Emerging Enterprise Center Blog - Commentary and Analysis For Entrepreneurs and Startups

Sometimes I tend to think that bubbles are all bad.  I keep a book on my shelf titled "Extraordinary Popular Delusions and the Madness of Crowds" by Charles Mackay, LLD.  This book was originally published in 1841.  I read portions from time to time to remind myself that bubbles (including those in the South Sea) come and go.

Sometimes it is good to be reminded of the past -- even if you lived through it.  Here is a link to a lengthy, but thoughtful, blog post on the "bubble" of the late '90s.  Peter Thiel's Startup Class Notes.  My favorite quote from this post is "Bubbles arise when there is (1) widespread, intense belief that’s (2) not true."  This is, of course, in different words what Mr. Mackay might have said about Dutch Tulips or witches in Salem.

It seems to me that bubbles (good, bad or indifferent) airse when there is a lot of money hanging around with the result that people do irrational things with it.  The recent $646 million lottery is a good example.  As the pot got bigger the odds got smaller, but the rate at which money poured in increase.  More money chasing smaller odds?  Go figure.

Congress has just passed, and the President has just signed, a new law that is supposed to support capital raising by smaller companies.  It contains the so-called crowd-sourcing provisions that have gotten so much press.  It will be seen if this does something or nothing for small companies, but one thing it might do is send a lot of small investor money chasing every smaller odds of success. 

The bad new is that I have taken a blogging holiday since February 2.  The good news is that the holiday is the result of being pressed on client matters and business travel (including to China).  But, it is time to come back. 

As I have done each quarter for some time, this blog presents a comparison of the published statistics relating to venture deals from my firm, Foley Hoag LLP, and the west coast firm, Fenwick & West LLP.  This time I am not including Cooley LLP because their year end edition has not yet been published. 

Here are some general thoughts:

Foley Hoag, in our publication Venture Perspectives, reported on a total of 46 deals in New England.  Fenwick reported on 95 deals in the Valley.  This puts the New England market at about half the size of the Silicon Valley market  -- entirely consistent with historical norms (at least for so long as I have been observing the scene).  The new comer, of course, is New York, where, according to Crain’s New York business.com, there were 51 financings in Q4 in New York in the following industries 20 in software, 17 in media and 14 in IT (for sure there were other in other industries). 

On the one hand, this might suggest that New England is losing ground to NYC.  On the other hand, it suggests that the north east (New England plus New York) is now as big a market as the Valley and is probably growing faster given the velocity in NYC.  (I can hear the Valley folks saying you’ve gotta include Seattle and San Diego – whatever.  If that is where they take it, they have in effect conceded the point.)

Even more interesting, is that most of the New York deals are software, digital media and IT related.  Based on anecdotal evidence there were a significant number of digital media deals in New England (unfortunately, our survey lumps media in with software so I don’t have precise number).  According to Fenwick, the most active sectors in the Valley were software followed by cleantech and hardware then came internet and media followed last by biotech.

If I had to pick something hot today, it would be internet and digital media – and the epicenter is not in the Valley!  The reasons for this are almost certainly that the advertising industry is headquartered in New York, there are lots of digital and data infrastructure companies in New England, and there is lots of money in New England and New York to fund these businesses.  It is efficient to be near the relevant infrastructure (the advertising world).  Apologies to Nivi and all the other “you have to move to the Valley” proponents, but if you are working on a digital media company – don’t relo to the Valley quite yet.

So, with that as a background, below is my usual table comparing actual deal terms.

Comparison of Terms for Q4 2010 Venture Deals from Foley Hoag and Fenwick & West

(some percentages are approximate)

It pains me every time I write this, but there is a persistent and consistent difference in terms between New England and Valley deals.  Look at cumulative dividends and redemption.  The numbers are consistent quarter after quarter.  At least as to these terms (and painful as it is to admit, I suspect as to others), entrepreneurs get a better deal in the Valley than they do in New England.

This post discusses the Commerce Department’s proposals for the use of Fair Information Practice Principles (FIPPs) and enforceable, voluntary codes of conduct, in connection with Commerce’s proposal entitled “Commercial Data Privacy and Innovation in the Internet Economy: A Dynamic Policy Framework.” to protect commercial data.  Note, the Commerce Department’s proposal relates solely to commercial data and is more limited than the FTC proposal.

Here is the regulatory proposal: The Commerce Department, in its policy framework, is affirmatively recommending that “the United States Government recognize a full set of Fair Information Practice Principles as a foundation for commercial data privacy.”

As the Commerce Department points out, the Department of Homeland Security (DHS) has adopted a set of FIPPs to govern its use of personally identifiable information (PII).  Just so you get a flavor of what FIPPs look like, here are three FIPPs taken from DHS (and cited in the Commerce Department’s framework):

• Transparency:  Organizations should be transparent and notify individuals regarding collection, use, dissemination, and maintenance of personally identifiable information (PII).
• Individual Participation:  Organizations should involve the individual in the process of using PII and, to the extent practicable, seek individual consent for the collection, use, dissemination, and maintenance of PII.  Organizations should also provide mechanisms for appropriate access, correction, and redress regarding the use of PII.
• Data Minimization:  Organizations should only collect PII that is directly relevant and necessary to accomplish the specified purpose(s) and only retain PII as long as necessary to fulfill the specified purpose(s).

These FIPPs are broad, unobjectionable principles in the “mom and apple pie” category.  They also lack the specificity to provide much guidance for compliance and enforcement.  For example, how much transparency is enough to meet the standard?  How much individual participation is practicable? 

As a result of these kinds of ambiguities, Commerce is proposing that the FIPPs sit on top of “voluntary, enforceable codes of conduct” developed through a multi-stakeholder input process.  In Commerce’s proposal, compliance with an approved voluntary code of conduct would operate as a safe harbor from enforcement action.  To be eligible for the safe harbor, a voluntary code of conduct would have to be developed through an open, multi-stakeholder process and approved by the FTC for sufficiency.  As Commerce sees it, FTC approval might be obtained as a result of a request from a party or as a result of the resolution of a specific dispute. 

In the absence of a voluntary code of conduct, Commerce is, apparently, prepared to recommend FTC rulemaking or actual legislation.  Commerce clearly prefers the use of FIPPs with codes of conduct because they appear to be more flexible than either rulemaking or legislation.  Commerce may be right about the flexibility, but, flexible or not, Commerce does not seem to consider the potentially differing effect of any of these processes on differently situated groups.

Here is the rub:  Google’s ability to develop a voluntary code of conduct through “an open, multi-stakeholder process” is completely different from that of an early stage company that just got five million dollars of venture money, let alone a start-up with few hundred thousand dollars of angel money.  The internet is still evolving at an astonishing rate.  Companies that were once tiny have become titans (look at Google or Facebook).  There remain many of these stories to come.  The Commerce Department itself points out that “Between 1998 and 2008, the number of domestic IT jobs grew by 26%, four times faster than US employment as a whole…By 2018, IT employment is expected to grow by another 22 percent.”  This growth is driven by innovation.  Innovation, in turn, is driven by small tech companies.  Burdening these companies with rules and regulations that might make sense for Microsoft, Google and Facebook is tantamount to slamming the breaks on progress in one of the US economy’s few potential bright spots.

Here is post from Clickz on December 21 in which the FTC tries to explain what it means by do-not-track.  Here is the key paragraph:

The recent FTC report envisions a do-not-track mechanism that lets consumers opt out of third party tracking for behavioral advertising, which is one of the most common forms of online tracking. If companies wish to share personal information with third parties for purposes other than online behavioral advertising, we think some greater form of user consent should be obtained. The system as currently envisioned would not apply to ordinary first party tracking or to a first party's use of a service provider for website analytics, assuming the service provider makes no additional use of the collected data.

It is important to keep in mind that the FTC is not proposing a blanket ban on all tracking.  Having said that, it is still not clear to me that the proposal is not based upon the perceived creepiness of tracking and the emotional response of many people to the idea that they are being tracked. 

The reason that third party tracking is “one of the most common forms of online tracking” is that there are substantial economic benefits to it.  No one has really answered the question:  What happens if do-not-track actually results in many people opting out?

One thing is likely, the people who make money as a result of this kind of tracking wont any more.  So, whatever “free” content is being supported this way will either disappear or will be paid for some other way.

Another thing that might happen was suggested to me by a well known entrepreneur and investor here in Boston.  A great deal of effort and ingenuity will be expended getting people to opt in.  If this happens, it could have a lot of ramifications.  One consequence that he suggested is that once people opt in, they will have expressly agreed to the use of their information and there is likely to be much more far reaching and free ranging use of their information compared to the current system in which abusers are likely to be outed unpleasantly one way or another.  A second consequence that he suggested is that businesses will try to position themselves as first party providers in various ways and thereby evade the ban.  Finally, he suggested that the cost getting people to opt in will simply be added to the cost of innovation.

One thing is for sure, there is significant money to be made through behavioral advertising.  Until the cost of getting to good quality behavioral advertising becomes so high that it become uneconomical to go there, the money will be seeking ways to get there. 

At the risk of once more stating the obvious:  All the good things we all get for “free” from Google, Microsoft, Facebook, MapQuest et. al. depend on the ability of these companies to sell targeted advertising.  Furthermore, I am betting that a lot (almost all) of the great new things entrepreneurs are planning to bring to you for “free” will depend upon their ability to sell targeted advertising. 

As WiredPrNews.com puts it, “If the Do Not Track plan is approved and implemented, the repercussions for the online ad industry could be catastrophic.”

You can think it is creepy, you can think it is an invasion of your privacy, whatever.  But, make no mistake about it.  If the Feds actually do away with tracking (by having a super easy opt out or in some other way), the basic business models that bring you (an everyone else) all that cool free stuff, will have to change.

It will have to be paid for some other way.  Subscription fees and pay per use are my bets.  Maybe that is OK because it protects privacy.  But, have no illusions about it, such a change would favor those who have the means to pay and make the internet a difficult place for those who do not.  It will change the fundamental egalitarian nature of the web and will make it a less robust less valuable place.

I have not addressed the free rider problem.  That is can you (as an individual) opt out and still get all the goodies from Google that require that all the rest of us agree to be tracked?  The problem with this is, of course, that each person is likely to be incentivized to opt out because they will not pay the cost in “lost” privacy but will get the benefit of “free” stuff.  If enough people opt out, the goodies wont be there for anyone.  And, by the way, the rate of development of new “goodies” will slow to a crawl.

So, what should the Feds do?  Perhaps, the Feds should consider a regulatory structure along these lines: (1) promulgate rules that protect populations that need protections (such as children) with specific substantive rules around what information can be gathered, stored and monetized about these populations, (2) promulgate rules that protect specific types of information that are rife with the possibility for abuse (such as social security numbers or personal medical information), and (3) for everyone and everything else promulgate rules that require full and fair disclosure around what is and is not being tracked.  Other than these three things, the FEDs should consider doing nothing at all.

If you really want to opt out, you will be able to do so by simply not using Google, Facebook, MapQuest or any of the others.  You won’t be free riding, and, frankly, the value each of us gets from all these “free” online services is so great that few, if any, will opt out when the direct choice is not to have these “free” services.

I attended the MassTLC Mobile Summit at the Microsoft Nerd center this morning and was struck by how little discussion of the FTC’s recent proposals around privacy there was.  The issue is that FTC will regulate in this area.  As a matter of politics, there is no avoiding it.  The only issue is what will the regulations look like?

The tech community seems to think this is no big deal because industry will prevail.  By "prevail" tech folks seem to mean that the regs, whatever they are, will be so watered down that the regs will be meaningless.  Their position is that anything else is unthinkable because the really big boys, Facebook and Google –as well as many others, depend upon tracking and targeted advertising.  To put a damper on them would create massive disruption.  Also, traditional carriers have huge value in the data they have, so Verizon, ATT and etc. will not let it happen.

At some level you have to agree with these observations. 

But, the counterpoint to them is that the FTC has now come out with a proposal.  There is great political pressure on Congress to do something. There is wide bipartisan support in Congress for regulatory activity to protect personal privacy.  Finally, among the non-tech world (which is most of the population) is creeped out by the notion that they are tracked onthe web.

I am concerned that the tech world just does not recognize that the non-tech population really does not like tracking 9and other data gathering).  I think the tech world also underestimates the appeal of giving people a choice not to be tracked.  Strangely, Fred Wilson’s blog makes this clear.  He refers to the “silent majority” who are not troubled by the data collection practices of most web companies and the “vocal minority” that are.  My concern is that he may just be wrong. 

So, it is predictable that some compromise will be reached between the FTC and the large companies who are already alerted to the issues and are working on changes that will be OK for them.

One problem: large companies have different interest from early stage and smaller companies.  For example, large companies will have far greater resources to deal with and comply with all sorts of regulation.  If they are required to incorporate specific privacy based procedures into their product development and other activities, they have the financial and other resources to do this.  If they are required to make the gathered information available to consumers or place restrictions on “new” uses of such data they can carry the cost of doing these things.  In fact, big companies may support this type of regulation, in part, as a trade for leniency on tracking and, in part, because it will form a barrier to entry for little companies.

If this happens, regulation could go a long way to undermining the economics of some start-ups.  So, you can’t rely on Facebook, Google, Microsoft et. al. to carry the ball for early stage companies.

The FTC has a process by which interested parties can comment on and influence the outcome of proposed regulation.  The resulting regulation will reflect this input.  The problem that arises for small companies is that it (the process) is expensive and time consuming.  it takes time and money to write comments, track proceedings, contact congressmen etc.  Google, Facebook, Verizon, and ATT will be hiring armies of lobbyists to do this (they may already ahve the armies deployed) – but they will not be lobbying for changes that work for start-ups.  Smaller companies just will not be able to compete in the fight to influence regulation and may end up with a regulatory scheme that is not hostile to them.

Small companies and the people who invest in them need to find a way to participate in the process.  If they do not, they could be looking at a pretty bleak future.

Businesses with advertising revenue underlying them are all the rage.  According to Andy Payne, Groupon is raising a next round at a $3 billion valuation.  That seems frothy to Andy, and it seems frothy to me.  But, who would have thought Twitter would be what it is today?

Here is a simple thought.  The value of advertising has to bear some relation to the value of the things it is selling.  If the gross value of all goods you are trying to sell is $X billion, then all the advertising has to be something less than $X billion.  There is some upper limit on the value of advertising based businesses.

The value of all these businesses in the aggregate can’t increase all that dramatically from year to year, unless the underlying market for the goods they are selling is also increasing.  That has not been the case in the past few years, yet there has been a boom in advertising driven businesses.  It may be that there has been a shift in value from old style ad based businesses (like print ads) to new interactive ad based businesses like Four Square.  But, I will venture a guess that it is not dramatic enough to account for the vast increase in valuations for these types of businesses. 

If the two trend lines, growth in valuation of ad based businesses and growth in the underlying businesses that use ads, diverge greatly there is evidence that there is a bubble and there will be a correction.  Here is a link to a short video on Richard Dale’s blog Venture Cyclist that kind of makes this point.

The US secondary market for private company stock has exploded nearly 3,200% in the last several years!  Longer lead times to an IPO, more companies becoming profitable faster and the weakness of the public equity markets are all touted as reasons why (See the FT’s recent article on “The New Stock on the Block” - The article reports that the number of venture backed IPOs from a decade ago have shrunk nearly 93.7% ,whoa!). 

The article makes for excellent reading, and I will not rehash its contents.  Rather, I’m going to focus on the efforts by lawyers like myself to curb the ability of holders of stock of emerging companies to resell their founder’s stock or vested options to third parties in a private transaction before the company’s stock is available on the public market.  Why do we do this?   To control your shareholder base, after all, as an emerging company the last thing you want (as the founding/executive team) is to be dealing with a belligerent activist shareholder.  There are some other side benefits to this as well.  Keep reading for more...

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How is this for an understatement?

Subscribers aren't keen on reading through the fine print at the bottom, and they'll feel betrayed if they click through to your site only to learn that the special offer isn't valid on what they want to buy. (from Exceptions* Apply: Keeping Your Legal Text Quick and Cool, an article in Email Insider).

Actually it is a pretty good article which makes a number of common sense points about legal disclaimers in various special offers. 

But the point that it really makes, although the article does not say it, is that you need quantity of disclosure (that is all the right disclosures) and quality of disclosure (that is the disclosure has to be user friendly).  Quality of disclosure is really important because it generates confidence in, and comfort with, the site.

I have written about this sort of thing before.  In my post, More on Privacy and Flash Cookies, I noted that one of the claims in the law suit against Specific Media was that their disclosures are opaque.  Here is what the article I was discussing actually says, “The company's "privacy documents require college-level reading skills for comprehension and include substantial legalese, ambiguous and obfuscated language designed to confuse, disenfranchise, and mislead the users," the lawsuit asserts. “

This sort of obfuscation goes a long way to creating that creepy feeling of being used and undermining confidence in the system. 

As many people have pointed out, if you want a “free” internet, providers of content have to be able to make money somehow, and (as in broadcast TV) advertising is the easy answer.  The more people participate in the system and the better information advertisers have about the participants, the more value there is in the system and the more robust a set of “free” offerings the system will support. 

That does not mean turning big brother loose and creeping everybody out.  To the contrary, it argues for a clear set of well articulated and well understood standards that give users confidence in the sites they visit. 

Here is a link to an article by Wendy Davis on the ongoing issues around the use of Flash cookies.  This article is sort of about a law suit against Specific Media for “allegedly violating Web users' privacy by using Flash cookies for tracking purposes.” 

According to Wendy Davis, the point about Flash cookies is this, “Flash cookies can be used to reconstruct HTTP cookies, even when consumers have deliberately deleted their HTTP cookies to avoid tracking. Because Flash cookies are stored in a different place from HTTP cookies, users who delete the latter don't also shed the former. People can trash Flash cookies via Adobe's online controls, but many users don't appear to be aware of the cookies.”

Two things caught my eye about this law suit.  First, apparently, the law suit claims that Specific Media’s privacy policy is sufficiently opaque and hard to understand as to be misleading.  Here is what the article says, “The company's "privacy documents require college-level reading skills for comprehension and include substantial legalese, ambiguous and obfuscated language designed to confuse, disenfranchise, and mislead the users," the lawsuit asserts. “

Can you imagine, privacy policy documents written in legalese – there is a shock and a surprise.  Can you imagine that “ordinary” users don’t really understand all that legalese – another shock and surprise.  Furthermore, when was the last time anyone really read all that stuff.  When did you last read the “terms of use” for anything?

Any setting of standards in this area (privacy) to be fair has to take into account actual behaviors.  Writing a bunch of policy disclosures that are not easily understood and are not read (at least in part because everyone has figured out that they will take for ever to read and even longer to understand), does not cut it.

Another article, also by Wendy Davis, quotes Joe Barton (R-Texas) as follows, “There is now a small army of companies collecting, analyzing, trading, and using information about consumers' habits, purchases, and private data, while some of these practices may be entirely legitimate -- some, in fact, ultimately beneficial to the consumer -- I do worry that not only are many Americans unaware of these practices, but those who seek out information in privacy policies often come up against complicated legalese."

Just in case anyone is wondering what might be ultimately beneficial to the consumer, again from the second Wendy Davis article, here is how John Morse, President of Merriam Webster put it, “We know that the twenty million people who use our site want it to remain free, and we work hard to balance the needs of advertisers, which is what allows the site to remain free, with the privacy needs of our users,"

As I have written before, this is an area that just cries out for some principled basis on which to set expectations about what information can be gathered and how it can be gathered.  Abuses in this area will ultimately undermine usage and adoption thereby undermining the value of the network.  Fair and respectful gathering and use of data will increase usage and adoption and therefore the value of the network.  My proposal is that the regulatory argument should be about where that line is – that is what maximizes the value of the network.  I think this law suit and others like it makes it pretty clear that there are limits beyond which confidence will be eroded and real costs will be incurred.  The costs are hard to measure because they are costs that all of us pay in the form of diminished value in the network.

The other point in the Wendy Davis article on the Specific Media law suit that caught my eye was right at the end she mentions the attorneys bringing the suits and says this, “All of the Flash-cookie suits were filed by lawyers David Parisi and Joseph Malley [who I could not find easily on the web], both of whom are among the attorneys suing defunct behavioral targeting company NebuAd for allegedly violating users' privacy.”  The fact that these cases have not attracted more lawyers and more action may indicate that the bar doesn’t think there is much there or it may indicate that it is early on in a game where the potential damages are poorly understood.

Marc Theerman has an informative post on the Ringleader Mediastamp Law Suit. You should read the post, but the gist of it is that Ringleader, a mobile advertising company, has been sued because it is using a mobile "cookie" technology called Mediastamp. Apparently, this technology does not permit the person on whose system the Mediastamp technology is placed to opt out. As if that were not enough, unlike traditional cookie technology, the Mediastamp coding, apparently, cannot be erased (or at least not permanently erased).

 The fact that someone has brought a class action case around this technology suggests that someone thinks there are some damages. In any event the mere fact of a class action claim is a hassle. If it goes anywhere, and maybe even if it does not, it is may well have repercussions for what other advertising companies do and don't do.

 The presence of a claim, without regards to the merits, also suggests that there is some lack of clarity around what advertising companies can and cannot do. Any time there is a lack of clarity around an issue like this one, where there could be real money at stake, there will be this kind of friction and waste in the system.

 This brings me to my next point:

Why would someone deploy such a technology? What if you made it erasable, like traditional cookies? What if you let people opt out or opt in? The implication seems to me to be that the user (Ringleader, in this case) does not think that people would opt in, or the user thinks all would opt out or erase the program. So, they make it hard for you. Once you have it you are stuck with it.

A company that does this sort of thing (depositing a tracker on your computer/cell phone/iPAD that you canÕt delete or opt of), is admitting that people would never voluntarily let them do that. Otherwise, just ask and let people erase.

The biggest single problem with this sort of behavior is that users of computers, smart phones and other devices, kind of know that there are companies out there that will be doing things the users don't like or want. It breeds distrust and lack of confidence in the web. This kind of distrust slows adoption and becomes a drag on use. This is why we need clear standards that consumers and advertisers understand and that enhance confidence and quality of experience.

The Dodd –Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) came about as the government responded to the Wall Street meltdown and the recession.  In it however were some pet projects that did not seem connected to the issues that caused the recession in the first place, one example - the originally proposed “Revised Accredited Investor Standard”.  For a recap of who is an Accredited Investor read my fellow blogger, Dave Broadwin’s exhaustive feature on the same subject.  Also, see Fred Wilson’s blog and the Xconomy article on the start-up community’s concern that perhaps the bill would penalize and cripple the ranks of an important part of the start-up ecosystem, the angel investor. 

In the end, when it comes to the new Accredited Investor definition - it’s not that bad.  The new standard for accredited investor does raise the bar (but not by much).  To qualify under the new standard an individual’s net worth (or joint net worth with their spouse) must be greater than $1,000,000.  However, the net worth must exclude the value of the person’s (or couple’s) primary residence.  Perhaps the government does not want people to make investments based on the purported value of their house.  Why should you be able to claim that you have the ability to make a liquid investment in a speculative investment when most of your assets are illiquid?  The alternative income test of annual income over the last two years of at least 200K annually (or 300K if factoring in a spouse’s income) stays the same.  As a tangential thought, should someone who meets the income test but not the new net worth test be making what is in reality a speculative investment?

I spoke about the new standard and its impact with one the firm’s senior securities lawyers, and his response: “Sure they raised it, they have been talking about doing that for ages, and frankly I am bit surprised that they only raised it the amount they did”.  On the other hand, there are good arguments as to why the old standard was sufficient given how the world has changed over the last three decades and the ability for more investors to protect themselves via access to information and services that was once only available to the very wealthy (see Dave’s blog on this very subject).  At the end of the day, any way you slice it a higher bar means less people who can invest in start-ups without going through the cumbersome registration process which mean less angel financers and unfortunately harder time for start-ups to raise capital to bridge the valley of death.

Check out Foley Hoag’s official advisory on the Revised Accredited Investor Standard and talk to your lawyer to see how the new standard applies to you.

One of the blogs I read regularly is Mandel on Innovation and Growth.  While I agree that you need to be a little skeptical about what he writes, as is true of anything written by an economist.  I always wonder about the stats he does not discuss.  But, he is very focused on the communications industry (broadly defined), an industry that interests me as well.

If there is any sector of the economy that seems to have more entrepreneurial vibrancy than others it is communications (broadly define).  Think about all the stuff that is happening in the world of broadband (in healthcare, education, security, advertising, location related services, etc.), or mobile, or social networking to name the big obvious ones.

Anyway, Mandel has a chilling post titled “Why We Struggle: Too Much Housing, Too Little Information Technology.” Reproduced below is the chart that forms the heart of his most recent post.

Below is the gist of his post:

“the net real increase in housing fixed assets was more than triple the net real increase in IT fixed assets.  That may help explain why we are in such dire straits now—plenty of new homes, not enough investment in IT.”

If you think about the stats noted above and consider the stagnation in the housing market (the drop in sales of new homes announced last week), it does seem like we (the U.S.A.) spend the last decade overinvesting in stuff we no longer really want (housing) and not enough in assets that produce something we all want – jobs.

Fred Wilson has a nice post on net neutrality. Here is the gist of what he has to say:

Somehow net neutrality got painted as "regulating the Internet" when it is really all about not regulating the Internet. Net Neutrality is about keeping the way the Internet works today; an open Internet where innovation is allowed and freedom reigns.

While I agree, here is how I think of it: The internet can only exist with the consumption of limited public resources. A clear example of this is its use of broadband spectrum. Spectrum exists in nature, but there is only so much of it.  In order for all of us to benefit from it, we have permitted many companies to exploit the resource (and they need to get a return – which they are doing).

Unlike oil, for example, we don’t know how this resource may be used in the future. In the last 20 years the uses have both expanded and changed dramatically. In the case of oil it is still basically electricity, heat and gas (not much change since way before WWII). The story of the last 20 years is that the internet has grown to bring ever greater numbers of people into it for ever greater and more diverse uses.

To permit a few companies with a vested interest to control a limited public resource would put an end to the growth and evolution of the internet. Here part of the comment I put on Fred Wilson’s post:

Here is a bit of a tangent -- a different kind of tragedy of the commons. Would your cow get any grass if a few big herd owners were allowed to control access to the commons? The commons needs to be available to all on some fair basis. It can't be controlled by a few whose economic interest is to exact a toll for use of a resource that isn't theirs in the first place. (I know carriers (and others) invested in the infrastructure and need a return so it isn't as simple as I am making it out, but this is the gist of it.)

BTW: Metcalfe’s law says that the value of a communications network grows exponentially with the number of users. According to Wikipedia it can be state as follows: Metcalfe's law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system (n2). To the extent that we put an end to growth in the internet, we will pay for that with lost value.

There has been surprisingly little (any at all?) buzz in the entrepreneurial and venture community around the joint meeting of the FCC and the FDA at the end of last week. 

There is surprisingly little buzz around the combination of broadband and medical devices. 

But, there is surprisingly much R&D in the space (and it will grow massively, I predict). There are today heart monitoring, glucose monitoring and responsive intervention devices that use broadband. All these devices, and many more that exist or will exist, are subject to regulation from the FCC and the FDA. If these two agencies don’t coordinate, it will be really bad news for med device entrepreneurs and investors.

Well, they (the FCC and the FDA) are trying. The joint meeting (a first of its kind between these two agencies) is a start. But here is something even more stunning: The FCC and the FDA have announced and published a memorandum of understanding between them. This is the beginning of a collaboration in which they “agree to work together to promote initiatives related to the review and use of FDA regulated medical devices…that utilize radiofrequency emissions or otherwise fall under the jurisdiction of the FCC.” The purpose of this collaboration is to “increase regulatory predictability and understating of regulatory requirements for medical device providers.”

This is an excellent example of where regulation can do some good and actually grow the market for these new medical technologies. If there is a clear regulatory process that makes the approval process for these types of so-called convergent devices predictable and (hopefully) short, it will reduce uncertainty and risk and, as a result, the cost of innovation in this space. It will also mean more access for more people sooner. In effect, it will grow the market. But no regulation or uncoordinated regulation will lead to chaos, increased uncertainty and increased risk. All of which is anathema to entrepreneurs and investors. 

According to Wikipedia, Metcalfe’s Law states that the value of a telecommunications network is proportional to the square of the number of connected users of the system (n²). Done right, this regulatory process can enable Metcalfe's law to operate and grow the power and value of the network; done wrong it can stifle growth and innovation.

Stuart Brotman referred to this MOU as an “historic” event. There might be a touch of hyperbole in there, but he is probably not far off.

This type of cross agency collaboration is rare, but given the fact that so many industries will be using broadband for more and more activities, collaboration will be needed across way more agencies in the near future. 

If you are innovating in the medical device space, the educational space, the security space, and others or, if your revenue model involves targeted mobile (or on-line) advertising, watch out the regulatory wave is coming. 

I confess not to have been much of a TV watcher back when Happy Days was on the air, and I confess I never understood the phrase “Jumping the Shark.” So I am glad that Jeff Bussgang has provided an excellent explanation complete with video clip in his most recent blog post.

Turning from the ridiculous (Fonzie jumping over sharks) to the serious, Jeff Bussgang’s point that Apple may have peaked, I have no idea if this is the case or not. Apple seems to me to have risen from the near dead with a series of brilliant product and marketing coups. It does seem unlikely that anyone can keep up that pace, but stranger things have happened.

The observation that Jeff makes that I find very convincing is this:

Many commentators are ironically observing that Android may be to the iPhone what Microsoft Windows was to the Mac - an open platform that simply wins over time on volume because of its superior ecosystem.

In many ways the history of success in the tech world (as well as in most parts of the world economy) has been all about increasing access. I think I have said this before: main frames gave way to minicomputers which in turn gave way to PCs (soon to become secondary to smart phones (?)). In each step, the population that could (and did) use the device increase by orders of magnitude. 

The Apple products are very cool and the experience is great. But, to the extent that the level of control that Apple exerts to make this experience great slows down innovation and, consequently, adoption, almost by definition Apple will soon fall behind.

If past tech shifts are any indication, the fall won’t be slow. (It will be slow in that it will take years – but those will be in low single digits and certainly not a decade.)

In the mean time, I am enjoying my macbook and my iPad, but I am going to the new Droid this week.

Washington never ceases to disappoint.  I guess The National Broadband Plan is no more immune than anything else to Washington gridlock.  Here is a link to and article on the regulatory logjam over access regulation of access to high speed broadband from the Benton Foundation web site. 

Yesterday I attended an MHT on Health IT and the cloud. There are a couple of takeaways. 

First, and no surprise here, cost reductions are what is likely to drive adoption of cloud technologies by hospitals. But, privacy and security concerns are going to make the rate of adoption very slow. 

Second, and I think more interesting, there were three early stage health care IT companies that did what MHT refers to as “fast pitches”. One had a technology for storing and sharing images (such as MRI scans) across practice groups etc. Another was using on-line games (think Farmville) to deliver enhanced healthcare. The first game was aimed at improving weight loss. The third was providing on line video plus data interactive consultation between patient and doctor. 

The thing that struck me is that every one of these companies will be affected directly by the rules and regulations to be promulgated under the National Broadband Plan. 

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Everyone thinks things in the venture world are looking up. Numbers of deals are up, valuations are up, terms are friendly. VCs and entrepreneurs are lining Winter Street and Sand Hill Road holding hands and signing kumbaya. Well, not quite. Foley Hoag LLP, Fenwick &West LLP, and Cooley LLP have now all published their reviews of venture financing transactions for Q1 of 2010, and, while there are some interesting differences, the tone is generally upbeat. Having said that, perspective is everything and sweeping statements about the health of the venture economy are l likely to be wrong if you don’t take all the available facts into consideration.

Reports from these firms cover a lot of the same types of material however they each look at some different things and they each source the data in different ways.

Foley Hoag, my firm, is headquartered in Boston. Our publication, Foley Hoag Venture Perspectives, is devoted to an analysis of financings for companies headquartered in New England. We try to cover all New England deals (that is we don’t limit our reporting to deals in which our firm is involved). We cover activity levels, valuations, and terms. In each case we break it up between Series A investments on the one hand and Series B and later stage investments on the other hand. We also report on activity and size of deals by industry.

Fenwick describes its report as “Trends in terms of venture financings in Silicon Valley.” This firm reports on venture financings for companies headquartered in Silicon Valley, and reports on financing rounds, price changes, and something they refer to as the Fenwick & West Venture Capital Barometer (you will have to look that one up for yourself). They also report on a variety of deal terms.

Cooley has this to say about its report, “This quarterly report provides data reflecting Cooley’s experience in venture capital financing terms and trends. Information is taken from transactions in which Cooley served as counsel to either the issuing company or investors.” This firm reports on numbers of deals, valuations and certain terms. Cooley has nine offices, so their data comes from many regions but, as noted, is limited to deals in which they were involved.

Because we cover similar data (but not the same data) in different ways and present it in different ways, it just isn’t possible to compare the data from all firms on an apple to apples basis. So, I have focused this post on (1) activity levels (that is numbers of deals) and (2) deal terms. 

Activity Levels

All three firms are reporting increased activity in Q1 of 2010 over Q1 of 2009 and over Q4 of 2009.

Foley Hoag found that activity levels for Series A investments in New England measured by the number of deals was up both compared to Q4 of 2009 and Q1 of 2009. The picture was mixed for Series B and later stage investments. The number of these deals was down from last quarter but up from a year ago. It seems to me that variability is too great from quarter to quarter, so the year on year comparison seems to me to be more telling of the general direction of the venture economy.

Fenwick had this to say about the results they found, “1Q10 results were similar to 4Q09, with up rounds exceeding down rounds in 1Q10 49% to 32%, with 19% of rounds flat.” They also noted that according to their findings, internet/digital media had the best results while cleantech had the worst results.

Cooley had this to say about the deals they were involved in, “Though we saw a slight decline in deal numbers, we saw a significant increase in invested dollars compared to the same quarter a year ago. Additionally, up rounds reached a level we have not seen since the middle of 2008.”

In a big picture way, all three of us observed a modest but steady upward trend in the tech economy. 

Terms

The upward trend also appeared in the terms that companies are getting from their venture investors. I have tried to consolidate the deal terms reported on by the three of us in the table below. This table shows the percentage of deals having a particular term and compares the findings of each firm (to the extent that the firm covers the particular term) with respect to particular terms that appeared in deals closed during the first quarter of 2010.

Cumulative Dividends

The most striking comparison in this table is the fact that more than half of all New England deals carry cumulative dividends but less than 10% of Silicon Valley deals have them. That is huge difference. And, it is hard to explain. Many VC funds have offices in both markets. Based on that fact alone, I would have guessed that there would be a tendency to have some homogeneity within a fund and that this alone would cause differences to be much narrower than an order of magnitude. So, I checked out historical numbers going back a couple of years and this seems to be a persistent and consistent difference between New England and Silicon Valley. It certainly suggests that Silicon Valley is more founder friendly than New England, I am sorry to say.

Preferences with Participation

If the differences are striking when it comes to dividends, the similarities are striking when it comes to participation. Cooley’s numbers for Series A and Series C transactions seem to be higher than the norm, but this may well be due to peculiarities in the sample. This really begs the question why there is a seeming convergence around participation but not dividends. I don’t even have a good speculation around this one.

Redemption

With respect to redemption provisions, Foley Hoag is finding numbers that are twice as high as Fenwick (Cooley does not report on this term). This one, however, I think has an explanation. In New England the incidence of redemption provisions is trending downward rapidly. As I have said elsewhere, I suspect that this is in response to changes in accounting practices. The numbers probably reflect a more rapid response to these changes in Silicon Valley than New England, but I predict the will converge at a very low percentage over the next year or so.

Pay to Play

The incidence of pay to play provision is low across the board, but higher in New England than in Silicon Valley and higher than Cooley reports. My sense, entirely subjective, is that the difference is not particularly dramatic and probably reflects a slightly more conservative investment culture in New England than in Silicon Valley. I also predict that, as the venture industry works through the current very rough fund raising environment and more funds know where the stand with investment dollars, that the incidence of pay to play provisions will both decline to a lower number and converge across the country.

Antidilution

No surprises here. Weighted average antidilution is the universal standard. Full ratchet deals are rare everywhere, and, I believe, that they reflect unique circumstances.

Conclusion

While it is nice to be able to report an upward trend in our sector of the economy, it is not time for kumbaya yet. Let’s remember that it isn’t 2007 (which was a good, but not a great, year). We are staring at some chronic problems (trends like the retirement of the baby boomers and how is that going to be paid for and the staggering debt the U.S. and other countries have run up) and some acute problems (the debt crisis in Europe and the volatility of the stock markets). We are not going to dig our way out of this hole with a strong manufacturing comeback. We need a thriving entrepreneurial tech economy to lead the way. Fortunately, this sector looks like it may come back to life.

On March 20 of this year,  Mike Rosen, one of our Partners, wrote a post in his blog on the subject of the pending noncompetition legislation in Massachusetts. A lot of folks in the Mass entrepreneurial community have been pushing for a legislative ban on noncompetes similar to that enacted many years ago in California.

As Mike notes, legislation on noncompetes in Massachusetts took a step forward. When it, or if, it will pass remains to be seen. 

I am generally in favor of the legislation. I don’t see how it can hurt the tech community to get rid of this restraint on freedom of enterprise. 

But, I hasten to add that I am not particularly excited about the issue. Let’s look at what the law is in California. Certain noncompetes (employment related ones) were made illegal by statute. OK, that sounds great but… consider the basic elements of protection that a company might want from a noncompete. 

First and foremost: Don’t solicit my customers. Well, nonsolicits are not illegal in California (and no one is proposing to make them illegal in Massachusetts).

Second and secondmost: Don’t solicit my employees. Well, employee nonsolicits are not illegal in California (and no one is proposing to make the illegal in Mass).

Third and thirdmost (I guess I should give up with this rhetorical device before I get to sixth and sixthmost):   Don’t disclose (or use) my proprietary IP. Well, NDAs are perfectly fine in California. Does anyone think they should not be?

Fourth: If an employee invents something on company time or using company resources – should it belong to the company? Well, that is what the typical inventions agreement provides. 

You get the idea. It is like a venn diagram. There is a circle in the middle called noncompetition and there are many overlapping circles called NDA, nonsolicit, inventions and whatnot. If there is any part of the noncompetition circle that is not covered by one or another circle , it ain’t very big.

My point is that making employment related noncompete’s illegal won’t change much. Even Bijan Sabet (who says he tries to avoid noncompetes - see the end of his post on east coast term sheets) probably asks for all these other things (maybe he will comment here and set me straight by saying that he doesn’t go for non-solicits etc.). I could be wrong.

Many people in the tech community (myself included) think getting rid of noncompetes is a good idea, but it is not worth a ton of effort, and we got way bigger fish to fry – like net neutrality.

There has been a ton of discussion on the blogosphere about Senator Dodd’s ill-conceived plan to make financing harder for start-ups. Check out Fred Wilson’s blog. It will lead you to lots more stuff (in addition to the more than 165 comments – when I last looked). I don’t think there is much I can add to the general dismay over the proposed legislation.

But I did post a comment about the genesis of the term “accredited investor.” One of Dodd’s proposals is to raise the bar on who qualifies as an accredited investor. In short, for a person to be an accredited investor, he or she has to have a net worth in excess of $1 million or an annual income for the last two years of more than $200K (or $300K with spouse) and an expectation of the same in the current year. For more detail on the definition here is a link.

Accredited investors are people the SEC deems able to fend for themselves (generally). So, the standards of disclosure that sellers of securities have to meet are (generally) less stringent if they only offer and sell securities to accredited investors. (I apologize if I am dumbing this down too much. I don’t want to get too deep into lawyerspeak,) As a result, it is a far far easier process to raise money from accredited investors than from non-accredited investors.

The point of my comment is that the accredited investor definition was created by the SEC in the early 1980s and has not been amended since. The SEC thought that this level of wealth was appropriate to deem a person able to fend for him or herself thirty years ago. If you think about inflation, $1mm was a lot more in 1980 than it is today. So, why is it appropriate to have a “lower” threshold today than thirty years ago?

One argument might be that the SEC set the bar too high thirty years ago, but I don’t recall anyone really commenting on this in the time I have been practicing. On the other hand, no one (until Dodd) to my knowledge has been complaining that the level is too low.

The argument that convinces me that the existing definition is OK and should not be changed is that there is a vast difference between 1980 and today. In particular, there is a vast difference between then and today in the whole securities and investment world. The biggest difference, of course, is in the amount and accessibility of information. Anyone can find out tons of information about almost anything: people, technologies markets, securities etc. at any time of the day or night on a moment’s notice.

In addition, people are very familiar with how to obtain this information. In the 1980s there was a lot of public information available (nothing like today, but a lot) however it was actually hard to find. The SEC kept paper records. It was actually difficult and expensive to get the information. The rich could hire lawyers and accountants who knew how to obtain and understand the available data. The ordinary person could not.

To the extent that your ability to fend for yourself depends upon your ability to access information and gather opinions and insights from others, there is just way more reach than there was 30 years ago. So, despite inflation, I think the definition still works.

I am no Peak Oil maven, but I read some commentary about it in the comments to one or another blog that I read regularly (perhaps Fred Wilson’s blog or Brad Feld’s or Don Dodge’s, I am not sure). Anyway it the issue was what the effect of peak oil would be on technology companies. Aside from placing a huge premium on all sorts of energy related technologies (that is why some massive percentage of investment is going into this space), I am not sure why technology should be affected differently from other industries. Anyway, it caused me to read a little about peak oil and the various debunkers of the peak oil theory. No surprises there. But it reminded me of something I have thought from time to time. I bet that all the peak oil theorists and their debunkers have their facts wrong. I can’t believe this is an original observation, but here is why:

In my capacity as corporate/securities lawyer, I have been watching clients, investment bankers, and others (by they way back in the days of oil and gas limited partnerships – the people who put those together) put together projections and financial statements. I don’t think any (perhaps a few) ever put together projections or financial statements in bad faith. But, whenever you put together these kinds of numbers you have to make choices. They can be totally legitimate and appropriate choices. Here is an example, in determining the net present value of a future payment, you have to pick a discount rate. This is a judgment call. Within the range of fair and proper, almost everyone errs on the side that benefits them.

I am guessing that the calculation of oil reserves is not an exact science. It involves judgment calls like the one I just described. Within the range of what is fair and proper, what kind of estimates do you think big oil is making?

My guess is that nobody knows what the world’s oil reserves really are (or even has a reasonably accurate guestimate). The same, by the way, applies to the calculation of demand. My guess is that nobody knows what the demand will be (or even has a reasonably accurate guestimate). The inaccuracies, of course, compound each other (that is my guess anyway). I would guess that the world reserves are less than anyone thinks (including OPEC). We may, or may not, find additional new and vast reserves – who knows?

My theory is that people who are making big bets on new enery technologies are going to get a pleasant surprise. (Although the rest of us may not find it so pleasant.)

David Wessel’s recent article in the Journal, “A Prozac Economy has its Costs,” asks: If we were able to invent the economic equivalent of Prozac – something that would take away the high-highs and the low-lows of our current economy (think the tech bubble of the late 90’s and the current recession) – would we elect for a prescription? Would we, given the choice between a dynamic, volatile economy with painful depressive phases, and a more mellow economy with fewer crises but a slower growth rate over the long term than its manic doppelganger, settle for a calmer existence? Though my understanding of economics is limited to my college-level macro and micro courses, from an entrepreneur’s and VC’s point of view, I think my answer would be: give me manic any day.

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As everyone in the tech world knows, California has a statute making employment related noncompete agreements illegal. There is now a movement afoot in to make them illegal in Massachusetts. For reasons that I have noted before, I don’t think making these agreements illegal in Massachusetts will make much, if any, difference in the tech community. On the plus side, it will take one irritating concern off the table for employees seeking to move. But will it really change the east coast tech culture to make it more like Silicon Valley? I don’t think so. Having said that, Paul Boutin in a recent article in Wired described the Silicon Valley employment culture with these words, "Worker mobility gives the tech industry fluidity, velocity, and energy. It creates a culture in which people routinely jump from one job to another, looking to get in on the next must-have product or service. As it happens, that lack of loyalty has been a key driver of the Valley’s rapid innovation over the past three decades…" As evidence he sites AnnaLee Saxenian to the effect that job hopping facilitates the flow of knowledge between individuals and firms. I am guessing that New England has certain cultural traits that make a culture of job hopping unlikely, and doing away with noncompetes, while it will take an important irritant off the table for employees seeking to leave companies, it will not turn New England into Silicon Valley. Much more likely to have this result is for local VCs to start behaving more like west coast VCs – but that is a topic for another post.

For those of us with businesses or clients in one social networking space or another, Don Dodge has a sobering post on how much traffic it takes to reach $1 million.

I attended the very successful Cloud Computing event sponsored by MIT on Wednesday, which Sim Simeonov and others organized. At this point the event itself may be yesterday’s news, but a few of things came out of it that seemed noteworthy to me. Some are “micro” things about the cloud itself, how it drives innovations, pricing etc., but perhaps the most compelling is that the cloud it here and people are building great profitable companies around it today compared to energy and cleantech, which get all the mindshare, but who knows when economic conditions will reach a point where these technologies will actually be profitable.

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This morning  I attended a “CEO Breakfast” with Don Bulens, former CEO of EqualLogic (here's a video interview of him from YouTube), sponsored by The Massachusetts Network Communications Council. He commented on a couple of things that are recurring themes in this blog. 

Don made reference to slide 49 from the now famous (infamous?) Sequoia Capital’s 56 slide presentation of doom. This slide has a red line labeled “Death spiral” which shows a hypothetical company that does not trim its burn rate falling off a cliff to presumed extinction some time in ’09. It also has a green line that shows a hypothetical company that trims its expenses right away, then grows at a slow but steady rate and survives the downturn. Don’s point was that the same kind of thing happened at the end of the dotcom bubble. He notes that some companies did hunker down and survive. Constant Contact was an example that he pointed to.   His general advice is don't fall into the trap of thinking you will be the one who captures the market by maintaining spend -- if you don't make it to the other side you will be the red line.

Don also made reference to the difference between east coast and west coast VCs. As he put it (1) Silicon Valley “celebrates” risk taking in a way that is foreign to New England and (2) the significance of this difference of style between the two coasts is way overplayed.