September 27, 2010
One recently recurring meme in Silicon Valley (and its mirrors around the investment landscape) is that “low” ($10m-$20m) exits are great — so long as the company’s cap table is structured in a way where all constituents benefit from such outcome. It’s obvious that a monotonic increase in a company’s valuation from $1.00 to $10m, made real by a liquidity event, is an unequivocally good thing, most likely for everyone involved. There does seem to be a systemic change worth highlighting.
Angel investors (in particular those with smaller funds) have fundamental incentives to encourage (or pressure) entrepreneurs to take a lower early valuation (and a priced round vs a convertible note), and then to subsequently consider lower, earlier exit opportunities. Such companies represent quicker returning, and frequently safer investments, where it’s also easier for angels to add more value (cool one-off perks, for example, go much longer way during the company’s first year, etc). Such exits also allow angels to redeploy capital faster, which generally fits better with their model. As a result, angels are implicitly pushing founders to aim towards lower, quicker, more realistic, and ultimately less disruptive/revolutionary products and services. After all, those crazy shoot-the-moon ideas are just that much more likely to fail.
One key criticism of the VC model (and resultant attitude towards startups and their founders) is that the ruthless Sand Hill Road crowd doesn’t really care about any one individual entrepreneur or their startup — they merely want to place enough diverse bets to have one or two pay for the follies of the rest, and then some. The positive externality of this behavior, however, is that VCs encourage (and indeed pressure) entrepreneurs to take more risks, delay gratification, exit later, to double- and triple-down, and therefore sometimes directly cause disruptive/revolutionary products and services to be created, or taken beyond where the entrepreneur thought they would or could go.
Neither of these two behaviors are new at all, and historically entrepreneurs tended to self-select towards the appropriate (for them) behavior just fine. However, the recent explosion of angels, the emergence of “super” angels, and their frequent self-positioning as antidote to venture capital seems to have tilted this balance significantly in favor of the former. Anecdotally, in my own angel investing activities I’ve most recently encountered founders that actually considered reaching out to corp dev departments of possible acquirers as a viable alternative to launching their product, less than 6 months after raising a convertible note.
Silicon Valley tends to go through cycles, and their causality is never entirely clear, but the correlations are often easy to see. At the moment, what amounts to lack of visible significant innovation seems to correlate with abundance of angel-funded startups shooting to get picked up for a fistful of dollars.
We should aim higher.
July 17, 2008
Social apps have the very same users of social networks like MySpace and Facebook (more than $100 per user, at last valuation and approximate current user count). On the other hand, social apps largely depend on social networks to acquire and reach users. Further, the industry is young and prone to shake-ups, so a high-beta discount rate must apply.
The social application developer segment is quickly bifurcating into companies that look more and more like a new breed of ad networks and those focused on depth and user engagement first and foremost, the most ambitious companies trying to build something like an “inner-brand” (e.g., “I go to Facebook, where I can SuperPoke! people when I want to be clever,” to toot my own horn).
While there can be some debate as to which one is generating more cash today, it should be obvious that the social ad network model is self-destructive at the limit: a meaningful increase of already abundant page views in the low-eCPM social networking ad market implies further price drops, unless the great ad spend migration really speeds up. The standard “more reach than all of the networks combined” counter-argument makes little sense for ad networks — the social networks have all the incentives to make that not be true before too long; it’s difficult enough for them to monetize their pages.
There are two subtler variants of the social ad network approach currently being tested by various social media companies:
1) owning a few proprietary, sometimes even engaging, apps and running a social ad network, selling the combined reach at eCPMs closer to the former than the latter; and
2) owning a large number of low-engagement proprietary apps.
The first is isomorphic to the social ad network approach, except that the sales pitch for advertising revenue is based on a bit of misrepresentation: “all our users are highly engaged, and ready to click on your ads” — engaged as they might be with the proprietary apps, the ad network has no control over the placement of standardized (and therefore easier to ignore) social ad units on the pages of its participants. Proprietary reach is not the same as network reach, no matter how it’s spun.
The second is more interesting. The totality of social app companies are startups, and so their resources are ultimately limited. Development cycles (even outsourced to far away, cheaper lands) can be invested in breadth or depth but hardly both. Going after breadth (lots of simplistic apps) and focusing on maximizing combined reach has characteristics similar to those of a movie production studio: find and produce a hit, market it, monetize it, and while the novelty is waning, chase the next one.
This model is actually in most ways worse than a pure social ad network play: you have to work very hard to build products that rise up to the top often and consistently enough to make the revenue at least somewhat predictable, while other players are competing to build engaging, long-term wins in the segment you are trying to blitz.
The more your business looks like that of an ad network (augmented or not by the current sex appeal of being “social”), the less ultimately valuable it is.