Associated Press

ANNAPOLIS, Md. — Maryland’s highest court has ruled in favor of Internet anonymity, saying Web sites involved in defamation suits don’t have to reveal the identity of readers who post comments on their site.

The ruling Friday by the Maryland Court of Appeals reversed a lower-court decision and said NewsZap.com, an online forum run by Independent Newspapers Inc., doesn’t have to disclose the identities of participants in a 2006 online exchange about the cleanliness of a Dunkin’ Donuts shop in Centreville, Md.

The company’s attorney argued that disclosing the names would have a “chilling effect” on the First Amendment right to speak anonymously. Businessman Zebulon Brodie argued that freedom of speech doesn’t extend to defamation.

Copyright © 2009 Associated Press

The venture capital industry is under assault from defaulting investors, declining public image, poor returns, and portfolio failures. Within this turmoil, the venture capital model provides some compelling investment opportunities by supporting nimble companies that will mature in the future, after the downturn passes.

Start-ups today show more promise than many banks and car companies, so venture capital may prove to be one of the best performing asset classes in the current downturn and recovery. But, the greatest opportunities to invest in venture funds are neither obvious nor traditional. Many venture funds are raising money today, and as much as one trillion dollars of private equity positions may be for sale, including billions of venture capital. What should a savvy investor in the venture capital model, a limited partner, be looking for in these uncertain times?

Here are six tips for limited partners from the inside.

Tread carefully with discounted opportunities in the secondary market. A growing number of limited partners are unable to honor current capital calls demanded by venture capitalists, selling their commitments for $0.50 on the invested $1.00 through banks and accounting firms. NYPPEX Private Markets reports a 9.1% drop for top quartile funds since the end of last year in secondary transactions. All secondary opportunities need to be heavily scrutinized with a careful review of the portfolio and the other limited partners. The first risk is to have a series of undercapitalized portfolio companies pursuing models that are no longer relevant in the current economic climate. Then, if the other limited partners do not honor their commitments to the fund, the best business in the portfolio will find it difficult to raise further growth capital, collapsing the entire fund returns.

Pursue direct private equity investments in promising start-ups. Investors with more free time should consider buying one or more equity positions in today’s most successful businesses, like Facebook, Twitter, Tesla, etc. Larger investors can contact significant shareholders of target companies to either invest in an upcoming round or purchase a current holding. Smaller investors can contact founders and managers that need liquidity to purchase a portion of their common equity positions. The likelihood of failure in some of the more established start-ups is low, and direct investment avoids expensive management fees and participation in other poor portfolio decisions.

Invest in the new breed of incubators. A series of capital efficient incubators has emerged over the last few years, producing a higher proportion of successful business than either early stage venture or angel investing. These “Incubator 2.0″ companies replace poor performing and cumbersome early stage options with a streamlined process that trains, supports, houses, and funds new companies, leveraging the newest trends in building a business. Firms such as Y Combinator, Seedcamp, TechStars, LaunchBox, and BrightHouse all present an attractive alternative for investing in the early stage market.

Back top funds in smaller venture markets. The availability of venture capital has consolidated significantly over the last ten years to the Bay Area in North America, Israel in the Middle East, or London in Europe. The best entrepreneurs will often migrate to these locations, creating higher costs, more competition, and false positives for the venture model within these hotspots. Markets with a weak venture industry, strong pools of talent, and entrenched industries present a unique opportunity for venture funds to generate greater returns by backing the best local businesses. Top funds in undeserved markets include Clearstone Ventures in Los Angeles, First Round Capital in Philadelphia, and Union Square Ventures in New York.

Take extra caution when backing industry-specific funds. Healthcare has been the least hard hit by the current economic climate, and there are still many opportunities in forward thinking sectors of cleantech. Yet, real estate, banking, insurance, advertising, manufacturing, and media industries are all experiencing transformational downturns. With an uncertain economic and regulatory future, it is difficult for any industry specific fund to create a forward looking investment thesis. So, scrutinize the investment thesis and delay participating as long as possible, since time will provide more data on where the industries are heading.

Back the best of the best, if you can. There are very few funds that have consistently performed, that are well regarded by entrepreneurs, and that have survived multiple downturns keeping a top position. The most prominent fund in this elite class is Sequoia Capital. If you have the chance to invest in one these funds, do it. They know the business of start-up investing inside and out. The problem is that these funds don’t really need or want more money, so getting a seat at the table is next to impossible.

The goal of Sci-fabulous, a group that I started after moving to California, is to encourage exploration of inter-disciplinary science and technology. It’s like a roaming TED conference held in the facilities and at the venues where the actual “stuff is done,” versus some boring convention hall or conference room.

Speaking of being “on location,” guess who ate the ant?

The following statements are available for re-print and re-publication with attribution.

“The Canary is Dead” presentation was delivered to a group of Harvard Business School professors to encourage classroom dialogue about better models for venture capital, before students graduate and enter the workforce with bad training.

The Model is Broken

Investing in entrepreneurship has proven to be economically and socially rewarding. However, the venture capital model of providing preferred equity investments in the $1 to $15 MM range is broken for three specific reasons. First, over 90% of companies that require investment in this range do not receive the capital they need, because they are rejected by the model, discouraged by the process or unaware of the rules. Second, the process of raising the capital has anecdotally proven to destroy shareholder value through enormous time commitments, significant legal fees and deteriorated morale. Lastly, the venture investment model, in its current form, does not generate returns for any of the stakeholders when examined in aggregate or on average.

Despite this flawed framework, the venture capital model has resisted change. Larger sums of money has flowed into the venture capital asset class as a result of allocation tables within prospering limited partners, and venture firms continue to receive the same management fees and economic rewards. The bursting of the Internet bubble eight years ago was an obvious time to re-examine the model. After unwinding bad investments from 1999, many VCs began guaranteeing returns by selling new portfolio companies to old ones at a premium. A small percentage of venture firms threw in the towel, and terms like participation were widely adopted to further protect returns, hurting entrepreneurs.

It’s Time for Change

Now, the venture capital industry faces a second major market collapse in eight years without a substantive period of prosperity in between. Limited partners are pulling billions out of the model, are selling positions and may end up rejecting capital calls. Again, this is an obvious time to re-examine the model. It also seems logical that all of the venture capital stakeholders, from entrepreneurs to limited partners, from the media to industry associations, should be involved in the dialog.

What’s Not Working?

Present day venture capital is in the business of finding a needle in the haystack, finding a truly great company from within the many new businesses formed every year. Let’s look at how the model addresses this challenge.

• First, venture capitalists haphazardly select industry sectors and invest en masse into various companies within a short period of time.

• Next, most venture firms select investment prospects from within their direct networks, and many firms don’t take inbound opportunities at all.

• Third, it is common that every partner in a firm, regardless of their experience, must vote unanimously to approve an investment decision in a specific company as well as the investment terms.

• Lastly, the company is put through a difficult due diligence process that can last multiple months before receiving the investment.

This process results in funding 10% of companies that require growth capital. Many start-ups tailor their operations to the present day venture requirements, creating many false positives for the model. Other start-ups fail at the polished presentation requirements, and get overlooked by the model.

Where Do We Go From Here?

The original presentation at Harvard did not include specific recommendations, as the slides were designed to inspire conversation and new ideas. A few recommendations seem obvious and were added to the slides afterwards.

• First, if the venture capital model is neither effective nor efficient at identifying great companies, then the whole selection process needs to be changed. Right now, a small number of highly filtered companies go through a hazing process to get the capital that they need. Why not make the process and the guidelines transparent, providing anyone in any industry of any gender or race with a fair chance to raise capital?

• Second, the fact that the model has been so resistant to change despite overwhelming evidence of failure means that the incentives and governance of the model are poorly structured. Venture firms earn management fees regardless of their portfolio selection or fund performance, encouraging firms to raise larger and larger funds despite the need for less and less capital among entrepreneurs. Additionally, there is no oversight, regulation, or governance on almost all of the venture partnerships. At a minimum, make the management fees contingent on some performance metrics and introduce a board of directors for the firms themselves.

• Lastly, it seems senseless that there are hundreds of undifferentiated firms serving physically small markets, such as the Bay Area, and it seems equally senseless that the purchase of preferred equity in pre-revenue start-ups should cost $25,000, $50,000, or even $100,000 in legal fees.

Now seems like the perfect time for a reality check in venture capital. Let’s start the dialog and fix the model.

In general, it remains an excellent time to start a business, but this window of opportunity may be running out. I will be posting slides from the Harvard University talk shortly on the state of venture capital, which will stir some conversation.

1. Use cliffs for founders
2. Use technology that has low maintenance cost
3. Use technology that you can easily hire replacements
4. If due dates are missed, find out why. If there’s not a good reason, get someone else.

TheFunded had an amazing party at the Tesla Showroom, which was blogged about here. I expect more photos to appear on the internet over the next few days, and there were quite a few Twitter posts.

So, early this morning, TheFunded.com underwent a significant upgrade that should be able to handle the increased load for at least another year. The servers just came back online, so I must get back to work. Enjoy!

Finding any investor is tough, but finding the right investor is an effort that needs to start when the company is formed. By taking the right steps, you can bring investors in like “moths to a flame…”

Being The Founding Member of TheFunded.com places me in an unusual position, and making angel investments creates various conflicts of interest. First, I feel conflicted when making a conscious decision to help some start-ups more than others. Second, it is awkward to be placed in a position to judge the future success of start-ups in a more meaningful way. Third, I don’t feel comfortable having unique opportunities to identify dealflow by processing the dozens of daily Membership applications.

So, as a general rule, I am not doing any angel investments.

If the conflicts of interest were not enough of a reason, being a good angel investor is a full-time job that requires a lot of follow-up. For example, I invested in Original Sin Hard Cider in 2000, and I have never once received a formal status update from the management. Over the years, I have made a few other angel investments, but no investments since founding TheFunded.com.