I was lucky enough to be on a panel with a bunch of great game companies at an event hosted by Investec. At Index we have probably done as many investments in online games as any other firm in Europe with King.com, Stardoll, Moshi Monsters, Playfish and Betfair.

So a few decent companies and no real flame-outs to speak of…yet But how in an industry which people often classify as “hit-driven” can a VC make a decent return? That’s exactly the question I try to tackle in the following video (links to external site). Thanks to Investec for inviting me to participate and putting on a great event.

Slightly offtopic, but interesting. For those readers outside Europe/UK, you should know that  as well as having the Volcano in the news a lot, we also have an election in May in our country. That means endless polls and too many pundits on telly and the interweb debating the likely result.

One interesting comparison to make is to look at the predictions from the Polls with the predictions implied by betting markets (Betfair is an Index investment). The following widget allows you to do just that. If you click on the “Seat” forecast below and then switch between Comres and Betfair you see there is big difference between the number of seats each is predicting.

At time of writing Betfair predicts 330 Seats for the Conservatives – a small majority, while Comres predicts 288 – well into hung parliament territory. While the betters will clearly be closely watching the polls and influenced by these, in this case the market clearly feels the polls are systematically underestimating the likelihood of a a Conservative victory. Will be very interesting to see whether they converge and which proves the better indicator on the night.

One of the most impressive aspects of Apple product launches is that even though the announcements themselves are usually fairly accurately predicted, there is always some element of surprise that remains.

The iPhone OS announcement which followed quickly on from the iPad launch was no exception. Multitasking was a heavily demanded feature and the main competitive weakness of Apple mobile devices versus Android. However the way Apple implemented it was unique and has lots of ramifications on the ecosystem partners.

By mandating that applications write to a multitasking API which is part of the OS, the only background processes which are running are under Apple’s control. While this will require some extra steps from the developers, it seems like a good compromise which will allow Apple to be confident of delivering a good user experience but also retaining a broad ecosystem of developers.

Here’s some of my thoughts on various aspects of the announcement and who the winners and losers will be.

1.  Multitasking – Music

Winners: Pandora, Spotify, Rhapsody, Napster, etc.

Loser: iTunes

Until now only Apple native music applications could run in the background. Other music applications although downloaded in great numbers were at a big disadvantage by only running in the foreground. At the event, Apple presented Pandora as complementary to the iTunes. I don’t think it is or perhaps there is more to this relationship between Pandora and Apple than meets the eye. I’m convinced that people will listen to more streamed music at the expense of downloaded music and by making these services run more smoothly Apple is accelerating the industry towards a future where music is predominantly network based (e.g. Spotify) rather than locally stored. I suspect Apple can see this and will need to own a music streaming service of their own. I think they will build not buy here. Apple always likes to launch a consumer service with a proprietary slant/innovation and you can’t do that if you are just buying a service people are already familiar with.

2.  Multitasking – Voice / Calling

Winners: Rebtel, Skype

Losers: Carriers

Wow, this really can’t have been a popular move with AT&T and the carriers with big iPhone subscriber base. Lack of multitasking for third-party voice services obviously made inbound calling essentially impossible. For IP-based mobile services like Skype and Rebtel (Index investment), enabling multi-tasking is a real godsend. Particularly for international calls and video calling applications I can see people abandon the overpriced tariffs of the mobile operators for third party applications which leverage the phone’s contacts and native calling UI.

3.  Gamecenter

Winners: Small independent App Developers

Losers: Openfeint, Scoreloop, ngmoco’s Plus+ network

The biggest problem however in the iPhone gaming ecosystem is lack of social discovery which was obviously vital to the growth of gaming on Facebook. The other key difference between Facebook and iPhone as gaming platforms is that Facebook is server-based and assumes a permanent connection whereas iPhone games are downloads which are generally designed for offline play or for a play mode where they are only sporadically connected. This makes it much harder to build the “mini-virtual-world” type of game which monetizes so heavily online (e.g. Pet Society, Farmville, Acquarium, Moshi Monsters). While the Apple ecosystem offers lots of games that offer quickfire entertainment, few titles build real emotional connection and engagement with users and hence the monetization per paying user is much lower e.g. $3 bucks versus $30+ LTV for paying users on the leading Facebook games.

The Gamecenter is Apple’s answer to some of these challenges. Apple was pretty fuzzy about what would be released and when but the key elements were a network-based high score table, a “quickmatch” engine for multiplayer gaming and basic social discovery. What they didn’t state was which social graph would power this social discovery. These features are directly competitive with the Openfeint, Scoreloop, Plus+ despite their claims otherwise. Directionally therefore the Gamecenter initiative is a big positive for developers. Will it give rise to a major new player as big as Zynga or Playfish or will these social gaming companies themselves attack the iPhone with more firepower? Watch this space…

That’s already a long post… I’ll call it quits there and well done for getting to the end.

All the best.

Many thanks to Rikke Eckhoff for giving me the opportunity to share thoughts and ideas on the Venture Capital industry. Currently to view it, you need to visit the Unquote site HERE. When I get the chance i’ll try and embed it here also.

Big news for me and my family this week was birth of a second child – Henry Lars Holmes. Comments may therefore go unanswered for a while…

Happy New Year and what an exciting start to 2010! Already we have seen the acquisition of Quattro by Apple, the launch of the Google-branded and specified Nexus One phone and growing anticipation of an Apple Tablet computer. I wanted to summarise some of my thoughts on what these events may mean for the Venture Capital.

Anyone familiar with the VC industry will know the bulk of positive returns tend to be driven by a fairly concentrated set of investments made by the Venture Capital industry. Often literally a handful of companies can drive the bulk of the entire venture ecosystem return over the course of a decade. Obvious examples over the last few years have been Facebook, Google, Youtube, Skype*, Betfair* and perhaps a few more companies spread over enterprise software, semiconductor and cleantech. Notably absent are any venture-backed businesses which have used the mobile platform as their primary means to establish a multi-billion dollar company. In fact the mobile applications sector has been a virtual black-hole for venture capital. Money poured in, yet between Jamba selling to Verisign in 2004 until the recent exits of Admob and Quattro, examples of good venture-backed exits have been like parrots in the Arctic – that is non-existent.

Why mobile (mostly) sucked for so long for VC?

I would boil it down to four major factors:

1. Operator Channel – Selling products and services to a mobile operator or relying on mobile operators to get applications to market has dire economic consequences for most VC-backed companies. Revenue share is typically exorbitant driving low gross margins. The length of the sales cycle and also the subsequent qualification, testing and implementation burden imposed by operators drives overheads to a level which ultimately can’t be funded.
2. Device Fragmentation – This kills an application or services company for two reasons. Firstly the cost and complexity to build, test and support an application on multiple handsets (which are subsequently configured differently by the operators) is prohibitive. Secondly and less well understood, marketing a service to a fragmented device ecosystem is much harder. In particular viral channels break down where people cannot easily adopt applications and services unless they share exactly the same device as their friends and colleagues. The perception that having a few common operating systems would largely solve this problem is I believe wrong. A standard OS helps, but if factors such as screen size, CPU performance, memory, user input mechanic and sensors (e.g. cameras, tilt-sensors, multi-touch, GPS) even differ slightly across phones running on the same OS, then the application developer still faces a meaningful fragmentation problem. This is particularly true for complex applications such as games. Hence why Google changed course with Android. Originally Google was adamant that Android was their mobile offering and they wouldn’t offer a phone per se. The launch of the Nexus One is I believe driven the realisation that that to build an application ecosystem to rival Apple’s, they need to specify the device as well as the OS or else the fundamental fragmentation problem is not solved.
3. Low smartphone penetration – Until recently, simply not enough phones in circulation had the screen size, CPU, browsing ability etc. to provide an audience large enough to build a big mobile application company around.
4. Consumer confusion over mobile data tariffs – The emergence of flat-rate plans played a key role in the initial phase of consumer internet adoption on the PC (e.g. Freeserve in the UK). Before these emerged people were nervous and unsure of what costs would be incurred when logging on. Mobile flat-rate plans are now widely available and bundled with most Smartphone purchases, although some areas such as international roaming can still spring nasty surprises on consumers.

As a result of these factors, Index Ventures over the last few years made relatively few investments in the mobile area and those that we did such as Rebtel* had business models which we believed specifically avoided the pitfalls outlined above.

Now however after 10 years of false dawns and frustration, the next few years could be very exciting and highly rewarding for VCs who place the right bets. Firstly almost all the issues listed above have now been largely eroded, at least in the high-end smartphone sector. While this still accounts for a small portion of the overall market, it is growing the fastest and is the most profitable sector. Apple alone may account for as much as 50% of all handset industry profits despite having one phone model (thanks Hussein.)

Another critical factor which will drive better VC returns is the very aggressive turf war that is now playing out:

• Apple will want to extend its iPhone dominance as the high-end smartphone sector moves into the broader mass market;
• Google needs to ensure its dominant position in the web advertising is preserved and extended as consumers increasingly access the internet from mobile devices;
• Operators will try to dress themselves up as anything other than the dumb-pipes they seem destined to become;
• Nokia, Motorola, Samsung and other handset makers will need to decide how to fight more convincingly in the handset sector or whether to retrench to low-end phones or developing markets;
• Facebook, eBay, Amazon and other web players will also need to invest in providing existing web customers with new and better services which leverage the mobile platform;

Which will mean acquisitions – Admob (Google), Quattro (Apple), and Jajah (Telefonica) will be just the beginning. I will get as involved as I can in finding great companies to invest in in this sector. Good luck to everyone for 2010!

*Current or past Index Ventures investments.

Congratulations to Kristian, Sami, Shukri, Seb and the entire Playfish team. It was simply wonderful to be involved with Playfish even if only for a short time.

ACCEL PARTNERS AND INDEX VENTURES ANNOUNCE EXIT OF PORTFOLIO COMPANY PLAYFISH TO ELECTRONIC ARTS

LONDON, ENGLAND – November 9, 2009 : Index Ventures and Accel Partners, two leading global venture capital firms, today announce the sale of portfolio company Playfish Inc. to Electronic Arts (NASDAQ: ERTS).  Playfish was acquired for a consideration of up to $400 million including an earnout of up to $100 million and excluding cash balances.

Kevin Comolli, board member from Accel Partners stated, “As the original institutional seed investor in Playfish it has been a pleasure to work with the founders and management team and to see them achieve such extraordinary growth.  Playfish has been recognized in the industry for its innovation and creativity and continues to change the way people play games by creating more social and connected experiences. We are sure they will continue to thrive under the ownership of Electronic Arts.”

Ben Holmes, board member from Index Ventures said, “We want to congratulate Kristian Segerstråle, the other founders and the entire Playfish team for what they have achieved in such a short time.  We are delighted to have been one of the investors in such a forward-thinking company and we wish them every success in the future.”

Kristian Segerstråle, Playfish CEO, commented, “I want to thank Accel Partners and Index Ventures who bought into our vision for a new type of games company and have supported us from the start and through our sale to Electronic Arts.”

Social media has been the investment sector which has created many of the biggest companies within the tech industry over the last decade. By social media, I’m using a broad definition of businesses which either rely heavily on user generated content as the underpinning of the service and / or user to user (viral) communication as the principal means of propagating and marketing the service. Successful exits in this space include Youtube, Skype, Last.fm, Bebo and MySpace and big private companies include Facebook, Linkedin, Yelp, Zynga and Playfish.

The appeal of this sector to venture investors are clear

• Rapidity of value creation. The ability to create multi-hundred and billion $ value companies in the space of a 1-3 years is almost exclusive to social media. Try doing that in software, semiconductors, ecommerce or cleantech. All typically require 5-10yrs to grow to this scale
• Reasonable cost / capex requirements. Limited capital is required to launch and test a product. Often the successful social media companies breakeven or at least have the ability to breakeven quickly. Hence capital at risk is lower and multiples on successful exits can be higher than in many other sectors
• Defensibility. Once at scale, network effects give these businesses a competitive advantage and robustness which acquirors value. Over the next 12-18 months, we will probably get to see how public markets value some of the key players in this space also.

So lots of good reasons to invest and a few exciting businesses which already validate the investment thesis. So far so good, now for the challenges…

The chart above shows the various stages which a social media business may go through and what the usage, revenue and valuation metrics might typically be at each stage. Also my perception of the probability of the business ultimately generating a great return which not only justifies VC investment but can contribute a substantial return.

This evidences some of the real challenges with investing in this sector

• Volume of investment opportunities in social media sector can be overwhelming. Particularly at early stages we see twenty business plans / investment opportunities for social media businesses for every one we see across the whole spectrum of other investment sectors (software, life science, hardware, semi, cleantech, etc). This means the chance of ultimate success for investments at pre-launch and early stages (1-2)  is vanishingly small and even the low valuations don’t typically reflect the risk inherent at these stages
• Late stage valuations (5-6) are very high and often leave limited upside for investors.
• Pinpoint timing is required. In my experience the best time to invest for a venture capital firm is post launch when the business has 100,000’s or low millions in Monthly uniques (stages 3-4). Here the metrics and to an extent the business model may be proven and the valuation still gives room for venture returns. However businesses can often pass through this stage  in a matter of a few months, so unless you are already very close to an investment opportunity as it moves from stage 2 into stages 3 and 4 you will likely miss the opportunity
• Early metrics are useful, but often don’t differentiate between future leaders and losers. The red and blue lines show the trajectories of 2 social networks (can you guess which?). These are essentially the same until a specific breakout point for one of them.

So while social media can offer the big and quick rewards for venture investors, it can also be a minefield and is particularly challenging and unpredictable for those tasked with making early stage investments.

Here is a presentation I put together last year that looks at a few topics.

• Whether to seek VC money and what to think of before you embark on the process;
• What a Venture Capitalist looks for and how to get fund-raising off on the right foot;
• A brief explanation of some of the typical terms you might find in a termsheet; and
• Recommendations on how to prioritise which VC to work with when you have multiple offers.

One of the topics introduced is the “Three Ts” (Team, Technology, Traction) which is my crude framework for prioritising investments. I typically don’t agonise about finding good reasons and robust intellectual arguments for not doing a deal. Generally we just look at these three factors for a Company and hope to find something exceptional in at least one of them. Obviously team is important but occasionally, particularly in the internet area we come across phenomena which have gained amazing traction, even though the team may not on the face of it have enormous experience. These situations can be just as exciting. As I outline in the presentation, it is more interesting to have an A* against one of the “Three Ts” rather than having an unexceptional B+ across the board.

There are a few other points covered in the presentation which I may return to future posts. Thanks to Ryan Carson for letting me present this at his event.

In the last year with the rapid growth in twitter and other “real time” information sharing platforms, many people have found that part of the rationale for blogging disappears. The new micro-blog alternatives simply offer a much better method for quickly disseminating  images, web pages, location data, quick comments and other snippets of information. My plan is to use all the micro-blogging tools for these high-frequency and short-form transmissions but keep this blog focused on sporadic (e.g. once or twice a month) but original postings where I either have some analysis to share or ideas I want to stress test on a specific topic. I don’t plan to spend much time re-blogging what I see as smart or stupid that is being written elsewhere. Instead the posts will hopefully achieve the following aims:

1. Demystifying the VC process

Just as a VC tries to understand the businesses he invests in, I think there is great value in entrepreneurs understanding the venture capital business. If they are better informed, they will know whether it makes sense for them and how to get the best out of a partnership with a VC. So I’ll try to cover what we look for in a business;  how we find, filter and evaluate investment opportunities;  what type of deal structures can make sense in what situations and more generally how we bring all these strands together to (hopefully) make a return for our investors.  Taking VC money is a big decision and many entrepreneurs and businesses can be better off without it. I’ll be as open and honest as I can about when it does and doesn’t make sense.

2. Getting feedback and testing  hypotheses on specific sectors

Dealflow is generally sourced from one of three broad channels:

1. Spontaneous inbound;
2. Referrals from portfolio companies, other VCs or advisors ;
3. Leads generated by specific sector research we conduct internally;

Often the most interesting leads come from the 3rd category. Approximately each quarter, we sit down as a firm and present and discuss themes which we think will influence the technology landscape over the coming year. Once the target themes are agreed we do more research to identify interesting companies or entrepreneurs who might be persuaded to take investment from us. Should our target themes be a closely-guarded commercial secret? In my experience there’s typically quite a lot overlap with what other investors might be looking at. So I will certainly discuss our ideas on some of these trends, but probably keep a few ideas up my sleeve…

3. Sharing thoughts on the tactics and strategies adopted in early stage companies.

As I mentioned in the prior post, boasting about what is going right with specific portfolio companies or lamenting certain failures or shortcomings would not be smart move. However there are a set of broader issues, challenges and learnings which are common to many early-stage companies where I might have the occasional idea or want some ideas.

That’s it for now.

Over the last couple few years an ecosystem of VCs and entrepreneur bloggers has built up. Why now, just as people are throttling back their blog engines in favour “tweeting” do I start to write? I will answer that in the next post. First though some of the challenges and pitfalls I have observed and will endeavour to avoid…

1. Divulging sensitive information. A VC’s thoughts about sectors and trends are generally formed though the insight they get through meeting companies or board involvement.  Conveying these ideas without leaking the commercially sensitive items (company strategy, metrics, product roadmap, marketing tactics, etc.) can be a tricky balance to achieve. Even though a Company itself might choose to be public and open about these matters as some do, these should never slip out via the VC. I put this item first because discretion is the pre-requisite for doing business as a VC. Whilst everyone in the industry intuitively knows this, occasionally VCs infected with blogitis can forget it.
2. Engaging in flamewars. Venture Capital and even more so the start-up ecosystem is very competitive. While it may be a viable or even a good approach for of a Start-up company to establish a highly public and fractious PR strategy with respect to incumbents and competitors, this approach never works as a VC. VCs cooperate and compete on a daily basis and running a blog replete with gushing torrents of abuse will quickly put you at the back of the syndication queue for good deals. Should be obvious, but amazing how easily it can be forgetton when pressing the “Publish” button.
3. Timewasting. Some VCs have a skill for maintaining a prodigious blog output whilst remaining highly effective investors. I wish I could be one of these. Don’t know what the optimal allocation of time to writing and reading blogs is, but I guess the key is not to let the allocation creep inexorably upwards until you eventually become a full time columnist and part-time VC.
4. Taking credit where it’s not due. By this I mean using the blog as a tool to reflect the glow of successful companies or a successful VC franchise onto yourself. A Company’s success is 90% down to founders and executives and the most successful VC firms are those with the cohesive and supportive teams. Blogging is about building a personal brand online, but that brand shouldn’t be built at the expense of others.
5. Being boring. So much of what a VC could write about is off-limits and rightly so. The danger is that in trying to be discrete and sensitive, the blog is reduced to a bland commentary on industry trends punctuated by occasional copy-pastes from other sites.

Let’s see how I get on and please tell me when I’m getting it wrong…