I had the privilege today to be on a great panel this evening organized by the Churchill Club on storing your data and personal experiences in the cloud. The discussion was kicked off by Gordon Bell (photo to the right) who recently published a book on the subject called “Total Recall: How the E-Memory Revolution Will Change Everything“. The book is a great read and I can definitely recommend it. While I have been moving a lot of my data to the cloud, my efforts seem trivial compared to Gordon’s vision.The discussion on the panel was fun with Rob Coneybeer of Shasta Ventures, Suni Vermuri of reQall and terrific moderation from Barron’s Eric Savitz.

One of the more interesting discussions was around what companies will do well in this space. It was great to see how Evernote, reQall and Eye-Fi (all represented by the people on the panel) integrate their services. I think the fact that many data stores with relevant information have no APIs for integration is one of the main issues that this emerging sector is facing.

It turns out that virtual economies like WoW are still very inefficient. The arbitrage opportunities and price fluctuations in the in-game auction house are large, and creating crafted items from raw materials often yields margins of 30% and higher. My initial assumption had been that working capital would be the main limitation for how quickly I could grow, but that turned out to be wrong. Instead market size and “shelf space” day set the limits for growth. The server I play on has an “active” market of about 2k players during peak hours (source). Assuming the average player spends 100g per day, this means the total addressible market is only 200k gold. About half of this market consists of items that are found in-game and not produced. Of the other 100k I was able to capture about 10%-20% a day for revenue of 10k-20k and profits of about 2k-3k. The main reason for only capturing a small part of it is that I listed items on the market only once a day, and would often get undercut quickly. Thus often I was only the cheapest provider for a small part of the day.

The in-game time keeping suggests it took about 170 hours of play time to to the peak, or around 1000g/hour. The WoW gold exchange rate fluctuates, but a quick survey suggests an exchange rate of around 150g = $1. Thus my account is now worth in the order of $1500 (although it is non-trivial to liquidate that much gold) and I made $8.30 per hour. While that is more than the the California Minimum Wage of $8, for now I’ll stick to my day job.

Typically the initial tally by the NVCA increases by 15% or so as additional closes are announced (see Estimate in the graph for where I think we will end up), but even then this number is very low the worst we have seen in the last decade. Total capital raised was $1.7 billion.

Given that a typical venture fund runs 4-5 years, and assuming 1.5 parallel funds per firm (e.g. health care and IT), the average firm has to raise funds every 3 years or go out of business. With 25 funds per quarter, this means the fundraising can sustain 300-350 firms total. Given that we have 800-900 active firms now, expect a major shakeout. It will be interesting to see where it stabilizes. The NYTimes suggests between a third and half of VC firms will disappear. This would require fund raising to go back to a level of 40 new funds per quarter, which seems possible.

And again, for the firms that survive as well as for the LPs this will be a good thing. VC returns have been too low for the past 9 years, and this development is the start of correcting this.

A second technology that is highlighted is Siri’s personal assistant software. I am really looking forward to trying out Siri’s product when it goes into beta later this year. For full disclosure, Morgenthaler is an investor in Siri.

Only 43 venture funds where closed in Q4, and the total capital raised was $3.3 billion. This is down from 84 funds raising $11.6 billion a in Q4 of 2007. This brings venture fund raising back to the levels we saw right after the crash of 2000. I would expect to see a further decline for all of the next year in both number of funds as well as total capital. What this means for the venture industry is that if you have fully invested your old fund, and not yet raised a new fund (or at least had an initial closing), you may be in a very difficult situation. Howeve if you just raised a fund, you can expect less competition (and thus hopefully better returns) in the next few years.

According to the NVCA release, the number of venture funds closed over the last quarters is:

    1Q'07           83
    2Q'07           83
    3Q'07           78
    4Q'07           85
    1Q'08           70
    2Q'08           76
    3Q'08           55

In 3Q of this year we saw a steep drop. However the impact of the current liquidity crisis and the resulting stock market decline didn’t become fully apparent until October. If I would have to bet, I would expect 4Q to look a lot worse. Venture Beat recently wrote about this and concluded that essentially what we are seeing, is a shakeout in the VC industry. While I haven’t seen numbers yet that conclusively demonstrate this, it intuitively makes sense. Firms that were burnt badly in the post-bubble of 2000-2003, now have fully invested their funds and realize that in the current financial climate they can’t raise additional capital. One would expect new entrants in the Venture Capital space to be the most vulnerable. A firm like Morgenthaler with almost 40 years of track record and an established network of LP’s is naturally in a much better position.

For those firms that do raise funds now, prospects are not bad. Less active firms means less competition and more attractive valuations. Public markets may stay closed for a while, but private companies have a lot of cash on their balance sheets that I would expect them to eventually use for acquisitions. In the end I do think venture backed companies are a more effective model for innovation than large companies doing it themselves. If this is correct, the value chain should continue to function and venture investors will make money.

In the mean time, congratulations to the Morgenthaler team for closing their ninth fund!

The 2008 MIT Technology Review list of top innovators under 35 came out today,  Sundar Iyer and Seth Hallem, both fellow Stanford Ph.D. students, made the list this year, and I am very happy for both of them. Sundar has had a profound impact on how buffers for high-speed routers work, and Seth has changed what is considered best practice for code checking. Both have also founded great start-up companies in the process.

Congratulations Sundar and Seth!

Update: As Sundar points out, Stanford CS faculty Andrew Ng and former Ph.D. student Meridith Ringel Morris also made the list. Congratulations here as well!

A few people mentioned that they were suprised about my move to Stanford after leaving Voltage. This post should be a lot less suprising: I am joining Morgenthaler Ventures as a part-time Entrepreneur in Residence. Spending a day a week at Morgenthaler Ventures is a very synergistic combination. The exposure to bleeding edge technology in Stanford helps understanding entrepreneurial opportunities. Vice versa seeing the hard technical problems that portfolio companies face helps define meaningful new research areas. And while some of you may not have heard of them before, Morgenthaler is a great firm to work with.

Morgenthaler Ventures is arguably one of the more low-key venture firms on Sand Hill Road. When I originally met Ken Gullicksen at Stanford, I had not heard of them before. Once you start talking to people in the venture industry, your perception of Morgenthaler rapidly changes. They are not only well known, but they have been so for a while. When David Morgenthaler became a founding board member of the American Venture Capital Association in 1973, I was still a few years away from Kindergarten. In the 40 year history of the firm, Morgenthaler has been one of the few funds that has not only strived in the rapidly changing venture industry, but actually helped transform it to the modern venture capital industry it is now. They have also had their string of home runs including Apple, Verifone and NexTag. Today, Morgenthaler has three separate teams investing in information technology, life sciences and buyouts.

For the founding team at Voltage, Morgenthaler was a reliable partner and incredible help while building Voltage Security. Ken turned out to be a great and very active board member. In the early days we were joking that we should give him (and Prashant from HumWin) Voltage name cards because they were around so much. Beyond Voltage he has done alright as well, with IMEEM being ranked the #1 music streaming site on the internet and #85 internet site overall, and Nominum becoming the de-facto standard for carrier DNS.

So if you are at Stanford, and are looking for funding or you just want feedback on an entrepreneurial idea let me know and I am happy to help. Morgenthaler has traditionally a good relationship to the Stanford Community, and if I can help it this will only get better.

Building a company is primarily about finding the right people and building the organization. Conversely, the in my count most common cause of death for an early stage start-up is dysfunctional team. At Voltage, we started with a founding team that shared a common vision and terrific investors that were an incredible help whenever we needed them (picture of the early days on the right). On these foundations we together built the great organization that Voltage is today. I am grateful for having had the opportunity to work with everyone in the company, from the executive team, to the board to each and every employee. In retrospect there are only few hires that I would not make again. Going forward I am confident we have the team in place that has what it takes to guide Voltage into the future.

Along with Voltage, Identity-Based Encryption (and more generally Pairing Based Cryptography) has come a long way. From an algorithm hardly known outside the research community, it has become a widely used technology that is becoming a standard. This week, NIST is holding a Workshop on Pairing Based Crypto.

The thing I will miss most is probably my product group. Building a new product from scratch in a short period of time, and getting it right on the first try is an amazing accomplishment.

I am not quite ready to post what I will do next, but watch this space for an update in the next few days.