The Decline of Consumer Web Startups

A mere week after we noted the Silicon Valley sturm and drang about the decline of Consumer VC funding, following the popping of the Social Media bubble, there is now a sturm and drang around the impact of the cash drain on the booming "startup production industry" as we called it in 2008 (the seed funding competitions, newly minted angels, incubators, optimistic lecture circuitry etc etc), probably started by Y Combinator's discombobulation this weekend just past. Now there is much more handwringing in the blogosphere as it becomes clear the oxygen of cash is receding.

To say this is totally predictable is putting it mildly, heck, we predicted it months ago - but it seems that time after time greed trumps sense. Anyway, a good summary of the basic dynamics acting in the tech startup funding space is well put by Chris Dixon:

Startups sit in the middle of two markets: one between VCs and startups, and one between startups and customers. These markets are correlated but only partially. When the financing supply is low but customer demand is high, entrepreneurs that are able to finagle funding generally do well. When financing and startup supply is high, customers do well, some startups do well, and VCs generally don’t. And so on.

When VCs get too excited, people talk about a bubble. When VCs get too fearful, people talk about a crash. Historically, downturns were great times for startups that were able to raise money because competition was low but customer demand for new technology remained fairly steady. Downturns also tended to coincide with big platform shifts, which usually meant opportunities for entrepreneurs.

These markets shift independently between different stages and sectors, although there are connections. The amount of financing available is relatively constant, because of the longevity of VC funds and the way most VCs are compensated (management fees). Less financing in one sector or stage usually leads to more financing in others.

The stages are related because the early stages depend on the later stages for exits and financings. The result is a bullwhip effect where changes in later stages (the latest stage being public markets) lead to magnified changes in early stages.

What this means is well satirized by The Kernel, as it allows a lot of vested interests to invest in it:

when you flood a market with former user experience consultants and professional “strategists”, each of whom has their own uniquely dreadful idea for a technology start-up (normally something that failed in San Francisco half a decade ago), then throw money at them, proper developers suddenly become hot property.

...There’s no shortage of marketing, public relations and even business development enthusiasts angling for a slice of the Old Street pie. But the sort of hard skills necessary to build digital products aren’t that easy to come by.

That’s because they’re simply not taught widely enough in schools or in universities [Oxford for example admits 10x more historians, economists and philosophers every year than computer scientists - Ed]. Needless to say, governments tend not to invest in higher education and research and development, because it’s a thankless, multi-decade endeavour that obstinately refuses to concord with the electoral cycle.

Instead, governments tend to pootle around with easy wins they can point to in the run-up to polling day. Investment into early stage venture capital and sponsoring drinks parties for luvvies in Shoreditch is an easy, cheap and measurable way to make it look like you’re supporting enterprise.

This creates a wall of hype that suck(er)s in aspirant startup CEOs....

Now consider that glut of start-ups in east London, aided and abetted by that noisy, hyperactive, undoubtedly well-meaning but ultimately insignificant Government department anxious to locate simple, measurable metrics of success – like the number of companies founded, or people employed.

There are aspirational, wannabe entrepreneurs, who foolishly view a tech start-up as a route to easy riches, everywhere. They will always be happy to show up to a sponsored booze-up, to nab subsidised office space and to cling greedily to taxpayer-funded investment.

They represent little more than the middle-class branch of the welfare state, funding themselves and their marketing departments with money from daft angels, a dafter public or, yes, the public purse.

Indeed, when newly minted Angels are stampeding over the Fools and Friends in a rush to the startup pot, you know its time to run far, far way. Sadly for all the startups out there, the "startup production industry" is a lagging indicator of a bubble deflating, i.e. by the time their clay feet are showing the cash tide has long gone out.