Right now, a small team with no money can start a real online business. If the founders are very lucky, they generate revenue and begin to grow. If they are exceptionally fortunate, they get sold to Google for $1.65 billion. But most of the start-ups we cover on Webware.com will languish for a while in obscurity and eventually die. The problems they are solving are not big enough.
This is one of the reasons that venture capitalists are having a hard time. Many are are sitting on funds of hundreds of millions of dollars, looking for places to put large chunks of that money. But you can't put more than a few hundred thousand into a typical Web start-up without drowning it in funds it can't use. Over-funding a company can kill it, just as surely as starving it of resources.
This is a problem, because if a business can be funded by credit card debt, a competitor can come in and start the same business, and undercut whatever profit margin the first business is relying on to keep the Ramen cupboard stocked. Big businesses have defensive walls around them, and often these walls are built with stacks of money.
These are the businesses that I really like--big plays that take big money and major industry expertise to start. If they work, they change the landscape.
The reason there aren't that many big ideas these days is because it doesn't make sense to raise a lot of money when the probability is greater that a "successful" start-up will be purchased by a large company within a few years, rather than going public over a number of years.
Just take a look at the facts...if you look at the acquisitions made by Google and Yahoo! over the last few years, the acquisition price for the majority of the deals was under $100M or "undisclosed" (which means that it wasn't a large number since they only have to disclose details on deals that have a material impact on their financials).
If chances are a start-up will be purchased before they are worth more than $100M, it makes sense not to raise a lot of money. The more money you raise, the higher the exit price becomes for all investors to be happy and it reduces the options a company has over time.I'm not saying this is a good thing. As I have argued a few times (here and here and here), I believe there is a fundamental disconnect between the currently liquidity climate for start-ups and the funding environment. Until this disconnect goes away, I think we will continue to see a lack of start-ups with big ideas.
2 comments:
Most all VCs are completely ignorant of the foreign IPO market (e.g., London AIM, Toronto, Hong Kong, etc.), which have been very hot. If one looks at the declining fraction of IPO exits since 1992, it would appear that most all of the 1,200 VC firms nationwide have never, ever taken a portfolio company to exit by way of an IPO -- and very well may not know how to do so. I’ve seen far too many VCs lead their portfolio companies toward acquisition as the only possible exit scenario. It takes far greater investment and diversified population of C-level insiders to create a complete standalone company, preparing for an eventual IPO, than it does just a future R&D department for Google or Cisco.
Since the 1970s, it is proven fact that the number one reason for limited (or delayed) entrepreneurial success is undercapitalization. The average start-up VC investment is just under $5M (and has a long-term trend line average of $4M over the past 10 years -- NVCA and Thomson Financial data). YouTube was indeed started on credit cards, but within a few months of the first website going live, Sequoia invested $3.5M, followed by another $8M just 6 months later. Sequoia helped grow YouTube to over 60 professionals in less than 11 months. That is how they create success out of almost nothing – the original entrepreneurs had no idea how to do so and went on one wild ride following, not leading, their investors.
Inexperienced entrepreneurs, naïve writers (like Rafe Needleman), and exploitative vulture capitalists alike who think anybody can succeed with just a few hundred thousand dollars deserve what they are going to get – Nothing but grief.
Lesson learned: As an entrepreneur you must have a kick-ass home-run idea, supported by detailed planning (not hype) able to withstand the greatest possible scrutiny, backed by in-depth personal market expertise, and pristine contacts -- meaning you can call up and speak with 10 VCs in less than one 8-hour day. Don't have some of that? Then your chances of success are so miniscule that you are fooling only the person in the mirror.
Definition of “home-run” is a company that can achieve a minimum billion-dollar valuation at VC exit (acquisition or IPO). Sequoia and Kleiner Perkins, I’m told, will not invest in any company that the VCs cannot convince themselves can achieve home-run status. And even they don’t get it right all the time (just less than 20% of the time by knowledgeable, informed insiders).
Jim F,
I have been lucky enough to experience 3 IPOs (Sybase, Business Objects, Sagent Technology) and last year, I was at JotSpot when they were acquired by Google. So, I have seen both sides of this equation.
In the 1990s, if you had a good idea, you didn't think about anything but raise a good chunk of VC money and then eventually go public. Sure, an acquisition was a possibility but it was more of the exception, rather than the rule.
These days, I think things have flipped. I believe the reason it has flipped is not only because of the current IPO climate but also because of the acquisition mentality of companies like Google and Yahoo! These large companies are being smart and they are acquiring interesting start-ups before they get too big (i.e., before their value is too high).
As a result, if you are an entrepreneur, you have a trade-off to make. Do you raise a lot of money with the hopes of going public after many years of toil? Or, do you raise smaller amounts of capital, which gives you the flexibility to consider an acquisition exit after just a few years? In other words, do you sell on the vision or sell on the execution? In the current climate, it is a rational decision that an entrepreneur needs to make.
Now, I'm not saying this is a good thing for the industry overall but it is what it is.
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