Hacks and Startups

Gabe Rivera used to say that Weekends on Techmeme were the time when "bitchmemes" came to the top - and this weekend its been Panic Bitchmemes galore, mainly aimed at those who dared suggest that the VC's penduluming from spend to save in 24 hours were a bit guilty of gate-bolting:

On TechCrunch:

The VCs are telling their portfolio companies to get ahead of the curve and conserve cash right now, and companies are starting to take their advice.

The criticism is coming from people who don’t understand that the world has changed in the last week and that companies need to change with it. And so they’re asking why VCs waited until now to tell everyone to conserve cash. Others are saying the boom is the VCs fault, and for them to lecture companies on conserving cash is ironic.

Actually, its the people who do understand very clearly that the world was changing who are asking the VC's what took them so long. But to be fair to Techcrunch, there's not a lot of scope for them to act differently. As TC notes:

They have one job: generate the best return they legally can from their investors’ money. In boom times deals get competitive and VCs make independent decisions on what deals to bid for....... Let me put it this way - if VCs ignored the economy and always invested super conservatively so that no one could accuse them of being irresponsible, they’d go out of business after their first fund failed to return capital to investors.

In other words, if they had behaved responsibly they would have been killed in the stampede from behind. Besides, even if you know What, its hard to predict When:

.....to argue that a company should always cut costs to the bare minimum is the same thing as asking that bear to act like it’s Winter in the Spring, just because someday Winter is definitely going to happen. All you end up with is a dead bear.

A bear market, mayhap? Onwards to Fred Wilson:

I've detected a bit of irritation, and even cynicism about the motives of Sequoia, Benchmark, Ron Conway, and others (including me perhaps) in the venture capital business who have been publicly and privately advising their portfolio companies and entrepreneurs everywhere to be cautious in light of the market meltdown and the potential for a long recession.

Interestingly, not all VC's think the above sentiments are on the side of the Angels - The very seasoned Alan Patricof:

Without challenging the comments, which expressed a heightened degree of doom and gloom for the economic prospects of young start-up companies particularly, I do think it calls for a somewhat more restrained response on the outlook and required action before throwing the baby out with the bath water.

Tsk. As Fred notes, this is a public service, not at all:

...some coordinated cynical attempt by VCs to talk down valuations or put entrepreneurs on the defensive.

Doesn't hurt though, as Mr Calacanis noted at FOWA last week - doing well by doing good

As I noted earlier, my take on this all is:

- The Internet isn't going away, its a global "once every 70 years or so" transformative trend

- Markets overcorrect - this panic is overdone, just as the hype was before it

- Reacting sooner rather than later is best.

- Bad times are good for starting new companies

That said, I think this was predictable awhile ago, and now is a bit late for VC's to be telling their charges its sh*t or bust, starting tomorrow. But they did exactly the same in 2000 so its not surprising. I'm with Louis Gray here:

It has only taken a few months of bad news on Wall Street to see some of the most visible proponents of Web 2.0 startups start to pick on them and demand significant changes. But the calls for a route to revenue and product quality should have been there when times were good, not just now.

Instead we got a whole heap of daft business models from dafter sounding companies, many of which got funded.....

'Nuff said for today.

It was very odd being at the Future of Web Apps initially - what was presented on stage had clearly mainly been written before the crashes of the last fortnight, so there was this sense of unreality as geeks talked about cool tech, entrepreneurs pimped dodgy free biz models and booth babes stretched tight T-shirts over well supported racks (not of the server variety).

But then on Day 2 Tim Bray of Sun stepped up to the breach and delivered the Sequoia Sermon ( hit bingo in about 10 minutes) and duly chastized the faithful - who loved the whipping they got (check out the Twitter Feed). And then the news came in of all the Web 2.0 companies taking the opportunity to hack heads without losing face (discussion after FOWA - can Google now afford to throttle down YouTube without losing face?)

Now readers of Broadstuff will know we've been sceptical more than once about the hype that has been heaped on a lot of the Webstuff in recent months, but this is penduluming the other way waaay too fast. But then thats what markets do, they overcorrect.

So, three thoughts here as counters:

1. Markets always overcorrect - it wasn't as good as the hype, it aint as bad as the hopelessness of the Sequoia scenario. What you are now seeing is the VC's et al doing the standard "its raining - we want our umbrella back" thing beloved of financiers everywhere, companies dumping people and stuff they couldn't previously without losing face, and the "citizen media" trying to linkbait with doom n gloom headlines rather than pump 'n pay ones.

2. The Internet is not going away - it is a structural transformation in society that reduces costs, and that sort usually wins. Especially in tough times. Web 2.0 will go the way of all phases in its development - I rather got the impression from FOWA that its got to the top of its S curve (of which more in my next post) but the growth of this whole next generation comms medium is only 10 years old in a 30+ year cycle.

3. They say its easier to start a company in a recession - that is cr*p, its far harder in my experience. But the companies that can succeed in a recession can succeed anywhere, and a lot of the dumb behaviour goes way. And at FOWA Jason Calacanis reiterated something that I've heard Nic Brisbourne says time and again to London startups - if you can get the traction (without giving away the farm of course), you will get the funding

This one is going to be worse than probably anything for a generation (especially as we have to pay up our children's college fees to keep those poor bankers in mansions and mistresses) but being employed in corporate life won't be any picnic either.

Om Malik gives some more details of the sage advice the Sequoia VC's are now giving to their clutch of funded companies - among the pearls of wisdom were such as:

Upin, who knows a thing or two about money and markets, told the room that we are in the beginning of a long cycle, what he called a “secular bear market.” This could be a 15-year problem, he said. This comment was accompanied by many slides that showed historical charts of previous recessions averaging 17-year cycles.

Given that this prediction could have been made anytime in the last 2 years, especially in the last few months after Marc Andreesen announced he was filling up his war chest for a Nuclear Winter, it is of course especially helpful now the horse has bolted. There are many other such insightful pearls of wisdom on the post, leading Techmeme's Gabe Rivera to remark that all this advice generation must be taxing the resources of the Sand Hill Mob, and:

Somebody should build a randomized downturn startup advice memo generator. Not all VCs have hours to kill writing these things themselves.

We agree, and humbly put forward our design for the Path 2 Profitability Present-O-Matic, using technology we developed originally for the Twitter Social Media Climber, to build these P2P presentations

It works, of course, by randomly generating numbers for columns 1, 2 and 3 and then printing the resulting 3 -word productivity pronouncement. Repeat for as many times as you see fit.



(Do I see a large number of Dotcom veterans wryly smiling at these Web 2.0 whippersnappers and sayin "yup, this is how it all goes...."? )

Sequoia Capital has called the end of the Good Times in bubbleventuring, as GigaOm notes:

The fund organized a meeting yesterday where it invited entreprenuers/CEOs from its portfolio companies. The attendees were greeted by a cute image of a Grave Stone, with a message: R.I.P.: Good Times, my sources tell me....

They want the companies to cut costs, to figure out way to survive and emerge at the other end of this downturn, which could last years. The speakers went through each functional area of the business and told the companies how to cut costs. By holding this special meeting, Sequoia is telling its companies to put survival strategies in place and figure out ways to outlast the broader market troubles.

Let me translate that for the FreeConomists out there, to those people who believe you can run business models with no visible means of making money - it means that they are not going to put any money into existing funded businesses that don't have a P2P strategy (yes, its time to resurrect that dotcom word - it means Path to Profitability). And they certainly won't fund any new businesses without one.

And when Sequoia panics, the thundering herd will stampede after, as Howard Lindzon notes... but he also has some sage advice:

I have been telling any of the CEO’s that will listen to me, to THINK about how we turn this panic into an opportunity. We all have weak investments and weak CEO’s, but a blast email on October 7th is absurd. Anyways, I am poor and they are rich, so that’s that. So while the rest of the world panics, you can panic too, or you can take a few steps back and remember how fortunate you are to be reading this blog, because if you are, you are ‘Too Small to Fail.’

Of course, this is what happened in Web 1.0 as well - after whipping companies to "grow grow grow" at all costs, the SV VC community suddenly turned round to all the dotcoms and told them to start breaking even as of yesterday. The pendulum swing from hype to hopeless in a very short time. Its very hard to turn around that fast when you have supply and delivery contracts you then have to get out of, people to fire etc, but far better take the pain early.

And put the FreeConomic kool aid packet away.....

Fred Wilson today:

There's a movement afoot by investors to back web services with a real business model instead of the pervasive "give it away for free and hope for the best" approach that's been in favor for the past four years. Don't count me in that camp, but the movement is happening with or without me.

Fred also points to useful comments by Roger Ehrenberg about his investment criteria, but with the same quibbles I have:

I have added a few criteria to my check-list:

- Initially sells to the enterprise for branding, credibility, awareness and early revenues
- Can get to revenues within 6 months, tops
- Is sold on the basis of ROI, e.g., helps generate revenues or reduce headcount/costs

Revenues in 6 months? In 15+ years experience, we've yet to see any form of Enterprise sale apart from stationary level stuff with less than a 6 (more usually 9) month gestation period. The only way to do this is to have a consulting or similar arm attached to generate early cashflow. Reminds me of the "path 2 profitability" edicts that VC's rolled onto their dotcoms in 2001, after 3 years of "spend for eyeballs".

Fred makes a point I would subscribe to, for consumer stuff:

It's much better, in my opinion, to go with the freemium model, give a version of the service away for free to all comers, get a lot of users, get good market feedback, then develop a premium version of the product/service for sale to enterprise customers.

Though I wonder how many will be prepared to wait for that premium model these days? I suspect it will become required early up.

Anyway, as you may know, we have been sceptical about Freeconomics for awhile - so when people like Fred start saying this, can one assume that the FreeConomic high-water mark has passed for now?

Good summary article by Charles Arthur in the Grauniad on what The Crunch means to the Technology sector. In a nutshell:

- Consumer stuff, especially expensive geek jewellery like Apple purvey, will suffer (hence the Apple stock price dive earlier this week)
- pay-by-the-drink (rental) rather than bought infrastructure will be more popular - more Cloud hype is a cert
- Open Source (free) stuff will be more popular, at the expense of (paid for) stuff. We expect to see growth in companies that can support OS systems as well
- Big tech companies with lots of cash in the bank will win most of the games, as cash becomes king again

We also hope that small niche consultancies (ie like us) do fairly well in tough times, as clients are less willing to use full time staff or high cost brand names.

Anyway, for startups, its not all doom & gloom though. Charles notes:

...it might - ironically enough - be slightly easier than before to get venture capital cash. That's because the people who have money need to find somewhere to invest it. Gold? Oil? US Treasury bonds? All are a rollercoaster right now. Finding a company with a really good idea and business plan - preferably not reliant only on advertising - looks, by contrast, like an excellent way to make money.

Having been through a few Tech recessions, and run a company through the last one,I'd say this is pretty sound advice. Especially the Advertising. The downwave world is all about productivity, efficiency and other cost reducing techniques.

The one thing I do think he missed is this:

- Sell to companies that have money, and / or in industries that are growing
- Make the stuff that customers say they want and will pay for, not what you think they want

Also, its a good thing to be on the "dis-aggregator" end of any disaggregation going on, in tough times people start to implement new, unproven stuff if it promises large cost savings whereas in easy times the tendency is to not fix wot ain't broke.

....they do it even in good markets.

Responding to a post on the top of Techmeme, where Jason Calacanis writes a long and winding article on Henry Blodget's (yes, that one) Silicon Alley Insider about company failure - the key hypothesis being:

It's my believe that the economic downturn will be much worse than it is today, and that 50-80% of the venture-backed startups currently operating will shut down or go on life-support (i.e. 3-4 folks working on them) within the next 18 months.

It kinda encapsulates the worst of Web 2.0 thinking for me, in that it is long on fluff and short on facts around the central hypothesis, which, while very plausible, is provably misleading with a bit of analysis. Not because there is no crisis, (nor that it won't have an impact) but because small companies fail in high proportions in any market - typically 2/3rds in the first 2-3 years* - so the 50-80% was a given anyway.

What is true however is that businesses being set up on FreeConomic principles (ie using other people's money) can only run as long as those others' pockets stay lined. So if they cannot mature into real business models (or sell themselves to Google etc) they will die. And there is a shortening of that runway in tighter times. (ie they will fail sooner). It is also true that there will probably be less money for me-too's now, as there is just less appetite for them.

The essay actually also has a lot of good sense at a tactical level, thus making it's central tenet very believable because much of the rest of it is good stuff for startup survival.

Because it is promoted by one of the Web 2.0 grandees (and don't get me wrong, Mr Calacanis is a very capable person, and is probably more skilled than lucky in my opinion - but even very smart people sometimes say daft things) it gets more uncritical acceptance than it otherwise would.

Except here of course

Update - the article has been pulled from SAI, sadly along with all the comments - c'mon guys, thats pretty poor form! And it wasn't that bad!

Update to the Update - its back on Jason Calacanis' blog - apart from the 50-80 stuff, the rest is tactical and rather more useful.

*I've never seen formal VC stats (wonder why ) but friends of mine in the industry used to tell me its 1/3rd die, 1/3rd live, (of which 1/10th make a decent return) and 1/3rd are "zombies" - living dead - that can stagger on for ages until either sold or put down. Hence the 2/3rd fail estimate

Imagine the scene down at the Hope & Anchor, watering hole for the entrepreneurial classes:

"Hey - we just got our follow on funding!"

Awesome, Congratutalions, Yays and w00ts in equal measures, drinks are bought, and the regulars settle down to hear the tale.... The CEO takes the floor:

"Yes, it was simple really - we just told all the VC's that there was no alternative, it was fund us or we all go bust, and that there would be total disaster if they didn't."

At that point a grizzled tech blogger coughs and says "But hold on - you guys spent your previous funding like there was no tomorrow, heck you made Boo.com look parsimonious, and you had already flamed out big time"

Scrape of chairs......but the CEO grins and says:

"Yeah, I know - but they said no worries, let bygones be bygones, its a new deal and we'll start afresh. Heck, they even valued our assets at the inflated book price we put in the year's year end accounts!"

In the corner, an M&A old soak says "OK, cut to the chase" - how much did they give you and how much of a stake will they take"?

The CEO positively crows:

They gave us the whole 7 yards, and they said they didn't want a stake at all - and in fact they'll guarantee our existing stocks and options at book once the money's in our trousers! And no guys on the board to oversee the spend either.

At this point there is an awed hush round the room, not a w00t is heard....it is impossible for anyone to imagine that dreamlike scenario - full funding with no stake, valued at inflated book prices, the execs allowed to keep their jobs, loot and made whole.

"Who are these VC's whose largesse knows no bounds", someone eventually asks.

"Oh, Capitol Capital", says the CEO "New outfit in the game. Head used to be a CEO, has a big backer in the background beating the bushes for bread - they ran rings round the LP's in the funding drive"

"And who are these dumb LP's and that who fund them?", someone asks, already clutching a biz plan to whiz round and get a snout at this magical trough.

"Oh that - they said don't worry, they'll sort it - they have a fund from a large lump of mom and pop investors and pension funds - and get this, they have to keep on paying into it! Said they'll tell em its for their own good, and they also said they'll get enough to sort out anyone here who needs some cash to bail out their dumber moves"

There were smiles all round as all the entrepreneurs started polishing off their business plans to get some of this wondrous largesse.

Update - I see Fred Wilson has written a similar, albeit more serious piece over here today

Interesting piece* in the New York Times today about AVC blog's Fred Wilson et al's Union Square Ventures being a new type of VC:

Mr. Burnham had spent his career investing in companies that made chips and routers, which differentiated themselves from competitors through groundbreaking technology.

Web services start-ups, on the other hand, use simple, off-the-shelf technologies and cost very little to get up and running. Their business advantage comes from their Web sites’ artistic design and ease of use, and their challenge is attracting and retaining users.

“That’s a different business than the historical bread and butter of the V.C. industry,” said Mr. Burnham. “So we had to change.”

This is something that has intrigued me - Web 2.0 companies tend to be an order of magnitude in cost less to set up than the "dotcoms", so handling investments in them with transaction costs (due diligence etc) at the same order of magnitude doesn't make sense. Union Square is doing sub $1m for sub 20% stakes (c 20%+ being the stake that gives a shareholder some rights in most countries' shareholding rules). This was Angel territory once, because Angels typically can add some real value to the day to day mix, and usually invest in what they understand, this keeping costs down. As the article says:

Because they join companies so early, they take a hands-on approach to building them and seeing them through the growing pains of start-ups. They have kept their team small, adding just one partner, Albert Wenger, and they must all agree before they make an investment, so no one can point fingers when they make mistakes.

In the UK at any rate, a number of the larger VC's have exited the startup market - some publicly like 3i, others in all but name. The interesting thing is whether this "Venture Angel" model is sustainable longer term, or if it is more just benefiting from being into the trend early (ie do VC's rush in where Angels fear to tread?). As the NYT notes:

Union Square’s investment strategy will continue to be tested. It is much harder to find promising Web start-ups now than three years ago. There are so many services and so much more capital financing them, and users have less time and attention for new offerings.

We hope it is sustainable, and is transferable to the UK, because in the UK the "Equity Gap" for small companies between the first £100k / $200k and the VC investment is a real issue, and all Her Majestys Government's attempts to bridge it with 50/50 grants etc have not really worked. Not sure about all that capital being around after recent weeks either. Whether there are still pickings in the 2.0 market is less clear though - again, quoting the NYT:

The partners said they planned to look at how Web services might transform sectors not yet touched in a big way, like education and the environment.

Ah yes...the Green wave, a well trodden path . I suspect to make money this way you need to be ahead of the main wave, not in its midst.

*In response to offline comments - yes, its a puff piece, but its interesting nonetheless. And yes, I am well aware that an early investment sets USV up well for follow on rounds. But it is still a play in the Equity Gap level, which in the UK anyway is rare.

The chart above shows the end of the Hubdub Prediction Market for Seedcamp 08 (or SCW08 in txtmode). (Seedcamp 08 being a UK based competition for funding for pan-European startups) The actual winners were (from the Grauniad):

uberVu: This team from Bucharest in Romania are launching in the next month; the service tracks conversation and comments from the web and aggregates them. But he's preparing to move over to London to be closer to the physical community here.

Codename Kyko: This is in stealth, so details are still under wraps. It's a gaming service... more details soon! The UK founder is just 21 and has had some hugely positive feedback during Seedcamp.

Basekit : Simple design kit for websites and applications. Great idea form this Welsh team - and they claim it could mean a site that might takes weeks of code would be put together in a few minutes.

Soup: The Viennese developers have created a multi-publishing system very much like Tumblr, but are concentrating on rolling out mutiple language version in markets outside the US where Tumblr is already established.

Mobclix: These are analytics to help iPhone application designers improve their products. A US firm.

Toksta: Messaging and video service for social networking.

Stupeflix: This French service creates video packages from photos, audio and video clips

Congrats winners, and good luck to all finalists - though after this week that huge reliance on Ad funding all the Seedcamp players seemed to be after is probably going to be a far bigger ask.

As to the usefulness of prediction markets - the results are that it predicted 1 of the 7 winners (Basekit) in its top 5, 2 of them in top 10. Not its finest hour, but I predict this is because there were just not enough "wise crowd" votes cast, more the passionate supporters.

Incidentally, I see on TCUK that Hubdub has won a deal with Reuters - did anyone predict that ? TCUK also covers the Seedcamp winners over here.