There's Plenty Of Oxygen In The Air
I’ve been reading Steven Johnson’s Invention Of Air and I’ve got images of Joseph Priestley‘s tubes and pumps in my head. Priestley’s experiments with mice and plants in the tubes led to the discovery of oxygen and the realization that plants made oxygen and animals consumed it.
So with that dancing in my head, I read Peter Kafka’s description of our portfolio company Tumblr as ‘the kind of company that should be gasping for air’ with some amusement.
If cash is the oxygen of the startup world (and it is for cash burning startups), then it makes sense that with less cash available for investment, money losing startups would be gasping for air.
But there’s a couple things wrong with that characterization. First, I’ve seen a number of indications in recent weeks that there is still a lot of money out there looking to get invested in venture deals. The news that Accel raised a billion dollars in two separate funds is an example of what I am talking about. And I’ve been fielding calls and emails from late stage VCs looking to meet with some of our portfolio companies in the past couple weeks. Contrary to the popular wisdom, there’s plenty of money out there for high quality venture opportunities.
The other issue with suggesting that Tumblr would be gasping for air is that Tumblr has six employees and a very low burn rate. Any company that can figure out how to get over a half a million rabid users/bloggers on it platform and reach 15mm unique visitors a month with just six people, three of which have just joined, isn’t going to be suffering from asphyxiation any time soon.
These two truths about web services; that there is still a lot of capital looking to invest in them and that they can be incredibly efficient to operate is what many people are missing.
When the market melted down, the tech blogs started talking about a rash of company failures. And yet we’ve not seen that many. We’ll certainly see a bunch but I bet its a lot less than most people think. And I think it will be mostly limited to services, like pownce, that never managed to get much usage. For those web services with real usage and a manageable burn rate, I think there will be plenty of oxygen in the air.
I see your point peter. There’s a lot of negativity out there and I think at times its too much. I am trying to bring some balance to the conversation. The bull market for “web 2.0” certainly did allow some marginal companies to continue on and get funding when they should not have. I am sure that is over. But I am equally sure that the companies that should survive will
Hey Fred. Glad to give you fodder for a post – normally works the other way, so the change is nice.I’ve gotten a couple comments now about the “gasping for air” lede, and I feel sort of silly having to explain my story, because it means I didn’t do a good job the first time around. But for what it’s worth: The point of the story — beyond pointing out that Tumblr got funding — was to explain that Tumblr’s story defied conventional wisdom, and to try to explain why that was the case.Separately, I’d argue that just because we haven’t seen a rash of company failures since the market melted down doesn’t mean that we won’t. I believe — and I know that people at some of your portfolio companies also believe this, and I assume you do as well — that many of these failures are going to occur within a year from now, as the companies that haven’t been able to secure more dollars will have to pull the plug. The fact that they are relatively lean allows them to linger on.But to be clear, I’m not talking about Tumblr here – as you point out, and as I did in my piece, they’re now at all of 6 people, with a big slug of cash to last them for quite a while.
“linger on” does not apply to a small group on the internet. I found it possible to launch great new products even after I’d slimmed down from 45 to 5 – all working remotely. In the end, I went bust because of the debt incurred.Internet companies have this option, however — they can cut their staffing by a huge amount and still keep building equity on the Internet.
I work mostly in bread and butter (enterprise apps) and have seen the deal flow of the majors slow but as every keeps reiterating there is still good options available for good technology. My experience is that the larger the source the more likely they are in a wait and see holding pattern, smaller and savy investors are using the perceived dire conditions to do quick deals and buy into bargains. I think the bubble burst gave investors some assurance that even after a major bust tech will quickly boom again.
Well said Fred. Irrespective of their cash position, Tumblr has clearly created value that would be attractive to a number of players in the online publishing world for the simplicity and elegance of the platform, for the traffic and users, and probably for the team, among other reasons.
Fred:Tumblr clearly has some meaningful traction, but as a longtime follower and participant in the industry I would say there is a frequent concern when the same venture firms invest from round to round. Most entrepreneurs have been trained to go find new venture participants to set a valuation. Frequently, current investors give that same advice. I’ve always felt it was an inflexible position because if I were a venture firm I would want to reup with strong portfolio companies for two reasons. First, I know the company better than most and have an advantage as a result of that and Second, money raising is enormously time consuming and distracting for growth companies like Tumblr. While I have not read all the publicity for this week’s announcment I did read Bijan’s post and yours and there was no real valuation or terms information. While this is not atypical, it does, rightly or wrongly, lead people to speculate in a way that’s different from say, Huffington Post, because that brought a new investor, Oak, to the table.To me all of this is about the “rules of engagement” in which veteran participants have been trained. I’m not sure it makes sense for them to apply anymore, but without transparency on the part of investors/entrepreneurs it’s hard to know what’s really changing, if anything.
Great points and questionsWe each only had 350k invested in tumblr. When it became apparent that there would be another investment oppty, we jumped on itOf course david had the oppty to go outside of his existing syndicate but I guess I’ll just say we made him an offer that we thought he wouldn’t refuse. And after a bit of negotiation, he didn’tNow that we’ve both got a decent stake, if there’s another round its possible that david and the investors would be eager to find a new investorBut when the vcs are doing the angel round, as we did here, its really unusual to see a new investor in the first real round for obvious reasons
Agreed. My view is That should be disclosed and the release should contain your enthusiasm (and Bijan’s) that you encouraged David to do a deal with you. A simple sentence such as “I guess I’ll just say we made him an offer that we thought he wouldn’t refuse. And after a bit of negotiation, he didn’t.” would have helped to give tumblr more of sense of momentum. This helps filter the noise in the maketplace about Tumblir and how it’s going. This eliminates down-round speculation. Also what you really did it appears was a Series A, but because you did an angel size investment previously, the press got confused. This is also new territory for the investors/entreperneurs.In the end, the reason its important is that “AVC” plays a vital role in bridging the understanding between VC and entrepreneur. I think this is an underappreciated value of the blog and community.
Great feedback. Honestly I didn’t know they were putting out a release and I only saw the news once peter had posted on itThere’s some good learning here for everyone, us included
Yes, I totally agree with you when it comes to web services.The lessons of ycombinator, techstars, and other programs like that is that you can go from idea to commercial launch in three months with less than 25k of investment capitalAsking investors to commit 1mm to an idea is a non starter in this or any other enviroment
I agree with your post, but to be sure it isn’t a time for ‘idea-stage’ startups to raise millions. esterday I had a chance to listen to elevator pitches from more than 60 companies at Rice University’s Rice Alliance event. Lots of interesting concepts and ideas. Many of these entrepreneurs are looking for $1,000,000+ to take their ideas from prototype to production. Twelve months ago it was VERY reasonable for many of these entrepreneurs to assume they would be able to secure angel or venture capital for their startups. The sad truth is that for 97% of these companies there is simply no chance they will be able to raise anywhere near the amount of money they ‘need’ given the realities of THIS market.For most of these entrepreneurs the ‘notion’ that they ’should’ be able to raise the money necessary to build their companies is holding them back. They are ‘waiting’ to move to the next stage until they get the cash they think they need. My advice to entrepeneurs (in this market) is to start building their businesses on the assumption that outside capital is NOT available. Partner with other companies, find paying customers, find employees willing to work on the side for a cut of the business – anything that will enable the business to survive.It is not 1999 – not even close. Stop acting like it. The key term in 2009 (for most of us, me included) is BOOTSTRAP! You CAN lift yourself up without money from Benchmark, trust me.
PeterThat’s all correct and is part of the investment equation hereBut there’s one thing you left out of your mathLet’s say that 5mm/year of revenue is achieved with a 15 person team, 2.5x what they have nowThen its possible that the profits could be 2.5mm per year on 5mm of revenue and at 12x pre-tax, that’s worth 30mmI’ve written a lot about this. With web services, its possible to get to interesting ebitda levels on a lot less revenue if you stay lean and capital efficientTumblr would be a good candidate for this model given what they’ve achieved to dateAnd I think the take rate on premium will be a lot higher than 1pcnt, but of course we’ll have to see
You wrote…Any company that can figure out how to get over a half a million rabid users/bloggers on it platform and reach 15mm unique visitors a month with just six people, three of which have just joined, isn’t going to be suffering from asphyxiation any time soon.Maybe so… however the real issue is this… can they get to measurable, sustainable, profitable revenue from volume? Let’s do some back of the envelope math… take 1% of 500,000 users as those who are willing to pay for a premium service. That’s 5,000 users. Let’s charge them $10 a month. That’s 50k a month or $600,000. Now lets say we get some attrition each year, however this is countered by growth of the premium accounts of say 5%. Net growth number is 3% a year. Over 5 years maybe they get to $5m a year in revenue.Most VC’s wouldn’t even show up for that. Heck most Angels won’t. However there is something here. Lets say that the $4.5m was done at a pre of $6m for a post of $10.5 – the real issue here (which of course no one talks about) is the number of outstanding shares. Let’s say there were only 3m pre and 5m post. (post share value is $2)Now fast forward a few years (they have enough runway for at least 2 more years). They grow the user base, add a premium channel and get to maybe a run rate of $2m a year. Big Co comes along and offers $10 a share for all the outstanding. (Total exit price is $50m which is right in the current M&A range)VC exits stage left with a 5x return over 2 years. Compare this to stock market returns over the next 2 years and this is a grand slam.So what’s left to do? That can be summed up in a single word. “Execute”. Deliver growth (doesn’t have to be huge) get people converted (at least 1%) to a premium model and then sell in two years.Tumblr has done 2 rounds – A & B. Total raise is $5m plus and “IF” they can exit in 2 years the VC has played it perfectly. If they need a C round then the 5x is going to drop.So there you have it. 5x if the Tumblr team can execute AND the VC can get the exit. If not then all bets are off. However what has happened here is risk mitigation by getting in early before the Cap table gets out of hand.You just have to remember that while profits are the mothers milk of companies, the price per share is the mothers milk to the VC. Get in early, control the cap table, get the team to execute and then get out before the C round and that’s what great returns are made of.Cheers,Peter
They haven’t done anything other than build a product they love and apparently a lot of other people love too. Seriously, they don’t do any marketing. This thing has spread entirely by word of mouth. The product really doesn’t have any viral hooks other than the small ‘get a site like this’ link at the top of a tumblog
Amazing. Funny, a great illustration that the fundamental rules for startups still apply. Product, user experience, simplicity. Period.
Fred, Glad to see some positive posts this week. Ironically, just before the Accel announcement, I posted along the same lines – good companies will always get funded – http://startupcfo.ca/2008/1…P.S. It would be amazing if the tumblr folks would post on some of the tactics they have followed to generate such crazy numbers.
A somewhat related comment and question – if you don’t mind.Do you think all of the recent scandals and otherwise poor performance in the Hedge Fund industry (e.g. Madoff, also Mr. Dreier now) will ultimately lead more money into the Venture Capital industry?In a certain way, at least VC’s help build new companies and form new products and services – although maybe backing companies that ultimately should not have received so much support . It’s quite amazing to see Hedge funds just evaporate in such a manner.Which then leads to my second question. I’ve often heard that one problem in the VC industry is “too much money searching for far too few quality opportunities”. If money moves from Hedge Funds to VC, is there an increased risk of Signal-to-Noise?
I don’t think VC will get more money, there’s just less money out thereperiodThink of what just happened is half of all the money in the world justvaporizedI do think VC will continue to be a good asset class in a investment fund’smixWhereas some other categories may see their allocations declinefred
I love tumblr. That’s all i have to say. 🙂
I realize this is slightly off topic, but Tumblr is on the brink of being awesome from my perspective. I’ve discovered them to be the best way to quickly get the word out to people that i need to get big chunks of information to. I use it for my personal blog, a ton of group charity blogs, and every single company blog I publish. As a customer, I wish that I could give them some money somehow – increase their oxygen as it were. I’ve got some ideas, maybe someone could drop me a note?