Embracing Chaos

I’ve submitted a talk for the next Ignite Seattle about some common terms in venture capital financing deals.  I’ll be talking about why pre-money valuation is not nearly as important as most entrepreneurs think it is when considering a VC term sheet.  I’ll explain how things like liquidation preference and cumulative dividends can have just as much impact as valuation on who gets paid in the end.  I’ll touch on one point here, but for the full 5-minute explanation, come to CHAC on August 8th.

Briefly, liquidation preference is the idea that when a company becomes liquid (generally through acquisition) the venture capitalists get all the money up to a certain point, at which point they start sharing it with everybody else at the fraction determined by the number of shares.  Shown above is an example of the payouts if the VC has 25% ownership of the company by shares, but liquidation preference on the first $30 million dollars.  At low to moderate valuations, the VC’s take a disproportionately high share of the company’s value.  But if the company is wildly successful, the entrepreneurs take the lion’s share of the company’s value, consistent with their fractional ownership of the company’s shares.

Some may question whether liquidation preference terms are fair or not.  I argue that without such terms, professional investors would not be willing to take the huge risks associated with venture investing, and so the funds would simply not be available to entrepreneurs.  I believe this also extends to early-stage investors such as friends and family since their interests are completely aligned with those of the entrepreneurs.

This is assuming that all parties are completely informed.  I know that often entrepreneurs sign up with venture capitalists without fully understanding the implications of the agreement.  I believe that the VC’s have an ethical obligation to explain the terms, especially terms like liquidation preference which are important and might be surprising.  Let’s explore this further with a digression into ethical economic theory, using sweat-shops as an example.

Free-market economic theory assumes that all business transactions are engaged in willingly by both sides.  All deals should be mutually beneficial, and if both sides understand what they’re getting into, then the deal will be.  Taxes and other government mandates are not free-market based, so the logic doesn’t apply.  On the other hand, sweat-shops might seem horrible to us, but to somebody who’s
alternative is subsistence farming, working hard for guaranteed pay is
great, so the sweat-shop is a good choice for them. 

For all private transactions, I argue that if both parties are fully informed, the deal is moral because both sides think they are benefiting.  Realistically, it’s impossible for people to be fully informed because there’s just too much information.  A more realistic condition is that of "empathy" — if each party were to switch places, would they still take the deal knowing what they know and what they think are the conditions for the other side.  If the sweat-shop job involves breathing toxic fumes that the factory workers don’t understand will give them cancer in 5 years, then the deal is immoral because the factory owners would never take such jobs themselves, even if the alternative was subsistence farming.

Applying this theory to liquidation preference is interesting.  If put into the entrepreneur’s shoes, a VC would certainly take a financing deal with a liquidation preference term.  This is because they know this is how the game works, and also because one trait entrepreneurs share almost universally is optimism — they’re thinking about the far-right part of the graph much more than the left-hand side.  So by the empathy condition, liquidation preference terms are moral.  But questions of ethics are often blurry, and I think this is such a case.  A VC who knowingly hides the implications of a term-sheet could certainly be more upstanding.  So ultimately the fairness of liquidation preference terms depends on how informed each party is, and how completely they communicate with each other what is going on.

I went to watch the latest Harry Potter movie last night with some friends.  One of the previews was for a new Bourne movie, The Bourne Ultimatum.  Typical lots of cars getting smashed and then at the end, on the text page, a URL:

From across the theater I heard a "Woah!" I think from Brady.  Why?  Because even without touching a web browser, this constitutes an apparent change in policy for Google.  Advertisers with enough money can now buy marketing URLs on the highly trusted and respected google.com domain.  In other words, they’ve sold out.  People intrinsically trust Google and will do lots of things that Google sponsors that they wouldn’t do for say AOL, Microsoft or (ahem) Real Networks.  Ironically, the reason people trust Google is because Google has never done these kinds of co-marketing deals.  They have previously only done things with clear customer benefit. 

Google is stepping down a dangerous path.  It’s not exactly evil.  But it’s putting more attention on getting revenue than on delighting the customer.  If Google keeps doing this, customers won’t trust the Google brand because they won’t know when Google is doing something to help organize the world’s information and make it universally accessible, and when Google is doing something to make money off you the trusting customer.  Thinking these two activities are both "good" (as opposed to evil) is a dangerous cultural shift.  Brand equity is like an old-growth forest.  You can cut it down and make lots of money.  But it will not regrow quickly nor easily. Real Networks did this after the bubble burst.  They were able to survive some pretty tough times using shady business practices like superpass which turned consumer trust into cold hard pennies.  But they will probably never be a respected brand again, largely because they cannot shake the addiction to business practices with the value proposition of pick-pocketing.  Has missing their numbers sent Google down a similar path?    (A couple weeks ago there was an interesting, somewhat related discussion on Radar.)

I have to say a few words about the experience of visiting that URL.  It immediately redirects you to another URL, www.searchforbourne.com, reinforcing the idea that all Google is doing is selling a trusted domain to hang a marketing URL on.  The launch page insists that you install Flash 9, and the upgrade experience from whatever version I had was not smooth.  (More echoes of Real Networks.)  Once inside, it asks you to sign in to your Google account to play some game it seems.  At this point I’m thinking that maybe there is some real integration here.  But no.  The next page explains it all:

"Google must provide Universal Pictures with the primary email address associated with your Google account for verification purposes."

Verification purposes?  I signed in with my Google account password — that’s verification.  This is something else, and that wording is deceptive IMHO.  Google just sold my gmail address to Universal Pictures!  Wow.  This is worse than I thought.  I wonder if Google will put an exception in its spam-filtering rules for Universal.

I’m gonna make a guess at to what Apple’s going to announce in August.  I’m thinking of the next gen iMacs with huge high-res touchscreens.  They’ll support apps like the iPhone has with draggable windows and the cool 2-finger resizing thing and all that.  It’ll merge Microsoft’s Surfaces technology with the iPhone’s UI and end up with something closer to the UI from Minority Report than anything we’ve yet seen.

Or maybe they’re not there yet, and it’ll take another year or two.  But this is what I think they should do.

Like a number of other developers, I’ve been beating my head against a wall for the last couple of weeks trying to figure out how to set up a facebook app using ruby on rails.  I finally figured out at least one major problem I’ve been running into — the standard library for writing facebook apps in ruby, rfacebook, has a bug in its latest version 0.6.4.

I haven’t figured out exactly what’s wrong yet, but I’ve figured out how to avoid it.  If you’re getting this kind of error message:

You have a nil object when you didn't expect it!You might have expected an instance of Array.The error occurred while evaluating nil.length

The error might comes from a stack trace like this:

.../rfacebook-0.6.4/lib/facebook_rails_controller_extensions.rb:37:in `fbparams'
.../rfacebook-0.6.4/lib/facebook_rails_controller_extensions.rb:60:in `fbsession'
.../rfacebook-0.6.4/lib/facebook_rails_controller_extensions.rb:130:in `require_facebook_login'

Astute developers will open up the code and see that fbparams isn’t being properly initialized because of a simple blunder — calling a method on a potentially nil object before trying to initialize it.  But correcting this mistake won’t get your app to run.  There are other problems too.  The way to fix your app is to back down to rfacebook version 0.6.3:

gem uninstall rfacebook
gem install rfacebook -v 0.6.3

And don’t forget to clear your cookies and your session objects

rm tmp/sessions/*

This has certainly helped me.  I hope it helps you.

A number of folks have been courting me for positions as a software development engineer recently.  Many of them sound really fun.  I love writing code, and even though it hasn’t been my professional focus for years, I think I’m still alright at it.  But I’ve had to come to a sober realization that I simply cannot take a job where writing code is my primary function.  I’m just not physically capable of it.  I just about cried during a job interview once when explaining this.

People come in my office and say "that’s a cool keyboard."  My response is generally something like "that’s what it takes."  I don’t use a $300 keyboard because it looks cool.  It’s more like a wheelchair.

I have repetitive strain injury.  It’s not carpal tunnel syndrome.  My wrists basically never bother me.  It’s more my pinkies, more the left than the right.  I can think of 3 causes.  In high-school I took a 3-day bike tour from San Diego to Santa Barbara wearing gloves that weren’t well padded.  For about a week afterwards I had no feeling in my left pinkie.  Then in 1996 a marathon perl coding session of several 100-hour weeks left my pinkies pretty sore because of all the mixed-case variables in our code. 

Also, I suspect cubital tunnel syndrome might have some part of it.  I’m not expert but my understanding is that it’s a result of spending too much time with bent elbows stretching some nerves causing problems with pinkies.  I understand the easiest thing to help is to sleep with straight arms.

The ironic thing is that with a good ergonomic keyboard I can write English text day
in and day out, but more than about 10-15 hours/week of coding and
things start to hurt.  Writing code on a laptop in bed, fun as it is, will get to me after about 10 minutes.  Code involves tons more time on the special keys
than English.  You don’t need a lot of
[]{}()<>*=+-~&^_!#@$%/|\ in e-mail or in specs.  And you don’t
need to bounce around the arrow keys for editing nearly so much
either.  The Kinesis advantage keyboard helps quite a lot, because it moves most of the keys that the pinkies do under the thumbs.  But it’s not quite enough for me, because the shift keys are still the responsibility of the pinkies.  I’ve tried using a foot-pedal for shift, but haven’t been able to
re-train myself.  And I’m not sure I really want to limit myself by
having a job I can only do in front of a super-tricked out
workstation.  Screwing up (gee it sure would be nice to get
something done on this here laptop) means having to use a microphone
and eat grams/day of ibuprofen for a few months which I’ve done and really really
sucks.

So physical disability has sent me down an interesting career path towards middle management.  I have tons of fun in this capacity, but sometimes I miss making things work with my own hands.

Also, if any of you have hints of repetitive strain injury, I strongly encourage you to shell out the cash for a good keyboard.  It’s way cheaper than the alternatives.

"The new phone books are here!  The new phone books are here!"
    -Steve Martin in The Jerk

Steve Martin was very excited to get the new phone book because his name in it meant he was somebody.  But in 2007 when 10 pounds of dead tree show up on my front porch, I’m just annoyed.  The phone company wants to deliver this to me because their advertising rates are based on the number of phone books they deliver.  It doesn’t matter that there is zero chance I will even open the thing.  I take it straight from my porch to the recycling bin.  Like many things, the internet has made these objects obsolete for many of us.  But the old business model tries to hang on anyway.

So I decided to do the planet a favor and help support the robolucion and try to get them to stop sending me these things.  I called…

…which was printed on the front of the bag, and after navigating their phone tree managed to speak to somebody who was happy to take my name off their distribution list.  I encourage you all to do the same. It was painless.