Five Years Too Late

January 23, 2009

Bootstrap ‘n Flip?

Filed under: Uncategorized — fiveyearstoolate @ 2:13 pm
Eric Wiesen

Eric Wiesen

It’s not the same argument as “VC is dead”, which we’ve addressed a couple of times in this space, but another common theme emerging out of the discussion around startups and how to fund them successfully is the notion of a dramatically new model for funding companies. In a nutshell, this new perspective is that the decrease in fixed costs (servers, enterprise software required to develop and deploy web applications, etc…) and the increase in developer productivity has essentially made it so easy to build a compelling web application that raising institutional venture capital is simply no longer necessary. Further, those advocating this position argue that viral channels like Facebook and Twitter make building an audience so easy that sales and marketing (expensive human capital) are no longer necessary. Lastly, they assert that big companies don’t want startups to grow into standalone businesses who compete with them, so they will snap up these companies early, before they ever have to raise a lot of money (or, presumably, make any).

In the world hereby envisioned, a new class of angel investors emerge who routinely fund companies with under a million dollars and enjoy quick exits in the $5-25M range, which provides them with a terrific internal rate of return (IRR) that would never be available to institutional VCs, because firms can’t deploy such small chunks of a capital. Some will point to a few firms like First Round Capital as paragons of this new world, but are quick to conclude that the rest of us have no place in the land of quick flips to Google and Yahoo.

Now as “traditional” venture capitalists, you’d expect us to reject this thesis out of hand, but we’re not immune to the appeal of such easy exits, even on small base dollar amounts. The question I ask is – is this really happening? Is there an entire generation of ultra-agile startups, built on open-source software on a shoestring that are being acquired for the same price as the valuation of a Series A company?

Well, as far as I can tell, the answer is no. Not really. I’ve had this conversation (online and in person) quite a few times. And it’s usually fewer than five minutes in that someone brings up del.icio.us, the social bookmarking startup Joshua Schachter built and sold to Yahoo in 2005. Sometimes Dodgeball (acquired by Google in 2005 and recently shut down) is raised as well. Or Mybloglog (acquired by Yahoo in 2006). These are the companies whose history is typically put forward as evidence for this tectonic shift that will upend the entire startup ecosystem. But let’s look at these companies a bit and note a few things:

1. These are all B2C web companies.
2. The exits were all in 2005 and 2006.
3. They were all to Google and Yahoo.
4. None of them have really worked for their acquirers.

So there’s an open question in my mind of whether there was simply a mini-bubble where Google and Yahoo were buying startups as features in 2005 and 2006. But generally speaking, none of this has made money for the acquirers (who themselves are hurting now). So I look at companies being built now.

One of my favorite early-stage web companies is tumblr, founded by my friend David Karp (note, RRE is not an investor in tumblr). Tumblr is, in a lot of ways, the perfect archetype for this 21st-century web startup. It was founded by two smart guys (David and Marco Arment), was originally built as a side project, and was run for the first year or so with just the two founders. They raised a small seed round to get the product off the ground and get traction with users. Which they did.

So what happened next? What happened next is they decided to make a go at turning tumblr into a real, standalone business. They went back to their investors (two institutional VCs) and raised a $4.5M “traditional” round. This round will, as such rounds have often been in the past, be used to staff up, light up revenue and prove that there’s a business behind tumblr’s user engagement. Were there quick flip acquisition offers on the table? I don’t know (like I said, we’re not investors). So I’m going off of what I see – further fundraising, from institutions, and in an amount much greater than one million dollars.

When we meet interesting companies creating B2C products on the web, one of the first things we try to figure out is – are they really building something sustainable, or are they trying to build something viral and flip it to Google? Because while that looked like a pretty good strategy in 2005 and 2006, I think we’re seeing a whole lot less of that now and for the foreseeable future. We look for companies who can build something real, and to do that you need products, sales, marketing, management and the rest of the pieces that constitute a business.

Is it true that the cost of building software on the web has come down dramatically since the 1990s? Of course. And angel investors and firms specializing in seed rounds play a very important role in nurturing companies through this very early stage. And sure, there will be a few easy, small exits. But in our view this is still a business of building companies, and the evidence we’re seeing is that the ones that really work usually wind up looking to the venture capital community for funding to do all the things companies built for the long term have to do. The ones that flip to an acquirer after 18 months will have our congratulations, but those aren’t the ones we’re looking for.

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9 Comments »

  1. Very interesting take on the business of flipping.

    To further underscore your point about the decrease in fixed costs: with servers and software costs decreasing for everyone, it means the other components of the business become even more important. Since everyone has the same easy access to these commodities, the unique pieces of a business are much more important (smart people, effective marketing, etc). The unique components of a business are always where investment money is best spent, as that is the source of competitive advantages.

    Comment by Ryan — January 25, 2009 @ 4:04 pm

  2. A couple of comments:

    >> Web/software/etc entrepreneurs want to flip their company. Making a big, quick exit (ala Mybloglog, feedburner, delicous, etc etc) is the ultimate entrepreneurial fantasy. The entrepreneur who visits an investor and says they aren’t interested in flipping to Google for a bunch of mil is LYING.

    >> If you build a business to flip, even in bubble years, you’ll fail 99.9/100 times.

    >> Flipping is dead, long live the flip.

    Comment by rick — January 26, 2009 @ 1:11 am

  3. The notion (from those who believe the model is dead) that’s it’s easy to build a big viral following seems pretty silly to me. For every Facebook there are thousands of “-sters” out there that we’ve never heard of because they never got further than the second floor of the dorm. That said, I’d be curious to know whether the case is that you either have a social rocket or you don’t. If the business isn’t on fire after a year with Angel money, can it still be worked into the next Twitter?

    Comment by Jason — January 26, 2009 @ 10:02 am

  4. Very interesting and well put. Thanks.

    Comment by Nate Westheimer — January 26, 2009 @ 6:37 pm

  5. Eric – I believe it really is happening and accelerating. The majority of tech exits are under $30 million in valuation. Many aren’t even press released. I am working on a list on my blog at: http://www.angelblog.net/Exit_Strategies_Acquisitions_are_Usually_Under_30_million.html

    I have a book coming out in March titled “Early Exits – Exit Strategies for Entrepreneurs and Angel Investors (But Maybe Not Venture Capitalists) http://www.early-exits.com/

    Comment by Basil Peters — January 26, 2009 @ 11:57 pm

  6. I will always vote for building for sustainability because if you set out to launch a company with the ultimate goal of flipping within a short period of time, it will be that much more difficult to keep going when the flip doesn’t happen. In the last six months, those who intended for that to happen have likely had tough time meeting that goal (and are probably getting calls from shareholders they made crazy promises to!).

    Comment by Toffer Grant — January 27, 2009 @ 8:32 am

  7. Toffer – this is a popular arguement, but I don’t agree with your premise. The goal of every CEO in a company with external investors is a successful exit. If we agree on that, the only question is timing. Focussing on an optimum exit timeline does not mean building a less ‘sustainable’ company – in fact it’s the opposite. The most valuable companies have the best long term prospects. I do agree that it’s important to manage expectations, both inside and outside, on every important aspect of the company.

    Comment by Basil Peters — January 27, 2009 @ 10:31 am

  8. interesting argument against the capital efficiency of web 2.0 companies:
    http://www.centernetworks.com/web-2-revenue-models

    Comment by brett — February 3, 2009 @ 6:24 pm

  9. […] are challenging, especially today. The really tough part is how many of them there are. As previously mentioned, there was an explosion of B2C web companies a couple of years ago, along with an explosion of ad […]

    Pingback by Rolling 8 the Hard Way « Five Years Too late — February 12, 2009 @ 5:45 pm


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