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Burn Baby Burn (avc.com)
224 points by jrwit on Sept 16, 2014 | hide | past | web | favorite | 114 comments



There is something missing in the startup mind-cluster, I think.

A lot of the ideas make sense from a certain perspective, even these incredible valuations and exits. There really is a chance to create or invest in the next Facebook. It's not a big chance, but the payoff is so big that it can fuel funding and building thousands of attempts.

One of the premises of this complexes is the idea that highly impactful businesses can be started fast and cheap leveraging the internet as a marketing and distribution channel, open source software, cheap computing power and other levers of these times. If they focus on building popular useful things, the scale can get so big that monetization is likely enough to come. That is, likely enough for the investors formulas.

But, what of businesses that become popular and useful and financially successful relative to the financial needs of running the business? Reddit. OKCupid. The proverbial Craigslist.

What if a business can employ 100 people comfortably, serve 100,000s of customers usefully and reward the founders to the tune of millions, but not billions. Can these exist? Can they last for decades? Generations?

Is it efficient to roll the dice on a hundred $10m per year businesses for the chance at one $10bn business. On paper it's a 10X improvement?

I'm not trying to ad my voice to the sour grapes tasting comments about valuations and such. I'm just wondering if we can let a million flowers bloom for a longer stretch, not just for their ability to win the big-or- go-home game.

I think I might be saying this backwards. Let me try it another way. A lot of the current startup thinking is premised on the idea that small teams can have a big impact relative to the cash requirements. A second idea is that a startup making a big impact has a decent chance of turning into a multi billion dollar company or a $100m+ acquisition for a multi billion dollar company. Is there no room to build on the first premise without later building on the second premise? Could Facebook have connected people as well as a 500 person company?

This is a tangent to Fred Wilson's point, but I feel like it might boil down to a similar enquiry.


Sad to see this downvoted.

You're homing in on the heart of the matter: VC goals are not at all aligned with entrepreneur goals. A good investment is not necessarily a good business because the VC does not get his/her return from just one business but from the outliers in a series of businesses.

So if they don't encourage everybody to swing for the fences then they are hurting their own prospects, after all if 2 in 200 investments will be 1000 to 1 returns then the other ones statistically don't matter at all, no matter how irrational that sounds.


So true. Many first-time founders do not understand the implications of this.

If you take money from Sequoia, and after years of hard work, you get an offer for an acquisition for $100M, which will make you, the founder, $10M in your pocket, set for life... would you take it, or would you rather risk it all, for a 10% chance to get to a $1B acquisition? I know that when I ask young founders, they'll casually say they'll go for the $1B. I strongly suggest you think slow and hard about this. Because some VCs will not give you a choice, and a 90% chance of making nothing from years of hard work is not fun.


That's why it's humorous to see the same people criticizing founder/employee cashouts.


I don't think it's quite as grim as that. A founder that has taken a business to $100M with a credible chance at another 10X growth period is now CEO of a substantial company. Companies of that size rarely just blow up with all equity becoming worthless. Salaries, bonuses or even equity sale can put some lump some in the founder's pockets.

It certainly can turn out better to take the early money, but it's not necessarily risking it all.


Yep, agree. I think more people faced with this question should see it posed as "90% chance of no return". (Cognitive irrationalities about asymmetric loss aversion and all that.)


Venture capital is supposed to be mechanism for funding at the highest levels of risk and reward. But somehow we've decided that it's the only model for Internet companies. So a lot of companies and individuals with perfectly workable small or medium-size ideas end up inflating them to VC size to get funding, and then fizzling out. A sad side effect is that it discredits the ideas.

We have a grandiosity problem in Silicon Valley. The problem isn't really VC, but the lack of alternatives along the other parts of the risk/reward curve.


It's not just a problem in Silicon Valley.

I recently ran a survey of my local startup community in Western NY and 47% of the software startups in the sample said that they intend to pursue venture capital financing in the next two years (with angel funding a distant second). It's likely that 99% of these startups are in for a rude awakening...

Unfortunately, many of these startups blame it on our local funding environment (or lack thereof), which pales in comparison to SV. I blame it in-part on the startup media over-hyping the role of VC in financing an internet company. Many of these startups could turn into profitable small or medium-size businesses, yet they've been brainwashed into thinking VC is the only way to go.

It's sad because they could boost our local economy if they chose to spend their time pursuing a more reasonable financing path that is better aligned with their business model and resources instead of wasting their time pursuing VC.


I agree.

Perhaps VC, or even the whole funding side of the startup world is unsuitable an approach which does not occasionally produce Goole-sized companies. Maybe different investors can take advantage of different areas on the risk/reward curve.

In any case, the current wave proliferation of startups is premised on the idea that relatively little cash is needed to get a beachhead. I think it's also true that there are viable ideas that would generate millions or tens of millions per year, but not billions.

I like OKCupid as an example. They actually came out with a blog entry that outlined what they saw as the problem with paid dating sites (a big industry), that their free site works better. It made sense. Free sites have more users, so more people to meet in your area. They don't need dishonest pay-to-reply gimmicks. A bunch of reasons. OKCupid is a popular service with a lot of users. Even if they are generating far less per user than paid subscription sites, they are still able to generate some cash.

If generating less cash by being free results in a better service, the free service should win. If they can make enough to be profitable, pay employees well and keep the service going that's great. Then they sold the company (and pulled that blog post). The site exists, but it's stagnated a little. It seems like a good case study, because there seems to be pressure that builds up for such a service. They're popular enough that people on the street around the world know the name, but not making the kind of dose that interests big money. It seems like there is a pressure for these companies to stop existing. They are pressured to risk massive revenue growth, sell, whatever. The bottom line is that it seems hard for something like this to remain like this. There's a belligerent invisible hand nudging them off the game board.

It's a pity. A dating site isn't saving the world but for people who meet up (or hook up) on the site, it's a good thing.

We would be better off if companies like this could continue in this state. Why can't a business that size continue to exist?

At the end of the day, the investing strategies and internal logic of VCs or angels should not be the sole determining factor for what businesses can exist, should it?


Doesn't fit what I knew: that most startups are Angel funded. Or did the pendulum swing, and we're back to VC funding?


I see a lot of startups taking angel funding with the expectation that they will then take on VC funding. This pattern has gotten so institutionalized that some people even refer to angel investment as a "round" in an of itself.

I think GP's point is that for most other businesses VCs are never in the picture whatsoever, neither at the beginning stage nor later.


I don't see a practical difference between the two in our industry. They're part of the same pipeline.


There are substantial differences between angel investors and VCs from a practical point of view, even if both will get you access to capital:

- Angels rarely do due diligence, VCs almost always do.

- Angels tend to look much more at who else is investing in the company, almost never want to be 'alone' or 'first'.

- Also they are typically much less experienced as investors and having them on-board can be a pain, especially when you're doing a start-up outside of their field of expertise

- VCs investment tends to come with some visibility perks

- it is usually easier to get investment from a group of angel investors than it is to get investment from a VC


You are certainly right. But that's a kind of insider explanation from within our world.

If you're explaining the economics of computerland in broad strokes, there's no significant distinction to make between angel investment and VC. The two groups intermingle, they fund the same projects (with the same expectations of risk and growth), and they even move in the same social circles.


> But that's a kind of insider explanation from within our world.

Good point, I will have to work harder on divorcing myself from that. It's hard though. For the purpose of founders that are relatively in-experienced the two groups appear similar enough that there is little to no outward difference. That viewpoint is worth correcting.


Why is it worth correcting? That viewpoint is correct.


All of the angel dynamics you're talking about here are premised on a trajectory that takes angel-funded companies through VC rounds. If there wasn't a presumption that N out of K portfolio companies would get an A round, angels wouldn't invest this way.


For the most part yes, but it's not an iron-clad law, I've seen angel funded companies do much larger angel rounds later on bypassing the VCs completely up to an exit.

But that's definitely exceptional.


My company is angel-funded, no plan on turning to VCs.


Sure. But you don't think that the terms you got for your company benefited from the broader angel market's expectations about how most companies will achieve liquidity (almost all of them through VC)?


> I think I might be saying this backwards. Let me try it another way. A lot of the current startup thinking is premised on the idea that small teams can have a big impact relative to the cash requirements. A second idea is that a startup making a big impact has a decent chance of turning into a multi billion dollar company or a $100m+ acquisition for a multi billion dollar company. Is there no room to build on the first premise without later building on the second premise? Could Facebook have connected people as well as a 500 person company?

If it were making less money then that's supposed to mean it was providing less value (or rather, the converse of this is supposed to be true). A $10bn business is worth 10x as much as a hundred $10m businesses, by definition - and the monetary valuation is supposed to reflect the human valuation. Corollary: if you stop working on your $10m business and instead take a 1% shot at a $10bn business, that's being more productive. And that's the game that VCs are in.

The last company I worked for, and another before that, were startups that got to the $100m stage and then sold to private equity (with a merger in the mix), to become mature, profitable, "boring" but useful businesses. It does happen (admittedly this is London rather than the Valley), it's just less newsworthy.

VC isn't the way to do it - that's not their business model - but in my (limited) experience they're happy to sell to the kind of entity that's in that business (private equity), and pocket the modest profit, if that's the way the business goes. As a founder you'll have to make the case for it, but it can be done.


>>the monetary valuation is supposed to reflect the human valuation

I think this is a misunderstood or over-extrapolated assumption from liberal economics. Especially with the economics of free or very cheap services, I think revenue can be far more disconnected from total "utility" of a business. Massive online services generate a lot of uncultured utility and it's not unreasonable (within the liberal economic paradigm) to speculate that a move which captures more utility as revenue could generate less total utility, especially when you bring high risk/reward financial modeling into valuation.

There are a lot of companies like you describe in the b2b generas. But services for consumers, especially those which are essentially communication services, seem to come up against this sell or grow pressure. I think twitter, Facebook, and many other services which sold at an earlier stage might have better served their "mission" as company's an order of magnitude smaller.

Think of the impact wikipedia (a nonprofit, but I think it's relevant) has had. How could that value possibly be represented by revenue or valuation. Twitter is now under tremendous pressure to create a hyper-profitable advertising business to rival Facebook & Google.

Twitter is now 4,000 employees and almost $2bn annual budget (growing at X 2.6 p/a) under pressure to turn twitter into a revenue machine within 12 months. They are employing armies of bizdev, ad sales and support to try and meet this goals. Does that kind of Twitter stand a better chance at value creation than an 800 employee Twitter with a $400k budget would have had?


I think if Wikipedia were ever put up for sale the industry would give it a valuation appropriate to its impact.

In my book Twitter was never creating value and that's part of why they've never been profitable; I've been bearish on Twitter from day 1. But maybe I'm just being old and grouchy.


Wow - I posted what I thought was a thoughtful comment on Fred's blog, disagreeing with his throw-away intro on paid content - and it seems to have disappeared?

My point was, why should we reward Business Insider for ripping off content, instead of rewarding WSJ?

Why not reward originators of content, instead of recyclers? Clearly, he liked the interview enough to link to it - why should BI get a benefit instead of WSJ? He seems to think that it is "inevitable" that digital content will get ripped off, but perhaps that's only true if they (a) don't innovate on payment models, (b) don't innovate on fair use rules.

One of the digital currency companies in USV's portfolio could surely work out a micropayments deal with WSJ to allow people to pay-per-use for content, instead of subscribe.

So - that was the gist of what I had to say. Insightful, maybe not.

But now I'll add to it - I much prefer the YC approach, where my comments are free to sit there, and get ranked accordingly.


> But now I'll add to it - I much prefer the YC approach, where my comments are free to sit there, and get ranked accordingly.

Sure, assuming you haven't been shadowbanned for some arbitrary reason years ago, in which case your comments are free to sit there invisible to most without you knowing.


There is something supremely funny about VCs complaining that their start-ups behave like funded start-ups and not like bootstrappers, who focus on revenues and profits right from day 1.

"At some point you have to build a real business, generate real profits, sustain the company without the largess of investor’s capital, and start producing value the old fashioned way. "

Exactly. So how annoying it is when you're bootstrapping a company, you have your price-points carefully set, you're doing a cracker job at concentrating on 'how to sustain the company without investors capital' and then boom. Out of the blue some never-heard-of before company that does the same thing you do starts to hit your customers with a price point that you simply can not beat because they are able to 'burn baby burn' or maybe even give away that identical product for free because they're racing for an acquisition before the money runs out.

That's real trouble. Sometimes it's not just one.

But there is good news: they usually don't survive in the longer term because they don't have a business model. Once it's free you can't really go back to 'old-fashioned'.

So once they've folded up, you've bought their Aeron chairs at 5 cents on the dollar and you're re-connecting with your old customers and picking up the pieces you have a fairly clear field. Contaminated by an over-promising under-performing competitor that thought that 'growth' is equal to 'health'. (If that were true then cancer or a locust plague would be good news.) How you're going to survive the interregnum of unfair VC funded competition is a really hard question for which I have no other advice than to cut every bit of spending and go into 'cockroach' or 'spore' mode, hang on to your core team at any price.

VCs should be far far more critical about the companies that they invest in, that the path to break even is clear and that they are not going to invest in a company whose business model is broken but where the cracks are paved over with marketing and growth by burning investors money.

That just spoils the soup for everybody and sometimes it kills entire segments.

Especially companies where investment is made in B, C or even later rounds should be looked at very carefully. A healthy company would survive and grow even without VC investment, it's supposed to be an accelerator, not life support.

So burn, but burn with care and a very good plan. Concentrate on your bottom line taking into account that VC capital will not last forever and make sure that the transition from 'supported' to 'unsupported' is a smooth one and that your business model does not somehow depend on the 'supported' bit in a hidden way.

If you're partying like it's 1999 you're definitely doing it wrong and your bubble will almost certainly pop, the more VC money there is the more of it will be dumb.


You read my mind! I've heard parents complain that their toddlers are getting too fat on sugary snacks, complaining about how much sugar is being put in snacks these days. Never once recognizing that they, the parents, were picking out the snacks, not their toddler.

VCs have a similar issue, which is that there are more LPs and other investors who didn't live through 2000 and are more 'growth' rather than 'business' focused. They are giving their money to people showing 'growth' then that is the metric that folks start optimizing. If VCs will only fund companies which are headed toward 'cash flow positive' then that is the metric that gets optimized. You can see this dynamic in action at YC demo day as the YC tunes what it is they want to see in the companies, what ever that is, it shows up in a lot of slide ware :-).

So I think Fred is grumbling that there is a lot of "less smart" money out there and he has to either sit out while it flushes down the toilet or compete with it in the companies where he wants in. And that cuts into margins and it cuts into discipline because people who think the next round of funding is 'in the bag' have much less concern with how they spend this round. It doesn't help that even the "smart" money has no where to go that will provide significant returns [1]. So that doesn't help either. The good news is that these things reset themselves, the bad news is that it always seems to catch some folks completely by surprise.

[1] The period of low interest rates has gone on so long it has now started flushing out 20 year t-bills and other multi-decade "safe" investments. This is probably a much bigger story than the WSJ and others have yet picked up. There is a lot of dynastic wealth getting crimped.


Not just dynastic wealth: it's crushing retired seniors (and there's a lot more of them).

My parents didn't inherit much, but made a lot of money in e.g. the '80s, and at least back then put a lot of that into Treasuries. They're now around 80 years old; I don't know the specifics of their asset allocation, aside from my father having some stock market holdings, but in general they're getting very little in the way of return.


Have US Treasuries ever paid more than inflation? Isn't that relationship basically stable -- meaning, when we had higher interest rates, we had higher inflation as well.


Historically yes, if you take into account that they are tax free their net return has been positive. Between changes in definitions of the CPI and the QE{n} programs however they have gone negative over the last 5 years. I expect that story to "hit" right around the time when the presidential race gets going in earnest, so later next year.


You seem to be confused:

1. US Treasury bills and bonds are not exempt from Federal taxation.

2. In your original comment, you referred to "20 year t-bills." There is no such thing. The longest dated Treasury bill is 52 weeks; they are most frequently issued with maturities of a year or less. You are confusing Treasury bills and Treasury bonds, which are not the same thing.

3. T-bills are short-term investments purchased for the security they offer; nobody buys them to beat inflation. Historically, they have never provided a real return significantly above that of inflation[1].

4. That the yields of 10 year Treasury bonds are not keeping up with inflation is not a news story. It's been talked about widely for years[2].

[1] http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/...

[2] http://www.bloomberg.com/news/2012-12-14/treasury-yields-bel...


You are correct, took me a bit to look it up by my tax exempt bond holdings are municipals not treasury bonds (well except for some series EE but that hardly counts).


I understood you to mean that seniors don't pay taxes on it, which in my parents and in-laws case is true (since they don't go over income thresholds to pay income tax). For seniors that are most affected by this (the ones with lower incomes), they probably don't pay tax.


The CPI definitions change to reflect consumption habits. In any case, CPI definition changes don't affect your perceived inflation or effective return -- it's just trying to measure what you might be feeling.

CPI affects Social Security payouts, that's a different thing than investment returns (but obviously does affect the well-being of seniors). CPI probably does understate perceived inflation for seniors. There is an index specifically for seniors (CPI-E) that has more healthcare in the basket of goods, and it's higher.


> It doesn't help that even the "smart" money has no where to go that will provide significant returns [1].

This is an inaccurate understanding of what is taking place.

It's not that there are no asset classes capable of delivering "significant" returns today; heck, the S&P 500 has nearly doubled in the past four years. It's that to get returns, investors have been forced to pay significant premiums and take on greater risk.

That said, the money that is pouring into startups (through venture funds, super angel funds and individual angels) is not money that was previously being invested in Treasuries. The startup bubble is being fueled by the public equities bubble, which is a rising tide that has lifted a lot of boats.


It's a cascade, isn't it? Money that used to go into Treasuries has shifted into money-market funds, money from those has shifted into equities and bonds, money from those has shifted into riskier equities and bonds and so on.


> which is a rising tide that has lifted a lot of boats.

More of an inflating bubble that has lifted a lot of boats...


> and he has to either sit out while it flushes down the toilet or compete with it in the companies where he wants in.

One of the dynamics that happened in the wake of the 2000 crash: There was quite a bit of back and forth between the VCs and the limiteds when everyone went into turtle mode. The result was that many VCs ended up reducing the size of the funds, which is in effect a pay cut since they take an annual percentage of funds under management.

It's really hard to justify 2% fees when you're only sitting on the money because that's the best investment at the time.


Whole asset classes are no longer viable investments, that's a serious problem. Especially with inflation now > interest.


>Whole asset classes are no longer viable

For example? Spreads between asset returns might be compressed, but I have a hard time coming up with assets that are no longer viable.

Nobody is entitled to "set it and forget it" returns. Loanable funds operate on the principles of supply and demand like anything else. When money is abundant - as it becomes when the Fed is easing - the risk premium shrinks. You don't get rewarded for money under the mattress or lent to the government. Instead, investors are incentivized to grease the wheels of capitalism by risking that money. That's our system.


> VCs should be far far more critical about the companies that they invest in, that the path to break even is clear

Or should they? My impression is that many VCs are seeing bigger gains in shooting for $100mm+ acquisitions by Google/Facebook/Apple/Microsoft and cutting their losses on startups that don't make it, rather than trying to build sustainable businesses.

Hence, our very own pg's "Startup = Growth" essay: http://www.paulgraham.com/growth.html

Hence, the rumors that some VCs actively discourage startups from making any revenue at all (let alone profits), since those could act as anchors that drag down the acquisition valuation.


I was about to write a comment similar to yours, but after re-reading http://paulgraham.com/swan.html I'm less convinced. In particular:

There's no correlation between the percentage of startups that raise money and the metric that does matter financially, whether that batch of startups contains a big winner or not.

Except an inverse one. That's the scary thing: fundraising is not merely a useless metric, but positively misleading.

[...]

We can afford to take at least 10x as much risk as Demo Day investors. And since risk is usually proportionate to reward, if you can afford to take more risk you should. What would it mean to take 10x more risk than Demo Day investors? We'd have to be willing to fund 10x more startups than they would. Which means that even if we're generous to ourselves and assume that YC can on average triple a startup's expected value, we'd be taking the right amount of risk if only 30% of the startups were able to raise significant funding after Demo Day.

In this model, the VC's willingness to make risky investments becomes a kind of "thermometer" for whether an opportunity exists for an investor to win big. In fact, pg seems to be saying, "If VCs are investing in all of the startups, then that probably means there aren't any big winners seeking investment."

If that's true, and if VCs are investing in every startup, then it's likely that all of those VCs are going to lose. Whereas if VCs are only investing in 30% of the startups, then it's more likely that a selective investor can win big by investing in one of the 70% of risky companies that other investors aren't willing to go near.


> Hence, the rumors that some VCs actively discourage startups from making any revenue at all (let alone profits), since those could act as anchors that drag down the acquisition valuation.

That's totally bonkers. But it's also 'rumors', do you have concrete examples?


I was told this. The idea is you can make up any numbers regarding future revenues and it is hard to dispute when you haven't implemented any serious conversions, but as soon as you show what your true conversion rate is, it becomes possible to make projections.


Many years ago, I watched a TV interview with an Austin startup who said things like, "We can't tell anyone what we are actually doing, because some larger company will jump in and take over our market." That was the moment when I said, "We're done here."

I'm suddenly having that same feeling. If you had solid examples, I'd probably have more than just a feeling.


No one should ever invest in a company without knowing an accurate projection. People who do this are just playing the lottery.


Yes. But being on the other end of such a deal is like running the lottery.


No examples (it's hardly something they'd be talking about openly). This article spells it out pretty explicitly (with at least one named source) and is probably where I got the idea from:

http://bits.blogs.nytimes.com/2012/04/29/disruptions-with-no...


It's not bonkers at all. A) investors/acquirers would rather see green fields and b) energy/resources diverted to revenue which would have been more valuably utilized for growth.


> Hence, the rumors that some VCs actively discourage startups from making any revenue at all (let alone profits), since those could act as anchors that drag down the acquisition valuation.

That should come with a "don't try this at home, kids" warning. I've seen a case where an entrepreneur and his angel investors have a joint delusion about being able to pull that off even though those Tier Zero potential acquirers have no idea they even exist. He could have had a novel product in commerce two years ago but he would rather not have to answer for sales numbers meanwhile.

There are some cases where that's a rational plan. But not many.


>Hence, the rumors that some VCs actively discourage startups from making any revenue at all (let alone profits), since those could act as anchors that drag down the acquisition valuation.

I am not familiar with the funded startups/VC/acquisition ecosystem, so can you explain how a startup that is having revenue would drag down the acquisition valuation? Is it because it would drag down the acquisition price of the other startups that don't have revenue?


It's a psychological thing.

If a company hasn't even tried to get revenue, then the sky's the limit. But as soon as it does it gets actual numbers, and those numbers are usually not as big as anyone's wildest dreams. Sometimes they're downright depressing, and they lead to that hard and unglamorous slog of optimizing business model and pricing strategy and such.

In big companies this often manifests in the form of the project cancelled right before (or right after) it goes to market. A project that's still pie-in-the-sky tends to excite the sales and business folks, but once it gets closer to go-to-market you start getting real numbers. A lot of times this leads to cold feet, the project loses favor, and sometimes gets cancelled right before it ships.

Reality is never as much fun as dreams.

The counter-argument though is that rapid growth in the beginning is necessary to have any chance of getting really big.

I've got an effort out there right now that's growing but has a revenue model in place. I know for a fact that if I take the revenue model away it will grow faster, and I've been having a huge debate with myself on this. The revenue isn't huge and the growth is slow-- do I trade that small amount of revenue for larger growth on the promise that I can get more revenue later? It's a tough question.


Here's an example to understand why revenue lowers your valuation. Twitter grows like crazy, adds millions and millions of users. Great, maybe it's worth billions.

But if Twitter had started charging for premium accounts, as an experiment, their revenue during the same period could have grown from $1M to $5M. Can a billion-dollar company have revenue of $5M? No. So the valuation of Twitter would have come back to earth, maybe $100M, maybe a bit more, but not "the sky is the limit" number.


So why don't investors discount a valuation because the fact that revenue is undefined, and not treat it like a near divide by zero?


It's important to remember that as brokers/agents of LPs' money, VCs price risk. The valuation of companies is distinct from that, and is normally the principal component of the pricing of the risk. However, if the market is in a mode of skyrocketing/bubbling, a larger component of the price is how much you can hype up the company before your exit, and basically trade on your own credibility/brand.

In a crude sense, it's a form of a confidence scheme...


No, the idea is that revenue provides something to run numbers on to arrive at a validation. Call it an anchor or a sanity check: the idea is that it limits the acquisition validation. Whereas, it is argued in the article I probably got the idea from (http://bits.blogs.nytimes.com/2012/04/29/disruptions-with-no... ), having no revenue means the only limit is your ability to excite the acquirer with "growth potential" or "strategic value".


Usually chasing revenue means charging for things - removing free and instituting freemium in its place, for example. Generally speaking chasing revenue means pissing off some portion of your user base (i.e., the people who had no intention to ever pay you), and in doing so limiting your growth rate.

Valuation is deeply linked to growth rate and user base in this crazy industry of ours, so "we have X committed, paying users" is worth less than "we have 100X actives!!!!11one".


> Usually chasing revenue means charging for things - removing free and instituting freemium in its place, for example. Generally speaking chasing revenue means pissing off some portion of your user base (i.e., the people who had no intention to ever pay you), and in doing so limiting your growth rate.

Not sure I agree. You can give for free a limited version of your product and charge something for a better version, or you can use the freemium model.


Yes, and the company that doesn't have to care about revenue can just give the entire thing away for free and get users to sing their praises.

They will grow faster than you. This is why the "no-revenue" play works (well, until it stops working).


Because revenue is easy but growth is very, very, very hard.


Seems to me the opposite is the case.

Any idiot can get signups when they have millions of VC money to burn. Getting people to actually pay you more than you're spending on user acquisition is infinitely harder.


Nope. It really isn't. The hardest thing by far is to get lots of usage. Once you have lots of usage, it's really easy to make money whether it's advertising, fees or whatever.

Can you name 2 or 3 "idiots" that have done what you suggest?


I don't think any of them are idiots. But here's a small sample of companies, off the top of my head, who have had serious problems in terms of monetization / revenue and needed to use investors / host company's money to run:

Pinterest. Groupon. Reddit. Snapchat. Instagram. Youtube (for many years). Twitter took a long time to make money. Most news sites have a hard time, which is why WSJ is paywalled (as mentioned in the article). On the "smaller valuation side", we could say FriendFeed, Zite, Hot Potato, Beluga, GroupMe, TweetDeck, Dodgeball.

It's much harder to than you may realize to monetize.


It's very hard to monetize, but it's orders of magnitude harder to get big in the first place.


Groupon and YouTube are printing money now that they are public. Pinterest, Snapchat & Instagram haven't even tried to make money (ie, they are doing what I explained). Most or all of those small ones never grew fast enough to matter.


Digg? Everpix? Myspace (though the original owners managed to cash out before it crashed)? Metafilter (not a VC-funded startup AFAIK, but having to shrink because they can't profit despite their popularity)? Twitter, though they haven't quite crashed yet?


Exactly.

The classic, ostensible rationale for taking on large VC rounds is to accelerate growth. Not to cause growth in the first place. If a company's entire business model depends on spending massive wads of capital on things like loss leaders, advertising, unsustainable pricing, etc., then it's not really a business. It's a gimmick. It's a race to the exit.

These sorts of plays can and will cause negative externalities in the markets in which they operate. They "disrupt" those markets for a short while. The disruption comes not from changing the fundamentals of the market, so much as temporarily and violently turning pricing on its head by ignoring the profit equation altogether. That's unsustainable by definition. (And it's not to be confused with the legitimate practice of running at a loss, or breakeven, by plowing available profits back into growth).


To the extent that this is true, it's one of the major social criticisms of Silicon Valley-- that it's a Ponzi financial scheme where the game is to spawn massive but deeply unsustainable growth juggernauts and then sell them to greater fools like the public market.


One big problem which is hard to solve is the way bubble companies can easily drive the price down below something sustainable but it can take a long time to recover, if ever. We've seen that with a number of free services and also things like App Store pricing where all of the free / $.99 apps seem to have permanently lowered people's willingness to pay even a modest price.


For services at least you can market on the fact that your thing is sustainable. People dislike churn and will actually pay a premium for some credible business model beyond "don't worry about how we pay for it".


It's definitely a good marketing message but you have to hope that it'll resonate with a sufficient number of people to be viable. That's easier to do for a business service or something like personal backups than it is for many other product categories.


That's a very good point.


Most of your post reads like wishful thinking. Do you have any examples to support your contentions? My sense is the opposite: all the companies that got extremely large we're investing massively (Facebook, Salesforce, amazon being the poster children). Are there any companies that got big under your approach? Suspects include 37 signals and atlassian, I guess.


Why would they have to get big, let alone extremely large?

That's an assumption on your part. There are lots of companies in the $1 to $10M pear year in turnover and 20...40% net margins range that make their owners consistent fortunes. And by your standards they would qualify as 'tiny'. But that doesn't mean they are bad companies for their founders.

Simply put, we have different definitions of what a 'good business' is.

37signals and Atlassian are just as much outliers as dropbox and airbnb are.


In Silicon Valley these sorts of businesses are often derided as "lifestyle businesses." The Valley -- especially the big VC ecosystem -- wants big sector-conquering victories. That's because the VC industry is driven and financed by mega-hits.

Building a respectable, profitable business might be fine from a traditional MBA or bootstrapper's point of view but it's actually a failure in VC-land since it will not yield a monster exit.


What cankers about reading your comment isn't that it isn't true, so much as the implicit approval of the assumptions that (1) small businesses are small by choice rather than ambition, (2) all businesses have viable ways to raise money on equal terms, (3) funded competitors do NOT distort the market in a way that penalizes their unfunded competitors.

Jacquesm is rightly irritated at how funding unsustainable businesses distorts the revenue-getting potential of sustainable but unfunded ones (#3). Another example is the difficulty of bootstrapped companies ranking for any competitive search terms or getting decent press without venture capital and a PR engine. It is a LOT harder to organically grow into multiple distribution channels in a short period of time if you have to fund everything out of a limited slice of the market because you are competing against funded competitors who don't have those limitations.

Jacquesm's point is dead on. The entire point of raising capital is to buy competitive advantage. So if a VC doesn't think the money is being well-spent, they shouldn't have invested in that business or market in the first place. It is ironic to be in the position to buy competitive advantage, then get upset because people act like that is how you run a business.


I wasn't disagreeing, just pointing out the incentives and the underlying structural reasons that things are done this way.


Ah, thanks for explaining, and sorry if I took it the wrong way.


It's a lot harder to get big without burn. Offering value for free or very cheap is the easiest way to achieve exponential growth.


Mailchimp is another fantastic bootstrap success story. Hugely successful, but not talked about much because (1) they're not in the Valley (2) didn't raise boatloads of VC cash. Oh, and the founders still own almost the entire business (not as if that is important or anything)


this old [2000] piece from joel spolsky on picking a growth model and sticking to it is still a good read:

http://www.joelonsoftware.com/articles/fog0000000056.html


It's a great read indeed. But I do disagree with the 'excel versus lotus 1-2-3' analogy. Microsoft engaged in plenty of unfair competition at that time and that's one of the reasons they succeeded.

So going into a market with entrenched competitors is dangerous except when you're backed my a monopolist that can afford to cross-subsidize.

> Think of your risk/reward profile. Do you want to take a shot at being a billionaire by the time you're 35, even if the chances of doing that make the lottery look like a good deal? Ben and Jerry's companies are not going to do that for you.

It took 14 years, but Markus Persson just proved him wrong on that one.


good point! it was very gratifying indeed to see minecraft explode purely via organic growth.


As much as I hate those soundbitey things, I think "If growth is equal to health, then cancer would be good news" is one for the bootstrappers :)

Fantastic points, well reasoned post. As I've only done niche bootstrapped things, I'd never looked at it from that perspective before, where a bubble startup could screw up the sector for a long while, not just steal that day's lunch.


> There is something supremely funny about VCs complaining that their start-ups behave like funded start-ups and not like bootstrappers, who focus on revenues and profits right from day 1.

This struck me as well. The irony seemed lost...

You can't have it both ways. Bootstrappers who don't need your money, won't take it. People who do need your money, typically spend it, playing the longer game you've encouraged them to play.

> A healthy company would survive and grow even without VC investment, it's supposed to be an accelerator, not life support.

A thousand times this.


> "People who do need your money, typically spend it, playing the longer game you've encouraged them to play."

More than that, if you want the middle ground - externally financed but slower, more sustainable growth, you need to establish that from the get-go. Founders are chasing the fast 1000x exit because that's what VCs expect.


This is esp. funny when the man writing the original article is an investor in Snapchat, which just raised $xxx millions at a $yy billions valuation.


+1000. You have hit the nail on the head.


It's really interesting how, from different vantage points, we have the same complaint.

This industry, in the state that it's in, selects for those who over-promise, impress others with their charming but vacuous stories, fail to deliver, and make a mess that's really difficult for the rest of us to clean up. "What do you mean you can't deliver <SaaS X> for 25 cents per terabyte?" "What do you mean you can't do this story in one week?" "What do you mean we'll have to hire a maintenance consultant to get out of this mess?"

Institutions are still the main players and can develop persistent reputations and execute coherent strategies... but the game of private-sector technology itself is most successfully played by sociopathic individuals who make unrealistic promises, generate "flashiness" with minimal substance, and are promoted away from the chaos (say, into corporate upper management, or the VC investor ranks) before things start to blow up under their feet.


I had a long comment written that I think may give you some actionable hand-holds, the only remnant of that which I'm leaving here (because I don't think HN is the place to give personal advice, especially when it is un-sollicited) is that I don't think our complaints are the same at all. Feel free to drop me an email if you want to continue that conversation out-of-band.


The words; Horse, Stable and Bolted come to mind. VC's and their stupid valuations have created this problem.

The idea that a business isn't worth investing in because it's only going to make millions, not billions, also doesn't help. VC's would be better off diversifying in lots more companies that have a better chance of making a more modest profit, than a few that are then pressured to make 10's of billions.

I guess ultimately it comes down to the point in which they exit, the dumb PE ratios of Facebook, Twitter etc allowed someone to cash out nicely when they floated, but for the suckers that brought the stock on the public market have no hope of recovering their cash.


You're referring to an extremely small percentage of the venture investment community that is dealing with concerning itself about making billions. I'd argue that's 0.1% of the venture investment activity in the US market (but not 0.1% of the dollars). It's basically a few markets on earth.

Go to St. Louis or Dallas and you'll find venture investing going on all over the place that focuses on companies that will make millions and not billions. When you start a hotdog stand, and raise $50,000 from your cousin, that's venture capital too.

The US economy is not lacking in VC activity around million dollar businesses. There are more venture capitalists running around funding smaller ventures than at any other time. As I'm sure you know, $50k - $250k is not what it used to be 30 years ago, and it's now very inexpensive to start internet companies.

In my experience and observation it has never been easier to raise money for a x million dollar business venture, and I believe this to be true for nearly any city in the US.

That investment activity however does not make the headlines, and few people bother to do their research into how many 'boring' deals are being done by investors worth sub $10m that put $25k or $75k into a startup in Cleveland.


Just to fact check you a bit:

- Facebook is trading at $76, IPO'ed at $40

- Twitter is trading at $51, IPO'ed at $42


If a company was going to reduce its spend to a sustainable rate, why would it want to mortgage itself to an investment firm?

I thought the main point of selling your soul to investors was to increase your burn rate. If you were bootstrapping your company it seems like you'd want to maintain control and ownership.


A good use of investor money is when you have a proven and controllable conversion from signups -> paying customers.

For example if you need $200 averagely to acquire a customer and the LifeTime value of the customer is $500 over a 10 months timespan. With a positive conversion, you can scale very aggressively with almost no risk, whereas if you re-invest your profit, it will take much longer to reach the same point. If you are in a competitive space, you especially might benefit from investor money.


Such a company with a proven ROI on its marketing should go for venture debt, not venture capital. If you can 2.5x your money in 10 months and capital is at 0% interest out there, why would you sell a huge stake of your business to get to that 0% capital?


No, if you're playing it smart then VC is used to accelerate development and roll-out, but the business model is already there and deemed viable.

This will allow you to capture a large(r) share of the market before you run into your competition.


Interesting take, was just thinking about this a few weeks ago talking with my wife about an idea i have.


Honestly, this sounds like Monday morning quarterbacking.

When all these companies lined up and raised umpteen million dollars, I'm all but certain they were asked about their planned use of funds. Further, I'm nearly certain they said they were going to spend in order to grow their business in their chosen market. And many are doing just that. And who the hell provided them with these funds?

Maybe Fred (and Bill Gurley) should be directing their criticism at those stewards of investors' monies and consider their own part in this cycle.


Fred Wilson has lived through a few booms and busts so he is kind of concerned about the next bust being very likely. I would just say, there is a very high likelihood of cheap money continuing for a while, given the stance of the Federal Reserve and the condition of U.S. economy. And, as long as money stays cheap, I do not see the bubble bursting 2001 style. Money will continue flowing into private and public equities because it really has nowhere else to go


When the cheap money stop that's when the adjustment happens. Until then, as Fred said, they have to keep on dancing. And eyeballing intensely the next empty chair.


perhaps, what I'm saying is cheap money is unlikely to stop for years to come


That's only true if the Fed's hand isn't forced and the QE equation can remain the same in regards to both the results they get per dollar of QE and the inflation they cause per dollar of QE.

However that's not how it works. The Fed is in a downward spiral scenario, in which their policies have ever less of a positive impact and ever greater of a negative impact, and that's what arbitrarily low interest rates also function based on: the longer you hold them low below absolute optimal, the greater the damage as a result at an accelerating rate.

The cheap money party is very likely to destroy itself in a way that is both hard for the Fed to predict and control. Just like it did the prior two times the Fed made the mistake of unleashing a wave of cheap money. You can read their minutes and speeches, they were so oblivious they (supposedly) had no idea the real estate bubble was underway or about to implode (true for both Greenspan and Bernanke).

What ends the cheap money is the asset bubbles get so large their downside poses a threat to the integrity of the entire economy. They have to raise interest rates to stop the extreme asset bubbles that cheap money causes. We're at that line right now, which is why they keep pushing headlines about raising interest rates, it's meant to artificially hold down asset prices without the Fed having to actually raise rates.

The stock market is already approaching the highest valuation it has ever had in a 'bull market' outside of the dotcom era and maybe 1929x. Real estate has almost entirely recovered, and in many markets is now higher than the peak of the bubble of 2005/06.

You throw another 30% gain on the stock market, and 20% on the real estate market, with continued mediocre earnings growth and 1% to 2% GDP growth, with little to no wage growth or full-time employment growth, while Europe is in a continuing depression, Japan is in a recession, and China is melting toward zero real growth, and you're priming for a crash across numerous asset classes that will send the US into a true depression.

15 years of horrifically bad monetary policy has yet to be paid for. They keep trying to prevent recessions from happening. The price for that bad behavior will keep climbing day by day.

If they don't raise rates, they crash the economy as asset bubbles become increasingly unsustainable. And even though the Fed will attempt to keep the cost of money low in that scenario, nobody will be able to get access to that cheap money (ala 2009/2010 but far worse).


How long has money been cheap in Japan? 30 years? we have some of the same factors at work in the U.S. not the same situation obviously, but fundamentally, we have a relatively slow growing economy which does not generate a lot of inflationary pressures and my guess, the Fed will keep rates relatively low for a long time.


> given the stance of the Federal Reserve

Could you expand on that point?



It says something when the money people (VCs) complain high real estate rents: changes might be afoot. It is possible that the property owners feel/know that the current situation is untenable and that new properties will be allowed to be built, hence their desire to lock in leases for 10yrs.


I'm not sure if I understand the point of this blog post. VCs give money to startups so these startups can grow faster than they would without external investment. So they will spend that money. It is not like startup come to VC and said: I need $10M and I will put that money in the bank.

Maybe the blog should be how it is important that startups are more focused when they spent? Or maybe how VCs are investing into companies with not so great ideas?

I'm just confused here.


Sometimes this happens when you give people free money to play with. What did you think was going to happen?


"At some point you have to build a real business, generate real profits"

The companies that seem to be able to switch off the growth and become cash flow positive will be fine no matter what.


So why are these companies in your portfolio in the first place?


sanity impending


Where's the data?


What you are asking for is asking for a VC to talk down their own book. That's a ridiculous request. Fred and his colleague are already taking a pretty daring step in writing this, you can bet that any future potential acquisition party will make damn sure they're not buying into one of the companies that Fred is apparently unhappy about today, and that a whole horde of junior associates at various establishments is currently looking through their portfolio to try to figure out which companies were the ones he was talking about.

VCs will never talk about specific portfolio companies in a negative way (in public) unless they have a direct financial motive for doing so (in which case storm is brewing or in progress, and likely the press has already had a field day with something).




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