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    Investment Risk

    (February 19, 2002) - We've been making an odd assertion over the past couple of days. Most people are well aware that making an investment poses a range of risks. The SEC required documentation and legal disclaimers that surround even the most mundane financial transactions make consumers aware of the fact that the return on an investment is a function of the risk associated with the investment. "Everybody" understands that risk and return are proportional.

    The case that we've been setting forth is that accepting an investment also poses serious risk. While the company that accepts the investment holds the largest share of the risk, customers and suppliers are easily and quickly impacted by changes in the risk. When we rant on about the irresponsibility of "monied amateurs", part of our complaint is that they take no real responsibility for their impact on associated pieces of the market. The degree to which investors are held accountable for the risk they cause is, roughly, zero.

    To be fair, all investors, from the little passbook saver to the huge pension funds, make the assumption that the recipient of the investment is in charge of the consequences of the investment. It's human nature that the hidden damage done by "venture-style" investors is assumed away in their accounting and accountability. Amateurs (usually mid-level managers of cash rich enterprises like newspapers and other media companies) who have no experience in investment management (and little understanding from the boards who authorize the expenses) simply extend their experience of consumer investment into their behavior as "wannabe-VCs".

    They're like the fellow who believes that his experience sitting in rush hour qualifies him to drive in a NASCAR competition with no additional training.

    Part of the difference with this class of big investor is that they are not looking to increase their personal wealth as a result of the transaction. Rather, they are looking for the next promotion, a bigger office or an "atta-boy" from the unreachable head of their complex organization. With low rent motives like these, it's hardly surprising that they essentially screw up everything that they touch.

    Real venture investors have broad experience in management and a personal stake in the outcome of the transaction. Their job, far beyond the financial commitment, is to assist the company in which they invest. Often, this means helping entrepreneurs understand the realities of business at the cash-flow and capital creation level of the game. Any VC with a real track record will tell you that this is like being Alice's guide on her first trip through wonderland. The process requires coaching, auditing, hollering and focusing. Someone whose only experience involves working for a boss in a company is unlikely to be able to communicate effectively with the kind of person who leaves personal security behind to start an enterprise.

    We are not arguing that VCs should stay away from the market. Almost all of the damage we're describing has been perpetrated by incumbent organizations who are trying to adapt to the new market. Professional investors routinely build the infrastructure and understand the various dimensions and implications of the risk they create. The incumbent organizations, looking to defend "their" turf are the usual culprits. To name a few, CareerSite, Pentawave and CareerCast have all been crippled or seriously damaged by badly executed investments and failed promises from the newspaper industry as it tries to protect itself.

    The state of the capital infrastructure of our industry ought to be a meaningful concern for players, investors and customers alike. Unfortunately, almost no one discusses the "elephant in the living room". As a result, we're going to see a continued stream of last year's fair haired new entrant turning into next years fire sale.

    - John Sumser

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