Looking For Failures

  Catastrophic 2 
  Originally uploaded by ern.

John Battelle follows on Paul Kedrosky's post Techcrunch party post on bubble 2.0 with a post about the lack of web 2.0 failures.

To all this discussion, I'll just simply add "just wait, they''ll come". They already are coming in fact. Kiko put itself up for sale on eBay and Tribe just went through a mass exodus of the management team and  investors and the founder, my friend Mark Pincus, is trying to restructure the company.

It takes time for companies to fail (thank goodness!). We like to fund them for 12-18 months although we'll do less for real early stage seed deals. And as John discusses in his post (which you should read if you care about this stuff), web 2.0 companies can operate at burn rates of less than $1mm per year.

So while I agree that there is a bubble in web 2.0 company creation (driven by entprepreneurs) and web 2.0 company funding (driven by VCs), there may not be much of a bubble in the VC markets in general because the financing sizes are still mostly small rounds. Sure there are troubling signs like the ~$20mm financing for Jobster and $50+mm funding for Zillow to date, but I believe they are still the exception rather than the rule.

I think if we all keep our heads screwed on straight and keep the funding amounts to reasonable levels, keep the burn rates down until we have demonstrated viable business models, and focus on building sustainable businesses instead of companies than can be flipped, we'll all be fine.

As Tom Evslin likes to say, "nothing great has ever been accomplished without irrational exuberance".

Comments

[steve]

i agree with your recipe for level headed entreprenuership and VC investing, but Bubble 2.0, if there is one, isn't in those places, its in the oversupply of VC funds, and undersupply of return/exits.

VC funds are enroute to raising, what, $25 billion this year (or more.) this seeming oversupply has now been going on for a few years and shows little if any signs of abating.

without getting too technical, using the Rule of 72 (Years to double = 72/IRR) and assuming 1) total public equity market returns at 7%/annum, and 2) VC fund management fees at 2% total committed capital/annum (or 14% total committed capital during 7 years management), then that $25 billion will have to essentially triple in value in 7 years -- that is, all of it, at 3X -- to provide VC LPs reasonably above-total-market, net-of-management-fees returns.

And remember thats just for VC funds raised this year. $25 billion PER YEAR is/has been going into VC funds at current rates.

Then factor in that, even in the best of times, VC is a hit driven biz, with maybe 20% of portfolio companies creating 100% of returns.

Then factor in the scarcity of exits these days, and puzzling but seemingly unending distaste for new technology issues in the public markets.

Then finally, factor in Fred's notions about small investments creating VC-like high IRRs but un-VC-like small sized absolute returns.

If there is a bubble, thats it. In Bubble 1.0, the retail public market investor was the greatest fool in the greater fool game. This time it may be the institutional LP, as well as a huge number of VC partners and firms who cant possibly survive, unless somehow Garrison Keiller's fantasy notion of a sweet place where "everyone is above average" -- lets call it "mega irrational exuberance" -- becomes VC fund reality.

IPOs, where are you when we need you?

[Aidan Connolly]

Re: Web 2.0 bubble...things could be worse for you guys in the USA - a lot of lessons have been learnt from the first internet bubble and I can't imagine the same mistakes being made again. Where I am (Ireland) we are competing for funds against property speculators... few Irish investors want to invest in technology here because of the 'irrational' returns they can get on property investment. So for Irish startups we have to look to foreign investors (typically US or European) for salvation.

[Zach Coelius]

Steve: What is the market cap on google? Take all the tech firms that have been started with the help of VC funds and I think you will see that VC funds are a raindrop compared to the value created. Do you really think that valuable companies will simply stop emerging?

The real question I think is important is not what stupid money is doing-since stupid money will always exist and always be stupid-but rather how are we going to understand the new ecosystem where a viable company can be started on a wing and a prayer.

In my opinion VC will have to shift from funding purely speculative "ideas" to funding crash tested models that need capital to scale quickly. Since I can test an idea these days for 50-100k there is really no reason to involve VC till the scaling stage.

Thanks for the great work you do Fred. We all really appreciate it.

[Tom Foremski]

Zach: That is a very insightful comment regarding VC involvement. Yes, you can test an idea for very small amounts of money. But also, any "Web 2.0" company can be reverse engineered in no time by a GOOG or YHOO, and those platforms already have the "scale" built-in. If a startup can build a community before it gets on someone's radar screen then it has a decent chance of being successful or even being sold. But that gets tougther as the nose level grows. The real VC investment opportunities might lay in discovering communities that you didn't know were there...

[Zach Coelius]

Tom,
I agree that starting a small under-funded company and positioning it poorly is a recipe for disaster. Like the community you mention, there are lots of way to protect yourself against competition such as niche plays, partnerships and strong customer lockin. It seems like one of the big problems of a lot of web 2.0 companies is that they don't think about competition when they build their baby.

[Ken Schafer]

Hi Fred,

I thought you might be interested in hearing why we bought Kiko.