The Cloud Hanging Over Skype

Early this week, eBay announced that after four years of owning Skype, the popular, and free, online phone service, it had sold the company to an investor group for around $2 billion. The investors included the Silicon Valley private equity firm Silver Lake Partners; Marc Andreessen’s new venture capital firm, Andreessen Horowitz; a London firm called Index Ventures; and the Canada Pension Plan Investment Board. Under the terms of the deal, eBay will retain a 35 percent stake in Skype, giving it a valuation of $2.75 billion.

Many people on Wall Street — and a number of telecommunications experts I spoke to this week — were stunned by the price Skype sold for, and not just because we’re in the middle of a recession. In 2005, when eBay bought Skype from its founders, Janus Friis and Niklas Zennstrom, it paid $3.1 billion. But the company had performed so poorly that by the fall of 2007, eBay had been forced to take a $1.1 billion write-down.

Around that same time, Mr. Zennstrom, whose relationship with eBay management had turned acrimonious, stepped down as Skype’s chief executive. (Mr. Friis had already left the company.) Although Skype’s performance has improved since the installation of a new chief executive last year, it was no secret that eBay was trying to unload it. Many potential buyers had walked away, believing that eBay simply wanted too much.

There is another reason that the Skype deal has raised eyebrows, however. Not long after Mr. Friis and Mr. Zennstrom left the company, they became embroiled in a dispute with eBay that has turned into a very nasty lawsuit.

It turns out that in selling Skype to eBay, Mr. Friis and Mr. Zennstrom retained control of a key part of the Skype technology, which they licensed to eBay. Although the details are under seal in a London court, the Skype founders’ essential complaint is that eBay tampered with their software, and in doing so, violated the terms of the licensing agreement. They were demanding that Skype be forced to stop using the technology, which, for all intents and purposes, would mean shutting down Skype itself. The case is set for trial in 2010.

Companies are sued all the time, of course. But this lawsuit feels different; to put it bluntly, it feels more dangerous than the typical lawsuit aimed at a corporation. In a court hearing in London last June, eBay’s lawyer told the court that if Mr. Friis and Mr. Zennstrom won the case, the result would be “devastating.”

In its financial documents, eBay says that it is “confident” of its legal position. But it also acknowledges that an “adverse result” could mean that the “continued operation of Skype’s business as currently conducted would likely not be possible.” That is hardly your typical corporate boilerplate. Indeed, after that court hearing in June, a telecom analyst named Jayanth Angl told Bloomberg that “if eBay can’t reach an agreement over that piece of technology, that could certainly turn the Skype acquisition into a debacle.”

And so, the mystery of the Skype deal: why were the winning bidders willing to pay so a high price for a company whose very existence could be threatened by this lawsuit? One possibility is that they have nerves of steel. The other is that they know something nobody else does.

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Skype was not Mr. Friis’s and Mr. Zennstrom’s first company. No, that was the infamous Kazaa, a peer-to-peer company that the two men founded in 1999, not long after Napster showed the world exactly how easy it was to steal copyrighted music using peer-to-peer computing. By 2001, the recording industry, having routed Napster, turned its sights on Kazaa.

Going after Kazaa was tougher because it was located somewhere in Northern Europe, outside the purview of United States law enforcement. (No one knew exactly where.) The Kazaa founders moved periodically to keep the recording industry from being able to subpoena them, and for years, they stayed away from the United States for the same reason. But the recording industry kept up the pressure, and as their legal costs mounted, Mr. Friis and Mr. Zennstrom finally decided to get rid of the company and move on.

Former Skype executives will tell you that the Kazaa experience did a lot to shape Mr. Friis’s and Mr. Zennstrom’s approach to business. It made them extremely secretive. They almost never talk to the press. (They didn’t speak to me for this column.) And it also made them extremely protective of the technology they created. Which is why, long before they sold Kazaa, they moved their peer-to-peer software into a new company, called JoltID.

In 2003, when they started Skype, that same technology that had powered Kazaa became an important part of the Skype code; it was the means by which computer users connected to each other and created a larger network. (VoIP — voice over Internet protocol — was the means by which they spoke to each other online.) But Skype never owned the technology; JoltID did.

Why eBay was willing to go along with such an arrangement when it bought Skype two years later will forever be a puzzle. But so long as the two men remained part of the eBay “family,” it didn’t matter much. Any changes to the peer-to-peer code were ones they approved.

When the deal went sour, however, and the founders left eBay, that all changed. And when eBay continued to tinker with the code — something eBay contends it has a right to do under the license — they entered into negotiations that went nowhere. Finally, by March of 2009, the two sides had sued each other.

At the same time, the founders, together with some big private equity firms, including Elevation Partners in Silicon Valley (yes, the Bono firm), and General Atlantic in New York, were trying to buy back Skype. It was, after all, their one big success. (Their third start-up, Joost.com, has gone nowhere.)

It is hard to know precisely what happened next. EBay claims that all the bidders were treated the same, and that the losers simply didn’t put up as much money as the winner. But according to supporters of the Skype founders, their investing consortium made three serious efforts, over the course of a year, to bid for the company. Every time, they say, they were stiff-armed by eBay’s investment bankers. About a month ago, they wrote a letter to eBay protesting their inability to get a hearing for their proposals.

And maybe the Skype founders did try to buy back the company on the cheap. The sense I got, however, is that the founders would have been willing to come up with a price that suited eBay — if they had been able to enter into negotiations. What is clear is that the bad blood that had developed between eBay and the founders was infecting the potential negotiations over a buyback of the company. (EBay denies this.)

And then, a few months ago, out of the blue, came the $2 billion bid from the Silver Lake consortium. One way it has dealt with the litigation risk is by persuading eBay to assume 50 percent of any losses resulting from the lawsuit. But that still doesn’t mitigate against the possibility that the founders could win the lawsuit — and put their creation, Skype, out of business.

So why were they willing to bid so high? One theory is that the Silver Lake people think they can win in court. Indeed, if by next summer the two sides are still arguing in court, we’ll know that is the answer to the mystery. That is the “nerves of steel” theory.

But how likely is that? In this environment, big-time private equity firms don’t commit $2 billion if there is a serious possibility the company they’ve just bought might be put out of business. As it happens, not long before Index Ventures became interested in Skype, it brought on board a man named Michelangelo A. Volpi, a highly respected former Cisco executive who — hmmm — once sat on the Skype board. In fact, he was so well liked by the Skype founders that they hired him to run Joost. Wouldn’t you know it? Joost uses the same peer-to-peer technology as Skype and Kazaa.

Mr. Volpi told me that not long after he arrived at Index Ventures, he discussed the possibility of making a run at Skype — and he and another Index Ventures partner, Danny Rimer, in turn rounded up Silver Lake and Mr. Andreessen, who — hmmm — sits on the eBay board. (As soon as he got involved with the bid, Mr. Andreessen recused himself from any board discussion about the Skype sale.) In the end, Mr. Andreessen committed $50 million to the deal — a very large percentage of his $300 million venture fund.

So another theory: because of his friendship with the Skype founders, Mr. Volpi believes he’ll be able to settle the lawsuit. Rich Tehrani, the president of TMC, a telecom publishing company, told me that he had just come from a conference where rumors were rife that the Silver Lake consortium had already cut a side deal with the Skype founders. (All the parties deny this.)

The third possibility is that Mr. Andreessen and the others have figured out a technology “workaround” so they no longer have to rely on the JoltID technology, something eBay had already begun working on. But almost everyone I spoke to said such a workaround would be, at best, difficult and expensive — and could cause such severe disruption to Skype’s business that it might never recover.

It is, alas, unsatisfying to delve into a mystery like this and not be able to solve it. But over time, it will become clear. Either the case will linger, and we’ll know that Silver Lake, Andreessen et al. do indeed have nerves of steel.

Or it will quickly go away, which will provide an answer of a less seemly sort. The mission of Skype, after all, is to shrink the world and bring people together.

 

Venture Firm’s ‘Green’ Funds Top $1 Billion

Vinod Khosla says most clean-tech companies need only a few million dollars to prove that their technology works.

Vinod Khosla, the prominent venture capitalist who has been investing hundreds of millions of his own dollars in green technology companies for the last several years, will now invest other people’s money, too.

Khosla Ventures, the firm he founded in 2004 after leaving Kleiner Perkins Caufield & Byers, is announcing on Tuesday that it has raised $1.1 billion in two funds that will invest in green technology and information technology start-ups.

This is the largest amount raised by a venture capital firm since 2007 and the largest first-time fund raised since 1999, according to the National Venture Capital Association.

Khosla Ventures will make initial investments of $5 million to $15 million from its main $800 million fund. The smaller $275 million fund will seed very early-stage ideas with investments of around $2 million.

“It’s really geared toward science experiments,” Mr. Khosla said. “The goal there is very much to take risks that nobody else will take.”

The new funds fly in the face of two of the prevailing investment philosophies in Silicon Valley. In response to diminishing venture capital returns, investors have been advocating small funds of only a few hundred million dollars and staying away from high-cost, high-risk alternative energy companies.

Mr. Khosla advocates precisely the opposite. Harnessing technology to address climate change will require the big risks that venture capitalists were once known for, he said. “We’re really about reinventing the infrastructure of society, which is the only way we’ll get the carbon footprint down, and we’re not afraid to fail.”

After a period of hyperactive investment in alternative energy start-ups, investors have been shying away from them, arguing that they cost too much. In the first half of 2008, venture capitalists funneled $2 billion into 139 clean tech start-ups. In the first half of this year, they invested only $513 million in 83 such companies, according to PricewaterhouseCoopers.

But Mr. Khosla said the notion that clean tech companies were too capital-intensive for venture capital was a myth. A start-up needs only a few million dollars to prove that its technology works, he said. If it does, it will attract interest from investors and big companies that may want to license the technology.

“This is the 1980s style of venture capital — real technical risk with small amounts of money and small teams,” said Mr. Khosla, who co-founded Sun Microsystems. “Clean-tech companies taking large amounts of money — that’s project finance, not technical risk. That’s a differentiation most people have lost.”

Mr. Khosla, along with partners who have joined the firm, has been investing upward of $400 million of his own money in such companies. They include companies that reduce dependence on coal and oil, make materials like concrete or plastic in an environmentally friendly way and increase energy efficiency.

One company used less than $10 million to show that improved membrane chemistry could be used to make water desalination plants more energy-efficient. Another company is working on compressor-free air-conditioners. Calera, a third company, takes the carbon dioxide produced by burning coal and drives it through water to convert it to carbonate and then cement. Calera is already producing concrete at a pilot plant in California.

Mr. Khosla invests when start-ups are barely more than an idea, and expects many of them to fail. That strategy worked fine when he was investing his own money, but could have been a hard sell to outside investors, which is why the firm started a separate seed fund for these high-risk deals.

“The terms I used to describe our seed fund were, ‘We don’t expect to be fiduciary all the time. We will often invest in things that have a high probability of failure,’ ” Mr. Khosla said. Yet to his surprise, there was more interest in that fund than the other.

“We insisted on being in a fund like that,” said Joncarlo Mark, head of private equity investing for Calpers, the California Public Employees Retirement System fund, which invested $60 million in Mr. Khosla’s riskier small fund and $200 million in the big fund. “The opportunity to partner with Vinod in his science experiments to us is as attractive as having a later-stage fund investing in more established businesses.”

One reason Mr. Khosla’s investors are comfortable with the firm’s high-risk bets is that the partners have invested at least $100 million of their own money in the fund, Mr. Mark said.

To help the five partners invest the money, Khosla Ventures has hired two new partners: Gideon Yu, former chief financial officer at Facebook, and James Kim, who ran the clean-tech practice at the venture firm CMEA.

When choosing partners, Mr. Khosla said his top priorities were finding people who had operational experience inside companies, not just M.B.A.’s, and technical expertise, two qualities he said were all too rare in Silicon Valley these days. He throws out résumés from English majors, preferring engineers who can have spirited discussions with entrepreneurs about technical risks.

Introducing our new venture capital firm Andreessen Horowitz

What marc andreessen wrote in his blog about his new venture ANDREESSEN HOROWITZ"

A NEW MILESTONE IN MARC'S WORK, HE HAD SHARED HIS EXPERIENCE IN HIS BLOG: 

"My partner Ben Horowitz and I are delighted to announce the formation of our new venture capital firm, Andreessen Horowitz, and our first fund -- $300 million in size -- aimed purely at investing in the best new entrepreneurs, products, and companies in the technology industry.

Between the two of us, Ben and I have started three companies directly, created many new products and services, run operating businesses at high levels of scale, angel invested in 45 tech startups in the last five years, and served on a broad cross-section of company boards with some of the best entrepreneurs and investors in the industry. Through all this, we have worked closely together for 15 years, and we could not be more excited to extend our partnership into venture capital.

In undertaking this new mission, our core principles include:

• Technology and its advancement is absolutely central to human progress. Entrepreneurs who create new technologies and technology companies are improving the standard of living of people worldwide and unlocking amazing new levels of human potential.

 

• While broad investor psychology whips wildly between euphoria and depression, technology change not only continues but is accelerating. In fact, we believe that technology change cascades -- each new generation of technology continues within it the seeds for even more profound advances to come. And, technology change creates continuous opportunity to build important and valuable new companies.

 

 

• A technology startup is all about the entrepreneurial team and their vision. Our job as venture capitalists is primarily to support entrepreneurs by helping them build great companies around their ideas.

 

 

• The process of building a new technology company is changing rapidly. For example, many of the best new technology companies require far less money up front to build the first product, but far more money later to scale into today's enormous global market, as compared to historical norms. We intend to not only embrace these changes but drive them forward as hard as we can.

 

 

• Building a great company is a team sport -- including the selection of the best possible set of investors and advisors for a specific opportunity. We have been lucky enough to work with many of the industry's best investors, advisors, mentors, and coaches over the last 15 years, and we look forward to continuing to be a great partner to all of them.

 

 

• Trust is essential to building a great company. Trust requires the highest standard of ethical conduct, which we will strive hard to achieve and maintain.

 

 

• While there are many exciting new entrepreneurial opportunities in fields like energy and transportation, there continues to be gigantic opportunity in information technology -- which is where we will focus.

 

 

• And, while there are many extremely bright and capable entrepreneurs all over the world, there continues to be a special magic to Silicon Valley -- which is where we will focus.

 

We will hang our hat as a firm on the fact that both of us have extensive direct entrepreneurial and operating experience. We have built companies, from scratch, to high scale -- thousands of employees and hundreds of millions of dollars of annual revenue. In short, we have done it ourselves. And we are building our firm to be the firm we would want to work with as entrepreneurs ourselves.

Here are some more specifics about how we will operate:

• We have the ability to invest between $50 thousand and $50 million in a company, depending on the stage and the opportunity. We plan to aggressively participate in funding brand new startups with seed-stage investments that will often be in the hundreds of thousands of dollars. But we will also invest in venture stage and late stage rounds of high-growth companies.

 

• We also have the ability to participate in a variety of investment structures, including but not limited to buying founder shares, investing in public stocks, and contributing to leveraged buyouts. We do not have a goal to do any of these things specifically, but rather we will be maximally flexible to suit our investing strategy to the opportunity.

 

 

• Ben and I will be the only General Partners in the firm, at least to start. We may add a small number of additional General Partners in the future, but we are not assuming that will be the case. We will also build a professional staff to support us in our efforts and to help our portfolio companies in various ways. However, we will not have associates or other General Partner-track junior positions.

 

 

• Ben and I will go on boards of companies in cases where we are investing serious money -- generally, $5 million or more, although there could be exceptions in both directions. We will generally not go on boards of raw startups -- in fact, in many cases, we don't even think today's raw startups should have boards.

 

Here are some more specifics about what kinds of entrepreneurs and companies we are looking for:

• Above all else, we are looking for the brilliant and motivated entrepreneur or entrepreneurial team with a clear vision of what they want to build and how they will create or attack a big market. We cannot substitute for entrepreneurial vision and drive, but we can help such entrepreneurs build great companies around their ideas.

 

• We are hugely in favor of the technical founder. We will generally focus on companies started by strong technologists who know exactly what they want to build and how they are going to build it.

 

 

• We are hugely in favor of the founder who intends to be CEO. Not all founders can become great CEOs, but most of the great companies in our industry were run by a founder for a long period of time, often decades, and we believe that pattern will continue. We cannot guarantee that a founder can be a great CEO, but we can help that founder develop the skills necessary to reach his or her full CEO potential.

 

 

• We believe that the product is the heart of any technology company. The company gets built around the product. Therefore, we believe it is critical that we as investors understand the product. We are ourselves computer scientists and information technologists by experience and training; therefore, we plan to focus on products in the domain of computer science and information technology.

 

 

• Here are some of the areas we consider within our investment domain today: consumer Internet, business Internet (cloud computing, "software as a service"), mobile software and services, software-powered consumer electronics, infrastructure and applications software, networking, storage, databases, and other back-end systems. Across all of these categories, we are completely unafraid of all of the new business models -- we believe that many vibrant new forms of information technology are expressing themselves into markets in entirely new ways.

 

 

• We are almost certainly not an appropriate investor for any of the following domains: "clean", "green", energy, transportation, life sciences (biotech, drug design, medical devices), nanotech, movie production companies, consumer retail, electric cars, rocket ships, space elevators. We do not have the first clue about any of these fields.

 

 

• We are primarily but not entirely focused on investing in Silicon Valley firms. We do not think it is an accident that Google is in Mountain View, Facebook is in Palo Alto, and Twitter is in San Francisco. We also think that venture capital is a high touch activity that lends itself to geographic proximity, and our only office will be in Silicon Valley. That said, we will happily invest in exceptional companies wherever they are.

 

Finally, one personal note -- my role as an active Chairman of Ning will continue unchanged, along with my board roles at Facebook and eBay.

If you have read this far, thank you very much for your interest in our new firm -- we will keep you updated over the months and years to come by blog!" -MARC ANDREESSEN