Archive for day April 21st, 2012

Male Office Flirters Do It Out of Boredom and Not For Sex—What? [Science]

Two studies by psychologists from the University of Surrey show that men who flirt at work don't do it with romantic intentions, but out of pure boredom. It also seems that they are emotional dimwits. More »


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Jesus Diaz

April 21st

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‘Instagram’ updated to version 2.4.0

Here is an update Apple’s Senior Vice President of Marketing Phil Schiller will not have to worry about: “Instagram” for iOS was updated to version 2.4.0 this weekend. It features speed improvements, minor user-interface tweaks, bug fixes, and improved accessibility support. Visit the App Store to grab the update.



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Jake Smith

April 21st

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Instagram updated to version 2.4.0

Here’s an update Apple’s SVP of Marketing won’t have to worry about. Instagram for iOS has been updated to version 2.4.0 this weekend, featuring speed improvements, minor UI tweaks, bug fixes, and improved accessibility support. Head on over to the App Store to grab the update



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Jake Smith

April 21st

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Online Video vs. Music – Different Game, Same Rules

netflix

Editor’s note: Peter Csathy is President & CEO of online video technology company Sorenson Media and is a frequent guest blogger for TechCrunch, as well as his own “Digital Media Update” blog.  Csathy previously was President & COO of online music pioneer Musicmatch (acquired by Yahoo!) and spent 10 years in the “traditional” media world, including stints at Universal Studios and representation of the rap group N.W.A. Follow him on Twitter @pcsathy.

Netflix — the poster child for premium Internet video services — was birthed by iTunes and other online music services before it. Yes, movies and music are fundamentally different forms of media. Apart from the obvious, in the online world, music tracks can be unbundled from albums (movies can’t), and the number of movies produced in any given year represents a small fraction of the total volume of recorded music (and these differences directly impact business models).

Nevertheless, despite these differences, three ingredients that have proven to be essential for the success of any online music service apply equally to the premium online video world. This trilogy represents the “Sacred Tenets of Online Media” that apply to any service provider. Apple was the first to get it right in the online music world with iTunes. Who will first get it right at massive scale for online video? Netflix may have the lead, but the game is still early. So, game on.

Sacred Tenet #1 – Quality, Quality, Quality.

I know this sounds trite, trite, trite, but how many service providers really get it right? Remember the early online music services (both legitimate and not)? Audio quality was frequently abysmal. The overall experiences were usually empty (meta-data, what meta-data?), and the bad guys infected you with viruses. Enter iTunes, which offered a healthier, better sounding product and far richer overall experience. That mattered. That was a game changer.

The same applies, of course, for online video viewing, no matter how big or small the screen. To “win,” service providers must ensure that movies and television shows look good on every device regardless of the explosion of new devices, form factors, endless specs, new formats (MPEG-Dash, UltraViolet) and variable network conditions. Consumers don’t care, and they aren’t patient. Not anymore. They just want the stuff to work. And, that ain’t easy. That’s why Netflix transforms each movie into over 100 renditions to account for different devices, formats, and network conditions. THAT’s a commitment to quality.

Here’s further proof that service providers are finding a commitment to overall quality (essentially user experience or U/X) increasingly critical. My company, Sorenson Media, provides video encoding solutions for video professionals to solve the fundamental problem of transforming video for optimized delivery over the Internet. We just recently surveyed our user base of 100,000+ video professionals (the full survey results were just recently reported in TechCrunch). Our users both confirmed what we already suspected, but also surprised us with what we didn’t. Not surprisingly, 75% of video professionals encode regularly (at least weekly), and no output format is unimportant as multiple formats are heavily used (although MP4 and H.264 lead the pack for both web and mobile).

Surprisingly, however, even though our product ships with over 200 encoding recipes (presets), a whopping 80% either tweak those presets or create their own. That’s how complex this stuff is. Our customers find it necessary to dial in video quality even further! Why? Because you gotta get it right, or the U/X is wrong. And, if you got it wrong, then your customers look elsewhere.

Sacred Tenet #2 – Deep Content.

We live in a world where iTunes, Rhapsody and Spotify offer virtually any music track you could ever think of – 15 million of them! We take that for granted. We expect it. But remember, it wasn’t that long ago when that wasn’t the case.

In the earliest days of legitimate online music services, music libraries were small and filled with gaping holes (how’s that for an oxymoron?). iTunes launched with a scant 200,000 tracks back in April 2003, and my former company, Musicmatch, launched its then-revolutionary music on-demand subscription service with 250,000 tracks later that same year. Think about that. Those numbers, of course, represent only about 1.5% of the total number of tracks now offered today. Ultimately, once customers got over the novelty factor of new music services, that paucity of content led to frustration – and opportunities to differentiate based purely on size. We at Musicmatch – and all others – soon realized that those gaps had to be filled as quickly as possible. And, the arms race was on to sign up the most record labels the fastest – and then boast about it as a major differentiator (which it was). I was there – I remember camping out in New York City for a week just so that I could pounce on any indie label I could to add “0’s” to our library (with the goal of ultimately adding “0’s” to our topline).

This same basic truth applies to premium online video services of course. What happens when you can’t find the movie you want? You bolt and look elsewhere. Well, none of the service providers want that to happen, so each of them is feverishly racing to expand its cache of movies and television shows. That’s why you read about deal after deal after deal. It’s the quest to get the critical mass they need for their customers to stay. At this point, since online video libraries are still relatively thin, deal scrambling will continue at a feverish pace and media companies (licensors) should have the upper hand. (For a further detailed discussion of the power media companies hold in these online movie licensing discussions, check out my earlier TechCrunch guest post on the subject.)

Sacred Tenet #3 – Discovery & Navigation.

It’s essential for online movie customers to easily find the premium content they want, when they want it. But, it’s also essential for them to find a way to intelligently and easily navigate the vast expanding universe of other content that they don’t necessarily know they want – until it “finds” them and they experience it. That is the fundamental role of discovery.

Back in my Musicmatch days, we offered a music discovery engine based on the tastes of other listeners. If you liked Arcade Fire, The Decemberists, and the Shins, then you would be introduced to other music that other artsy indie-types like you liked. (By the way, for you music fans, Pandora recommends Bloc Party and the XX if you plug-in those three bands.) Effective discovery enhances the user experience – and leads to more content consumption (meaning more opportunities to monetize).

The same holds true for premium video. As movie libraries expand online (which they absolutely must do since we are still in 2003-like online music numbers), it is essential to give the consumer powerful tools to make sense of it all. Many flavors of discovery exist, including social. Service providers will look to differentiate themselves here too as music services, like Pandora, do in the online music world.

iTunes got it right 10 years ago – and rules the online music world still to this day. But, things are very different in the online video world. Many hats are in the ring this time around. Netflix is the leader, but certainly isn’t a lock. And, Apple isn’t a significant player (yet). The players who pay homage to the Sacred Trilogy will best position themselves to be the big winners tomorrow.

As fundamentally different as the two different forms of media are, the recipes for success in the online media service provider world largely stay the same …



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Contributor

April 21st

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Giant Airbags Will Be Used To Float the Costa Concordia Back To Port [Ships]

Starting next month the salvage operation for the capsized Costa Concordia will begin, with American and Italian companies being chosen to work together to bring the $600 million cruise ship back to port in one piece. More »


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Andrew Liszewski

April 21st

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Facebook Ends the Careers of an Entire Generation of Future Politicians [Video]

If you think recent elections are getting too personal, just wait until 2040 when today's Facebooking frat brothers and sorority sisters start running for office. Forget economic issues, we want the candidate to explain this naked picture involving a horse and a handle of vodka. More »


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Michael Zhao

April 21st

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Knock-Off Neck Massager Soothes and Tears Your Hair Out [Video]

You probably don't need another reason to avoid buying cheap knock-off electronics on the street or eBay. But in case you were tempted by a surprisingly sweet deal on a neck massager, here's an important PSA to stay clear of them. More »


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Andrew Liszewski

April 21st

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Convertible Note Seed Financings: Econ 101 for Founders

economics for dummies

Editor’s note: Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, a boutique corporate law firm specializing in the representation of entrepreneurs. Check out his blog or follow him on Twitter as @ScottEdWalker.

This is the second part of a three-part primer on convertible note seed financings. Part 1, entitled “Everything You Ever Wanted To Know About Convertible Note Seed Financings (But Were Afraid To Ask),” addressed certain basic questions, such as (i) what is a convertible note? (ii) why are convertible notes issued instead of shares of common or preferred stock? and (iii) what are the advantages of issuing convertible notes?

This part will address the economics of a convertible note seed financing and the three key economic terms: (i) the conversion discount, (ii) the conversion valuation cap and (iii) the interest rate.

Part 3 will cover certain special issues, such as (i) what happens if the startup is acquired prior to the note’s conversion to equity? and (ii) what happens if the maturity date is reached prior to the note’s conversion to equity?

What Is a Conversion Discount?

As discussed in part 1, in the context of a seed financing, a convertible note is a loan that typically automatically converts into shares of preferred stock upon the closing of a Series A round of financing. A conversion discount (or “discount”) is a mechanism to reward the noteholders for their investment risk by granting to them the right to convert the amount of the loan, plus interest, at a reduced price (in percentage terms) to the purchase price paid by the Series A investors.

In other words, the founders are saying to the investors, in effect, if you take this risk and give us money today, we’ll reward you by giving you “20% off” at our Series A round down the road (20% being the usual discount, as discussed below). For example, if the investors in a $500,000 convertible note seed financing were granted a discount of 20%, and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price (referred to as the “conversion price”) of $0.80 per share and thus receive 625,000 shares ($500,000 divided by $0.80). That’s 125,000 shares more than a Series A investor would receive for its $500,000 investment and a 1.25x return on paper ($625,000 divided by $500,000). (The foregoing example does not include accrued interest on the loan, which is typically about 5%-7% annually, as discussed below.)

Discounts generally range from 10% (on the low side) to 35% (on the high side), with the most common being 20%.  In Fenwick & West’s 2011 Seed Financing Survey (the “Fenwick Survey”), the percentage of convertible note seed financings that granted a discount to investors was 67% in 2010 and 83% in 2011; and the median discount was 20% in both 2010 and 2011.

One of the significant advantages of issuing convertible notes, as opposed to shares of preferred stock, is the extraordinary flexibility they offer in connection with “herding” prospective investors and raising the round. Clearly, a greater discount can be offered to early investors who are assuming more risk, particularly where the startup is closing its financing on a rolling basis over an extended period of time (as is the trend).

Moreover, a note can include a discount that increases over time – e.g., (i) 1.5% per month up to 25%; or (ii) 10% if the Series A round closes within 6 months, 15% if it closes between 6 and 12 months, and 20% if it closes after 12 months. In the Fenwick Survey, the percentage of convertible note seed financings that included a discount which increased over time was 25% in 2010 and 5% in 2011.

Finally, founders should be aware that investors will sometimes push for the issuance of warrants in lieu of a discount. In a seed round, this makes no sense and only creates more paperwork and, accordingly, higher legal fees. In the Fenwick Survey, the percentage of convertible note seed financings that included the issuance of warrants was 0% in both 2010 and 2011.

What is a Conversion Valuation Cap?

A conversion valuation cap (or “cap”) is another mechanism to reward the noteholders for their investment risk (and for their efforts in increasing the value of the startup as a result of introductions, advice, etc.). Specifically, a cap is a ceiling on the value of the startup (i.e., a maximum dollar amount) for purposes of determining the conversion price of the note — which (like a discount) thereby permits investors to convert their loan, plus interest, at a lower price than the purchase price paid by the Series A investors.

Using the example above, let’s assume the cap were $5 million and the pre-money valuation in the Series A round were $10 million. If the noteholders invested $500,000 and the price per share of the Series A Preferred Stock were $1.00, the noteholders would convert the loan at an effective price of $0.50 per share ($5,000,000 divided by $10,000,000) and thus receive 1,000,000 shares ($500,000 divided by $0.50), which is 500,000 shares more than a Series A investor would receive for its $500,000 investment and a 2x return on paper ($1,000,000 divided by $500,000), not including any accrued interest on the loan. Notice that if there were a 20% discount and no cap, the noteholders would only receive 625,000 shares or a 1.25x return, as noted above.

If we bump-up the pre-money valuation to $20 million and the cap remains at $5 million, you can see how the noteholders are rewarded (and protected): Their $500,000 loan now converts at an effective price of $0.25 per share ($5,000,000 divided by $20,000,000) and they would thus receive 2,000,000 shares ($500,000 divided by $0.25), which is 1,500,000 shares more than a Series A investor would receive for its $500,000 investment and a 4x return on paper ($2,000,000 divided by $500,000), not including any accrued interest on the loan. Again, if there were a 20% discount and no cap, the noteholders would only receive 625,000 shares or a 1.25x return.

As you can see, noteholders with a 20% discount and no cap would receive 625,000 shares whether the pre-money valuation in the Series A round were $10 million, $20 million or $50 million.  This is why sophisticated investors vehemently argue that a note without a cap (i) misaligns the interests of the founders and the investors; and (ii) penalizes investors for their efforts in helping the startup increase its value. The math can be tricky, but the bottom line is that noteholders without a cap do not share in any increase in the value of the startup prior to the Series A round.

Accordingly, as discussed in detail in part 1, a cap is akin to a valuation in a priced round (i.e., if the startup were issuing shares of common or preferred stock); however, the beauty of a cap is that it is not a valuation for tax purposes — which facilitates the financing by allowing the founders to grant different caps to different investors.

In the Fenwick Survey, the percentage of convertible note seed financings that included a cap was 83% in 2010 and 82% in 2011; and the median valuation cap was $4 million in 2010 and $7.5 million in 2011.

How Do the Discount and the Cap Interrelate?

If the convertible note includes both a discount and a cap, the applicable language will typically provide that the conversion price will be the lower of (i) the price per share determined by applying the discount to the Series A price per share; and (ii) the price per share determined by dividing the cap by the Series A pre-money valuation. As reflected in the examples above, the reason the conversion price is the “lower of” (not the “higher of”) is because the lower the conversion price, the more shares the noteholders are issued upon conversion.

In the first example above where the discount was 20%, the cap was $5 million and the pre-money valuation was $10 million, we saw that the conversion price was (i) $.80 when we applied the discount to the Series A price and (ii) $.50 when we divided the cap by the pre-money valuation.  Accordingly, the conversion price would be $.50 (the lower of) for purposes of computing the number of shares issued to the noteholders upon conversion.

Now watch what happens if we drop the pre-money valuation to $6 million: Applying the discount, the conversion price, of course, stays the same at $.80; but when we divide $5 million (the cap) by $6 million (the pre-money valuation), we get $.83, which is obviously higher than $.80 — and thus the discount applies, not the cap. This is a bit counter-intuitive because the pre-money valuation exceeds the cap by $1 million. Notice, however, that unless the pre-money valuation were greater than $6,250,000, the cap would not be triggered ($5,000,000 divided by $6,250,000 equals $.80).

If this weren’t confusing enough, there is one other complex issue that founders need to be aware of with respect to discounts and caps: the additional liquidation preference that is created. Indeed, this is a particular problem, and could result in a substantial windfall to investors, in a large convertible note financing with a low conversion price.

For example, in a $2 million convertible note financing with a 50% discount (or a 50% conversion cap ratio), the noteholders would receive $4 million worth of shares of Series A Preferred Stock upon conversion (not including accrued interest), which would include whatever liquidation preference is attached to the shares (typically 1x). Accordingly, the noteholders would receive an extra $2 million of liquidation preference.

There are several different approaches to solving this issue, the most elegant of which is to convert the notes into a different series of preferred stock (e.g., Series A-1), with a liquidation preference per share equal to the conversion price; however, for purposes of this post, it’s enough for founders simply to be aware of this issue and how it relates to discounts and caps.

What is the Typical Interest Rate and How Do the Investors Get Paid?

The third and final piece of the economics puzzle is the interest rate component. Again, a convertible note is a loan and typically requires the startup to pay simple (not compounded) interest on the amount of the loan. Interest rates on convertible notes have historically been in the range of 7%-10% annually, but recently have dropped to the 5%-7% range. In the Fenwick Survey, the median annual interest rate in convertible note seed financings was 6% in 2010 and 5.5% in 2011.

As alluded to in the examples above, the interest is not paid in cash on a periodic basis like a typical loan, but instead accrues (or accumulates), and then the total amount of interest due is added to the loan amount and converted into shares of preferred stock upon the closing of the Series A round. For example, if the interest rate were 5% in a $500,000 convertible note seed financing and the Series A closing occurred on the one-year anniversary of the convertible note closing, the investors would convert an additional $25,000 ($500,000 x .05).

Each state has its own laws (called “usury” laws) that limit the maximum interest rate that may be charged on a loan. In California, for example, unless an exemption applies, the maximum annual interest rate for a non-consumer loan is the higher of (i) 10% or (ii) 5%, plus the rate charged by the Federal Reserve Bank of San Francisco on advances to member banks on the 25th day of the month prior to the date of the loan (or, if earlier, the date of the written loan commitment).



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April 21st

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Seismic Mics Buried Under This House Turn Tremors Into Beautiful Music [Earthquakes]

Artist Doug Aitken's new house is designed to bring the outside world in, with accents like plant prints on the walls, and extensive use of greenery throughout. But the eyes aren't the only thing his home appeals to. More »


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Andrew Liszewski

April 21st

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Behold the Crazy Monster Machine That Can Mow and Clean Everything [Video]

Watch this monster mowing and cleaning machine in action. I want to drive it and go wild with it. Clean every filthy thing in sight in New York, from traffic signals, building and parks to hipsters, hipsters and hipsters. Everything. More »


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Jesus Diaz

April 21st

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