The Coming Zombie Startup Apocalypse

Are we in a bubble?

And if so, when will it burst?

Everyone likes to debate it, and statistically, almost no one gets it right.  Not only is it notoriously difficult to time the market, but even if you did, you'd miss out on individual winners.  Sam Altman of YC recently pointed out that pulling back during the downturn in 2008 would result in several big misses:

In October of 2008, Sequoia Capital—arguably the best-ever in the business—gave the famous “RIP Good Times” presentation (I was there).  A few months later, we funded Airbnb. A few months after that, a company called UberCab got started.

Those companies would have not only returned any fund that invested in them, but would likely return an entire career's worth of investing over the course of several funds.  

Still, no one wants to be the one holding the back when things do pop--and they will, right?  Doesn't every good run have to come to an end?  Will this bubble also end in a blaze of glory with companies shutting down left and right in a massive startup apocalypse?

Probably not, since that's not exactly what happened the first time around.

Would you be surprised to know that almost half of the dot com companies founded when the boom started in 1996 were still around in 2004--four years after the peak of the NASDAQ?

A paper by two University of Maryland researchers who arrived at that number concluded the following:

"...Observed financial losses did not, in fact, equate with firm failure...tectonic changes in the
underlying entrepreneurial landscape were obscured by the financial bust. Against a
highly salient backdrop of destroyed market value, we interpret the high survival rate of
Dot Com firms to mean that many of the business ideas that flowered during the Dot
Com era were basically sound. In other words, good ideas were oversold as big ideas.
Most internet opportunities were of modest scale – often worth pursuing – but not usually
worth taking public. Because most internet business concepts were not capable of
productively employing tens of millions of dollars of venture capital does not mean they
were bad ideas."

Another way to look at it is to track how companies wound up leaving the NASDAQ Composite.

These companies were, even in the worst times, worth sometime to someone. 

So if you think what's going on today is a repeat of what happened 15 years ago, you may be right--but I think what you'd be right about is that "good ideas were oversold as big ideas".

There are lots of those around.  I have a feeling that a lot of these "on demand" companies aren't going to be as gamechanging as we think--and will come back down to earth with valuations that look more like temp agencies than the next big thing.  

So where does that leave us? 

I have no doubt that companies like Uber, Airbnb, Dropbox, Slack, Snapchat, Pinterest, Stripe, Square, etc are real businesses.  They're not going out of business, nor are 100's of other new companies created during this time.  They'll be around 10 years from now.

But at what valuation?  That is the real question.

It took the NASDAQ fifteen years to get back to it's March 2000 peak--and I think that it's possible we're looking ahead at the same kind of period, but one without the huge trough.  Why?  Because companies today have way more revenues than the companies that went public or had huge up rounds back then.  And, they aren't necessarily revenues from other dot coms.  They're consumer, SMB and enterprise revenues--maybe not enough to justify their valuation, but much much further from zero than companies in the past.  They're real businesses that would have had great outcomes if not for the go go growth round unicorn creation machine we've got going.

My own personal prediction is a long period of market stagnation at the top end.  At some point, the music stops, the greater fool theory fails to find a greater fool, and companies start a mad dash to break even.

Enter the Zombie Startup Apocalypse.  

What happens if you can't grow enough to sustain your multi-billion dollar valuation and there aren't any more growth funds or hedge funds willing to give you another up round?  That's when the heads start rolling.

Any one of these unicorns could be profitable right now.  All they would have to do is cut a few hundred people or two, and stop buying growth with venture dollars.  That would actually be pretty good for the talent market--it would bring salaries back down to normal.

Instead of paid acquisition fueling an up and to the right hockey stick, these companies would grow organically.  Retention, referral and growth hacking experts would be in high demand, asked to squeeze blood from a stone in order to grow a userbase without paid acquisition.  All of the sudden, Facebook ad pricing would become reasonable enough again for startups to start using it.  

With growth rates reduced, IPOs would be even tougher to come by--but companies would survive.  They might even find themselves operating more efficiently than they ever had been--newly focused on core metrics.  

Each month, they'd tick up just a little bit.  Tick.  Tick.  Tick.

Eventually, they might be worth what they're valued at now to the public market or to an acquirer, but not for a very long time.  Meanwhile, they'd just continue to go somewhat sideways and maybe a little bit up.  

Founding teams, bored of a decade of being tied to one company, would start to churn out.  

Seed and early investors might get bought out--perhaps by the growth funds that were fueling the valuation growth.  Why invest at top dollar in the last round, when you can offer liquidity to early investors at a huge discount to the last round?  It would still make for a huge return to the early investors.  The later stage guys would just have to wait longer for the company to grow into its valuation.

If you're a long term investor, you'll realize that the market for new technology continues to grow.  Innovation continues to disrupt older industries, create opportunities, and create new streams of revenue.  These sound fundamentals drive the venture capital market over the long term.

In the short term, the sector is susceptible to a lot of hype and valuation volatility.  Financial fortunes around hype cycles are made and lost, but the underlying idea that new technologies are worth investing in at reasonable valuations remains sound.  

No Comment

All of three of you seemed to notice that my new blog design is missing comments.  That's because it was rare that any more than three people ever commented on my blog in the first place.  

Don't get me wrong.  I wanted feedback.  I love feedback, but most of the feedback wasn't happening in the comments.  It was happening by e-mail and on Twitter.  So, I'd occasionally get a comment or two... and once in a blue moon I'd get like eight.  

In over a decade of blogging, I've never found a consistent writing schedule.  I write like I do now, finding twenty minutes here and there in between meetings, and then I rush off to something.  So, if I get comments, I can't seem to prioritize responding to them sooner than two days later.  

On Twitter, however, I'm very responsive.... so Twitter has always been a much better way to interact with me around my blog anyway.  It's probably where I get most of my traffic as well.  I still get a lot of e-mail subscribers as well, and they just hit reply.

So, I decided, in an effort to clean up all of the superfluous design elements from my blog, that I wasn't going to carry over my Disqus comments.  I never go back to them and they weren't much of a community.  I'm happy to engage around any aspect of my blog in public on Twitter or by e-mail, but I won't be doing it through a comments feature anymore.  It's a time and effort thing, and a quality bar.  

Also, you're welcome to disagree on your own blog.  :)

Why the New Seed Might Be a Bad Seed

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About a year ago, I started hearing about the existence of a "pre-seed" round.  At first, it sounded ridiculous.  Actually, it still sounds ridiculous to me.  The term "seed" implies the very beginning to me.  If you can't go to "seed" investors for your very first investment because you're too early, that just seems weird to me.  

At Brooklyn Bridge Ventures, I want to be part of the first money to go into a company, no matter what you call it.  I do the same kind of rounds today that I was doing five years ago.  Two of the first deals I ever did at my previous fund were part of an $800k round of investment into Backupify, which recently sold to Datto, and an $850k round into GroupMe, just after they built a prototype at a Hackathon. They're at a similar stage to my investments now out of Brooklyn Bridge backing Tinybop pre-launch, Canary before their Indiegogo pre-sale, and VIXXENN with just an alpha site and a few stylists.

What's interesting is that those earlier rounds wouldn't be called seed rounds today--and many of the investors in those rounds wouldn't have necessarily participated in them now.  Fund size has a lot to do with it.  The larger your fund, the larger the checks you need to write and so putting $200k to work at a time doesn't make economic sense for many investors.  So whereas seed rounds five years ago may have been less than a million dollars on a pre-money valuation of three or four million, today's seed is up and over a million and usually closer to two million, with post money valuations nearing $10 million.

Josh Kopelman wrote recently that these rounds are much more entrepreneur friendly, especially in the wake of the "Series A Crunch".  In fact, he wrote a few things that I think there's another way to look at.  

"The problem is that the number of A rounds hasn't changed. That amount of Series A capital HAS NOT increased. So, if you have 4x the number of companies with seed funding, that's 4x the players competing for the same money… making it 4x harder to raise an A round than it was five years ago."

Does it make sense to think of the amount of Series A capital as static?  

New venture funds get raised all the time--and big ones, too.  If there were suddenly a flood of fantastic deals at Series A valuations--the cheapest valuation a big fund is likely to ever get in on, wouldn't VCs be doing them left and right?  So what if they put their fund to work earlier than expected?  Or maybe they just take some of that reserve capital for follow ons and put it to work now?  So what that they can't maintain their 20%?  If their entry valuation is that much lower because more dollars are in the Series A, they will still be able to make their return.  Do you think you make a better return by putting in a ton of money to buy expensive growth equity and maintain 20% or by being in a future IPO at a $15mm pre?  

I think the problem isn't the lack of Series A money--it's that there are 4 times the number of seed funded startups, but not four times the number of great ideas and great teams.  If there are four times the number of seed funds, the seed quality bar is much much lower--but what investor wants to say that to entrepreneurs?  It's so much easier to blame those stingy Series A guys as to why your startup isn't getting funded.  It's not our fault as seed investors and definitely not your fault as the entrepreneur that you didn't execute will on your idea which, honestly, was pretty mediocre to begin with.  

I believe that if you build great companies, someone will fund them.  The private market is pretty efficient that way--and to look at it otherwise is to reinforce the notion that everyone trying to start something, instead of joining the teams with the best ideas is a good thing for the market.  

Yay, participation trophies!

"Why not raise $2.5M in seed money instead of $1.5M to give yourself the best shot at perfecting this data? You should target 18 to 24 months of runway post Series Seed."

Sounds good, right?  It's a very compelling notion--only I think it glosses over some of the side effects.  First, we're not going from $1.5mm to $2.5mm.  We're going from the $500k-750k of yesteryear (four or five years ago) to $2.5mm today.  That's a huge jump, not only in terms of how much a founder will attempt to bite off and chew, but also in price.  You're ending up at a post-money valuation of $10mm versus $5mm.  

Is it the Series A funds that are moving the bar, requiring these bigger rounds, or are they just saying that if you've already spent a few million bucks and the post is $10mm, you should have accomplished more?  The more you raise and the higher the price, the more expectations people will have of you--so taking more money isn't without its downside.

Also, no founder who ever raised more money believes the limitation will distract their focus.  They're going to do the same thing, but just give it 24 months to take hold.  What $2.5mm seed round has lasted a company 24 months lately?  It's like cash in your wallet.  You just wind up spending it faster--and moving fast with lots of money, especially for a first time founder, is bound to be more mistake-prone and less focused.

If you're worried about the runway, try doing less things.  Focus on the one number or one goal that validates your model, instead of hiring a team of 12 to boost 15 key metrics.  

The other thing that worries me about this split between seed and pre-seed is that it institutionalizes the thinking that "seed" funds shouldn't be making half million dollar bets on two awesome people and half a barely-working prototype and that that mess is best left to the "pre-seed" folks.  We're all worried about the people who had a million or more to spend and didn't do anything amazing with it, but what about the bootstrappers and do a lot with a little types who haven't yet gotten any funding from anyone?  If you're too busy making sure everyone who gets funded at all has two million bucks at an $8 pre, are you missing out on the next big thing?

I think we are.  I don't think early stage investors are taking enough risk.  We need more crazy flyers where someone takes a shot on something unproven, and certainly gets paid for that with a low initial valuation, but rolls up their sleeves to help make it take off.

Otherwise, we should just call this new $2.5mm seed round what it really is: Series A circa 2006.  We'll ask for all the same metrics we used to in a Series A--some revenue, a full team, etc., and at least it will all make sense.  Then, I can go back to just being a Seed investor instead of figuring out whether it makes more sense to call it "Pre-Seed" or just "Soil".  

 

The Gift of the Ask

It's very easy to think of an ask as a negative--of a burden on someone.  

When it comes to startups, however, especially when you've built up a great reputation and done a lot of good work for others, people are not only eager to help you, but they take great pride in being asked.  Working with you is an opportunity.  Getting a chance to take a leap with you is an opportunity.  Earning equity in your endeavor, or having the opportunity to buy some of it on the ground floor, is an opportunity.  It's a gift and you have to start thinking of it as one.

So, not only does that mean not being afraid to ask, but it also means realizing that if you don't ask, people can feel left behind.  We join the startup world because we want to work with the best people.  We want to work with innovators and those on the services side of the business--the lawyers, recruiters, and even investors, because I do think investors should be servers, want to be that first call. 

When I raised my first fund, I send out a note to a bunch of people whoes input and experience I valued--people I would have been thrilled to work with.  I didn't know if they were fund investors or not and I didn't want to put them in an awkward position by making a direct ask--so I just bcc'd them all.  I said, "I assume you're not fund investors... but if you are and you want to be involved, I'd love to work with you.  The last thing I want is anyone who I admire wondering whether I didn't value them enough to make the ask."

I'll be doing that again for my upcoming second fund as well.  I don't expect many to respond, but if I truly think of my fund as an opportunity, it's important for me to know that I would have wanted to work with them.

Some thoughts on #Meerkat

Downloaded Meerkat yet?

It's the new new thing.

The app is five days old and getting in with all the right names in the Valley.  (The company has been around for a few years, but this is a new product for them.)

It's so new, we don't even know if people are using it a second time, yet already it's been in the Wall Street Journal.  (PS...   Yuliya is really becoming an asset to the WSJ's tech coversage.  Future star to watch.)

In 2007, I was at the SXSW where Twitter blew up. That's how I was able to get into the Hatching Twitter book, where, for some reason, Nick Bilton refers to me as short. I'm 5'11'', thank you. How tall is Nick, anyway?

In 2010, Foursquare hit it big in Austin not long after their funding, which I accidently kicked off with a blog post. If only I could have pulled that off with my own startup. [sad trombone]

In 2011, GroupMe seemed to be the winner. I had funded it out of a hackathon earlier that year.

So after being around all these apps, eight consecutive years of going down to Austin, speaking three times, judging a thing, hosting the first SXSW wiffle ball tourney, I'm feeling pretty darn qualified to weigh in on the ultimate future of a five day old app.  I've even used it a couple of times!

If you can't tell, I'm being sarcastic...

You know the only answer VC's should feel qualified to give on this one?

¯\_(ツ)_/¯

Here, however, are a few early thoughts:

1) It's obviously the best live streaming mobile app we've ever seen. It's stupidly easy and the quality is way better than technology could ever get Qik to be back in the day.

2) Yes, it is definitely going to be a huge thing at SXSW. Yes, those of us not at SXSW (which I won't be this year... that's another story... just too big), will find it completely insufferable. You think we didn't want to see the Tweets and Instagrams of the parties... just wait to see how much we'll hate the drunk livestream of the parties.

3) Yes, it will get funded with a lot of money, very soon. I might even say that the Meerkat funding is peak VC for this cycle... b/c there's a chance that their next round is so big and so ridiculous that all the VCs just put the wire transfers down and step away for a bit. (How big? I'm thinking $25mm seed for 10% of the company... If only I was kidding.)

4) I keep thinking that it's going to get very popular among a 30's and 40's crowd of people that don't quite get that this kind of production and consumption kind of already happens on Snapchat. Snapchat may not be "live" but neither really is Meerkat. There's a few second delay... so what's the real difference between a few seconds and the minute or two if you get the Snapchat notification of a story being posted. Is it the interaction? Well, I don't think the comment interaction is that compelling. If you've ever sat in on a livestream (ustream, istream, weallstream...) and watched someone answer the comments, it's about as exciting as watching someone peel the skin off their feet.

5) Meerkat's UX is all about getting popular. The focus is on getting an audience. We've seen all that play out before in several mediums... and it just didn't drive quality. In social, most people don't want to popular, they just want to connect with their friends. It's too much pressure, and most of us just aren't popular or interesting--so it becomes a less than interesting experience for most of the users. If that's the case, then it becomes a broadcast channel, but one where each broadcast must be watched right away. That's pretty much the opposite of where TV is going. We don't want to have to watch things right away. That's a simple feature fix... let the streams last for even a couple of minutes. It's just as relevant... and it will bring more people to the water cooler. Otherwise, it's Youtube where you've got to watch the video as soon as it gets posted otherwise it disappears. I don't see that gaining mass adoption.

6) This one will be a struggle to monetize. Who's going to want to watch a branded Meerkat--and that's where the big dollars are, in ads. Brands work better in places where agencies can produce great content. Agencies aren't going to be able to produce great livestreams quick enough or fast enough to make the ROI worth it. Instagram is a lot better brand medium. If it's all about premium ones, that's fine, but that's not a multi billion dollar revenue stream.

7) If you thought that the bandwidth issue was soon going to be solved, think again. Austin infrastructure is going to bust open at the seams at SXSW. Meerkat is going to create all sorts of issues, especially for venues. First, if it wasn't clear before, free wifi has become table stakes. You just need it, like air conditioning, because the guy down the street has it. As quickly as they invent 4G, 5G, some hacker is going to create a mobile thing that sucks up a ton of bandwidth again. This creates the need for friendly network management. Venues won't want Meerkat broadcasting the Fall Out Boy concert via their wifi--or will they? Some will, some won't. Some might let you do it in exchange for something else (A premium purchase? Tweeting out the venue? A check in?). This is why people are starting to talk to companies like SocialSignIn--because they know wifi can be used for good and not evil (i.e. just a big cost sinkhole), but they don't exactly know how. When everyone is Meerkatting, how can brands and venues leverage access to more bandwidth, a key component of livestreaming, to their advantage?

8) All this being said, I am finding the notifications pretty addictive.  I do want to see what people are up to... and some people are pretty cool, funny, etc.  If it gets critical mass, watching a series of streams live from news events could be amazing.  Clearly stream discovery will be key, but this could very much be the dream of see anywhere in the world, right now.... which a lot of people have been thinking about but no one has made easy. 

And that's everything I know and think about Meerkat five days into the life of the service.

I reserve the right to be completely and unequivocally wrong about this whole thing, which, as a VC I tend to be about 50% of the time.