Starting Points: venture capital

Mar 8, 2010

How Pandora Avoided the Junkyard, and Found Success

By CLAIRE CAIN MILLER

OAKLAND, Calif. — Tim Westergren recently sat in a Las Vegas penthouse suite, a glass of red wine in one hand and a truffle-infused Kobe beef burger in the other, courtesy of the investment bankers who were throwing a party to court him.

It was a surreal moment for Mr. Westergren, who founded Pandora, the Internet radio station. For most of its 10 years, it has been on the verge of death, struggling to find investors and battling record labels over royalties.

Had Pandora died, it would have joined myriad music start-ups in the tech company graveyard, like SpiralFrog and the original Napster. Instead, with a successful iPhone app fueling interest, Pandora is attracting attention from investment bankers who think it could go public, the pinnacle of success for a start-up.

Pandora’s 48 million users tune in an average 11.6 hours a month. That could increase as Pandora strikes deals with the makers of cars, televisions and stereos that could one day, Pandora hopes, make it as ubiquitous as AM/FM radio.

“We were in a pretty deep dark hole for a long time,” said Mr. Westergren, who is now the company's chief strategy officer.. “But now it’s a pretty out-of-body experience.”

At the end of 2009, Pandora reported its first profitable quarter and $50 million in annual revenue — mostly from ads and the rest from subscriptions and payments from iTunes and Amazon.com when people buy music. Revenue will probably be $100 million this year, said Ralph Schackart, a digital media analyst at William Blair.

Pandora’s success can be credited to old-fashioned perseverance, its ability to harness intense loyalty from users and a willingness to shift directions — from business to consumer, from subscription to free, from computer to mobile — when its fortunes flagged.

Its library now has 700,000 songs, each categorized by an employee based on 400 musical attributes, like whether the voice is breathy, like Charlotte Gainsbourg, or gravelly like Tom Waits. Listeners pick a song or musician they like, and Pandora serves up songs with similar qualities — Charlotte Gainsbourg to Feist to Viva Voce to Belle and Sebastian. Unlike other music services like MySpace Music or Spotify, now available in parts of Europe, listeners cannot request specific songs.

Though Pandora’s executives say it is focusing on growth, not a public offering, the company is taking steps to make it possible. Last month, it hired a chief financial officer, Steve Cakebread, who had that job at Salesforce.com when it went public.

It is all a long way from January 2000, when Mr. Westergren founded the company. Trained as a jazz pianist, he spent a decade playing in rock bands before taking a job as a film composer. While analyzing the construction of music to figure out what film directors would like, he came up with an idea to create a music genome.

This being 1999, he turned the idea into a Web start-up and raised $1.5 million from angel investors. It was originally called Savage Beast Technologies and sold music recommendation services to businesses like Best Buy.

By the end of 2001, he had 50 employees and no money. Every two weeks, he held all-hands meetings to beg people to work, unpaid, for another two weeks. That went on for two years.

Meanwhile, he appealed to venture capitalists, charged up 11 credit cards and considered a company trip to Reno to gamble for more money. The dot-com bubble had burst, and shell-shocked investors were not interested in a company that relied on people, who required salaries and health insurance, instead of computers.

In March 2004, he made his 348th pitch seeking backers. Larry Marcus, a venture capitalist at Walden Venture Capital and a musician, decided to lead a $9 million investment.

“The pitch that he gave wasn’t that interesting,” Mr. Marcus said. “But what was incredibly interesting was Tim himself. We could tell he was an entrepreneur who wasn’t going to fail.”

Mr. Westergren took $2 million of it and called another all-hands meeting to pay everyone back. The next order of business: focus the service on consumers instead of businesses, change the name and replace Mr. Westergren as chief executive with Joe Kennedy, who had experience building consumer products at E-Loan and Saturn. Pandora’s listenership climbed, and in December 2005, it sold its first ad.

But in 2007, Pandora got news that threatened most of its revenue. A federal royalty board had raised the fee that online radio stations had to pay to record labels for each song. “Overnight our business was broken,” Mr. Westergren said. “We contemplated pulling the plug.”

Instead, Pandora hired a lobbyist in Washington and recruited its listeners to write to their representatives. “A lot of these users think they’re customers of the cause rather than users per se,” said Willy C. Shih, a professor at Harvard Business School who has written a case study on Pandora. “It’s a different spin on marketing.” The board agreed to negotiations and after two years settled on a lower rate.

Some music lovers dislike Pandora’s approach to choosing music based on its characteristics rather than cultural associations. Slacker Radio, a competitor with three times as many songs but less than a third of Pandora’s listeners, takes a different approach. A ’90s alternative station should be informed by Seattle grunge, said Jonathan Sasse, senior vice president for marketing at Slacker. “It’s not just that this has an 80-beat-a-minute guitar riff,” he said. “It’s that this band toured with Eddie Vedder.”

Yet in 2008, Pandora built an iPhone app that let people stream music. Almost immediately, 35,000 new users a day joined Pandora from their cellphones, doubling the number of daily signups.

For Pandora and its listeners, it was a revelation. Internet radio was not just for the computer. People could listen to their phone on the treadmill or plug it into their car or living room speakers.

In January, Pandora announced a deal with Ford to include Pandora in its voice-activated Sync system, so drivers will be able to say, “Launch my Lady Gaga station” to play their personalized station based on the music of that performer. Consumer electronics companies like Samsung, Vizio and Sonos are also integrating Pandora into their Blu-ray players, TVs and music systems.

“Think about what made AM/FM radio so accessible,” said Mr. Kennedy, Pandora’s chief. “You get into the car or buy a clock for your nightstand and push a button and radio comes out,” he said. “That’s what we’re hoping to match.”

Mar 7, 2010

And Google Begat...

Image via Wikipedia

The search giant's former employees are seeding tech startups—and shaping another wave of innovation

By Spencer E. Ante and Kimberly Weisul

During the holidays last year, Aydin Senkut and Elad Gil gathered 50 of their friends at a health-food restaurant in Palo Alto. Over turkey burgers and tofu wraps, they talked about tech trends and how to get rich. Or, more precisely, how to get richer.

Senkut, Gil, and their dining circle are alumni of Google (GOOG), one of the greatest engines of wealth creation the U.S. has ever known. Since going public six years ago, Google has generated more than $170 billion for its employees and investors. Many of the millionaires the company has produced are young, wired into the latest developments in tech, and at ease with risk. Which explains why so many Google alums—including many of those at Senkut and Gil's gatherings—are active angel investors, attempting to add another zero to their bank accounts and another innovative company to their list of accomplishments. "I feel like we have such a strong network, it's almost like we've recreated Google outside of the Google walls," says Andrea Zurek, a 39-year-old backer of 26 startups.

More than 40 ex-Googlers have invested in about 200 fledgling companies since 2005, according to the research firm YouNoodle and reporting by Bloomberg BusinessWeek. At least a half dozen current Google executives, including CEO Eric Schmidt and co-founders Larry Page and Sergey Brin, are also financing young companies. Numerous angel-watchers say the Google group has more in common than just pedigree. Unlike many venture capitalists, the Googlers like to swap investment ideas and back startups together. They're also willing to take big chances. "[They're getting into] very risky deals that can be extremely rewarding," says Jeff Clavier, a veteran venture capitalist who founded Palo Alto-based SoftTech VC in 2004. "They have been very active as a group over the past two to three years."

MORE THAN MONEY

The results have been impressive. Companies backed by Googlers include Twitter, Tesla Motors, and gamemaker Tapulous. "As Google matures, its alums are continuing to have a huge impact on Silicon Valley and the tech industry," says Ron Conway, one of the Valley's most active angel investors, who has backed 190 companies, including Google, Facebook, and Twitter.

One reason for their success is that Google's angels have more to offer struggling entrepreneurs than just money. Bart Decrem, a Stanford University law grad, turned to the Google network when he was starting Tapulous in 2008. The company's Tap Tap Revenge game requires players to tap on-screen balls to the beat of a song—not exactly a sure thing of an idea. But Decrem thought the game might become a substantial business by selling it on Apple's (AAPL) iPhone. He raised $500,000 from a dozen angels, including Senkut and Zurek, who advised on strategy, connected the company with new partners in Asia, and helped it explore platforms for mobile phones that use Google's Android software. Today, Tap Tap games have been downloaded more than 25 million times and Tapulous is solidly profitable, with $1 million in revenues a month.

Google's Angels dabble in a wide variety of businesses. Zurek has money in a premium vodka maker and a South Korean frozen yogurt emporium. Yet the angels tend to concentrate their cash in what they know—search technology, mobile computing, and the consumer Internet. Already, Twitter, backed by former Google executive Chris Sacca, is the hottest startup in Silicon Valley, pioneering a new field of real-time communications. The online personal finance service Mint.com, with money from Senkut, proved so popular that market leader Intuit (INTU) bought it for $170 million last year and made founder Aaron Patzer one of its top execs. Search provider Powerset, backed by Senkut, was acquired by Microsoft (MSFT) in 2008, and its technology became a key part of the Bing search engine.

SERIOUS SCHMOOZING

The most active Google angel thus far is Senkut, a 40-year-old native of Turkey who has invested between $25,000 and $150,000 in more than 60 startups. Senkut joined Google in 1999 as its 63rd employee. He left in 2005 and promptly took his mother to Paris for her 60th birthday, purchased two multimillion-dollar homes in the Bay Area, and treated himself to a Lamborghini.

With that out of his system, he set about becoming a full-time angel. Senkut is often the first investor behind an idea, and to date 11 of the startups he helped fund have been bought by companies including Google, AT&T (T), and Microsoft. Senkut also fosters the investment of others by organizing two regular events for alums, one for angels and entrepreneurs, and another for all ex-employees, at spots such as the Calafia Café in Palo Alto, owned by Google's first in-house chef. Senkut is raising money for his firm, Felicis Ventures, according to two angel investors, and could not comment on his investments for this story. (Securities laws prevent the public solicitation of funds.) In an interview last October, though, before four of his companies were sold, Senkut said his investments had produced double-digit annualized returns and that, at the time, he was being pitched new business ideas several times a day.

If Senkut is the established star among the Google angels, Chris Sacca is the up-and-comer. The 34-year-old Georgetown University law grad joined Google in 2003 and left in 2007. Of the 31 startups he's backed, his biggest hit is Twitter, in which he invested $50,000 just as it was getting started in 2007.

Working out of a 3,000-square-foot home in Truckee, Calif., a small ski town near Lake Tahoe, Sacca hikes and snowshoes most mornings before breakfast and commutes to San Francisco for three days every two weeks. It's an unconventional way to supervise investments, but Sacca has an unconventional approach to investing, period.

One Friday night in December 2008, he posted a message on Twitter asking if any startups were working late. "We tweeted back, 'we're FanBridge and we work hard every Friday night,'" says Spencer Richardson, its 25-year-old co-founder. FanBridge makes software that helps musicians manage marketing and relationships with their fans. A few weeks later, Sacca flew to New York and met with the company's founders. "They had day jobs and built this site that had 20 million users, adding 100,000 users a day," says Sacca. "It was a no-brainer."

Over the next few months, Sacca invested $50,000 and pulled in several hundred thousand dollars from other angels. Last year, FanBridge's founders considered offering their products to authors, comedians, and other artists; Sacca advised them to stay focused on the music industry. Today, FanBridge is profitable and used by 55 million music fans. "The feedback from him was, 'start by being the best at something, then branch out,'" says Richardson.

The Google Angels may have several more breakout companies developing in their portfolios. Sacca has invested in Lookout, a promising developer of security software for mobile phones. Several ex-Googlers and current Vice-President Marissa Mayer are behind Square, which aims to displace credit-card swiping machines with a cheaper payment system that works through smartphones. And current Google exec Joshua Schachter helped finance Foursquare, a mobile phone service that lets friends share tips on local hotspots and is being used more than a million times a week. "What drives us is the innovation, the excitement of working with people we like," says Zurek.

Paul Graham, who co-founded the startup incubator Y Combinator, believes the tech industry has just begun to appreciate that Google's wealthy ex-employees may have not just a single innovative second act, but potentially hundreds of them. "When people write the history of Silicon Valley 20 years from now," says Graham, "the true impact of Google could come more from all the things that Google people go on to do after they leave Google."

Who are the top angel investors? To find out, go to www.businessweek.com/go/10/angels

Ante is an associate editor for BusinessWeek. Kimberly Weisul is editor of BusinessWeek SmallBiz .