With HootSuite surpassing 3m users and generating significant revenue, I thought that this would be a good time to reflect on the investment we made back in December 2009 and share what I’ve learned since.

For quick background, I reached out to Ryan, the CEO and founder, in spring 2009. It was apparent that this thing called ‘social media’ was going to be big, but from a risk profile and investment size standpoint getting into something like Twitter or Facebook was difficult to say the least. As we looked around at tools companies, HootSuite’s focus on the marketing stack and businesses seemed like a differentiated approach. Ryan also had a keen focus on the product and vision for the future that really stood out amongst everyone we had spoken with in the space.

Around July, we presented to Hearst management and got approval to lead the Series A. We wanted a co-investor at this early stage and it ultimately took another 5 months to find and close with Blumberg Capital. They too had the vision to understand the need for social media tools and recognized the value of Ryan, his team and what they had built to date.

When we closed the deal, HootSuite had approximately 200k accounts and was in fierce competition with the likes of CoTweet, TweetDeck, PeopleBrowser and even Twitter. Our main concerns were:

1. What is the business model? Would users pay or is it an advertising play?
2. Can HootSuite succeed in Vancouver? Successful startups traditionally are born in NYC, SF or Boston so it was a bit of an odd duck (this made it very hard to find that initial partner as investors in general are uncomfortable deviating from normal patterns). 
3. Will it be a winner take all market? We agonized over competitive set for quite some time.

As I look back with HootSuite now a clear leader in the space, the following are some of my key learnings:

1. Freemium SaaS is an incredible model. The hurdle for someone to join such a service is low since the bar is free and the product thus markets itself. Switching costs become high over time and with the user investing nothing to get onto the platform, stickiness starts to build quickly — even before the user realizes it. With price not a competitive lever, it then becomes quite difficult for new entrants to gain traction.
2. With price not a differentiating factor, product is. It’s all that matters so you need to have a visionary who can not only determine what features go into the product, but also what stays out. Over building and complication is a huge risk.
3. Rapid iteration is mission critical. Of all the learnings, this is the least understood and appreciated in the investor community. It’s also the single most important factor to a freemium success, in my opinion. As such, when I look at other freemium software models, I always ask the founder, “What differentiated strategy do you have to scale the dev team”? In the case of HootSuite, it turned out that its biggest perceived weakness (located in Vancouver) was its most important asset. Up there, surrounded by quality dev talent with limited competition, HootSuite has been able to attract A+ people at a fraction of the cost of its competitors. This advantage has only grown as HootSuite now is one of the top tech companies to work for in Canada and can pull from across the entire country. 
4. Don’t over focus on competition. So long a space is big enough, it can support multiple SaaS solutions. Just look at Box.net and Dropbox or MailChimp and ConstantContant. Both are similar offerings in their space, but each has carved out a unique value proposition that serves a certain segment of the market particularly well.
5. Be patient. It can take a long time for a freemium software businesses to scale.  If and when success comes, it is not immediately obvious either as the difference between linear and exponential growth is hard to discern when looking at short intervals. I equate it to how people do not seem to change when you look at them every day. However put some time in between meetings, and progression seems obvious. In the case of HootSuite, it took more than a year after funding to add a million users. Now that takes just a few months.  

Bottom line, if you convince yourself that it’s a big space, you believe in the product chops of the founder and he/she has a differentiated strategy to secure talent, you have the recipe for success. Happy hunting!

So as many of you know, someone hacked my PayPal account for $6,000. Here is what I have been able to piece together.

1) Sometime on Sunday, someone used a blackberry device (which i do not have) to access my PayPal account with my username and password and send $6k to another PayPal account. The belief by PayPal is this person got the information from another site with less security and tried it out on PayPal. The only problem with that is the two other sites that I use this username and password are T. Rowe Price and Facebook who I imagine have pretty robust security. 

2) Despite this transaction being 20x larger than any I had ever made and being done on a blackberry device (which I had never used to make a payment via PayPal), PayPal OK’d it and took the money from my bank account (which was linked to PayPal) and actually funded the other person’s PayPal account. To repeat, PayPal security is so lax that it actually put $6k in this person’s account despite this transaction obviously being fraudulent. 

3) Eleven minutes after funding this fraudster’s account, PayPal’s crack security algorithms realized something might be wrong. Luckily the money had not been withdrawn and PayPal was able to take back ownership of the $6k. Had this person moved the money fast enough, PayPal would be out $6k because they still refund fraud like this to users like myself. 

4) Despite PayPal now identifying possible fraudulent activity, they never send me a text or email or call to notify me. Instead I notice this when I log into my bank on Tuesday and notice a $6k withdrawal from PayPal. How’s that for customer service?!?!

4) Now that PayPal has identified this as clear fraud, they claim that my money will be returned to my PayPal account on Friday, which I will then deposit into my bank account. Let’s keep our fingers crossed on this one.  

The moral of this story for all of you is PayPal is no where near as secure as any of you believe or PayPal claims. The fact that this company would actually execute this transaction and ask questions later is astonishing to me and should scare the shit out of any PayPal user or eBay shareholder. For now, I will still use PayPal; however, Amex will be the only form of funding because I trust that company’s security 1000%. 

I’ve been a happy user of paypal for many years…UNTIL TODAY. Upon logging in to my bank account to grab information needed for my ongoing mortgage application process, I noticed a $6,000 withdrawal from PayPal. Immediately, steam emitted from my ears as I had not made any such payment and have never made any payment over a few hundred bucks via PayPal. Some type of fraud had obviously been conducted on me despite PayPal’s claims of having an impenetrable system to which I was stupid enough to link my checking account. 

Getting on the phone with Paypal was easy enough and the issue was immediately sent to to the resolution center, which I suspect will be resolved rapidly since I do not know Sergio Sosa to whom I so graciously gave $6,000. What was most concerning to me however was that despite such a large and abnormal payment (I have never made a payment via PayPal for more than $350 since opening this account in 2004), PayPal did nothing to reach out to me. I mean, it doesn’t exactly take sophisticated algorithms to notice something funny happened here. However, despite all of PayPal’s vaunted security technology, I didn’t get a email, a call or text alerting me to potential fraud. Instead they withdrew the $6,000 from my checking account and were ready to send it to the lucky Mr. Sosa.

Upon speaking with PayPal they did say that their detectors picked up the large transaction and put it in some type of escrow in case I did dispute it. That said, had I not contacted PayPal within 10 days, they would have sent the money on. What if I had been on vacation? It is the middle of summer after all. What if I had not checked my bank account for 10 days? Had I not been in the process of getting a mortgage I probably would not have. The fact that PayPal leaves it up to their customers to find fraud is absolutely nuts to me (I am a bit annoyed at my bank as well. While I do have much larger transactions than $350 going through them, they should have raised some red flags to a $6,000 withdrawl from PayPal). 

Going forward, I will no longer link PayPal to any bank accounts and I highly suggest that anyone else who has accounts linked removes them as well. PayPal always talks about how great their fraud system is; however, the fact that they leave it to customers to notice the fraud gives me zero comfort giving them access to my checking account. I will now use Amex as the sole funds provider because you bet your a$$ they would have been on the phone with me within 30 seconds of this transaction if PayPal was trying to pull the funds from them. I will keep you updated on this process and I pray that I do actually get my money returned…

In the last few days, I drove by st. Vincents hospital in west village and north general up in Harlem. Both are now shuttered and completely abandoned. I have to imagine we will see more hospital closures and that this phenomenon is not unique to NYC. Meanwhile millions of Americans don’t have access to healthcare and costs are going thru the moon. How about instead of closing these hospitals we create a government healthcare system where anyone can seek care. It’d be exactly like the VA and probably cost far less than Medicare and Medicaid. If you don’t want to go to these, buy private insurance. Seems like an very easy solution. http://amplify.com/u/bz0sy

Trying to return a computer to dell and have been shipped around to 3 different departments who all ask the same questions. Isn’t there a way to store all of it I don’t have to repeat myself over and over again…
http://amplify.com/u/byfef

Something about this #MTA fair hike plan just doesn’t seem right. They are punishing those that ride the subway every day. Seems like they should hit those who just use it infrequently. Raising the single fair price and increasing the discount on monthly and weekly would make more sense. So would charging even more for every new card you needed. The best and long-term solution though is cutting costs #NYC #subway http://amplify.com/u/c0o2 http://amplify.com/u/c0o5

What becomes a more popular product: an apple branded tv set or an android powered desktop? http://amplify.com/u/bx91

I found this post by Jim Moran, one of the founders of YipIt, quite interesting and wanted to write a longer post to share my thoughts. In it, Jim suggests 4 ways that local publishers can compete with the likes of Groupon and Living Social in the local deals space. While I agree with all of his suggestions, including leveraging existing email lists and content, I think it is worthwhile to highlight one of the inherent flaws of local media companies and explain why it will lead them to fail in this space, in my opinion. 

At their core, local media companies are just that: local. As such, even the largest do not have national coverage in any one business line. For example, just look at Hearst where I work. In our newspaper group, our largest markets are Houston, San Francisco, Seattle (only a website now), San Antonio and Albany, NY. Not exactly a national footprint now is it? Unfortunately, on the web, scale is hugely important and having a national brand, strategy and footprint is critical to success. This relentless national focus is a significant reason why Monster.com, CareerBuilder, Craigslist and eBay were able to obliterate classified revenue at newspapers and why the likes of Groupon and Living Social will suck even more local ad dollars from existing media players. 

As Jim points out in his post, local players like WaPo, NYT and Hearst are partnering with existing players in the daily deals space, but we’ve all seen this game play out before. Sooner or later, users interested in local deals will circumvent the media partner and go directly to the local deal provider. The poster child for this phenomenon is the migration to Google.com for search when Yahoo! integrated Google as their search provider back in the day.  

In order for existing local companies to really compete in the daily deal space, something larger needs to be done that includes launching an independent, new brand focused on just daily deals (I would suggest buying a smaller player to get to market more quickly). To get national scale, these companies would then need either to partner with one another (ala Classified Ventures) or leverage all of the local assets in an single company. In the case of Hearst, this would mean promoting the local deals product across all of our newspaper, TV station and yellow page properties (including online) and leveraging their sales forces to source the initial deals.

Neither the partner nor internal cooperation plan that I reference above are things that I think would be easily accomplished, especially in a world where local media companies are struggling with so many challenges in their existing print business lines. As such, I think the flow of local ad dollars out of existing media players will only increase leaving them even further damaged by the creative destruction of the Internet. 

I’ve recently spoken to a number of people at traditional media companies and there seems to be an increasing sense at the highest levels of these organizations that this ‘Internet thing’ just doesn’t work. In many ways, you can’t blame them either with Scripps recently selling off uSwitch at a fraction of the price it paid. Things seem to be going so badly at Bebo that AOL is reportedly considering shutting it down for the tax benefit—unlikely the return that AOL/Time Warner envisioned when it paid $850 million for it way back in 2008. And now you have News Corp (the one player that everyone thought “got it”) seemingly ready to rid itself of every digital media asset it bought over the last few years. While I highlight these high profile examples (and let’s not forget CBS and CNET/Last.fm), the truth is that no media company has been immune to this carnage, even at Hearst where I work.

So what exactly happened? In my opinion, the biggest mistake many media companies made was simply buying the wrong types of assets. Instead of pursuing platforms that leveraged the network effects of the Web, media companies went after digital businesses that they understood, so ad supported, editorial-based content sites. The challenge was the success of most media companies never really came from the quality of their content, but rather the proprietary ownership of analog distribution infrastructures. This distribution advantage does not exist online and competing more on the merits of the content has proven much more difficult than any media company could have ever imagined. For those media companies that made more prudent decisions and targeted platforms versus content businesses, most were unable to find ways to properly incent and motivate key personnel who were more comfortable in entrepreneurial environments and had just been handed multi-million dollar payouts. What a shocker, huh? 

So what does all this mean and what will be the fallout? First, I believe strongly that the exit strategy of selling to a media company is all but dead for entrepreneurs and venture capitalists over the next several years. Sure, we might pay $5-15m for a tuck in here or there, but the days of the single transformational acquisition for these companies is over in my opinion. There is just too much bleeding in the core business units and too much scar tissue from failed Internet promises for most traditional media organizations to go down that path again.

The second, and larger, implication is I expect all types of acquirers to eventually reassess the multiples that they pay for digital media and platform businesses. After all, I am hard pressed to think of more than a handful of $100m+ acquisitions in this space that will actually pay off over time. In fact, as I sit here writing this, Paypal and Overture are the only ones that easily come to mind. I know that there are others and welcome the responses, but please don’t mention MySpace. Had they not been blessed with scoring that wildly unprofitable deal for Google, Rupert probably would have jettisoned it years ago.

As I learned in business school, the multiple paid for a business should at least equate to the sum of its future discounted cash flows. In the digital world where distribution is available to most everyone, market dynamics change every few years, if not every few months. This makes the evaluation of future cash flows more difficult than any other industry so, at a minimum, the discount rate applied should be drastically increased. Additionally, with it difficult to retain core founding teams who would rather be entrepreneurs than operators of a business unit inside of a larger corporation, buyers often lose the only leadership that had a chance of attaining those expected future cash flows. Should this view of the market become more widespread, M&A multiples for digital media and platform companies would compress significantly. That is clearly not happening any time soon however as startup valuations continue to go up and up. I guess maybe it’ll all be different this time around…

For those reading that don’t know me, I work in the venture capital group at the Hearst Corporation. We play the role of a patient, growth capital investor for startups looking for validation from (and partnerships with) a traditional media company. As a result, the majority of our capital is invested in Series B and Series C rounds in startups that have been operating for at least a 18 to 24 months.

As I look at the market today, this positioning is proving quite difficult for a couple of reasons. The first has to do with the troubled nature of traditional media companies no longer makes them as attractive a validation partner for entrepreneurs. Additionally, with the fragmented nature of the Internet, a deal with any single media company can no longer “make” a startup’s business. While not the case with Hearst, some budget constrained media companies will even invest in a startup to use it as a captive development shop, making the partnership an albatross for an entrepreneur with limited resources him/herself.

While the above issues are hurdles, the biggest challenge my group is currently facing is the “it gets late early” phenomenon. The truth is that it costs very little to start an Internet business these days. Thus, by the time a promising startup needs to raise even its Series B, it has already generated a fair amount of user adoption and can drum up a very competitive financing process. As a result, instead of $15-20m Series B pre-money valuations, we are seeing $50m and even $100m+ valuations. Keep in mind that most of these companies still have very little revenue and are yet to develop clearly defined business models.

With the recent explosion in seed/Series A funds and the significant later-stage money still in the market, I expect valuations in B rounds to get bid up aggressively for at least the next 12 months. However, the supply of quality early-stage companies should increase and I expect this to drive prices down to more reasonable levels. Will Series B valuations in promising startups return to levels from a few years ago? Unlikely given it simply costs less to initially fund a digital media startup. But if you believe a business is a several hundred (or billion) dollar opportunity, there should still be enough returns to go around.

As a result of these market conditions explained above, I find myself spending more time building relationships with entrepreneurs than chasing live deals. Hopefully, when/if the market returns to a more rational equilibrium, this work will pay off. Only time will tell I guess.