Advice for Transitioning from Wall Street to Start-ups

In my last post, I talked about some the challenges and barriers to success facing Wall Streeters interested in the start-up world. Difficult doesn't mean impossible - it just means that you are going to need the same passion, intensity, steely resolve and thirst for learning for transitioning from Wall Street as you'll need for either founding or working in a start-up. So it is actually a pretty healthy and necessary self-selection process, in my opinion. Over the last 4+ years I've done stuff that I couldn't have imagined that made all the difference in my acclimation to the start-up/technology world. The thing that will be difficult for most Wall Street refugees to understand is that being at a technology start-up, whatever your capacity, isn't a job: it's a way of life. Because success is partly dependent upon being an active learner, opening both your mind and your heart to new and non-intuitive things on a daily basis.

While I am only one data point, I will share some of the steps I took to make the transition from Wall Street to Silicon Alley, and continue to make every day.

• Reach out to friends who either work in or are investors in start-ups. Duh, obvious, right? One of the guiding principles on Wall Street is using data to make decisions, and it should be no different when making this transition. You need to speak to lots and lots of people who have either gone through what you are contemplating, or who have experience with those who have attempted the same. I was lucky to have guys like Fred Wilson and Jeff Stewart as early resources, both as data points and as connectors to others who gave me even more data. While your experience, personality and skill sets are unique, those of others can be very, very instructive.

• Immerse yourself in the start-up ecosystem. This means going to relevant Meetups, presentations offered by law and accounting firms, select conferences, etc. Subscribe to Gary'sGuide.org and other meeting notification services in order to keep your finger on the pulse of the technology and start-up scene. See, be seen, collect business cards from both investors and entrepreneurs, and hand out zillions yourself. Eventually you will become a fixture in the community. And this is a good thing.

• Become a "Let's go out for breakfast" and a "Let's grab a coffee" madman. Network, network, network. Entrepreneurs. Venture capitalists. Angels. Potential clients. Potential partners. Smart people in your domain of interest. These meetings exhibit exponential - not linear - benefits upon your networking and data collection process, as people in this realm tend to be incredibly helpful and introduce you to lots of other people who become nodes - offering new connections - themselves. Once you get this ramped up your learning absolutely skyrockets, and the contacts you make can help land a job, locate a business partner or de-risk a new venture through an advisory or commercial relationship.

• Read lots of good blogs. There is so much great content out there, stuff that seems like it is written JUST for you given your areas of interest. Take advantage of this. It is also a great way to meet people with common interests with whom you can start a dialogue, out of which might come - who knows? I've commented on people's blogs, sent them emails and built dialogues that evolved into great relationships. Becoming an avid consumer of the medium is very important from both knowledge and networking perspectives but also for getting your head around being a start-up guy.

• Start a blog yourself. I know, it's not for everyone. But if you fancy yourself a start-uppy kind of person, then you must have the ideas necessary to populate a blog. The value, however, is well beyond that. It is a place you can refer people for greater insight into you both as a person and as a professional. It is a platform for igniting conversations around topics of interest to you. And it brings with it a certain aura of engagement, of caring enough to set it up and maintain it. This is pretty important cred when interacting with technology types, many of whom have blogs and use them to great effect. While it takes a meaningful amount of time to do a blog and do it well, it is a valuable mechanism for getting fully ingrained into the technology ecosystem.

• Join and use Twitter, Facebook and LinkedIn. While I've been on LinkedIn a long time, I find myself spending the most time on Twitter, followed by Facebook. LinkedIn is a distant third. While I think it is important to have a presence on all three, Twitter is clearly the most dynamic, fastest moving, and most powerful vehicle for getting a grip on the conversations happening in your areas of interest. Twitter and blogs. Choose the Twitterers and bloggers you follow well and it will pay off in spades. You will be extremely well-informed, on the cutting edge of information, and have a circle of influencers with whom to interact. It's all good.

• Separate - really separate - from Wall Street. It is really, really hard to sever the spiritual umbilical cord. The political machinations that were irritating while you were on the inside are a compelling soap opera once you go outside. Resist the Siren's Song. Also, it can make the fear even greater when you stay close to people still on the (albeit smaller) gravy train while you've made the break. Don't hang out with them. Spend the time getting acclimated to your new world. This doesn't mean saying goodbye to friends; it just means having a clear delineation between personal and professional boundaries, and refusing to allow yourself to live in the past. Making the break is hard. Once you've done it, DO IT. Don't let yourself get sucked back in. Because you will end up depressed and frustrated, and further way from your goal of being a different kind of person, a different kind of professional. You deserve better. Move on.

• If you can, do a little angel investing and/or advising start-ups. I am strongly against "dabbling" in the angel investing domain, but I view this as a little pocket money akin to going to Vegas or AC to play poker. Becoming an angel, getting to see how others start companies, pitch ideas, interact with investors and staff their firms is invaluable education, well worth the price of admission. I'm not suggesting spending a material amount of your net worth doing this, but enough so you are able to see some deal flow and perhaps use a more experienced friend to help select a few small-ticket investments. Also, putting yourself out there as a potential adviser to start-ups is a great way to learn about how they work. With your domain expertise from Wall Street, you could add a lot of value to a nascent company. Get engaged. Help out. And learn, learn, learn.

• Acknowledge the challenges but don't be daunted. If you come into this transition with humility, excitement, intensity and focus, you can make it happen. Invariably the road will contain some potholes (if my own experience is any guide), but persistence is what makes great entrepreneurs and great partners, and what makes victory at the end of the day just so sweet.

Don't worry, be happy? Not at all. There is plenty to worry about. But there is a lot that you, former Wall Streeter, can do to make your move into the world of start-ups a much more satisfying and successful experience. Best of luck and get on with it.

Will Ex-Wall Streeters Fuel an Entrepreneurial Boom? Well...

Much has been written about the unleashing of entrepreneurial potential in the wake of lost jobs, frustrations with being a "depressed survivor" and general dissatisfaction with life on Wall Street 2.0. For those of us who spent time at the big firms during Wall Street 1.0 and have a sense of 2.0 life, it makes sense that many of the smartest, most capable people would either head for established boutiques or leave to create their own ventures. But it is important to distinguish between different kinds of ventures, in particular those that reallocate the value pie versus those that expand the value pie.

At one end of the continuum, populated by guys like Ken Moelis, Frank Quattrone and their banker buddies, you've got the value reallocaters. What these people are doing isn't rocket science; in fact, it's not materially different than what they had been doing previously. Sure, they might be providing higher-touch service, deeper advice and more senior partner attention, but all they're doing is taking share away from Goldman Sachs, Morgan Stanley and JP Morgan. Is this entrepreneurship? Sure. Is this the kind of entrepreneurship, however, that's going to fuel an economic resurgence? Not a chance.

Then you've got all those IT professionals, middle- and back-office pros, and less senior bankers trying to figure out what to do with their lives. These are the potential value expanders. Some would like to apply their skills to the ideas of others, get out of the big corporation and go and work for a start-up. Others want to be their own boss and pursue their own dreams as entrepreneurs. Bravo! Assuming the idea makes sense, taking big company skills and applying them to new and exciting problems is fantastic. However, here are a few issues to consider:

• The physical environment and resources of a start-up are light years away from that of Wall Street - at any level. I went from a corner office with an assistant, an IT staff, oodles of resources and most anything within my grasp to a sixth floor walk-up (the building had an elevator, but I wouldn't be caught dead in it - or maybe I would), a bathroom with a washer/dryer that blew lint in your face and a sink that was falling off the wall such that a permanent cesspool existed at the bottom. Oh, and up to eight of us were crammed in an office that was smaller than my corner beauty on Park Avenue. Shocking, yes. But I was ready for it. No assistant. No IT support. Nobody to order my lunch. I went straight back to college, after nearly two decades of being a coddled Wall Street denizen. For whatever reason I was psychologically ready for the shift, but I've seen others for whom the transition was somewhat more challenging.

• The culture of a start-up is night and day from that of Wall Street. Fiefs and political barriers exist all over the place on Wall Street, and "playing the system" requires a defined skill set: toughness, cynicism and mistrust. Fact is, these attributes that helped you succeed on Wall Street are more than simply unhelpful in a start-up environment; they are toxic. Start-ups are truly collaborative, roll-up-the-sleeves, we're-all-in-this-together kinds of places. If you are withholding information, managing politics or constantly positioning, you'll both damage the company and your chances for success. I can personally say that it took me a while, particularly in negotiations with financing sources, to lay down my arms and to stop being the aggressive and tough Wall Street animal I had become. It doesn't mean being a pansy; it means not always thinking people are trying to screw you and to alter the tone of communications. It's not that easy.

• The risk of a start-up is worlds apart from Wall Street. Salaries are sharply lower. Bonuses by Wall Street standards don't exist. Upside is in the form of highly illiquid, massively volatile call options. It is a completely different payoff profile. This is hard to swallow for someone who has been on the gravy train for a long time. And even if that gravy train no longer exists, it doesn't mean the adjustment isn't very challenging. It takes time to adopt the start-up mind-set, and it isn't easy for people who come from such a radically different world.

Without a doubt, there will be some Wall Streeters who migrate towards the "value expanders" bucket and do great things. But the challenges of making the switch should not be underestimated. A lot of mentoring, a lot of patience and some hard-core retraining is necessary to help these talented professionals successfully make the transition into the start-up world. This is a place where some stimulus dollars would be well-spent. Let's unleash the entrepreneurial spirit, but do so in a way that both expands the value pie and prepares these nascent entrepreneurs for success.

Government Stimulus and the Venture Industry: It's Not the Bankroll, But the Chip Size

What is the optimal size at which to do real venture capital, the kind of investing that nurtures tomorrow's Googles, Amazons, Ciscos and Microsofts, as well as the loads of applications and technologies that add real value to existing companies and customers? The answer to this question has undoubtedly changed over time, as the cost of enabling technologies has plummeted and massively scalable businesses can be built for a fraction of the cost of even 10 years ago. But still the debate rages on, particularly given the problems of the large-scale branded venture players and worries over a sharp drop in the availability of start-up capital. The topic has recently bled into the political arena, with President Obama's tech-friendly bias and the hundreds of billions of dollars going towards programs many feel will lack real job-creation power. Perhaps a portion of these funds can be intelligently deployed across the venture capital arena?

My friend Matt Harris, his partner Bo Peabody (both Managing General Partners of Village Ventures) and I have been talking about the right way to scale the venture business for quite some time. The issue: while the most attractive risk-adjusted returns are available at the early-stage end of the venture continuum, and it arguably hold the promise of creating more and better jobs than at any other stage, it is very hard for institutions to access this asset class due to scalability problems (read: can't deploy enough capital in a single fund to be material). Therefore, when problem-solvers think of throwing big dollars at venture industry, they immediately migrate to the larger, later-stage venture firms. The problem is, as Matt explains below, simply providing large firms with more dollars isn't going to facilitate more and better job creating, higher returning investments. The solution required is more complex and textured than that.

While Matt doesn't have a blog, he frequently has terrific thoughts and powerful ideas, and this is one of those times. While we were all struck by Tom Friedman's recent Op-Ed in the New York Times about deploying big stimulus dollars into venture capital, Matt put thumbs to Blackberry and came up with the following thoughts:

Tom Friedman recently advanced a proposal to deploy $20B in $1B chunks to the country's leading VCs, to spur investment in start-ups.  The problem with Tom's plan isn't that injecting $20B into the entrepreneurial economy is a bad idea, it's that giving it out in billion dollar chunks merely exacerbates the problem, which is that managing large funds drives VCs away from being early stage company creators, and towards being financiers.  VC firms only have so many talented check-writers, who are typically pretty fully employed investing in 2-3 companies per year.  If you give those firms more money, they can't (or won't) make more investments; they will make larger investments.  As a result, their deals will be less likely to be raw, early stage, potentially game changing start-ups, and more likely to be expansion stage companies who might otherwise raise debt capital in healthier times.

Most thoughtful amendments to Tom's plan have involved using the capital to subsidize seed and angel investing, which can be interpreted as VCs wanting more "prepped" deal flow, in that angels and seed funds tend to be feeders to established vc funds ... This is not a bad thing. But it may not solve the entire problem.  One area of inefficiency in the venture business is the paucity of funds with between $50MM and $150MM under management.  Because of the large size of most Limited Partners, they want to invest a minimum of $20-30MM in the funds they invest in.  But most of them aren't allowed to constitute more than 10% of any fund.  So by definition, they can't invest in funds with under $200MM under management.  This makes raising modest sized funds challenging, and as a result the % of VC funds of this size has dropped. In the 1990s, 42% of funds raised were between $50MM and $150MM. Since 2000, only 23% have been in that range.  This is despite relatively clear data that funds in this size range outperform; in fact, they have out-performed larger funds by almost 25% over the past 18 years (data: Cambridge Associates). Of course, it's also more profitable for the VC to raise a larger fund, but it's hard to blame them for failing to resist this temptation when their own LPs are asking them to grow.

A productive application of government funding to the world of entrepreneurial finance requires a nuanced understanding of where the inefficiencies are.  While I agree that angels could use some incentive to be more active, I also think that there is no replacement for a focused and sophisticated venture investor.  It probably comes as no surprise that some of the most talented young GPs would rather have their own small, focused fund than be in the way back seat of a larger fund, where carried interest has the feel of a mythical animal. Government funding, thoughtfully applied as an anchor Limited Partner in funds managed by these young stars, could spur entrepreneurship in one of our country's least innovative sectors:  the venture capital industry itself.

Heresy? I think not. Matt touches on several themes I've written about for a long time, and places it in the context of the current debate around how to best stimulate economic growth. I think these ideas and others raised on this blog warrant some serious consideration. Given the impact a small allocation of the stimulus budget could have on creating vibrant new businesses, increasing our economic efficiency and laying the foundation for strong economic growth, I think it is a no-brainer. But brains are needed to make sure the capital gets to the right place - the early-stage end of the venture capital industry.

Citigroup: The Difference Between Dramatic Action and Drama

The latest approach to the "big sick bank" (BSB) solvency crisis appears to follow this arc:

1. Convert existing preferred stock into common stock (and not just the US Government's shares);
2. Further tighten the US Government's managerial noose around BSB management's necks;
3. "Stress test" bank balance sheets;
4. Inject additional capital to bring the BSBs into regulatory compliance;
5. Tighten the managerial noose even more, bowing to Congressional pressure; then
6. Pray that rising asset prices bail out both the US Government and public shareholders.

The US Government has clearly determined that its preferred stock investment has lost its "preference value," e.g., it has a better chance of recovery by subordinating its interest and buying more time for the sick banks to become healthy. This entails placing additional regulations on how the BSBs are managed, forcing stress tests and potentially investing even more capital. This is a scary and wrong-headed way of approaching the problem.

Public Management of Private Entities: The US Government, or any government for that matter, should not be in the business of managing private entities. By imposing rules on compensation and expenses, it is mixing morality and economics in a toxic and dangerous manner. It should figure out which assets should be managed privately and which should be held and worked out publicly, and structure oversight to that end. By thus far refusing to get aggressive by either taking over the BSBs and spinning out the good assets or forcing a Good Bank/Bad Bank restructuring, public bureaucrats are confusing the notion of public and private and tossing in a big dose of moral hazard along the way. Yes, this is clearly a less shocking and dramatic step towards solving the banking crisis, but one filled with drama and poor outcomes, I'm afraid.

Stress Tests vs. Mark-to-Market: There is a big shadow lurking over the top 20 banks as they prepare for a review of their books to assess asset quality and solvency. This process, lacking both transparency and timeliness, only serves to further confuse investors, customers, and the global financial markets. What is an appropriate assumption for a further decline in housing prices? Just how high will credit card defaults go? How many counterparties will default on their CDS obligations? Stress tests are only as good as their assumptions, and with the Treasury and the Federal Reserve driving things, I'd be very concerned as to their linkage with the real world. I've got a great idea - why don't they just ask for prices on all these things and stop assuming? Everything has prices. Let's find out what they are. This is called marking-to-market. You might not like the answer but it is the market's best guess of what something is worth, and I guarantee you it is far better than something regulators will conjure up. But just as with the large, meddling, minority shareholder approach the US Government seems to favor, forcing mark-to-market of bank balance sheets is simply too decisive, too dramatic for our regulators to stomach.

I hear that SPX futures are rallying on new of the US Government's plan for Citigroup. My guess is that this is yet another dead-cat bounce; once investors really think about the implications, these steps create even greater uncertainty and are even more de-stabilizing than what we have today. Thanks guys.

Riding the Roller Coaster

Could the macroeconomic environment be any more screwed up? Just when you thought it was safe... Fact is, there are no band-aids for the current economic crisis. It's high time for old US shibboleths to be cast aside to make way for pragmatic solutions and long-term thinking. People need to get over the issue of taking over hopeless banks, even if they happen to be really, really big. Let's get on with it. Many also need to come to terms with modifying mortgages for millions of homeowners on the edge. We can argue forever about how it's not fair, the borrowers screwed up, etc., but we are way, way beyond the point where intellectual jousting will help us achieve a better outcome.

Picture this: 10-15% unemployment. Millions out of work, millions more out of their homes. What will this do to our psyche as a nation, as Americans? Are we going to live with industrial cities across Middle America becoming Hoovervilles and shanty-towns? This was a version of America known by many of our grandparents, a version which most thought impossible to see again because of "enlightened" monetary and fiscal policies. Well, if we don't play our cards just right - and quickly - we might awaken to see the nightmare of generations past.

It is clear how Congress, President Obama and his advisers are looking at the banking crisis: as a giant option. By injecting cash into sick institutions (Option Premium), they are hoping to buy time value (Theta) in order for asset values to rise back to their marks and beyond (Intrinsic Value). There are, however, a few (very large) problems with this analysis: even by stuffing hundreds of billions of dollars into sick banks, it neither creates banks willing and able to lend nor builds trust in our financial institutions. Without addressing these points bank asset values will continue to decline, wiping out the value of the US taxpayer's investment and leaving us worse off than we are today. And option value will have worked in the opposite direction: we will have burned valuable time pursuing patchwork solutions instead of swallowing the bitter pill of taking over our largest, sickest banks.

Trust is at an all-time low. Madoff. Stanford. What exactly did Ken Lewis discuss with John Thain about bonuses? Every day there is a new scandal, a new probe, a new indictment. It is almost as if the fates are conspiring to test our mettle. What's really happening is that rising markets mask a lot of problems (and wrongdoing); how else do you explain billion-dollar Wall Street research budgets only seven short years ago that are now threatening to plunge towards zero? In short, sentiment absolutely stinks. But is the market really pricing in the possibility of a draconian 10%+ unemployment scenario with multi-trillion dollar deficits? I don't think so.

As bad as the public markets feel, the private markets feel much better. Sure, you need a long time horizon to play, but it is hard to describe the early-stage vibe. Money is tight, no doubt. But deals are still getting done, even as the public markets grind down, politicians bicker, and global unrest looms. Social media is alive and well, and advances in ad targeting and ad optimization continue to produce fresh start-ups. I am super excited about new investments like Stocktwits and TweetDeck, while existing portfolio companies such as Buddy Media, TheLadders.com and Clickable continue to do very well. And the deals - good deals - just keep coming. As negative as I am towards the public markets is how positive I am about early-stage investing. While a vibrant public market certainly helps private companies, well-positioned firms can still thrive either by disrupting and taking share in established industries or by creating new markets and opportunities that didn't exist previously.

Every day these days feels as if I am riding an emotional roller coaster. And from where I'm sitting there appears to be no end in sight.

Buy the Rumor, Sell the ...

The equity market certainly bought the rumor of the bailout plan (hereafter referred to as the "Geithner Plan"), rallying like crazy over the past week on nothing but bad news across the globe. But on the day when the big news was finally expected to hit, Treasury Secretary Geithner's release of his "comprehensive plan," he said absolutely nothing. Weeks of planning. A day's delay in making sure he was ready, really ready for his coming out party. Only problem was, those that came to the party left. Immediately and rapidly. Today's market news was no better or worse than any other over the past week, but somehow equity traders proceeded to lop almost 5% off its value. Do you think investors, like the Treasury, might be just a little jittery, placing a little too much hope on the impact of a plan that few thinking rationally consider a panacea?

My friend Paul Kedrosky posted an excerpt from President Obama's discussion on ABC Nightline tonight. The punch line: while being creative with statistics, the President dismissed Sweden's (successful) approach to restructuring its banking sector on both economic and ideological grounds. His stance that Sweden "only" nationalized five banks, while the US would need to nationalize thousands to achieve the same effect, is both specious and absurd. No discussion of relative GDPs. No comparison of the size of the banks that were nationalized relative to, say, the top 10 banks in the US. It was one of those typical "a politician says it on TV so it must be true" moments, only I'm really disappointed that President Obama is resorting to such tactics to sell the Geithner Plan not a month into his Administration.

His discussion of different cultures is slightly more valid but no less meaningful as the problems at hand require sharp and decisive actions, like those specifically avoided by Geithner and his advisors thus far. President Obama had this to say:

Obviously, Sweden has a different set of cultures in terms of how the government relates to markets and America's different. And we want to retain a strong sense of that private capital fulfilling the core -- core investment needs of this country.

And so, what we've tried to do is to apply some of the tough love that's going to be necessary, but do it in a way that's also recognizing we've got big private capital markets and ultimately that's going to be the key to getting credit flowing again.

The approach of Good Bank/Bad Bank, with an immediate requirement for mark-to-market accounting across all portfolios not supported by term financing embraces private capital and, in fact, requires it. A principal difference between this approach and the Geithner Plan is that it places the costs where they belong - on lousy managements and moral hazard-hoping shareholders and bondholders - instead of where they do not (the US taxpayer). Further, it forces swift accountability and dealing with the depths of the problems upfront, instead of deferring the pain and hoping for a market recovery to bail us out. Plans built on hope invariably fail, and do not establish a solid foundation on which to re-build broken balance sheets, businesses and industries. Messrs. Geithner and Obama would have you believe otherwise, and hide behind ideology as a principal motivator of their actions.

I had hoped for so much more coming out of a stirring victory, broad-based enthusiasm and words filled with promise and action. Instead, we've gotten a plan and an ideology that appears frighteningly similar to that which preceeded it, which failed miserably by any accounting. No real accountability. No real acknowledgement of the magnitude of the problem. Deeply concerned with stock market reaction today instead of where it might be in three years, five years, ten years. This is why I'm scared out of my mind.

YOU, the U.S. Taxpayer, Can't Handle the Truth

The Wall Street Journal just came out with a piece outlining a multiple-choice hairball of options which Treasury Secretary Geithner is considering. The sad truth is this: his plan will fail. Why? Excessive complexity. For a plan of this magnitude to work, it needs to be straight-forward, easy to understand, clearly communicated, brutally transparent, and ruthlessly executed. The chance of the Treasury and Congress arriving at a plan that meets these criterion appears to be approaching zero. Further, the plan is still missing a few key components, such as transparency of bank asset values and avoiding the forced requirement to lend money, flying in the face of rational decision-making and market forces.

But wait, it gets even better. Consider this comment from Rep. Brad Miller, a Democrat from North Carolina and a member of the House Financial Services Committee:

"If we had regulators go in an examine the books like we did at Fannie Mae and Freddie Mac a great number of our systemically important financial institutions could be insolvent."

And this is exactly what Mr. Miller and Treasury Secretary Geithner want to avoid; the transparency necessary to figure out exactly where the industry stands, in order that a proper prescriptive can be put in place to begin real healing, not some illusory band-aid that will only set us up for greater suffering down the road. For a member of the House Financial Services Committee to make a comment like this only highlights the disconnect between the politicians and the real problem: dealing with the systemic insolvency that threatens our country. Mr. Miller would have you believe that putting our collective heads in the sand is a better approach. He is just so wrong.

He knows the problem is there, but is unwilling to face into the truth. He thinks we can't handle it. Reality is, we can handle the truth: it's he and his scared-out-of-their-minds Congresspeople that can't handle the truth. We need some different people making the big decisions. They appear too big and too important for our small-minded Congresspeople to make.

A "New" Bailout Plan? Hardly.

I watched our President's brief address on prime time this evening. His delivery was passionate. His message, strong and partisan. His intentions were clear. Rally support for his stimulus program. In the wake of a few really bad days of press, his honeymoon period clearly over, I thought he did a strong and ballsy thing. Problem is, the plans being bandied about concerning the financial sector are still off the mark. How is it, after the mistakes made by Paulson and the prior Administration that we are still unclear as to what the plan should be? As I've said before, I just don't get it.

But now it's even worse. It seems as if the discussion among those in power has gone back to what we had during Bush II, injecting capital into sick institutions, yet on "tougher" terms than we had previously. Simply doing more of something that was flawed from the beginning isn't going to help solve the problem any better. Why the brainy President Obama or the equally brainy Larry Summers don't seem to get this is beyond me. From tonight's WSJ Online:

WASHINGTON -- The Obama administration's financial-rescue plan is shaping up to include capital injections with tougher terms than the first round and an expansion of an existing Federal Reserve lending facility that could potentially buy up toxic assets clogging the system, according to people familiar with the plans.

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Instead of buying preferred shares, as it did before, the government is discussing taking convertible preferred stakes that automatically convert into common shares in seven years. Such a move could help banks as they look for ways to bolster common equity. When a bank takes a loss, it has to subtract that amount from the value of its common equity. As losses mount, investors increasingly believe banks need to find ways to shore up this first line of defense on their balance sheets.

To get money, banks would likely have to pay a higher dividend to the government than the 5% rate the government charged in the first round of infusions and agree to a host of new restrictions, such as lending above a baseline level, reporting frequently on their use of the money and curbing executive salaries. While Treasury wouldn't preclude healthy banks from participating, the stricter terms would likely attract primarily weaker banks in need of capital.

Does anyone else see how dumb this is? Let's see:

1. The sickest banks with the lousiest managements get access to Government (read: taxpayer) capital.
2. The Government is looking to play accounting/ratings games by making the instruments convertible into common after seven years, by which time any self-respecting and solvent bank will have paid off the preferred well before its conversion date.
3. The curbs on salaries will likely cause many firms to reject Government capital even if they are very sick, preferring to hang onto their compensation "call option" and hope that things turn around in order that their firm avoids bankruptcy. By this time they will have scooped out far more compensation than what is permitted under the new Government guidelines.

And let's not forget these not-so-trifling issues:

1. Banks with toxic asset-laden balance sheets will still be reluctant to lend, even with Government capital injections. And forcing them to lend will only put us right back in to the world of the GSEs (Fannie Mae, Freddie Mac), which may well cost taxpayers several trillion dollars.
2. Bad managements will still be running the show, even after losing billions or even tens of billions of dollars.
3. Common equity holders and debt holders are still being bailed out, perpetuating a moral hazard that should have ended months ago for many (Citi, BofA, etc.).

Have we learned nothing over the past six months? The ideas being proposed simply won't work, and I don't care which Harvard Ph.Ds are saying so. It is a matter of transparency. It is a matter of good governance. It is a matter of creating healthy institutions that are in a position to fund the renewal and growth of this country. Current plans do not contemplate any of these things. Why not? That is a mystery. President Obama has his chance to take a stand, the right stand, and I'm afraid his first big step forward will in fact be two steps backwards. And the country will suffer for it.

The Straight Deal on Angel Investing Today

Today's New York Times' article Angels Flee From Tech Start-ups is more an indication of poor reporting than it is on the state of angel investing in today's environment. One could argue that today's environment has made for better, more effective angel investing, since lots of "dabblers" have been scared away while the "professionals" (full-time angels, small venture funds, etc.) are seeing an increasing number of high-quality deals. Are fewer companies getting funded by angels? Of course. Should all the companies that had previously been funded by angels, many of them dabblers, gotten funded? Definitely not. So is value creation in the early-stage space really being inhibited by a dearth of angel investment? I don't think so.

Bottom line, if you have a strong, technical founder, a solid business plan, a market either ripe for disruption or fertile for rapid growth and some early traction, you can get a business funded. Clearly there are a lot of variables at play, but deals are getting done and don't let the morose people in mainstream media tell you otherwise. As discussed previously, the venture industry IS broken; but this doesn't mean that true early-stage investing is broken. In fact, it is arguably the place to be. The combination of fewer players seeing more and better deals together with falling valuations makes this a good time to place some intelligent bets, IMHO.

Let me take this analysis one step further: angel investors and small VCs often like to build strong syndicates, including those people who are strategic and can open doors, provide advice, and generally de-risk the business plan. Larger venture firms frequently like to control funding rounds themselves, often limiting their ability to get the best people involved who may only be willing to invest $50k but can add hundreds of thousand if not millions of dollars of value through their active participation. This is the way I approach the business, as do many of the people I work with who lead financing rounds of, say, $500k-$1.5 million.

So all is not lost if you are a start-up and need angel financing. But take heed: it is super competitive out there. And if you are unable to stand out from the crowd along the key dimensions mentioned above, then this is not the market for you. Wait for the next up-cycle, when all the dabblers come out of the woodwork and are wiling to try their hand at early-stage investing once again.

Key Themes in Financial Services 2009-10

Regardless of how deftly or inept the financial crisis is handled, the financial services sector is facing tectonic change: how firms are managed; how staffers are compensated; how ideas are generated and researched; and where transactions will take place. Mega-trends such as transparency, centralized exchanges, increasing specialization and disaggregation of services will rule the day, and will sharply impact the size, scope and power of the industry relative to its meteoric rise over the past two decades. Risks will be taken, money will be made, and innovation will continue, just not at the pace and in the same manner to which we've become accustomed during the halcyon days of the 1990s and early 2000s. Here are a few of my prognostications for how the industry will change in the wake of Government intervention over the next 18-24 months.

Compensation

TARP money or not, high-performers will be paid. But cash compensation will be capped at a fraction of the amounts previously paid out, and the stock that is awarded will have long-dated vesting and be subject to clawback for losses attributable to personal performance. I believe we'll see a $1 million cash compensation cap, 5 year cliff stock vesting and a clawback on unvested shares. I think smaller amounts of total compensation will also be likely, but the changes will be less stunning than the cash limitation and cliff vesting provisions of all new restricted stock and option programs.

Research

Once dominated by the sell-side, the majority of research consumed by the buy side will be sourced from third-party providers. Many if not most top sell-side research analysts will leave to set up their own shops, and leverage lightweight, flexible technologies for publishing and disseminating their research. They will likely leverage the services of third-party brokers to monetize their research through Commission Sharing Arrangements (CSAs). Further, "expert networks" will continue to proliferate, seeking to connect those with domain experience with those in need of deep, targeted insights. Gerson Lehrman Group (GLG), the 800-pound gorilla in the field, will continue to flourish, but the long tail of expertise not covered by their network will also become available. The key to accessing research in a fragmented landscape is the discovery layer, the matching of interests with knowledge. This will continue to be a "hot button" topic as investors work to become more efficient and streamline their investment process.

Exchanges

Derivative contracts will migrate towards exchanges, forcing standardization across much of the derivatives industry. Interest rate swaps and options, credit derivatives, the whole lot, and not just for standardization and transparency, but for collateral management. Possibly the largest element of the "bailout black hole" relates to counterparty risk, e.g., were AIG to have gone bankrupt, it could have dragged many of its counterparties down with it. However, had it been forced to post collateral pursuant to a centralized clearinghouse function, it couldn't have delayed its day of reckoning to a time when the problem was so large it didn't have the necessary liquidity. While the largest over-the-counter derivatives dealers might have squawked at such a move in the past, nobody has demonstrated the financial management required to earn the right to squawk now. And while this move will take away significant profitability from the banking sector, it could make up some of the losses through higher trading volumes due to liquifying and deepening previously opaque markets.

Hedge Funds

More regulation will come, and if done sensibly should not prove to be a damper on a healthy, robust hedge fund marketplace. Revealing the names of investors? A dumb, patently political move. Focus on risks and reporting. For hedge funds that aren't publicly traded, and whose investors are accredited, the main purpose of disclosure is for regulators to understand the concentration of risks across the financial markets, and to avoid the "too big to fail" problems we've had repeatedly ever since LTCM bit the dust in 1998. Somehow, Meriwether and Co. seemed to have started a trend. Few got the joke back in 1998 and even fewer got it in 2005/06, when risks were really ramping up (i.e., the GSEs) yet more fuel was added to the fire. I've said it before and I'll say it again: hedge funds aren't bad and they play an essential role in fostering liquid, efficient markets. But the SEC has been understaffed and ill-prepared to monitor these risks. With a well-trained and appropriately staffed SEC, hedge fund should simply be another part of the regulatory rubric covering broker/dealers, RIAs and mutual funds.

Conclusion

This is simply the beginning of a discussion concerning the changes we're likely to witness across the US financial landscape. The Obama Administration has an historic opportunity to use its brains to support sensible, thoughtful, changes in our legal and regulatory environment. It will invariably have to fight against politicos in Congress that have other, more populist agendas, divorced from the realities of fostering healthy financial markets and more geared towards garnering headlines in the local papers. That said, it is time for some changes, and the ones I've outlined above should help investors, the markets and the institutions charged with financing their growth.