The Expanding Birthrate Of Web Startups
There is a general consensus that web startups are being created at a faster rate than ever. The impact of accelerator programs like Y Combinator, Techstars, Seedcamp, and dozens more are one factor. The expanding pool of angel, seed, and super seed funds is another. And the most important factor is how cheap it is to build and launch a web service these days. You can bootstrap your way into existence.
I like to think of the venture capital business like parenting. When I invest in a company, I am committing to the care and feeding of the company until cash flow breakeven (the startup equivalent of adulthood). That care and feeding includes the decision to call it quits and give up on the project sometimes, but honestly that doesn't happen that much in our portfolios.
So when I look at this expanding birthrate, I think "who is going to house, feed, school, and send all these kids to college?"
Part of the answer is that this crop of startups is going to be way more self sufficient than what has come before them. I believe that is certainly true. We invested about a half a million of seed capital into a company last year and it is already profitable and there is a good chance that company isn't going to need any more capital from us. But it will continue to need advice of other sorts.
Part of the answer is that this crop of startups will get bought out earlier than those who have come before them. Look at Hot Potato. Josh Kopelman said "we've only been investors for a couple of months" about Hot Potato. That is a good outcome for the founders. Not so much for the investors. But it is going to happen more and more as large tech companies look for teams that have a proven record of building and launching strong products.
But even with these two very positive factors, I worry like a parent with too many kids. "Who is going to take care of all of these kids?"
I am an investor in some of these super seed funds personally. I see the capital calls. When a fund has called 40% of its committed capital six months into its existence, I worry. What happens when the money runs out? Will there be more?
Flatiron Partners came into existence in 1996. Today we still manage a portfolio of four companies. That is down from something like 55 total companies we funded. But the fact is fourteen years later we still have four portfolio companies.
Union Square Ventures' first fund was raised in 2004. We invested in twenty-one companies and we still have sixteen active companies. And we still have $25mm on reserve for them. Christina and I calculated last week that about half of those sixteen active companies still might need more funding from us. So we have eight "kids who have not yet reached adulthood". That is six years after we raised the fund.
The thing that nobody understands until you've lived through it is just how long it takes for some companies to get profitable and self sustaining. And just how long it takes for some companies to get liquid and leave the portfolio.
The VCs I talk to who have been doing this for 25 years or longer aren't so much worried about the "dipshit companies" (as if there were such a thing). They are worried about the entry of so many new investors with relatively small funds birthing so many companies. These veterans may not be as connected to the latest web startup, but they sure are connected to the realities of the venture capital business. They've lived through it and they know what is involved with getting a company all the way to profitability and exit.
The venture capital business is contracting. There are less VC funds than there were a few years ago. And there will be fewer in a few more years. And the birthrate of web startups is expanding. That is the challenge we all face.
So, if you are an entrepreneur you should be very focused on either getting to profitability or getting a VC firm or two with deep pockets into your company (or both). If you are a seed investor, don't go quite so fast. Reserve some funds for follow on investments. And help your portfolio companies get to profitability or get a VC firm or two with deep pockets into your company.
I think this expanding birthrate is a great thing. Entrepreneurship is alive and well all around the world. Smart and scrappy entrepreneurs are imaging new products and services and building them. But we all should be careful to think about how we are going to fund all of this company creation. Not just the first part of it, but all of it.
I’m not sure I understand the paragraph where you say ” Today we still manage a portfolio of four companies.”? Because you say a few sentences later that you still have sixteen active companies. What’s the difference here?Also… you say that entrepreneurs should find a one or 2 VCs and have a long term relationship with them. Isn’t this true for VCs too? Doesn’t it make sense to have the same investors lead the company from birth to adulthood and not one VC for the “toddler” period, one of the “child”, one of for the teen?If we take that analogy a little bit further, we know that foster kids who are taken from foster family to foster family usually don’t end up as “well” as the ones who get the same frame all along?
the answer to your first question is it is two different venture capital firmsflatiron partners has four active companies leftUSV 2004 (our first fund) has sixteen
on your second question, i prefer a small syndicate that funds the company all the waybut that doesn’t happen that often.new investors want in to the best investments and will pay a premium to get in and so the syndicates expand
Interesting timing as a few of us were having this conversation last night, yet from a different perspective… With web start ups popping up left and right it seems (to us at least) that a lot, perhaps even a majority, are being started with the sole intention of getting invested and “striking it rich” and not really because the folks are passionate about what they are building.It’s more, “Hey there’s a sector no one is building something in, let’s do X, even though it’s been done a million times already over there… we’ll give it techy name like Hoochr, a fancy logo, slick web 2.0 website, mobile app, and poof we’re done.”In reality a lot of these start ups probably shouldn’t get a dime, yet the Angels and VCs seem to be afraid of missing the next FB or Twitter. It reminds me a heck of lot of the late 90s, just not on the public IPO scale. Maybe that’s just me. I see a huge contraction of capital coming to web start ups. Maybe not tomorrow, but in the next few years. With so much money being thrown at so many rather weak ideas and weak companies so fast the returns just won’t be there and these funds will die.
Are investments being made to fund the development of Features & Functionality which can be acquired and added on to a Platform company or Companies which are designed to become stand alone profitable and self-sustaining platforms themselves? Seems like a lot of what we are seeing now are investments in Features. Which isn’t a bad thing but make sure you know what it is you are trying to build or invest in and plan your cash and funding accordingly.
This is where I think the onus on startups to be more customer-focused — a much deeper understanding on specific needs of specific or underserved segments, and how to prioritize features, to capture the market.The “crank out a cool product and then find a market for it” strategy becomes tougher. Not because of the cost of technoloy, but the cost of time with no salary bootstrapping.The only way to get to product-market fit in that scenario is for the founding team to include a deep tech with a deep customer knowledge person.
Found it very interesting that in a recent post @dharmesh included a marketer in the ideal web startup team (after the developer and designer). He made it clear that he didn’t mean an advertiser or someone just pushing the message, but rather someone who understands the customer and pulls them in — and I would add — influences ongoing development. Perhaps, it’s my limited exposure, but I haven’t seen that thinking around much — more “if you build it they will come.” Or you can take Twitter’s early approach which I found intriguing — put it out there and let the users continue to develop it! What I called real-time product development.
Yes. Not that I was very sentient about this stuff in the late 90s, being all of 10 years old, but I often wonder the same thing. How much of this is really sustainable, especially when we think about the quality of companies being built?The thing is, I think a lot of these companies are building “apps,” but we don’t necessarily understand the difference between “apps” and a “business.” Also, what surprises me is the kinds of companies being invested in are so similar in thought – it’s not just the catchy name (haha Hoochr FTW), the slick site and the app, but also the type of engagement: quick, repetitive, shallow. This is the nature of mobile, at least in the past, but I’d want to see some more thought go into that assumption. If we’re going to overinvest in an area, let’s at least try many different assumptions and ideas, rather than remixed versions of the same thing. Perhaps, though, I’m just missing something and this is obviously the way people like to interact to everyone but me, but I don’t buy it.EDIT: also, I love your use of the word “passion” here. That’s in many ways my life’s obsession, and I worry about that. I’m a bit jealous of all the guys in green tech who have spent 10 years getting a PhD in some obscure thing and now are starting to turn that into a company – it’s a totally different mode of “startup.” Obviously, you do not have to be in that situation to be passionate about a company, but I do wish that theme was more present in the stories and people you hear and meet.
I’m looking for something different. Like you, I don’t remember the 90s, but I want to really make an enriching web, not a one off web that is so so SHINY!!!Honestly, the best products on the web follow my waterglass philosophy: They have multiple uses than derive from the very form of the object itself. A lot of the shiniess we’re seeing is because we’ve moved away from that very model of what objects are on the web, so they tend not to hold are attention very long because they can’t engage us on deeper, more creative levels.(remember the waterglass makes an excellent bud vase and a doorstop)
I’ve been throwing an idea around for something that’s meant to cater to “obsessives,” and I’ve been oddly surprised by the response – “oh, people don’t want to do that,” “why would anyone spend time on something like this?” etc etc. As such, I think many people assume that people won’t do anything beyond “simple.” (Simple and shiny.) I’ve noticed a corresponding “shallowness” with my interactions across much of the web: they’re certainly engineered to appeal to some part of my brain, but since there’s no higher-order fulfillment, it’s the same dissatisfaction I get after eating a bag of potato chips.
I really think over time that property is unfair the the user and is oddly damaging to the web and internet. As both integrate more fully into our lives, I just want to give the thing a little damn respect to it respects us, lest we have the internet equivalent of an obesity problem.
I must be losing my mind. Do you mind rephrasing your comment? Not sure I fully understand what you mean…
sure. The simple and shiny property I think long term these one off apps damages some of the creative, thoughtful mental processes of the user. These applications are not simple in a way where despite being web products, they don’t have multiple uses that stimulate the mind about how to use said web product in a different way than its stated intent.I think the one off experience is as you say similar to potato chips- a known cause of obesity (fat salt and processed starch) Tasty in the short term, in the long term can and will teach you that the web is a place for doing these one off mindless tasks that aren’t stimulating at all. It makes it harder to build something that is “nutritious” to market (it’s cheaper to do a potato chip, after all), since the user expectation is now for potato chips.and I find that upsetting
Yes, wow, not what I was thinking when I was thinking of potato chips (Ijust meant the junk-foody aspect of it: you appeal to some brain circuitryso I eat you, but then after I feel a bit sick because you’re actually kindof gross), but very true. People are not very good at looking at productsand imaging how they can be used, at least not right off the bat. That said,once they start interacting with products in this self-defined, creativemanner, it becomes easier to see new products and imagine new uses, new usesthat more carefully align with our individual needs. So it’s not just thatwe expect one off experiences, it’s that we never even learn to identifyproducts for things we want to do in the first place – leading me to answerquestions like, “Is there a website that lets you do…?” with services thatuser has already heard of.
“…a lot of these companies are building “apps,” but we don’t necessarily understand the difference between “apps” and a “business.”Really astute observation, Nina (IMHO). I only pulled out this one quote, but very much appreciate your thinking in these comments.
It diverts attention away from potentially interesting models as well that having nothing going on with consumer. Or change the way consumers deal with the internet
So I guess there is a difference between developing and offering a product and actually building a company…
Pretty cool that you also invest in the super seed funds. Kudos to the fund managers who are savvy enough to have your faith in their web investing ability
i do that personallyso do my partnersour firm and our funds do not make those sorts of investments
Yes, that’s my point. For you to invest your own capital with super seed funds is a great testament to the faith you have in those fund managers, considering your level of expertise and knowledge of the market.
Entrepreneurship is alive no doubt but so is Darwinism. In the end, competition will weed out the poor companies and ideas allowing the best to thrive. This of course also applies to those who invest in such companies.
In some of your previous posts, you have discussed the increased capital efficiency of the current generation of web startups. This might explain your comment today that the vc industry is contracting. However, your comment about the high birth rate of web startups suggests that not all forces are pushing the vc business to contract. You might have posted about this before, but I wonder you thoughts on the interaction of the factors contributing to the contraction of the vc business.Professionally, I am at a somewhat distance from the vc industry but this decline seems inconsistent with what is implied in the general press especially with all this talk about “clean energy.” Perhaps the decline is non-uniform across industries.
the VC industry has performed poorly for at least a decade and the large investors who fund the venture capital firms are pulling backthat is the main reason the VC industry is contracting
Sagely advice, Fred. One of your best in a while.The entire ecosystem is changing (constantly), and while I think there’s strong backing for the seed/super-seed investors, you’re right to encourage them to pace themselves [this from an entrepreneur raising money!].Sometimes it seems like a few of these companies are getting funded by investors, simply because the investors want an option on a potentially bigger business in ___________ [insert: LBS/GroupOn clones/mobile anything].But that’s not good parenting… if you want your child/portfolio company to succeed long term, you’ve got to consider where the road will take you, because the easy road/early exit isn’t a lock and is usually a lot harder than you think.
It’s hard to imagine that there are enough ads (to support them) or enough large acquirers (see: Hot Potato) for all the companies that get started.Where to matriculate? In a world with fewer large corporations to act as acquirers, it would seem more important than ever to get to cash-flow positive rather than hope that some large company is going to acquire you.We make fun of parents today who enroll their kids in the right kindegarden so they can get into Princeton, Yale, Harvard, but perhaps they aren’t so wrong if we applied that logic to startups….what do you need to do as an early stage company to ‘get into the right school’ when you come of age?
You ought not project the dynamics of your fourteen year-old Flatiron companies onto the latest batch of web X.0 startups. For one, the newer breed of companies themselves are cheaper experiments by design and as such won’t have nearly as much inertia and throwing of good money after bad due to large capitalization that you see with older companies (in many cases zombie companies and portfolios). If they are working they will profitably exit much sooner and smaller, and if they aren’t they’ll be shut down much faster and with much lower all-in costs.If all you’re saying is that some super-seed funds are under-reserved, then that problem is cured either by raising additional money from their LPs if they can, learning the lesson for the next fund(s) if they’re allowed them, or just drying up and blowing away leaving super-seed funds that have proper reserves.Either way, in almost all cases, the information services, software, and internet companies have moved beyond the traditional funding models… which will adapt or disappear.
I recognize that and the post explains things are very differentfifteen years laterBut some things don’t change as much as you think
As the cost of starting up is coming down and there are more start ups I think you’ll see more companies concentrating on a business model that gets them to (smaller) profitability earlier (or failing earlier) and exits will be smaller although there may be more of them. You’ll still get the real success stories like Facebook and Zinga but you will also get more companies that get sold at smaller prices and bolted on to the likes of Google and Yahoo or bought for their technology/team.There seems to be a lot of companies being started at the moment that really are features for other websites rather than stand alone products.
Thanks for writing this, Fred. I’ve been saying it privately for months. I wrote a long blog post on the topic but haven’t published it yet (the Wall Street Journal is considering an excerpt so I’ve held off). I worry about this phenomenon both in terms of “orphaned startups” as well as “angel returns.” I think both will suffer. Obviously the best startups and best angels / angel funds will do well, but … it feels like the same phenomenon as happened in the broader VC market in 2000 to me.
mark – sounds like you’re worried that what goes up must come down? do you think the “orphaned startups” will suffer because their “parent investors” remove themselves –> other investors will be wary and wonder why? i have a feeling i see where you’re coming from, but what if those original investors just weren’t cut out for subsequent financing?-adam
Not exactly. My fear is:1. Most startups will need multiple rounds of financing to get to a point where they’re self sustaining. Being lean is fine when you’re young and have limited personal costs. When people have been in the company for 3-4 years and are still “lean” people will start wanting pay checks. If your company takes off massively on its own – awesome for you. But that’s the minority.2. So most companies need follow-on financing to grow. That often comes from VCs. The VC industry is shrinking so many of these startups won’t have somebody to finance them. 3. It has become fashionable for both startup entrepreneurs & angel investors to bash VCs. I understand the sentiment (I was an entrepreneur once!) but the reality is that the VC section of the industry is as important as the angel segment, the growth equity segment and ultimately the M&A or IPO segment.4. So ultimately I worry that too many companies are being created and then angel funded relative to their ability to get financed in later stages. This will lead to “stranded startups” and also lost angel money.I’ll elaborate when I publish my post.
wow, i like it as a point…not so much as an entrepreneur…to fred’s point, i think entrepreneurs as a whole are learning to be much more capital efficient so hopefully the ones that get “stranded” will be revert to their original bootstrapping tendencies if they do not want to abandon their startup altogether. either way, i think this topic has the potential to be very powerful moving forward, and I look forward to hearing from you, fred & others on the subject.
That’s true, although for some startups that might create a problem. If the startup bootstrapped and then suddenly gets 250K-500K in funding, then they might pull the trigger and hire some new developers or biz development folks to accelerate progress. If you run out of money, then suddenly you have to pull back to the bootstrapping ways that newly hired employees might not be able to endure (specifically if they expect to have a roof over their heads and maybe some medical coverage).
In a way, what you are suggesting requires the participants to put think about the macro instead of just that deal at that moment in time. I wonder if they will.
Actually, I’m proposing that each individual company recognize that they need to think about the full life-cycle of their future financing needs before starting the process. Those angels that have better relationships with VCs will have an easier time helping the company raise money down the line when they need it. And I’m asking angels to invest pragmatically and understand that angel investing is a tough way to make a return. More on that when I post …
Point well taken Mark.But the reality of the situation (from my small window) is that young entrepreneurs are just trying to get some seed and get something built to prove the concept. Not common and not easy to get past that point when you are boot strapping your first venture.Things we can all do:-If a seed funder, advise on this early and build bridges to VCs for them-advisors/mentors help. I’d like to see tighter connection between advisors and mentors and funders so information flows to the right place correctly.-blog on it. Fred and yourself provide great service to early and first time entrepreneurs with this info. One bit of advice is to target your info to the entrepreneur with a VCs understanding built in…not the other way around.thnx
Can you please expand on your final point – I’m not 100% sure I understand it.
Sure…I’ll try.We all (myself included) have a tendency to talk (and write) to ourselves.Figuring out valuation, funding, equity plans…is really complicated and foreign stuff to most entrepreneurs who don’t come from a B School background. It’s important to address these to the entrepreneur’s point of view, not the funders. And you and Fred do a great job of this BTW.For example, I really enjoy Fred’s MBA Monday’s cause they are not addressed to the CFO or the financier, but to the info that a first time business person needs to know..in their language.Hope this helps.
I think Bussgang’s book really adds to the mix as well. (Mastering the VC Game)
Q though- if they think about the full lifecycle of their funding, it bucks the trend of lean startups, which seems to want to break out of funding needs as soon as possible.How do you mesh both trends?
I think “lean” and VC are not necessarily at odds. I’m part of a $200 million fund but I resist throwing large amounts of investments at early-stage, unproven companies. I’d rather pass. But getting people involved early who understand “lean” OR working with angels / VCs (like Keith Rabois, First Round Capital) who understand the need for VCs at growth stage will suit entrepreneurs best. Beware of taking money from an angel who bashes lest you need to eventually raise money from these monstrous VCs 😉
Having been ‘in the Valley’ as a startup guy for a long time, I’d posit that along with Capital Efficient early stage (New Series A) investors, there’s a need for a new class of VC which might best be called the Rational B investor. It will be difficult (because of charter and lifestyle) for existing VCs to modify their investing behavior in order to fulfill this role.The Rational B (and, subsequently, the Rational C investor ??) has the obligation to think through the life cycle, and consider the nature of the portfolio company. As Fred points out in the post, and in comments, this begins the discussion on the premise that the startup is a ‘web-based’ startup, by which (I believe) he means low cap ex, rapidly revised in response to initial customer response, and provable traction after a modest period of time. The assessment of what FURTHER investment is required based on experience PLUS the rationalized, verifiable business plan of record, calls for a ‘new due diligence’ and the assembly of an appropriate investment team.The description of Capital Efficient investing for web-based companies reminds me of ‘parenting’, but in an environment not unlike pre- or emerging-industrial third world nations. High infant mortality, the necessity of conserving scarce resources for those infants with provable indications that they CAN survive the initial impediments. It doesn’t mean that the parents love or value the survivors more, but rather that as a practical matter there are few options.When, at the outset, it becomes clear that substantial investment in capital equipment, research and development, or extended operation at a loss is required if a ‘gifted child’ is to be sustained through the vagaries of infancy, then it’s important for both the company and the investor(s) to consider this up front.For investors of all shapes and sizes, pretending that all startup companies now require a fraction of the resources required 10 years ago is silly. You need to turn away those that are not built for it … not because they’re bad investments or poor risk, but possibly because you’re not set up to support them adequately. As an entrepreneur, posing as a candidate for ‘capital efficient’ early stage investment when you’re not, is suicidal.
I will be. Thank you for the advice.
Mark – do publish that post soon! Very keen to read it.
It’s widely understood that it’s easier to start a company these days, though as this post suggests, it still requires both additional capital, as well as significant nurturing to scale. Isn’t it possible that, as a broader market trend, this will wind up being a good thing?As an entrepreneur, the seed movement means that there are many more funding sources to help launch your business. Given that it’s cheaper to get started, combined with better tools to show quantifiable business metrics, in theory, funding should be less elusive for businesses that “should” live on.From the investor perspective (seed & more classic VC’s), you can put less money into startups and learn further upstream whether it’s worthwhile to add incremental capital to assist in the process. Putting in $500k for a VC feels like the equivalent of putting $5mm in 10 years ago, so proving concept should come at a more feasible risk for the fund.Of course, aside from the companies that exit early or get follow-ons, we know most of these startups won’t be able to emerge fast enough and will disappear. Darwinism will take over, but failing faster might be good thing in the grand scheme – investors can limit their risk, while entrepreneurs can quickly learn whether their business is something they should continue to pour all their passion into.While it’s easier said than done, Fred’s point about picking the right partner early is a critical one for entrepreneurs and angels alike. If I were starting a company and raising money, I’d be sure to try to partner with a VC that could work with me through the company’s maturation process. As an angel, I’ve also made a point to try to align myself with smart VCs at the seed stage, in order to protect my own risk.Clearly we’re in a transition period, so it’ll be interesting to see what happens next with the seemingly huge number of early stage companies being funded. If 2010 is the year of the seed investment, will 2011 wind up being the year a massive number of startups die on the vine? If so, is that a bad thing at the macro-level if the best live on?BTW, great post Fred. Very timely for a lot of people in the startup community.
Agree with all of you points. It’s important for entrepreneurs to align themselves with future funding sources and important for angels to have good VC relationships. That’s the point of the post I wrote. I’m surprised when angels “VC bash” because it assumes that they don’t care much about future financing needs.
Gotcha. Seems there are two camps of angels who bash VCs:1) Those who don’t understand (or don’t care) how the cycle will inevitably play out.2) Those who are criticizing the industry/old guard model, but almost always make a carve out for the new breed of more adaptable, top tier firms like you guys, USV, True, etc.I look forward to your post.
there isn’t enough of the “new breed” to fund all of the seed funded startups unfortunately
Precisely why this is such an interesting moment in time…
fred, you’ve clearly raised a very powerful and important issue. mark and josh’s comments both strongly resonate with me. to me the issue is one of the seed funding business model.as mark accurately stated, there is a lot of (traditional) vc-bashing going on. while some of it is warranted, some of it is not. my fund, ia ventures, regularly partners with larger funds on seed deals, fears about signaling aside. i personally feel the signaling issue of larger funds investing in seed deals to be overblown, as in my experience high-quality firms make high-quality decisions that generally reflect the risks and rewards of the company.while running a seed fund, we are focused on appropriate reserves to be able to follow on, but clearly acknowledge that other syndicate members (with deeper pockets) will need to participate if an inside round to buy more time is warranted. many other seed funds have chosen to invest small amounts in many deals and to avoid reserving for follow-ons. this is certainly one person’s valid business model but it isn’t mine. what happens to those syndicates where there aren’t deep-pocked funding sources at the table (and more time is needed for the company to hit key milestones) is a worry to me as well. angel syndicates are great and can add lots of value. i spent the better part of six years leading and participating in such syndicates. but as i’ve matured as a seed stage investor i’ve come to embrace larger fund partners as a constructive way of helping to address the follow-on/bridge problem as well as having another smart and engage set of partners as part of the syndicate.i’ve written about ia ventures’ asset allocation model, and believe it to be a right and valid approach, at least for me. 20-25 deals, a mix of incubation, smaller “opportunistic” positions and larger “concentrated” (more classic VC-type) positions. this likely requires $20mm or so to minimally prosecute properly. however, additional value can be created by moving from $20-$40mm. would this money go into new deals? no – it would simply represent additional reserves from which to follow on. i firmly believe that the life cycle approach to investing is the right approach to maximize ROI, build strong and lasting entrepreneur relationships and to be “in the market” at the time maximum value is being created. but after so much de-risking has been done at the seed stage of the deal, wouldn’t it be great to have additional reserves to lean heavily into winners and to increase stakes when opportunities present themselves? indeed it would.
there is something to be said for investment expertise rogeryou’ve got plenty of that
This trend also will also result in angels having more and more startups in their portfolio. How do you think investors will respond to the challenge of advising / supporting 35 startups, instead of 15. Will there be a new breed of hired guns at these Angel shops who will play the role of mentor/coach/board member on behalf of over-stretched angels?
I think Josh’s point about how ‘funding should be less elusive for businesses that “should” live on. ‘ is correct and deserves a little more discussion.I find it hard to believe that, due to shrinking VC and growing angel-funded startups, there won’t be enough dollars to go around to startups that legitimately deserve it. Won’t capital always seek out areas of highest return? Is the concern that VC is so badly beaten down from the last decade + such a slow moving industry that there will be a period where truly interesting companies will starve from lack of VC capital?As an entrepreneur in the midst of all this, what I’ve noticed is that the bar to get <$500k from angels is low, the bar to get Series A from VCs is high and getting higher, and in the widening gap is an opportunity for seed funds / super angels to step in and do the bridge rounds that regular angels can’t afford to do. What will also be interesting is if early stage VCs begin to compete with seed funds on those pre-Series A deals because they’d rather the first round they invest in be rounds valued at $5M rather than $10M.Definitely curious to hear what Fred, Mark, Josh, Roger, etc think on this as experienced investors (or if I’m totally off the mark).
All I can say is … read “Delivering Happiness” – the story of Zappos. They struggled to get funded in 2003 with more than $60 million in gross merchandise sales. If they struggled despite performance just know that it can happen to much lesser companies in tough times. Right now the startup funding market feels mildly bullish but this can change on a dime. Plus, the definition of “deserves” funding is broad. Many companies you read about and are “killing it” in the media are internally struggling with the economics.
You are going to need to start training people that not all statups can be lean after a point.Already people are trying to deconstruct the money in a negative way. Joy of opening up.
i’m not surprised you are worried markmost VCs I know are concerned about thisi do think it is different than 2000we have way more tools to use to turn these companies into self sustaining businesses
More Worrying:Why aren’t more startups concerned from the beginning on being self sustaining businesses? It’s almost like there is a new breed of startup developed to be sold as an incubator to a big bad company out there
Easy way to displace their worry and stress of competitors. (Not saying it’s good or bad)
I’m playing a bit of devil’s advocate here, but I don’t think that’s necessarily a bad thing for those entrepreneurs, if selling their “talent” for loads of money to a big company is what they want to do. (Or at least I don’t think I have any power or right to tell them they shouldn’t be doing it.)It may be a bad thing for venture capitalists who gave those entrepreneurs money, though.
I’m ok with it to a point. But to play devil’s advocate back, there was a comment made about the feminist movement and choice that if we get a large sum of people making some choice, it could destroy the pillars on which feminism was built out of.Same goes for startups. If too many startups go for “I will start a company as a way of gaining entrance to some larger corporation for a greater than salary payout initially” it could make it harder to build companies that are not for that purpose, since funding was divert to an understood paystream.It also points to a form of structural instability and a possible opening for those who really want to be innovative: Companies that we think are innovative are starting to outsource their innovation and buy it because it is too expensive to do R & D inhouse. I have totally mixed feelings about this (Chris Dixon points out historically antiviral land works this way- web startups in general seem to have not) Should large companies kill more internal projects as well if they are going this route (they’re not right now) Should innovative companies be stocking for a hire price-point if de facto they are really the external labs for some big companies?We live in interesting times.
Yes – very fair point.I think it would be harder to build companies that “make a dent in the universe” if potential employees, partners, and investors weren’t able to differentiate between those out to get acquired for talent and those out to make a dent in the universe. If you think it’s tough to differentiate, it will be harder to tell one type of company from the other, and fewer would-be denters will get funding, stellar employees, partnerships, etc. However, if you think one could differentiate, you’d also assume investors would start allocating capital to companies that aim to make dents. Arguably this is a more efficient outcome than what (may be) happening today.I think your second-to-last paragraph has fascinating questions, and I’m very curious to see how things will play out in the near term.
I’m not sure how easy or hard it is to differentiate. I do hope it gets easier over time. I also make no assumption about investors since both with PE, Growth Equity, and with VC it seems that only the top performing firms make money, and everyone else doesn’t seem to (Weird piece of advice I got in Penn Station about the subject- stick to your investing thesis/idea strictly helps a ton). So while in theory you’d get better returns since it would be more market efficient, I think it might cause a dropoff in certain kinds of calls for capital as it becomes more obvious who is whom in firms. (Eg: USV doesn’t do a megafund) Those companies that work along the lines of say OpenTable (7 years, a long slog) may find themselves mismatched out the market, at least in the short term, since unless you are trying to build the next facebook with this small group, why bother?I also wonder a great deal about that second to last paragraph. All I can say is, we live in interesting times, and it also may be the case that we are underpricing talent in the US.
ShanaC I agree more startup should be concerned from he beginning with being self sustaining businesses. Your second point, in my opinion, is the culprit for the rise in startup birth rates (to borrow Fred’s words).A lot of the new comers to the VC/Angels space are not in for the long haul and don’t give a rats hoot about the longevity of the industry and what it provides to deserving entrepreneurs; they are simply trying to make a buck. Hence they latch on to anything that seems to be able to bite on to a current trend with the hopes of an overnight pay day. (I think) Fast Company did an article on the “like a” companies… which I believe are started only with a big sale in mind as opposed to building anything of lasting value. For this reason, I am not overly concerned: nature will take its course and a vast number of these ill-advised companies will crash and burn.
There are startups out there that are working on self sustaining business. I am on the cusp of rolling out a project as we speak that doesnt even require seed money until we reach some critical hosting issues should the project blow up. In the mean time we bootstrap along with some sound monetization and work our 9 to 5 in the meantime. Welcome to the new era of tight startups.
You said at one point that though it is cheaper to get started, it still seems to take the same amount, about $20m to get a startup to cash flow positive.Do you see signs that that is changing? You seem to be hinting at that. Is earlier profitability and ability to fund growth themselves an emerging characteristic? Are you just seeing isolated cases or a trend towards earlier profitability?I think of “early profitability” as a subset of the lean startup model, best characterized by 37signals (as their 100 billion valuation joke demonstrates.So between an increased birthrate and earlier profitability and exits (sometimes without a VC stage at all), what is not clear to me is whether the overall infant mortality is/will be going up or down. There are forces pushing in both directions.
i am very hopeful that the overall “infant mortality” is going downand i think it isbut i don’t think it is going down as quickly as it may need to go down given the increasing rate of startups and the declining amount of “traditional VC” available
Fred…really accessible post and one that is actually a social commentary as well.Being on the consulting and advisory side of the biz (with a small project of my own as well), the landscape has certainly changed and there are start-ups a plenty everywhere building little pieces of solutions. I was thinking it has to do with the ease and speed and cost-effectiveness of building prototypes. Your point on seed though completes the ‘why’ of it for me.The crush used to be finding funds to start. The crush now will be finding markets, finding go-to-market funds, or as you imply, being bought as a team with their project a proof of the teams ability to deliver.Maybe this huge crop of new entrepreneurial groups are the “seed-boomer generation”. And yes, concern about who’s gonna manage the seed-boomers is valid. Although I’d rather have that energy and growth now…and deal with some of the Darwinian fallout later…rather than the opposite problem.Great post.
“go-to-market funds” summarizes the whole idea.
Facing the market once you have a prototype done is the great moment of truth. Requires funding but also understanding of how to spend it appropriately.
Go to market funds still means there is a gap
Hmm…don’t quite understand why you think one begets the other. But…honestly, there is always a gap, always a reach, always choices to make do. That’s just healthy.
There was a comment about this (who wrote that comment) about what the new round sizes look like. The commentator mentioned a gap to get to the point to move the compony possibly away from middling. We’;re back at that issue now- how to close that gap.
There’s no shortage of follow on capital… it’s a mirage.Foursquare got a $20 million follow on after a million+ seed round. Traditionally, that would have gone to four or five startups at 4-5 mil a piece.Twitter gets $100 million for a top-off/pre-IPOish growth round. That used to go to 4-5 $20 mil rounds in companies.If more and more of these seeded companies look promising, two things will happen. One, the big later stage guys will start making more bets, and maybe writing slightly smaller checks. Two, if there’s still an opportunity gap to fund later stage companies, someone will come in and fill it. Perhaps some of the seed guys will go down market–Accel is looking more and more like a growth equity fund everyday.The capital needs of all these companies are micro-micro cap relative to the rest of the market… There should be more than enough to go around–and if the returns are there, LPs will have no trouble funding it.If there returns are there, there should be no trouble funding it. If there not, we have bigger fish to fry.
the foursquares and twitters of the world will never have a problem raising moneybut that is not the marketit is the average startup i’m worried aboutnot the best ones
I agree, but my point was, they’re accessing way more capital than companiesat that stage used to… and if more companies achieve what they did, andneed capital, the next time around, late stage firms might write 10s insteadof 20s, and spread the wealth, until new capital sources come online to fillthe gap.
unfortunately the late stage VCs only want to invest in the very best companiestheir model is to cherry pick the top 10 or maybe 20 percent of the VC funded landscape, at most
Perhaps there is no room for “average startups” in a market Facebook steals every feature any small startup innovates with?… or perhaps the market for average is a “dude business” that breaks even and makes the “dudes” happy every day?
facebook “stole” a bunch of Twitter’s featuresi don’t think that hurt Twitter too muchmy gut tells me web services are different than desktop softwaretime will tell if my gut is right
Charlie, I wish I were as optimistic about this as you are but I don’t think your assessment will hold. The best companies can get follow-on financing at huge valuations PRECISELY BECAUSE there are so few high potential companies. But the reality is that returns weren’t in VC because too much money poured in and the same thing is likely going to happen in the angel category.It might be trendy to be angel / seed investing these days but this will only remain so as long as 1) the economy improves [my bet is this won’t happen in the short-term] and 2) angels as a class / stage get the returns they are expecting. I suspect you’ll see similar as VC where the top angels / seeds perform exceptionally well and the majority have zero or negative returns.
Agreed. But it’s really tough to pinpoint the optimal mix of capital amounts and staging. The market oscillates around optimal allocation, but never gets there.There is still room in the market for focused seed and growth shops, but the ‘lifecycle’ approach to venture investing is the one that particularly interests me – invest early, lean hard into winners and have enough capital to support companies through a reasonable stage of maturation.
Both yours and Fred’s comments seem to rely on investors (both GPs and LPsalike) being able to weed out the best from the average. Historically,there’s a lot that looks like it *could* be great and that promise is whatdrives the market.
Charlie, I think this is actually what the problem is. There are many companies that “could” be great. Companies with the right management team, interesting product and initial traction are the definition of “could” be great. That’s why they’re so easy to fund for $500k.BUT … “could” be great is a much harder funding proposition for A investors (usually $3-5 million investment), especially in a market where angel / seed deal prices go up and M&A prices (e.g. when companies are acquired) goes down due to a glut of companies being created. Still, most A investors are willing to accept “market risk” when they invest. Just less so than seed investors.I have been arguing lately that the biggest gap in the market is for B deals. This is where companies typically raise $8-10 million and often at prices North of $20 million pre-money. This is much harder to do when the exit potential is less clear and the traction is less proven. If you’re Twitter, Foursquare or the like you raise at what ever price you want (up to a point). But for the masses the B round is really, really hard. And once you’re passed over it’s hard to recreate momentum.So the “could be successful” companies can end up withering on the vine. And this happens at the same time as the management teams start to question whether they are being paid enough, whether there will be an exit some day or whether they should be looking for their next gig. It’s a classic middling outcome for all involved.
B rounds are def also the most succeptable cyclical valuation swings…
Over time, it means that someone will mess up the best possible startups. Pandora I heard went through hell. Not everything is insta-success and take a little more pump priming. All sorts of companies are out there in this economy that can do positive
Great commentary on that state of the venture/angel funding and the impact on young companies. While its cheaper and easier than ever to start a company, the basic’s of fund raising still apply to all but the very few who can take an idea to profitability without $3-5M. While thats down considerably from the historical $10-20M, it still takes investment to build meaningful and sustainable companies.
“…And the most important factor is how cheap it is to build and launch a web service these days. You can bootstrap your way into existence…”Thank you Fred for your article. However, as to the quote above, I’d be very interested to hear some more and/or getting directions where to look at. For example, how do you define “cheap” and “web service” in this context?
Jan – there is no formula. a lot depends on the cost and quality of your dev team
Thanks, may I still ask; is there something in particular that has dropped in price and/or changed technically so that you can say that it has become cheaper than ever? Just all the hardware/software in general?
you can rent infrastructure from amazon or rackspace or someone else instead of buying servers and managing them yourselfand you can use open source and rapid development toolsboth of these things make a huge difference
Maybe this is the result of a new class of startup – lean/bootstrapped businesses look nothing like the capital hungry monoliths of a decade ago. The shape of future businesses will be the result of “new rules” investing (super angels). One shot investors are pattern matching to rapidly maturing startups. Small companies will be forced to become profitable sooner or die without the presence of follow on rounds. Only a few outliers will attract large follow on VC rounds. The vast majority of web businesses that you see coming into existence today may only have the benefit of a single seed round. That means a lot of things have to come together much faster, and rapid business maturation from babes to adolescents. Bootstrapping and customers is the most reliable investor a startup can count on to fuel it’s growth trajectory.So we are witnessing the meeting of multiple forcing functions:- the need for lean input capital- rapid convergence on profitability- increased demand for mentorship and introductionsInvestors which can provide first and the last, to startups capable of the middle will surely prosper.
This is like the venture math problem in reverse, in a sense, right? If the VC math problem was one of too much money in the system, this current case is one of too much demand for money as the total pool is shrinking. The one constant for both cases is the absence of exits. Once this issue is addressed, both supply/demand imbalances should be resolved.
i don’t think there is an absence of exits, nor do i think there ever has been onei think what there has been an absence of is IPOs and liquidity for founders and investors that isn’t tied to a sale of the businessi am hopeful that we are seeing a renewed interest in web service IPOs and i am also hopeful that the secondary liquidity market is around to stay
I am referring to a trickling effect that begings with an exit environment to substantiate a certain level of venture capital in the system. You quantified this dynamic really well in the VC math posts last year. “Absence” of exits is obviously an exaggeration and wasn’t meant literally, but the level of exits – in the IPO as well as M&A environments – has not corresponded to the amount of venture capital raised. For this reason, the venture capital segment is shrinking, as indicated in this present post… which trickles down to the seed-stage level by providing lesser follow-on resources to seed-funded companies. In a sense, that would have been a sort of exit for the earlier rounds, at least in establishing another valuation benchmark, perhaps minus the liquidity. Anyway, point is, there is a domino effect that begins with the ultimate exit scenario when the company is sold or IPO’d. I think that has been the root of the problem, in terms of both the original VC math post and this current issue raised.
i got it now dan. good discussion point.the one thing we have to keep in mind is the long latency of VCit has taken almost a decade for VC to shrink because of what happened a decade ago
Thanks Fred, I see the point. In the interest of all involved, I hope the future begins soon.
great comment, dan.
At some level, this feels like a natural structural ripple from the technology shifts in the last 3-4 years. With the dramatic reduction in upfront fixed costs (and internal capabilities) that saas/cloud/elance, etc. have brought to the typical startup, it’s easier for new ventures to get farther away from the starting line with less outside capital. No surprises there.The shift we’re talking about is the increase in the advice-to-funding ratio that VCs will experience. Rather than focus on what happens as VCs stick to the historic balance that makes their business models work, I think it’s more interesting in how the VC market might segment itself to offer lower “service levels” for smaller placements or earlier stage firms (angel+). I wonder if this isn’t similar to what happened in brokerage with the advent of online trading for the mainstream.
There appears a consensus around the lowered costs to starting & building an early startup, but do you think it is cheaper (or takes a shorter period of time) to get to profitability? The last figure I’d seen was something like 4-5 years on average, but not sure what sectors. While you can get a lot further initially on smaller amounts of capital, does that change the capital requirements for the lifecycle of a company?On another point, while there is a growing number of incubators (and I learned a ton from participating in TechStars), I wish there were more “grad schools” for startups. So for the time period after you’ve launched when some things have gone well, some things haven’t. If I had a critique of the model of some incubators it is they focus on the raise & launch more than ongoing execution. Which is part of my excitement about forthcoming Project11 (http://project11.com).
Maybe this trend is good in the long-run. If what you think will happen, it should only have short-term effects. In the near future, if past companies cannot get additional funding – then maybe the next wave will either have to better manage the funds they do receive, pick investors that bring more to the table than just cash or find (invent) innovative ways to build internet companies from start to profitability without having to burn some $20 million plus.The recent financial meltdown forced banking firms to regress back to normalcy regarding lending policies and this might just be what both investors and entrepreneurs need to maintain a sense of equilibrium here.
i do think it will be good in many waysthe bursting of the internet bubble in 2000 was very good in the long runit forced a lot of good habits on the emerging industry
I’d ask Ron Conway. He’s got the most experience with this kind of model.His and Bob Bozeman’s 2000 vintage svangel fund during the boom had ~400 small holdings, and all their LPs were individuals. As of a ~5 years ago, there were only one or two private/alive ones left to manage. They were stable, profitable small businesses without add’l capital requirements if memory serves.Barring Ron chiming in, I’d guess the near-absence of an unprofitable living-dead population and the inability to pursue one’s pro rata for more than a round or two reduces the hangover tremendously.
good pointi doubt ron will chime in via the comments because that’s not how he communicatesbut i would love to know what he thinksthe “living dead” don’t have to be unprofitableflatiron hasn’t made an investment in years. we still have four portfolio companies. they are self sufficient now. but still in our portfolio.
So, I guess the big issue is that VCs won’t have closure on these crazy profitable, self-sustaining companies? :-)Which raises the question: Why not ask the “Flatiron final four” to start paying dividends and/or buy out the investors? Perhaps they are not in the cash position to do so (or maybe they already are).The big difference today is that these startups can sustain themselves due to the sick amount of revenue infrastructure that has been built out (i.e. AdSense, Ad networks, subscription services, paypal, etc).Bottom line: as a tiny angel investor in about 15 companies over the past year (trying to do 10 a year), I am sensing a bubble in angel investing as well. The valuations are high, the number of angel investors is stunning and the speed at which the market operates is dizzying.I’ve STOPPED angel investing for the rest of the year just to work on helping the folks at Blippy. GDGT, Gowalla, Backupify, ChallengePost, Postabon, etc. refine their products and businesses.I don’t think I could keep up a 15-25 investments a year pace AND provide value to the startups (at least I haven’t figured out how to do so AND run a top 200 site in Mahalo).good thoughts.
“Which raises the question: Why not ask the “Flatiron final four” to start paying dividends and/or buy out the investors? Perhaps they are not in the cash position to do so (or maybe they already are).”Having lived the issue the problem is the investor really, really doesn’t like this outcome.I wrote about this at justanentrepreneur
the final fournice one Jasoni’m wondering which one will be the champion
Sheer curiosity- which companies are they, they’ve got an interesting story to tell no matter what happens.
In the future, I hope to be in a similar parental position as you state, and adopt some of the companies who are looking for an out or in need of a guardian.I believe there will be many but it might be hard to find them.
Great post and great attitude.Some points:1. Is there a limit to the productivity gains of the knowledge/information industry? Are we at it?2. What pie these startups aim? If it’s the cannibalization of the available online services pie, maybe a problem.3. What about startups with non-CS experts leaders, aiming to the still not online biz? isn’t there plenty to do?4. Does the web economy change the rules of economy of scale, and lets many players co-exist? Or we still at the 1-2 leaders markets? 5. Apparently developers are more productive in a small start-up settings.
Re #3 I agree, I think there is still lots of value to be gained in not-yet-online or not-yet-social businesses.
Great post. It was interesting to read. HBR wrote an interesting article linked to this: http://bit.ly/asbQLZ
Following this line of though, it seems that Hansel and Gretel is actually a story about entrepreneurs seeking for funding.Not that I’m taking a stand who the witch is 🙂
Who needs venture capitalists or seed money? It’s so easy, fast, and cheap to create web businesses these days. I create a new one almost every week. The broken VC model from the 1990s is dead, it’s now time to return to the 1970s and 1980s.
what happens to all those web businesses you create?are they all profitable day one?
Some make it, some don’t; but that’s a product success decision rather than a financial one. It becomes a matter of internal startup darwinism. Those that show promise get the attention (get new features, further marketing effort, etc). Sometimes you’re not sure if a business just needs a little more time; in my case, giving it that time to marinate costs nothing.I keep expenses extremely low, use Google and social media (word of mouth) as heavy promotion engines. Nothing I build comes with a real cost beyond time, and I build everything myself. There’s almost zero cost, and I’m talking about businesses that span several different industries. Right now I’m working on two web startups for the real estate market. Under a month build time, and being deployed on existing infrastructure that is paid for by other services. Margins of 97% (until I hire support staff; after that margins drop to 80%).Leveraging what I’ve already built, I can push millions of ad impressions on my own sites to promote anything new I want to launch. I roll technology forward, accumulating large amounts of code and experience; so even if a project is discarded, it always creates value. I use MySQL, Sphinx Search, MongoDB, PHP, Linux, Apache, et al.I’ve been building web businesses since 1995 (15 years old when I started). There has been an incredible acceleration in the ability to roll web services off an assembly line (for numerous understood reasons). I’ve probably built more businesses in the last year than the prior 15 combined. This is a new era of platforms for the web that has massively enhanced the ability to build and distribute over night. Just as the era of Windows meant you didn’t have to recreate the wheel, and you had a massive, consistent platform to distribute on – the web is now acquiring the same exact benefits from all sorts of platforms from Foursquare to the iPhone and Android to Facebook to Twitter to even Wikipedia and Freebase (and on and on) – it’s the age of the API, generating a compounding effect as it goes.
that is great. you are doing it right. and i suspect you are bootstrapping all of these.
That’s basically correct. I do what I love and I don’t want to give up large pieces of my businesses cheaply. Bootstrapping radically improves your odds of being able to raise capital on your terms later if need be.Short story – around 2002 there was a lot of commotion with eBay increasing seller fees. So I thought it might be an interesting time to target them, and build a competitor with a ‘free’ business model based around charging for data tools on the platform (tools that help sellers generate recurring business, track data points on sales, send out sales contacts to prior customers, demographics et al.). Anyway, I spent a year and a fair bit of money on the effort. I got my ass handed to me, and I learned some incredible lessons in the process; first and foremost: launch fast, iterate fast and spend as little money as humanly possible (launching fast helping a lot with that).
There is very little commentary on this approach. It seems to me that the vast majority of web start ups do not necessarily need VC funding and could focus on keeping costs low and generating revenue (like any other business). IMO the reason so many web start ups seem to chase investment harder than revenue is because that is all everybody writes about – getting investment has become such an important validation point. However, I am not sure that a techcrunch type blog focused on companies pursuing the long hard bootstrapping journey to profitability would be that interesting. So, what to do?
Maybe the future won’t be like the past and the world can support more profitable startups. A lot of these old school VCs are thinking about optical switching and enterprise software companies and such. For me the key question is whether this new pool of founders are super talented and devoted entrepreneurs or just trend followers.
i am an old school VC and I am not thinking about enterprise software and optical switches christhe future won’t be like the pastthat is for surebut it will be more similar than many thinki remember in the first half decade of the internet when we all talked about the “new economy” and suchit turned out not to be that different from the old economy
I guess to me it’s all about people. If programs like Y Combinator are getting our smartest kids to start companies instead of going to law school, McKinsey etc then that’s going to lead to good things for our industry and our economy.Also, a lot of web companies could be profitable a lot sooner if they didn’t raise so much money and expand so quickly. e.g. IMO Twitter should be like craigslist – a small team with crazy good margins.
Totally agree on all points. The only problem will be exits for the investors which will drive them crazy and therefore drive the company crazy.
A thousand times yes Chris.Twitter should have used the “lifeboat” framework – there should be max, 50 seats in the Twitter lifeboat, each one having a value that’s accretive as the business grows. Rather than sell “equity” to buy a bigger boat in the hopes of finding land, every seat must be upgraded with a stronger member. This is a true lean startup, that exercises the at-will nature of employment contracts to reduce wasteful expansion.The problem is one of size substantiating power substantiating executive pay, a ruse at startups and public companies alike.
What is new is old is new again- I’m all for disrupting enterprise software way before a social commerce site. There are a ton of klessons learned from social media and a host of other consumer trends that are long overdue to in the business world- and I just wish was slightly less scared of myself, because that is my long term dream (amen)I see more trending than super talented people. Some of it is direct, some of it is are trending people who are super talented and know how to create brilliant derivatives. And I see a chunk doing their own thing. it takes a long while for paradigms to shake away. Now isn’t quite that time where that is happening.
What do you look for to make that assessment? What’s the tell?
I think it’s going to be a problem, but not the one you’ve envisioned.The problem is I believe many of these companies will end up being ten to twenty person teams with $1-5M in revenue with growth rates that are in the low double digits.That means they’re viable companies but the exit for the investors is a bitch. Too small to move the needle to be acquired, unable to leverage more investment, and so you get a return of your capital and accrued dividends.This is a problem I have lived….and it is a problem that can be solved but it’s not fun. It’s where you have to negotiate a divorce.
i have plenty of experience with that outcome too Philnot a great place to be for sure
Understand as Chris points out its a much better use of talent and is ten times better for the economy as a whole than having talent trying to pickup nickels in front of a steam roller on Wall Street.Overall its great to have companies that provide a great web service to a niche, and its great to have talented tech teams work for themselves rather than spend a life full of meetings and TPS reports at mega-corp. Added benefit is they can play the get rich slow play of making a multiple of what they would make at mega-corp….just not the out of the park homerun.I don’t know how to solve the problem for the investor. Nobody took a financing round modeling this outcome in their spreadsheets, and no investor can be happy taking 2xers when they need to make up for companies that failed, and to provide better returns than lower risk alternatives (although I wish I less money in those alternatives the last several years)I just don’t want to see that value wasted and that is actually my biggest fear. That investors and companies that are providing real value will go for the go big or go home theory no matter what even when it doesn’t make sense and the outcome is to blow up and squander all the value.
If there are so many of these companies now, why is there no market for them taking on debt instead of equity, considering interests rates are so low? Junk bond underwriting or something like thgat per say might not be a bad option.
You can’t get a loan period. Even with a personal guarantee with assets to cover it.The problem with a “junk bond” is they don’t exist but if they did the minimum interest rate would be 12% compounding. The problem with that is you better being running one hell of a profitable enterprise or just like having credit card debt you will be on a treadmill with no end. Think about it….a $500k loan would double in six years and with taxes you’d need to come up with $200k every single year just to cover the interest!! No principle just interest.
yes, and I keep thinking that is why the stock market is screwy. In my ownhead, debt and equity depending on the growth of the company should havesome balance. While a startup should be mostly equity, debt can be goodgrease in really small amounts. It also means your not diluting everyoneover time to raise more cash.We forget that a lot of early 70s-80s technology was funded by debt- but itwas also a moribund time for stocks.Even with the 12% rate, (too high for extremely early stage,. i’m thinking alittle later) if the company is profitable, a much smaller offering mightget some of these small but already profitable companies onto the nextstage.
I’m still not sure that there’s a problem in what you describe. It seems like early entrepreneurs, especially those without a track record, have got a better chance than ever to get capital and try their ideas thanks to the growing ranks of angels and super angels.Because the VC industry is shrinking, a smaller proportion of these companies will receive follow-on funding than in the past, but I don’t see what’s wrong with that. As other in this thread have pointed out, entrepreneurs will be trained to become heat-seeking missiles, as Josh Kopelman likes to write about.Angels will enable more entrepreneurs to take a crack at their idea and VCs will get more data to base their decisions on. And the entrepreneurs, they’re trading easier access to capital for higher bars for success. I can’t speak for anyone other than myself, but as an entrepreneur, that seems like a fair trade.
GREAT post and so relevant to the current ecosystem.One thing is certain, capital markets are always in a state of flux constantly evolving and adapting to new broad dynamics, always trending towards an optimal balance of supply and demand but never quite getting there. The issue you raise seems like the next ‘zig’ to our most recent ‘zag’.Within the last few years we have seen the market adapt to address the issues of general over supply of capital, and more recently, the under supply of early stage seed capital. To Charlie’s point above, if there is a gapping hole in the chain of venture financing I’d expect to see capital flowing to capture these opportunities. This capital will come either in the form of more ‘lifecycle’ funds like True Ventures or USV, or more dedicated late stage growth funds (with a broader investable mandate than just the top 10-20% of cherry picked venture deals).Of course, market corrections take time, but it’s much easier and quicker to raise new capital to fill an opportunity gap when there is under supply than it is to burn off excess capital when the is oversupply.
The “parenting” metaphor superb.”like to think of the venture capital business like parenting.”, I’m looking for a new parent then :)”I worry like a parent with too many kids..”, I like that as well and experience in the edu industry would be most desirable, but oh it’s not up to me…
Interesting post. As most startups are not powder kegs, I think the situation you describe is going to result in a lot of frustration all around. More often than not, the hottest ideas are actually iterations or spin-offs of ongoing nose-to-the-grindstone efforts. Thomas Edison wasn’t a lucky guy.In reality most successes are born out of an entrepreneur relentlessly iterating and innovating. Good products require patience and time. Startups are not seeds, they are farmers. VC will eventually make a comeback, because they are designed to support efforts, not ideas.
Really well said!
It seems like there are two contradictory phenomena here: that companies are taking longer to generate a return, and investors with smaller reserves are becoming more active deal-makers. Great post, Fred.I thought you were going to make a separate point, that there aren’t enough acquirers — Google is active, Microsoft, Yahoo and others much less so — to adopt all the kids who don’t go public. The number of companies that can make large-scale tech purchases has certainly declined.
there are plenty of buyers if you look elsewheretake redfin for examplethere are a lot of companies that should want to own that business
Do you think the startup birthrate is expanding everywhere or just in the U.S.?If you think it is hard to raise follow-on capital in the U.S. because the venture capital industry is contracting, try raising money in other parts of the world that have no VC industry at all.
Nice picture on this post Business Insider! Roll on you Bears!!!
Not sure about this disqus UI update.No. of likes has gone, new community features have dissapeared and all replies are foldered away and need clicking on individually to read them.I predict a riot.
that’s on a mobilereplies are not foldered on the web
Hmm, I just noticed that tooStill annoying on mobileWould be nice to have a toggle choice on top
Fred – Long time reader of your blog, but don’t think I’ve commented before this. First of all love and respect USV.The fundamentals to the cause of your worry is that you see yourself as the parent and startups as your kids that you feed. I believe, this is changing a lot more these days. The super-angels and the angels, don’t try to play “parent”. They play friend. It’s a mutual benefit relationship, but the ultimate control is to the entrepreneur. Usually the friends and family who are excited about your seed round (when you leave their company), are not thinking about follow-on. I think that is extending into the ecosystem. Each investor operates in his own layer, without causing signalling problems. YC is the biggest example of this. Super angels seem to fall there too.I wonder what your views on this “round focussed investor” are, because it moves the burden of “calling it quits” to the entrepreneur, who in my opinion deserves that right.
funnymy kids are old enough that the parenting is mostly doneand friend describes the relationship better these days
very good analysis, I also see it this way, parenting is a good way to put it. Unsure about the “pulling the plug” comparison though, doesn’t go very well with parenting!ping me next time you’re in SF? Would love pretending to be in Paris at Tartine again and catch up
i’ll be in SF in mid Sept Loicwe’ll do the pretend Paris thing for sure
great, let me know when, will be with pleasure
I take a Malthusian view. Expanding birthrates are fine and healthy, and when the environment can’t handle the population any more, the fittest will survive.
think about RP in 2004 Mattgood thing you had VCs with deep pockets in your camp
Short answer: A lower % of these “kids” will make it to their 3rd birthday.I posted this last week about being on the “right side of the app rush”: http://andyswan.com/blog/20…
Thanks for writing this Fred. It’s something I’ve seen in the music world as well. Major Labels have been going through a long phase of investing in tons and tons of artists in the pop market, simply to throw them against the wall to see which ones stick. The ones that don’t show immediate success are discarded, and that capital that was invested is just written off. An example of a label (VC) that stuck by their artist (start up) was Octone Records who worked the first Maroon 5 record for two years until it broke, and then it broke hugely of course. It took that band a long time to get on their own feet, and they needed several rounds of funding, and they got there due to the support of their label (parent). Many artists that have the initial round of investment end up way short of the finish line, with some initial “sexy” success, but no follow-through. They’re left to their own devises, and more often than not become well-known enough to be considered failures later on.
wonder if the capital needs having been lowered to start these web services, does that correlate to more darts being thrown by the Angels/VC’s etc with less need for accuracy and more need for just one of every ten darts to stick on the board.Wonder if it also means the risk averseness ratio has been lowered for Angels/VC’s etc. My experience of dealing with that group has been generally been informed by their lack of real ability to make bets with high odds. Most of the funding that happens even when a small amount of capital maybe needed still happens only when there is some historical evidence ( knowledge of previous successes).I would like to hear Mr.Wilson comment on how he sees investing in ideas over investing in people.It would tie nicely with the earlier post by Tereza on women in startups and being funded. I think these children may not have deep pocketed VC’s but most have connections once they get a basic funding as the Investing family be it super funds, or angels or established VC’s all tend to have a pretty closed incestuous relationship within their ilk.I wonder when the shift ( after the dotcom bust yes but how much after) in thinking happened for the venture capital community to seek exits of the M&A kind as opposed to trying to get their portfolio companies to be IPO’s.
okay fred,i’d like to hear just how cheap you think a web service company can be started for? i often read others saying something similar. but for a social media driven type web business, what is the cost? for the site alone?and if it’s so cheap why doesn’t the VC just pay for the idea and leverage the in-house talent to build?
Are you implying that there aren’t enough follow-on funds given the quantity of new startups?I’m curious if this is based on a specific success rate assumption; i.e. assuming that only the ones with traction or successes qualify for follow-on.
History: birthrate without control produces malnourished kids. Though producing more kids may be a modern trend in funding … it is DEFINITELY going to produce more malnourished kids than healthy kids. I don’t think anybody out there is re-writing history. I like your “Not just the first part of it, but all of it” principle…as a good VC who thinks of those malnourished kids even before having sex … Survival of the fittest experiment may work good for nature which never cares about who is who and what is where. It will never work for elements with sentiments. Those advocating birth without control may be “Pandorans” …
An excellent post and point Fred, i think to many people think they can just invest and leave it at that. People are naturally optomistic, so you need keep money aside for their rainy day.
Not sure I agree with your analogy that the investor is the parent. For me the entrepreneur is the parent, and the kid is the start-up. Indeed I’ve been using the analogy when I give talks or courses:”Do parents know about educating a baby? so why do we say to founders to gain experience first?”Do parents control everything it does, forever? so why founders are so paranoid about losing control?”Would they give/abandon responsability to teachers, doctors, “professionals”? so should not founders just hire the best people to increase chance of success?”And maybe because I am a bit traditional, I strongly believe single-parent families/companies are tougher for the kid so find a partner, never found a start-up alone.”A start-up is a baby which needs to grow and its founders should help it succeed (and yes your start-up baby is the most beautiful on earth… )Si I am not contributing here to the topic directly but I like your use of “parenting”. I agree with another comment, that the investor is more a friend, a godfather….
Friend and godfather don’t bring bread for the family…There are lots such arguments going on…Parent includes father and mother… who is the father and who is the mother. Then there is this biological-father and biological-mother, adopting parent etc.,etc.,There is still fight going ON on who is the actual mother of Windows OS (Xerox, apple, Microsoft,….Wuz) :-)Shall we settle with Founders + Funders = Parents?
Well I do not disagree with your point (Founders + Funders = Parents) though I usually consider the two-founder company as the best model/analogy, Brin-Page, Yang-Filo, though it does not always last long (Jobs/Wozniak, Bosack/Lerner). Which is why the investor is out of my own analogy. And we all know that sometimes mentors/godfathers are much more important than biological parents.
It feels like there will be a real opportunity for the venture funds that remain in existence to fund the best of the litter from this increase in birthrate and that venture returns should increase as the industry contracts.
I often see new angels become infatuated with start up clones solely designed to mimic a model proven popular by one of their predecessors. (As seen in geo-location and coupon sites.)This bandwagon mentality and these “me too” models that have no inspiration other than the hopes of being the remora to the shark are toxic to the health of our ecosystem.The longer this continues the greater the lack of biodiversity will exist in the start up realm due to perpetuating and encouraging this type of behavior from both the investors and “entrepreneurs” as well as the lack of resources being allocated to fresh ideas and risky endeavors.I’d like to add that this behavior is likely causing a generation of entrepreneurs that think safe not big and where’s the fun in that?
Fred, This is an excellent post as usual.My worry is that the historical statistics of start-up failure are not going to change. That high historic failure rate will only magnify the question of many kids to house and feed. As funds get smaller and the VC industry shrinks, the historic failure rate will only magnify to limited partners that VC has not been a good asset class since 2000. That will lead to even smaller funds. It’s a vicious cycle until the # of companies and # of exits is more normal (as you posted on last year)I ran some numbers in one of the large venture return/benchmark databases last week:For US internet/IT companies receiving initial investment from 2000-2010, 76% of all realized exits have been 1x or less. That’s up from 50% in the 1980s.More scary is that for US internet/IT companies receiving initial investment from 2000-2010, only 9% of realized exits have returned 3x+ to investors. That’s down from 27% in the 1980s and 29% in the 1990s.I’m still very hopeful that a new generation of dominant web companies are being funded now. That said, the odds of success are low. And probably going even lower given the birthrate issue.
The low cost of starting up a web business is the biggest factor, IMO. More so than readily available capital. Another factor is the ubiquity of useful APIs. The fact that I can build a web app and not have to worry about creating some of the more complicated pieces means that we’re launching for less money and in less time. Lower investment and faster time-to-market makes me (non-technical founder) very happy.For example, my company is building a web app that will land in a market with lots of established competitors. Because of APIs from Twilio, Viddler, and Chargify, we’ll be able to hit the market from a totally new angle and iterate quickly instead of having to manage the more difficult technical issues that those three companies are already handling.
If collectively, as a community of entrepreneurs and investors, we are not careful, the excitement of the flurry of starts and the ever reported flips can send us the wrong message. That flipping your company for a nice profit only quarters after you started is a common occurrence. But as a percentage of companies founded, it’s, of course, only a tiny fraction of the whole. I don’t know the statistics but I’d guess that the odds are inline with winning some small lottery.As entrepreneurs and investors we need to have a system where the capital is allocated through the system derivative from the reality of how long it actually takes to build most businesses into something of lasting value. If collectively our capital for innovation is spread among too many seeds that we then don’t have the nutrients to sustain until they are independent, we’ll have done ourselves a collective disservice.My worry went up when the other day after speaking with a young (a few years out of school) talented and smart internet marketing person. She was telling me how she was a few job offers she’d received. In evaluating one of the options she said “well, maybe they’ll just flip it to Facebook in a year”. I all too vividly remember the casual “we’ll flip it” culture of the first dot com bubble – though that was, of course, done on a scale far more massive than anything happening today. And with public (IPO) money. That is something we should endeavor to avoid repeating.My strong belief is that the reality is that 7+ year “overnight successes” are the norm for building lasting value (e.g. OpenTable). As a community we need to be excited not only by the start but also by the build. It’s not how many companies get started – it’s how many last the distance to create real sustaining innovation and economic activity.
All in all, I think a “back to the future” moment for VC is over-due – smaller funds, fewer firms, better operating experience and a thorough understanding of how to be a good investor and board member (sometimes mutually exclusive). Yes, this change is fundamentally different than the era of the last 20+ years, and it requires more from all the constituents – entrepreneurs, investors, and advisors. Too often the VC who is trying to “parent” lacks the skills or experience to guide and advise in a way that helps the business, and the “child” suffers as a result.I, for one, think the current shift is a good thing and will help re-calibrate what LPs and entrepreneurs have become frustrated by – too few VCs with the wisdom and perspective to raise healthy, self-sufficient, happy “children”.
This was the first article I’ve read on your blog, but it won’t be the last. Thanks for some very pragmatic, sound advice. As an entrepreneur getting ready to launch my first web start up, it is always helpful to hear the perspective of a VC veteran like yourself.