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what’s the real deal?
financing ideas to IPO

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shannon henry: q&a

Shannon:  First, I'd like to thank Jeff.  He doesn't know this, or maybe he doesn't remember, but I have been covering the local tech community for about five years.  I was the editor of TECHCapital magazine before I came over to The Washington Post about two years ago.  In between, I took two weeks off for a vacation.  I was just kind of hanging out one day, I think I had been to the gym, and my new editor from The Post called and said, “The market has crashed and we need you to pitch in.”  This was two Septembers ago.  I hadn't started yet, hadn’t written anything.  He said, “We need you to find someone to be interesting and quotable about the crash today.”  I called Jeff Osborn.  It turned up on the front page the next day above the fold.  Did you see the placement?

Jeff:  Oh, yeah.  It was great.

Shannon:  Jeff has always been insightful about what's going on, about both the good times and bad in this technology world, and he also helped me out at that moment in my first story for The Post.

Jeff:  The funny thing is I never met you in person until tonight.

Shannon:  Exactly.  It's a virtual world.

          The first question I have is about something you touched on a little bit already.  Explain to us what kind of company shouldn't go for venture capital.  I’ve talked to people at some companies who say that it's kind of a rite of passage, but I can see some VCs saying that even though a business is making money, it’s not going to make them a billion.  Especially after what happened in the spring, who is going to have a hard time getting the attention of a VC?

Jeff:  That is an excellent question.  They are getting a little tougher now than they had been.  A VC wants to be able to make a heck of a lot of money as soon as possible on the investment.  The nice thing about VCs is that there’s nothing complex about them.  When VCs talk, there is a great phrase called “the bag.”  If you turn $100 million into $700 million, that's a six bagger because you made six times your money.

Shannon:  It's a pure motive.

Jeff:  It's a very pure motive and a very simple game.  There is no love; there is no art.  There is cash.  There is an ROI.  There's a return for the limited partners, period.  Everything else is just nothing.  There is a purity to it that's nice because you don't have to worry about what they are really doing.  It's real simple.  If they think you can make them more money than somebody else, they will fund you.

          Currently, the fashion in what people like is getting very narrow.  They like Internet infrastructure, anything involving optical switching.  There are like 40 people in the world who understand this crap, and I don't think any of them are in this room.  The bad news is that what's hot when they are giving away money is something you had to have started doing a year or more earlier, and started learning about five or six years earlier.  It’s not hard to figure out what's right; the really hard part is figuring out what's right early enough so that you can actually do something with it.

          What's unpopular, now, is business-to-business (B2B) and business-to-consumer (B2C).  If anybody is trying to do a consumer-oriented Web-based thing, get a clue.  The thing is, a lot of entrepreneurs get so positive about how great they’re going to be and how successful, it's like they're dogs sniffing their own butts and calling it market research.  Three people sit around drinking beer saying, “This is going to be really cool.  The world needs another spreadsheet.” or “The world needs a word processor.”  They come up with these stupid ideas, and, then, the dumbest thing is that they operate in “stealth mode” like somebody is going to steal their idea to make a word processor that corrects the words on the computer. “We are thinking about adding a spell checker.”  They operate in this stealth mode, which means they get no input.  Stealth mode is the stupidest thing I have ever heard.  Usually, I know that when somebody hands me a nondisclosure agreement there is a 90% chance they are going to have the stupidest idea I've ever thought of because there's no cross-pollination.  It's three people in a box having an idea.  We can't talk to customers, it's stealth mode.  What is that?  There is a marketplace out there. How do you plan to advertise this thing?

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Shannon:  But, are there companies that could just do good, old-fashioned business with no need for VCs?  Maybe they haven’t got the greatest business idea in the world and they’re not going to make a billion dollars, but they have customers.  How do you see that kind of person?

Jeff:  The best way to fund a company that I can think of right now without having to rely on somebody else is to start with a service-oriented company.  Gold Wire Technology did that, one of our companies in Boston.  It was four MIT grads who were real smart and had a product they wanted to build.  They didn't want to deal with VCs and give anything away, so they started renting themselves out as consultants.  They were getting fairly big coin doing it and got relatively profitable.  They put something like seven or eight hundred thousand dollars in the bank, and, after eight or 10 months, said: “Eeny-meeny-miney-mo . . . Okay, Art, you stop consulting.  Stay here and start developing the product.  We'll go out and bring in the money to bring this thing alive.”  Then they got more consultants.  They peeled off more of them so that by the time they had a working, demonstrable product and shopped it around to VCs¾which is fun to do¾they could walk in and go “Pfffft! Here.”  The VCs said, “Nice attitude!” and these guys said, “Hey, I don't need the money. Ha!  The product is done and we did it all ourselves.  It's brilliant and you know it.  What do you say?”

          I wouldn't necessarily recommend that attitude, but what a relief to not have to go in with that “forgive me, father, for I have sinned” approach.  “Please, give me some money.”  The usual butt-kissing that goes on with a VC gets old really fast, so I would recommend that's how you do it.  That's the kind of company that doesn't need a VC.

Shannon:  I'll ask a few more questions as people in the audience come to the microphones or pass their questions to the front on the cards provided.

          Jeff, how do you spot a great idea?  I heard a joke that training a VC costs $30 million because, like all of us, they make mistakes and bet on the wrong companies.  So many of us would never have bet on America Online, for example. Many of us have bet on other companies that aren't doing well.  How do you spot greatness in a company?

Jeff:  Know your stuff.  If you went to the clubs every night in DC for four years and somebody asked you whether such-and-such is a good band, you could listen to them for two hours and say yes or no.  It's the same thing with companies.  I have been screwing around with data communications for almost 20 years.  If somebody comes up with a good idea, you know intuitively that at least 20 other people aren't doing it.  I'm similar enough to their average customer to say, “I would use that.”  A lot of it has to do with just knowing your stuff.

          Between Eric, Sara and me at Osborn Capital, and I'm bragging on this, the three of us have a combined 40 years of experience in the Internet.  Pretty much, if something comes along, we have seen it before.  My contractor came up and tried to sell me on some guy doing 80211 antennas today.  I said, “Steve, you are a carpenter. What do you know about this?”

          “Well, it seemed like a really good idea, and he is trying to pitch me.”

          “Steve, if you came in and told me about siding that's washable or insulation that doesn't itch, maybe, but what do you know about this?”

Shannon:  Have you ever had a company you bet on, that you liked the people or something else about it, and it didn't work?

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Jeff:  Sure.  I'm trying to think which ones I can admit to.  I can't do the crashing one because I don't think any of them are clear enough that I'm allowed to talk about it in public.  Okay, I won't mention the company, but I was a really early investor in a company in a state in America, a dot.com that was trying to sell a product that people don't buy a whole lot of.  They created huge excitement, were raising money left and right, and I don't think revenues ever exceeded $500 a month.  It was just too easy with the whole dot.com craze.  “We'll just raise some more money!”  At the very end, they had a $5 million offer on the table in April when everybody was panicking and it got yanked, so, basically, they had about no money one day and it went under.  They had a lot of guts; they were trying, and it just didn't work.

Audience Member:  Have you ever turned anybody down that went on and was successful?

Jeff:  I had an email that begged me to buy 380,000 shares of a company called Critical Path in California for $100,000.  I would have made $75 million for 100 grand and I didn't do it.  It was a 750 bagger.

Audience Member:  Maybe they will crash.

Jeff:  So what?  The lockup's done.  I could have gotten my money out.  That one just killed me.  Thanks for bringing it up.  That's a very painful memory.

Audience Member:  We are now five months past the April crash.  Where do you see things going six months from now?

Jeff:  Lower.  See, the thing that's interesting is that while it was all going up, there was a big incentive to buy quick.  If you didn't put your money in early, you were going to miss the next step, the next uptick.  I think that the general feeling now is that it's all drifting downward.  If anybody here was an economics major, you know that in a deflationary time there is every incentive in the world to wait.  Why invest today when it's going to be cheaper next week and the week after and even cheaper the week after?  If you have a company with three months payroll, and you are asking for a valuation of $10 million, I’ll bet I get a better deal in six weeks.

Audience Member:  Where is the IPO market heading six months from now?  Does it come back or are we still plateaued?

Jeff:  Well, I'm 41.  Most of the people I deal with have never been out of high school and in a recession at the same time.  I remember recessions.  I remember the cover of a magazine . . . was it Business Week? . . . that said “The Death of Equities.”  I remember in college listening to financial radio, “Your money should be in CDs, bonds and gold, period.  What is this equities crap?  It's a fool's game and everybody knows it.”  So much manipulating has gone on that, oh, well, if you bought stocks and held them for a long time, if you bought this Fortune 500 company in 1900, how good you would be doing now?  You would be doing squat.  It included things like American Ice.  Where is that?  It's a changing bundle of stocks.  If you were smart enough to know when to change out, you might have done well, but nobody did.  RCA fell 95% from 1929 to 1932.  Cisco is still trading at 140 P&E.  That's not right.  That's not normal.  So you are asking the wrong guy because I'm actually calling a recession on this one.

Audience Member:  That's that eternal optimist entrepreneur, huh?

Jeff:  Well, there is optimism and there is stupidity.  You know, it was a nice run, but I have a concern, you know, not everybody went out of business in a recession.

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Shannon:  When?

Jeff:  This year.  I think we are already in it.  I think this quarter will end, we just don't know it yet.

Shannon:  I have heard a lot of the VCs start to say there is denial going on.

Jeff:  Huge.

Shannon:  That they are starting to talk about it among themselves.

Jeff:  One little aside.  The Washington Post ran something last week about companies like Lucent, Cisco and others that have been doing a deal for the last year that's creepy.  With every dollar in revenue they have, their stock price goes up $10 or $15, so one of those geniuses figured out, “Hey, if we loan somebody $100 million to buy $100 million worth of our stuff, we'll be worth another billion dollars.  Then we'll loan another 100 million and then, and then, and then . . . .”  They have billions and billions in loans out to VC-backed companies that aren't necessarily making it.  When these guys go under, what are the earnings going to be like?  I'm expecting the third quarter earnings to be kind of terrifying.  If not the third quarter, it will be the fourth because eventually this catches up.  The first and second quarters were all fluffed up with their dot.com holdings that did okay.  How do you maintain an earnings increase when you can't use that trick anymore?  I could be completely wrong, but . . .

Shannon:  Who knows?  We'll be back.

Jeff:  How do you short a recession?  That's what I'm thinking about.

Audience Member:  You said something that I have never heard from a funder before, that you accept nondisclosure agreements. I have never found a funder who did and, in fact, it was the best thing that ever happened to me.  They told me to go do something with myself every time I showed up with one.  Why do you sign them?

Jeff:  You misunderstood.  I said that if somebody shows up with a nondisclosure, it means it's 90% likely that their idea sucks.  I'll sign them because they're amusing, but what's the point?  It's like signing a cocktail napkin.  Have you ever read one?

Shannon:  We have to sign them at The Post.  Can you tell us where your money comes from?

Jeff:  The US Mint has these big printing presses.

Shannon:  The money from Osborn Capital.

Jeff:  All mine.

Shannon:  From UUNET?

Jeff:  That's where it started.

Shannon:  Will you tell us your net worth?

Jeff:  Business Forward made a guess in March that was high, and they said $100 million.  It's lower than that now.  It was never that high, and it's lower than that.  Yeah, I'm kind of uncomfortable.

Shannon:  I always love to ask that.

Jeff:  I get asked it too, all the time, and I usually give this answer, “It's eight figures.”  Not nine, and it's not seven.  It would hurt me to buy a new jet aircraft, but, on the other hand, I don't look at the prices on cars or houses, so I don't know.  There is a great term called “the minimum financial unit.”  It's the dollar amount at which you check the price, like if an item was for sale here and over there, there is a low enough price that you wouldn't walk three feet to pay the lower one. I realized mine is well over $1,000 now, which is kind of scary.  My wife's is still like eight cents.  She'll go to another store for chicken.  I talked to Steve Walker and he says he has gotten to the point where he will buy a helicopter without having a discussion with his wife.  That's a lot of money.

Shannon:  If the market is cyclical and VCs and the public markets are investing in infrastructure, etc., do you see the B2B and B2C markets returning after all this technology is in place?

Jeff:  No.

Shannon:  It's over?  Over, over, over?

Jeff:  Well, no, it's over.  It was being done in a dumb way.  Early on, some of the neatest Web-based companies were two people in a room coming up with a great idea.  The bad ones were¾do you remember Pathfinder that Time Warner did?  They took 200 people and a budget of $50 million, threw them on this Web thing and said, “Do something.”  Two guys in a dorm room are cheap, and any money they make is a bonus.  If it becomes even vaguely profitable, it's a huge deal to them, but what the heck are three hundred people going to do?  They just shut down Pathfinder because it was a stupid idea.  There is a lot of that going on.  The seventh guy to raise money to sell ice over the Internet went broke.  He should have.  It was a really stupid idea, so I don't see it coming back anything like it was.

[continued]

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