be opportunistic within the confines of a fairly narrow strategy, yet still meet very high quality startups within this smaller sphere.

2) Vast Human Capital Outside Our Walls - Rob, David, and I all try to draw on our experience as founders, operators, and investors in software & internet companies both in looking at new startups and forming investment themes.  But at the end of the day there are thousands of entrepreneurs out there who have deeper knowledge about exciting markets than we will ever have.  There are also new vectors of innovation (wholly independent of any industry sector) that are constantly emerging.  I have no doubt there will be exceptional entrepreneurs working on startups that fit clearly in NextView’s strategy, but might be outside themes we’re currently pursuing or who’ve come up with incredible innovations that can disrupt an area we previously dismissed.  We want to make sure we’re open to thinking about these opportunities with a blank canvas.

3) Great Opportunities Help Draw Us into Some Themes - While we are opportunistic in some regards, we also think specific themes can be very important.  Sometimes we develop themes on our own and then pursue investments based on that thesis.  A good example of that has been the thesis my partner Rob built around online education which actually began even before we formed NextView.  It led us explore a large number of potential opportunities, including our ultimate investment in Boundless.

But other times the entrepreneurs we meet opportunistically end up catalyzing new investment theses we ultimately pursue more thematically.   A good example of that is our theme around the consumerization of business software.  Back in 2010 we were observing more and more new B2B startups emulating the product and customer acquisition strategies of existing consumer web companies which my partners & I have long been familiar with.  We ended up making two investments in these sorts of B2B SaaS companies in 2010 (InsightSquared and SalesCrunch) and as they say two points forms a line.  In 2011 we developed this into a more comprehensive theme which helped form the basis of our investments in GrabCAD and Objective Logistics.  We VCs like to pride ourselves on pattern matching, and in this case a pattern emerged from our opportunistic approach which directly led to a more specific theme.

So we’ll continue to blend both thematic and opportunistic investing here at NextView.  It suits our team and investing style, and it least for us we find the two approaches to be highly complementary.

Farmeron announced the closing of its $1.4M seed round today.  NextView is thrilled to have co-led this round along with our friends at SoftTech VC and Farmeron’s existing investors 500 Startups, Seedcamp, and TAG.

I first met Matija Kopic, Farmeron’s co-founder & CEO, a few months ago.  It was one of those first meetings where you’re instantly impressed by an entrepreneur and the ambitious vision they’re pursuing.  We’ve invested in quite a few SaaS businesses though I have to admit this is the first time we’ve invested in one that’s not priced by software seats or flat annual subscription but rather $/animal/month.  So it  took me a minute to describe to my partners why SaaS for cows is incredibly exciting…

Farmeron is a SaaS company focused on the data management challenges facing the agriculture sector.  When you think of web-enabled startups, farms don’t instantly spring to mind.  Yet agriculture is a massive global industry and one that is increasingly reliant on data for a range of needs – improving production, benchmarking across farms,  even regulatory and financial reporting.  Trained as a computer scientist and coming from a family whose background is in large-scale corporate farming, Matija saw a clear opportunity to solve many of these data challenges with easy to use web-based software.

Initially focused on dairy & livestock operations, Farmeron’s system takes in data from a myriad of sources from farm production systems (e.g. automated milking machines that spit out data) to veterinary data (e.g. age, weight, immunization, breeding status, etc) to inventory management info (e.g. feedstocks).  Some of this data remains in “siloed” offline computers (pun intended) or even requires manual input.  But increasingly even centuries old industries like agriculture are becoming highly automated, in both developed and emerging economies, with more internet connected systems and data nodes generating raw information.  In time Farmeron will likely expand into crops farms (e.g. wheat, corn, etc) but livestock alone represents a massive market opportunity for the company.

More broadly, the business Farmeron is building is an example of an overall wave of an “Internet of Things”.  There are now more internet connected devices and sensors than people accessing the internet, as Cisco highlighted in 2011.  The white paper they wrote about it is here and there’s also a useful infographic.  In fact Cisco highlighted a company making wireless sensors for tracking cows and other livestock.  As the number of systems and sensors connected to the internet continues to proliferate, we strongly believe this will create opportunities for both B2B and consumer-facing startups to help build this infrastructure, enable applications on top of it, and derive insight from the data they generate.

We’re incredibly excited and privileged to work with Matija and the rest of the Farmeron team to build a great company.

As many of you may know, we have a section on the NextView website called “Ethos” where we describe five key principles to how we operate.  My partners and I have blogged about some of these including Invited Guest, Golazo, Authentic, and Tribe.  The last is Blank Canvas which I wanted to touch upon today.

To us the notion of painting with a blank canvas has both inward and outward facing components.  We love meeting entrepreneurs who take this blank canvas approach when thinking about disrupting markets.  Just because it hasn’t been done before or hasn’t been done in a particular way doesn’t mean it can’t be done… in fact many of the greatest businesses have been built by doing just that.  This is how new markets get created.

Sometimes even what seem like incremental innovations can have radical impact, if talented and creative people start with that blank canvas and envision the future as it should be not as a derivative of how it’s been.  Apple’s not a startup but thanks in large part to the spirit Steve Jobs infused in the company, they do an incredible job of imagining a product from scratch as it should be.  This is true not just for entirely new product categories like tablets, but even existing ones… smartphones had been around for 5+ years before the first gen iPhone launched in 2007 (remember Palm Treos and the original Blackberry phones?).  On the startup side, Square’s done a particularly good job of this in payments.

My partner David recently wrote about how investors tend to bring their own inherent biases (both good and bad) into pitch meetings with entrepreneurs.  We try hard to bring our own blank canvas into these meetings so that we can better conceive and appreciate the vision of founders we meet with.  It’s not easy to check our preexisting biases at the door and sometimes we leave meetings as true believers and sometimes as skeptics.  But it’s something we strive to do and I believe serves us well.

Similarly Rob, David, and I try to think with a blank canvas, both in starting NextView in 2010 and on a continuous reevaluation of how we invest and how we might better help entrepreneurs build great companies.  I wouldn’t say we’re radically reinventing venture capital and there are many firms we respect who have been innovating recently in connecting a portfolio of startups into a network, taking a different approach to how to staff a VC firm, and even the pace of VC investing.  But whether it be how we collaborate or seeking new/different ways to help our portfolio with technical recruiting, we aspire to constantly rethink how we might improve… each time starting with our own blank canvas.

I was back in the SF Bay Area last week for a bit of work and a bit of fun.

I spent some time with some startups in San Francisco proper, as opposed to the heart of Silicon Valley (see Note 1).  Startups in the city of SF are not exactly a new phenomena… a bunch of startups have been founded/built in SF in the last five years or so.  And going even further back there have been a few random ones have been built before like Salesforce.com and e-tailer RedEnvelope (IPO’d in 2003 though now defunct as a company).  But it’s only very recently that you have a large number of startups reaching scale in SF – companies like Zynga, Yelp, Square, Dropbox, Twitter, AirBnB, Yammer, and others that employ hundreds of people.  The kinds of places where you have to sign an NDA when you walk in the lobby…

When I lived and worked in the bay area (2000-2005) virtually all the startups were down on the peninsula somewhere.  The prevailing view of senior startup execs was that trying to build a company in SF would be too distracting for employees, and frankly most startup employees at the time preferred to live in the suburban areas of the peninsula rather than in the city.  If my memory serves me, <10% of our pre-IPO employees at PayPal lived in SF and literally 1 of the first 40-50 folks at LinkedIn were city-dwellers.  Also all the big anchor companies that a startup might want to partner with at that time (eBay, Google, Oracle, Yahoo!, et al) were down on the peninsula.

“Silicon Valley” (see Note 2) is hardly alone in this urbanization of startups trend.  Here in Boston the same dynamic as Silicon Valley has been afoot… at least in the software/internet sphere, the majority of startups have migrated from the suburban loop of Rt 128 back into the urban core of Boston & Cambridge.  New York never went through a phase as a suburban startup hub… basically just an urban boom as Silicon Alley 1.0 in the late ’90s and then again a renaissance in the last 5yrs (both in Manhattan & Brooklyn) which has roughly coincided with a broader urbanization trend.  And if you look elsewhere at places like Seattle you see the same pattern; Microsoft may have been built in Redmond, but Amazon and many of the more recent startups like Zillow, Redfin, Zulily, etc are all in Seattle’s downtown core.

So why are software & internet startups more urban today than 5-10 years ago?  And what are the implications for these various startup hubs at an ecosystem level?

1) Younger people building companies - Many of the biggest technologies companies ever built were started by people in their 20s.  This is true well before the internet era of Facebook, Yahoo!, and Google… Bill Gates & Paul Allen at Microsoft were a decade or two earlier and going even further back Bill Hewlett & Dave Packard were fresh out of grad school when they started HP in 1939.  And the potential rewards to joining a startup as a young person have always been there… not just financial if a startup is successful, but also the ability to have outsized influence and leadership roles relatively early in one’s career.

But the last 3-5 years has seen a significant increase in the number of young (<30) people starting companies and working in startups, relative to the ’90s and early ’00s.  I describe this in part as the “Social Network” effect… not just the movie itself but the example of Mark Zuckerberg and many other high profile young founders as role models (who can forget this image?) for college students and recent grads to work in startups.  But more broadly than just that,the direct costs of launching a startup have obviously plummeted which makes being a founder more accessible than historically.  And for non-founder employees, as the broader employment markets even for college grads has gotten softer, the opportunity costs of a joining a risky startup have never been lower.

2) Design ethic vs engineers - Over the course of the last 5-10 years, many software-based startups are being built on competitive advantages of design and business model rather than technical differentiation.  I’m not suggesting that there aren’t lots of hard technical problems being solved in today’s startups… nearly any developer worth his or her salt could build Facebook or Twitter like products for a few hundred users, but few can make them scale to hundreds of millions.

But as design and UX become more core elements of startups, it’s natural that companies will be started by and increasingly staffed by design-oriented folks.  And many of these folks are drawn to working and living in urban centers.  I know this is a gross generalization… there are plenty of developers sporting Warby Parker frames or designer shoes rather than a Warcraft t-shirt and beat-up sneakers.  A hacker ethic is compatible with an urban setting just as design oriented one is compatible with a suburban one.  But generally speaking as more startups are being built with a “design first” mindset, it’s natural that the kinds of talent attracted to these places changes slightly and more of them are being built in city centers.

3) Big companies follow – As more startup talent is concentrated in urban centers, it’s not surprising that large tech companies may follow.  Google started and is still headquartered in Mountain View, but they opened an office in SF at the end of 2007.  Here in Boston both Microsoft and Google have made significant expansions in recent years in Cambridge, and PayPal/eBay is poised to do the same in downtown Boston through acquisition and organic growth.  And to some degree these are reinforcing trends… as big tech companies build their presence in urban centers, it promotes additional startup growth nearby.

To be fair, an urban location isn’t for everyone.  Facebook’s in Palo Alto, LinkedIn is in Mountain View… clearly the ‘burbs still work just fine for building monster companies.  Apple’s been in Cupertino since inception and that seems to be working just fine.  And for the record NextView’s office is in downtown Boston but my wife & I choose to live in the ‘burbs.  But I think the urbanization of startups nationwide is here to stay.

==========

Note (1):  For those not familiar with the geography of the SF Bay Area, the city of San Francisco proper sits at the north end of a peninsula that stretches down to the smaller city of San Jose.  In between is the area generally referred to as “Silicon Valley” which literally sits between the Santa Cruz Mountains to the west and the western shore of San Francisco Bay itself.  It encompasses a stretch of towns including Palo Alto, Mountain View, Menlo Park, Sunnyvale, Cupertino, and others.  Most local folks don’t use “Silicon Valley” as a geographic term, rather people talk about the “City” (San Francisco proper), the “Peninsula” which is most of the middle part of Silicon Valley, or the “South Bay” which is the southern reaches around San Jose and further south.

Note (2): Now even startups in SF have co-opted the term “Silicon Valley” as it has more global recognition as a tech/startup hub than “San Francisco”.

Several years ago I wrote a post about the three business models of the consumer web: commerce, advertising, and user-paid premium services.

The consumer web landscape has changed meaningfully since I wrote that in 2006.  But I still firmly believe the overall framework holds true.  Some believe that there are “new” revenue models being created by consumer web companies, like virtual goods or “freemium” services.  But virtual goods are simply new flavor of a premium, user-paid service… it’s like paying for a game in intermittent installments, rather than an up-front license (e.g. most console games) or a monthly subscription (e.g. MMOs).  That’s why Zynga assiduously courts and coddles its whales.  And a freemium model is similarly a type of premium service, or potentially a hybrid between premium and ad-based business.

We’re witnessing a new wave in “big data” that extends far beyond just the consumer web.  That phrase means different things to different folks, but broadly speaking we’re now in an era where there’s vast amounts of data “exhaust” being generated by a wide range of activity… from consumer web browsing patterns to financial trading to social media content to purchasing behavior.  Lots of people more forward-thinking than me have rightly said that data is a powerful asset and aggregating, mining, and making it useful will be a core element of many businesses currently being built.

So is “data” now a new business model, as some suggest?  After all there are various ways to monetize data assets.  The good folks at IA Ventures have a primer slide deck publicly available, as big data is the core element of their investment thesis, and they divide the world into companies that sell data, those that compute & sell data, and data driven products.

But for consumer web companies, I think the short answer is not really.  At the end of the day, the actionable insights that come from various forms of data are capitalized through existing business models like commerce, advertising, and to a lesser extent premium services.

Let’s take a look at some examples:

1. Twitter – I recently argued that Twitter is essentially a media company, despite their protestations to the contrary.  Clearly the data within Twitter is a valuable asset both for the actual content of tweets and the meta-data around tweets (who, where, when, etc).  That’s why Twitter’s initial revenue came from licensing the firehose to search giants Google and Microsoft to increase the breadth of their search and potentially improve targeting of search ads.  So regardless of whether Twitter is a media company or not, even if one considered them a “data” business they’d essentially be an enabler of other advertising businesses.
2. Dropbox - Most people wouldn’t consider Dropbox a “big data” company per se, but clearly their product’s success is directly tied to the ever increasing data storage needs of consumers and small businesses.  That’s why even if Dropbox didn’t add a single new user this year, their 2012 revenue would still double from existing users increasing their premium storage needs (truly phenomenal).  But at the end of the day Dropbox’s business is as a premium service, and in fact what they do is essentially raw storage rather than generation of insights from the massive store of data they sit on top of.
3. Pinterest - Pinterest is capturing tons of data about consumers’ interest in products… what they like, how they share and influence others, what they categorize in relation to other products.  Their first revenue stream is simply inserting affiliate links to e-tailers into the pinboards that users create.  In the future they might sell data and data-driven insights to brands or e-tailers to help them better target their products and advertising, or they might engage in commerce themselves.  But at the end of the day Pinterest will monetize all of this data either directly on their site or indirectly through others via commerce and/or advertising.

There are countless B2B companies pursuing big data opportunities as well, and at NextView we think this is an incredibly exciting area of innovation.  That’s why we’ve invested in companies like InsightSquared, Hyperpublic, and Objective Logistics and are looking at many more opportunities in this vein.  Broadly speaking though, these B2B companies are essentially “picks & shovels”  businesses that are creating products and services to empower businesses to capitalize on internal and external data assets.

The enthusiasm for data-driven businesses is well founded, and I heartily share it.  Data is clearly an asset that can be monetized either directly or indirectly by driving more commerce, advertising, and premium services.  But “data” isn’t fundamentally a new business model, especially for consumer web companies.

CEO Dick Costolo famously said that Twitter is not a media company about six weeks ago at the AllThingsD conference.

To be fair, Costolo said that Twitter isn’t a media company but is “in the media business”.  To some that may be a distinction without a difference.  Costolo clearly wants to position Twitter as a complementary part of the media ecosystem (which it is by and large) rather than a competitor, and there remains a chance that Twitter will have other forms of revenue besides ads.

Like many in the tech startup ecosystem, I’ve been intrigued with Twitter as a business for years.  But frankly I can’t see Twitter as anything but a media company.  Here’s why:

1. Virtually all of Twitter’s revenue comes from advertising.  The rumors and estimates vary, but the most widely cited for 2011 was eMarketer’s guesstimate of $140M.  And Twitter CRO Adam Bain is focused primarily on growing this advertising base.
2. Most mass market usage of Twitter is by and for the media and celebrities.  Those of us in the tech ecosystem think of and use Twitter in slightly different ways, but the mass market usage of the product is consumers seeking exposure to news, celebrities, and sports stars.  In this sense Twitter’s real-time content is truly unparalleled in terms of not only reach but also depth.  But all the peaks in usage occur during sporting events, celebrity awards shows, and breaking news.
3. Twitter’s data is valuable primarily for advertising.  But what about Twitter as a “data” business not an ad-based one?  Twitter’s data could be valuable, which is why the company’s earliest revenue came from data licensing deals with Google and Microsoft.  But that data is valuable mainly as a way to better target existing forms of advertising (display and search) or to enable advertisers to increase exposure or better target Twitter’s new types of ad units like sponsored tweets and trends.  So even if Twitter’s data revenue were somehow to eclipse its own ad business, it will most likely be as an enabler of other ad-based models.
4. Twitter is unlikely to ever have a true commerce business.  There are lots of celebrities leveraging Twitter to sell their own products or establish e-commerce curation businesses.  That’s why companies like Beachmint are raising big rounds and why the Kardashians’ can sell millions of dollars worth of branded perfume, apparel, and jewelry.  And established companies like Dell and others use their Twitter accounts to drive e-commerce revenue.  Twitter itself can undoubtedly generate ad revenue to increase the e-commerce of other businesses, just as Google does.  But I’m highly doubtful Twitter will ever have a good opportunity to directly (as a seller of physical or digital goods) or indirectly (as a marketplace or hosted storefront) be a commerce business itself.
5. Twitter has ceded the premium service business to others.  While Twitter has acquired various client apps like TweetDeck, they let various 3rd party developers pursue the premium service revenue opportunity.  It’s highly unlikely Twitter’s product would support a premium service business for consumers (a la Dropbox, LinkedIn, NYT, etc) but there’s clearly an opportunity for businesses and marketers (e.g. Hootsuite, CoTweet, etc).  It’s probably not a huge market though.
6. Twitter isn’t really a social network.  The popular press frequently lumps Facebook and Twitter together, and in my mind both are essentially media companies.  But Twitter isn’t really a social network.  The “follow” modality is an interesting one and Twitter was a pioneer here where many others have now followed (sorry, no pun intended).  But it’s not the same thing as a social graph, and furthermore it’s not a platform in the same way Facebook is.  Compared on typical media metrics of reach and engagement, Facebook stands apart which is why it’s both much larger as a business (30-40X bigger in revenue) and a far more valuable company.
7. Even a filter for content can be a media company.  Dick Costolo rightly boasts that Twitter is one of the largest referrers of traffic on the web.  A huge percentage of tweets contain links to other content, and consumers undoubtedly look to Twitter as both a source of content and as a filter or discovery tool for other content. But that doesn’t mean Twitter isn’t a media company.  We don’t think of it this way, but for most of the last century Reader’s Digest was essentially a filter for the traditional print media industry by condensing or rewriting articles that appeared in other publications.  At its peak it became the most widely read magazine in the US and generated billions in annual revenue, before its circulation ultimately waned and the company went through reorganization by a private equity firm and ultimate bankruptcy.  But it’s hard to dispute that Reader’s Digest was anything but a media company.

In all fairness to Twitter, they’ve build a remarkable product and may be on their way to building a remarkable business.  As a source of real-time content and information, Twitter really has no peer in most global markets (China being the most notable exception where local clones dominate).  In the private markets Twitter commands a higher revenue multiple all the other high profile Web 2.0 companies (Facebook, Zynga, Groupon, LinkedIn, etc).

But it puzzles me when companies publicly and vociferously deny how most of the rest of the world views them.  Google and Facebook are very different companies than Time Warner, but at their core they all provide content and information to consumers and monetize that engagement with advertising.  They’re media companies.  I wonder if Twitter, as a business, will be able to fulfill its significant potential if it doesn’t embrace its true nature.

Yesterday Yahoo! filed it’s much awaited lawsuit against Facebook for patent infringement.  New Yahoo! CEO Scott Thompson alluded to their plan a couple weeks ago but the IP lawsuit itself was only official late afternoon yesterday (and now public).

You can read the whole complaint in the embedded document here (from AllThingsD’s coverage).

I’m not a lawyer so I can’t provide a deep analysis of Yahoo!’s claims of IP infringement or offer a litigator’s perspective of Yahoo!’s chances in court.  I have some limited experience in dealing with patents though, both from my time as a VC and also back in my own startup days.  In the early days of LinkedIn we jointly acquired an issued patent of the defunct SixDegrees.com which directly pertains to social networking as well as acquiring a nascent startup in part for its in-process patent filings.  And at PayPal we were hit with a couple patent disputes while in the midst of our IPO process.

I skimmed the text of the Yahoo! complaint.  The bulk of the patents they believe Facebook is infringing pertain to things like A) display & targeting of online ads, B) online privacy, C) personalization of a user’s web experience, D) general online messaging (Yahoo! owns a bunch of patents around email, IM, etc), and yes E) social networking.

My layman’s reading is that Yahoo!’s claims are pretty lame.  Regarding social networking, Yahoo! holds a patent (USPTO #7747648) which essentially details a system of modeling people, places, and objects within a website.  It was filed in 2005 and issued in 2010 which means there was a good deal of prior art around SNS before Yahoo filed.  While it was still a college-focused SNS, Facebook of course launched in 2004 and there were plenty of other examples of social networking already… Friendster (2002), LinkedIn (2003), MySpace (2003), Orkut (2004).

All the other stuff Yahoo! claims (A-D above) could describe the vast majority of consumer-facing websites today, many of which incorporate elements of personalization, privacy, ad targeting, and messaging.  Ultimately a judge will have to sort all this out, unless Facebook & Yahoo! settle out of court or Yahoo! simply drops its suit.

So if the claims themselves are pretty lame, how about the timing of Yahoo!’s lawsuit?  On the face of it, that too seems pretty crazy.  It’s not as though nobody’s heard of Facebook before, yet Yahoo! only notified them of potential IP infringement two weeks ago on February 27, 2012 (as described in the lawsuit) and Facebook heard about it through the media rather than in private.  So Yahoo! hardly tried to deal with Facebook on this issue outside the court system.  But despite it’s tenuous merit, the timing of Yahoo!’s suit is actually pretty rational.

Patents and the threat of patent infringement lawsuits provide maximum leverage against a competitor when they’re in the middle of a strategic inflection point… a major financing, acquisition, or large product launch.  The threat of disrupting a strategic inflection maximizes the power a plaintiff holds, since the defendant may be more motivated to settle regardless of the merits.  With Facebook in the late innings of its IPO process, Yahoo! has essentially made the best play of what my estimation is a pretty weak hand.  At PayPal we made the calculated decision to settle a patent suit in early 2002 (for a minimal amount) which had little merit in order to minimize the disruption to our IPO process.  Yahoo!’s seeking a preliminary injunction in their lawsuit and I’m doubtful they’d seek a de minimus payment in any settlement process, but they might try to seek some other accommodation with Facebook that Yahoo! deems valuable.  That being said, it wouldn’t surprise me in the least if Facebook’s leadership takes a scorched earth approach to fighting Yahoo! in court if necessary even if it meant delaying their IPO slightly.

In addition to leverage, new Yahoo! CEO Scott Thompson clearly believes that proceeding with this lawsuit will serve as an external or internal signal.  New CEOs often like to take a bold step early in their tenure to establish their leadership, appease restless shareholders, or otherwise tell the broader marketplace that things are changing.  Thompson reportedly dealt with this IP lawsuit personally along with Yahoo!’s chief legal counsel, with few other senior Yahoo! execs involved.  So put in the context of Facebook’s IPO process and a new Yahoo! CEO at the helm, Yahoo!’s timing starts to make sense.

Again… let me be perfectly clear, I think this lawsuit is really lame.  If I were involved with Yahoo!’s leadership team, I personally would have vigorously opposed this move because I think any benefit which might accrue to the org would be overwhelmed by a range of costs.  Whatever few good people are left at Yahoo! are probably utterly demoralized that Yahoo!’s strategy and ability to compete in the marketplace has been reduced to the level of patent troll.  Whatever door might have been open for Yahoo! to collaborate with Facebook now or in the future has been slammed shut.  And whatever esteem the broader tech world might still hold for Yahoo! is being eviscerated.  But if Yahoo! was ever going to pursue patent infringement against Facebook, now is arguably the best time for them to have done it.

I remember when Yahoo! was my browser home page, easily my most frequently used site.  I didn’t use every Yahoo! property over the years, but certainly frequented not just search but also News, Yahoo! Mail, Sports, etc.  Maybe I’m just a fuddy duddy of the internet world… but it’s sad for me to see that it’s come to this a true pioneer and former pillar of the consumer web.

In the fall of 2010 I laid out reasons why all the tech “bubble” chatter was really more the hallmark of a reasonably sustained boom, and then revisited the topic almost one year ago to the day.

Well what’s happened since then?  Three of the five “blockbuster” tech IPOs I predicted have happened (LinkedIn, Groupon, Zynga) and the biggest of all (Facebook) has filed and will likely go public within the next 90 days.  The secondary wave of VC-backed IPOs has also come to fruition… both consumer facing (Yelp, Demand Media, Pandora, Carbonite, HomeAway, Angie’s List, et al) and B2B (Jive Software, Brightcove, Imperva, Responsys, etc).  The pipeline of companies in registration has continued to grow.

It’s taken more than a decade since the tech bubble’s inflation and bursting but to me all of this is part of a long-term normalization of the tech IPO market.  New regulations (Sarbanes-Oxley), changing dynamics in the public investor landscape (greater influence of hedge funds, HFT, etc), and a shifting focus of investment banks all contributed to the lull too.  But even during the macroeconomic boom of 2004 to early 2008 (inflated by various credit bubbles – housing, sovereign debt, LBOs) tech IPOs were extremely rare and then the global economic crisis of late 2008 – 2010 only further dampened hopes for a recovery.  I remember when it was a rare, extraordinary thing for a software/internet startup to even file an S-1.  Now there are filings virtually every week and quite a few of these companies have already gone public.

So now what?  What are the implications for other late-stage private companies thinking of making the transition to public markets in the near to midterm future?  What’s the impact for early-stage startups?  I see several dynamics at work in today’s IPO markets.

1) Macro Environment Still Dictates IPO Windows - While 2011 saw dozens of tech IPOs, macroeconomic conditions still dictate when companies can successfully complete an offering.  There’s some natural seasonality to the capital markets, but if you recall companies like Zynga and Groupon originally expected to price offerings in September 2011 after the summer lull.  But the latest fit in the slow motion train wreck that is the European sovereign debt crisis quickly dashed those hopes.  Groupon didn’t manage to get out until November and Zynga in December.

Right now the macro economic conditions are comparatively calm.  The US economy is still in a weak recovery mode, but fundamentals are sound and continue to progress.  But another flare up of the Euro crisis could happen at any time, or oil shocks prompted by Mideast conflict and escalation are still very real possibilities.  While I believe the tech IPO market is normalizing when taking the mid-long term view, short term disruptions are still likely to occur.  Would be issuers may have to be patient, but hopefully only for months and not years.

2) Viable Businesses – The Bar Remains High - By and large, the only companies (and by extension their bankers and existing VC backers) attempting IPOs are ones that have viable businesses of meaningful scale.  Investment banks of varying size and prestige might say slightly different things, but typically it means over $50M in trailing sales and a run rate near or above $100M.  For SaaS or other recurring revenue businesses these figures might be on a bookings basis rather than GAAP revenue, but conceptually they’re similar.  Also top line growth rates matter… a $50M business that’s still doubling every year is in a strong position, a $50M business growing 10-20% a year will struggle to get public.

Most companies in the IT sector are profitable at least on an operating or cashflow basis, though often not on a GAAP basis when non-cash expenses are taken into account.  It’s pretty rare to see smaller scale businesses or wildly unprofitable ones in the IPO pipeline, which is again good for the overall normalization of the market.  And finally margins matter… a $50-100M software company can go public given it’s 80-90% gross margins, an e-commerce company with 20-30% gross margins and high customer acquisition costs needs to be much bigger (probably 5-10x at least).

3) Public Markets Distinguish Strong From Weak - It takes 6-12 months for public market investors to get “comfortable” with a newly public company, and also for idiosyncratic factors like small float, insider lockups, etc to work themselves out.  We can have a healthy debate about what the multiples of rapidly growing software & internet companies should be in absolute terms, but the public markets are very clearly distinguishing between the stronger and weaker businesses based on profit margins, growth, competitive advantages, etc.

Bill Gurley’s post last year does a great job analyzing why some businesses are valued at 10x+ revenue and most aren’t.  If you look at newly public companies in the software & internet sector you see a wide spread.  As of this week, here’s a sample of multiples:

• LinkedIn – 16x+ trailing revenue
• Zynga – 8x+ trailing revenue
• Carbonite – 3.4x trailing revenue
• Active Network – 2.4x trailing revenue

My point isn’t that Active “should” be valued at 2.4x or Zynga “should” be over 8x or any other specific company is appropriately valued.  Some tech IPOs have performed very strongly in the secondary market, others have struggled.  But importantly,  public market investors are clearly distinguishing between companies based on a variety of intrinsic and sector-specific factors and valuing recent IPOs pretty differently.  This is a good thing for the overall health and sustainability of capital markets… it’s bad for the ecosystem if all recently public companies go straight up or straight down.

4) Post IPO Consistency is as Important as Ever - If your company’s revenue and profitability are still quite unpredictable, you’re probably better off staying private for now.  Recently public companies that surprise to the downside are brutally punished.  Hardly the only one but Pandora was the latest to experience it this week with their earnings announcement for Q4 2011, the stock price dropping about 25% and well below the original IPO price of $16.

===========

So now what?  Well for entrepreneurs running late stage companies prepping for IPO in the next 12 months, it’s an excellent time.  If we experience additional macro disruptions (Euro zone, etc) it might constrain your ability to IPO for a brief period, but as of now the normalization of the IPO market appears healthy and sustainable.

For startups many years from IPO, it’s harder to predict what things will be like 2-5 years from now but I’m more hopeful the last 10-12 years were an aberration.  I’m not predicting a return to the unsustainable late 90s but rather a long-term normalization, where strong and rapidly growing tech companies have a decent shot at IPO’ing.  And even if your startup is unlikely to IPO someday, an aggregate increase in the number of public tech companies (coupled with large cash piles for big established ones) should make the M&A climate more favorable in coming years.

Startups in NextView’s portfolio frequently receive inbound interest from other VC investors who are intrigued about what they’re doing, and I often talk with other early-stage entrepreneurs how to approach similar situations.

It’s obviously a nice thing to attract the interest of smart folks you might want to get involved in your startup as investors at some point in the company’s lifecycle. And fundraising is rarely easy so it feels good when the “top of the funnel” essentially starts to fill itself. Each situation is unique of course, but there are a handful of suggestions which I think are common across most startups for how to think about this type of preemtive interest from VCs.

1) Timing Matters – Sometimes startups garner the attention of VCs shortly after they’ve made a big press announcement, which often is closing a round of funding. If you start receiving inbound interest from VCs within the first couple months (or even weeks!) after you close a round, decide up front whether you want to engage with them.

If you and all the people around your startup (co-founders, advisors, existing investors) feel strongly that the company A) could benefit from additional equity capital at this time and B) you’ve accomplished value accretive milestones since your last round of funding, then it might make sense to talk with potential new investors. You might raise your next round of capital sooner than anticipated, but as long as it’s from folks you’re excited to work with on terms you and your constituents find acceptable that’s a great outcome.

The difficulty I’ve seen some startups encounter is when they’re uncertain about A or B above and they do engage new inbound investors. Entrepreneurs can sink a lot of time into fundraising discussions that go nowhere or end with actual term sheets but ones they’re not prepared to accept (firms you don’t want to work with, terms you don’t like, etc).

2) You’re Entitled to Say No – Some entrepreneurs I’ve discussed this topic with feel compelled to speak with VCs, whether partners or junior staff, that reach out to them.  At the end of the day it’s your company and your time… be intentional about what you do.  One needn’t be a jerk about it, but if you don’t want to talk with a particular VC that contacts you or if you don’t want to talk with any VCs at present you should feel free to say no.  Even if it’s someone you want to talk with in the future, good investors respect entrepreneurs who say “we’re not talking with new investors right now, but I’ll be in touch with you if we do start raising additional capital.”

3) Smoke vs Fire – You also need to parse the nature of the interest you’re getting. A GP you respect from a firm you like asking to meet in person with you is different than a cold call from an associate or other non-partner level investment professional.

Different VC firms take different approaches to proactive “prospecting” of this sort.  Some are highly targeted… they have a clear investment thesis and approach a small number of companies they learn about that clearly fit that model.  Other firms basically take a shotgun approach, and have associates call virtually every company that’s raised a seed or Series A round.  There’s unfortunately no easy way to determine whether a lobbed in call or email represents smoke or fire.  This is one area where a good set of advisors or existing investors can often provide useful input based on their dealings with a broad set of individuals and firms in the VC ecosystem.

Also there’s different schools of thought on whether to talk with associates or other junior staff.  Some folks feel you always should, some feel it’s a waste of time and you never should.  Larry Cheng had a good post which detailed how VC firms handle these kinds of calls… Volition is a later/growth stage firm but conceptually this is similar to early-stage investors that do outbound calling too.  My perspective is basically to make an informed decision on a case-by-case basis.  If you’re contacted by an associate at a firm you’ve wanted on your own radar (based on their knowledge of your market, the firm’s reputation, whatever), then by all means speak to them.  This is sometimes a good path to getting the attention of partners in the firm if you don’t have other avenues.

But be honest with yourself too.  Getting a bunch of cold calls from associates from firms you respect may feel good, but it’s the very beginning of a process.  For every 100 calls these folks make perhaps 1% or less result in an actual investment.  Don’t mistake smoke for fire, and make your own independent judgement whether you want to raise capital or not.

4) Know Your Reservation Price - If you do engage with inbound VCs, know your reservation price before you start these conversations.  And when I say reservation price I don’t just mean valuation… I mean the broad contours of a round that you’d be willing to do which includes not just valuation but size of the raise, syndicate, etc.  If you’re in a preemptive conversation or set of conversations before you’d normally be raising additional capital, know what it would take for you to accept a potential offer so that if you do get it you’re prepared to deal with it.

5) Mix It Up - As I often say, either be fundraising or not… there is no “try”.  If you do decide you would consider raising a preemptive round and you choose to engage with inbound VCs, there’s nothing that says you can’t also approach other firms you want in the mix even if they didn’t contact you inbound.  Again, be intentional.  We sometimes see startups engage in a process just with the VCs that contacted them inbound and regardless of what the outcome is, they’d usually be better off if they spoke with all of the potential firms on their target list simultaneously.

We recently completed the final close of NextView Ventures, LP and we’re excited about both our progress to date and our plans for the future.

My partners and I wanted to peel back the curtain slightly for those of you who’ve been following our progress, and also acknowledge the help and support numerous folks have provided as we got this new VC firm off the ground.  NextView’s inaugural fund is just over $21 million.  We’re thrilled to have among our limited partners a select group of individuals from the startup ecosystem as well as several large institutional investors (including a university endowment, a corporate pension fund, and a multi-family office).  We held our initial close in March 2011 and then wrapped up the final commitments towards the end of 2011.

As many of you know, NextView is a seed-stage VC fund.  We make initial investments of $250-500K in the seed rounds of software and internet startups and reserve capital for follow-on rounds.  We typically lead or co-lead these seed round with other co-investors including other seed VCs, large lifecycle VC firms, and angel investors.  Our portfolio has grown to 15 companies today, the bulk of which is on the US East Coast and roughly half the companies have already progressed from the seed stage to completing Series A rounds.  The first of these to exit was recently announced, with Groupon’s acquisition of Hyperpublic, though most of the portfolio will continue to build for a long time.  Just under half our portfolio is B2B in nature, slightly more than half is consumer-facing in some way.

In launching NextView and raising capital for this first fund, we had the privilege of meeting a lot of potential limited partners.  Some said no to us for now though may track our progress for future funds, but several chose to invest in NextView now and we value their early commitment.  The venture industry continues to go through a contraction and upheaval… something like 80% of all capital committed to VC in 2011 went to just 7 large funds, so raising capital for a new firm during this time posed its own challenges.  As I’m fond of saying to entrepreneurs, startup fundraising isn’t about convincing the skeptics but rather finding the true believers.  A startup VC fund is no different and we were fortunate to find many true believers in NextView.

There are countless folks who offered guidance, support, introductions, and help throughout the last 12-18 months as we launched NextView.  These include many of our colleagues in the VC industry, folks from our prior firms, and a handful of people in the LP community who offered constructive guidance.  There’s literally no way to name them all and Rob, David, and I have tried to acknowledge all of them privately (you all know who you are).  We owe you and many more a debt of gratitude.

As one of our mentors is fond of saying, being a VC is easy… all you have to do is raise a fund and invest it successfully.  Neither are easy, but Rob, David, and I are excited to be done with the first part and can focus our energies on creating a successful first fund and building an enduring firm around our strategy and ethos.  The model’s working well so far but we know it’s very early days and the bulk of the hard work is ahead of us.