With the market for initial public offerings in a deep freeze and a dwindling number of potential buyers, start-ups have fewer opportunities to exit and retire to Costa Rica.
This is worrisome to entrepreneurs, but if anything, it should be of even greater concern to the venture capitalists that fund them, a point made by TechFlash's John Cook. Venture capital firms simply aren't structured to invest efficiently in this market.
VCs raised billions of dollars during technology's boom, and it's unclear where they can now profitably invest those dollars. IBM, Oracle, Cisco Systems, and Microsoft can buy only so many companies. The industry consolidation that paid big returns to VCs earlier this decade has left far fewer potential buyers, with an anemic IPO market to provide an alternative outlet.
The situation has the potential to get worse. As IBM's Savio Rodrigues writes, Oracle has been hit hard in its middleware business as enterprise IT seeks to minimize the damage from Oracle and SAP price hikes in applications. This could make it harder for the company to afford acquisitions down the road.
In venture investing, small is the new big. Smaller, strategic funds like O'Reilly Alpha Tech Ventures can score big on a "base hit" $20 million exit, given its seed-stage investments of $500,000 to $1 million. Meanwhile, a large firm such as Kleiner Perkins Caufield & Byers will struggle to break even on such an exit, given that its investments need to be much bigger because its funds are so much bigger.
Venture firms have compensated by throwing money at weaker companies that arguably shouldn't get funded. This isn't sustainable. If exit options are dwindling for good companies, they're nonexistent for bad ones.
Compounding the problem for VCs, not only are exits likely to shrink in the new technology economy, but start-ups need less cash to thrive due to low-cost open-source and cloud infrastructure. This is true for most start-ups, but particularly so for companies that sell open-source software.
VCs potentially need to trim their existing funds, and almost certainly should be raising smaller funds.
For those that want to put existing capital to work, it might make sense to swing for the fences with consolidation around portfolio companies. I've described one winning open-source combination (Acquia, Magento, and OpenX), but there are plenty more. The upside to this strategy is that it fattens up a potential acquisition. The downside is that equity positions get heavily diluted in the process, and there are few potential buyers.
It's hard to make early-stage investments in a climate when entrepreneurs need less money, and when the exits promise to return far less. But that is precisely the environment in which VCs find themselves. It may be time to trade in that Porsche for a Honda.
Those who joined the technology industry in the 1990s can be forgiven for believing that dramatic wealth for paltry effort is the norm.
For everyone else, it's worth being reminded of something that Trevor Loy, a partner with venture capital firm Flywheel Ventures, said in recent congressional testimony:
We expect to hold a typical venture capital investment for 5-10 years, often longer and, since the technology bubble burst, rarely much less.
Unfortunately, Loy is not alone. In fact, as Tim McAdam and Jim Tybur of Trinity Ventures told me over breakfast Thursday morning, 20 years of National Venture Capital Association data (PDF) suggests that very few companies grow to $100 million in revenue in fewer than seven years.
This chart shows the value and age characteristics of venture-backed IPOs from 1980 to 2008.
(Credit: National Venture Capital Association)If you're looking to flip your Web 2.0 start-up that sells fashion accessory widgets, this will come as bad news. But for those open-source entrepreneurs who are dismayed that they're only at $50 million or so after a few years in business, take heart: that's the way it's supposed to be.
It's supposed to take years to grow a solid business. Sure, Salesforce.com hit $1 billion in revenues after just 10 years in business, and $100 million in its first 5. Google made it to $100 million even faster.
But those are anomalies, as all the data suggests. Red Hat, MySQL, and other leading open-source businesses took at least 7 years to ripen financially. They were built for profitability, which should be the focus of every open-source entrepreneur. We're growing businesses, not hype and fan clubs.
Follow me on Twitter @mjasay. Please note that if someone offers you $1 billion for your company that is still pre-revenue, disregard all advice above. Just take it.
Venture capital has not died, despite a big dip in Q1 2009 financings. But honestly, everyone might benefit if a significant percentage of the industry's members went on life support.
So while ReadWriteWeb waxes hopeful about the venture industry's 61 percent jump in financing in Q2, I'm not so sanguine.
As The Economist notes, we still have an oversupply of poorly managed venture capital firms:
(The) root cause of the (VC) industry's problems...is that most venture capitalists have failed to find enough decent companies to deliver the return they promised investors....Although many venture capitalists have been outstanding at raising cash, they have been pretty lousy at investing it.
The problem may not be that VCs aren't bright, but that there are simply too many of them. As 10-year returns increasingly look negative (as Paul Kedrosky and others have written), we're likely to see a shakeout in the VC community.
In fact, we're already seeing it, with venture funds raising just $1.7 billion in the second quarter, a 13-year low, as TechFlash reports.
Wheat, please say goodbye to the chaff.
Yes, ReadWriteWeb is right to suggest that more money means more employment for entrepreneurs, but I think it's dead wrong to suggest that more entrepreneurs necessarily lead to a rosier outlook for the economy.
Indeed, it strikes me that what we need are better entrepreneurs (and better VCs), which is something that scarcity seems better able to produce, not abundance, as called out by recent studies. "Survival of the fittest," in other words, should produce better startups than "subsistence by VC food stamps."
It is telling to me that many of the best open-source companies--Red Hat, MySQL, JBoss (now Red Hat), etc.--have taken relatively little venture money. They've had to strain earlier at profitability than many of their Silicon Valley peers, and it has been a great boon to them.
We talk often about how cheap it is to start a company these days. If this is true, we should see far less money raised, yet we still see Twitter raising huge piles of cash ($55 million and counting)...yet hardly seeming to spend any of it.
Unfortunately, that money will be spent, and money often ends up hurting as much as it helps, as it tends to amplify character flaws, both personal and corporate.
So, here's hoping that it will become harder, not easier, to raise money, whether you're a VC or an entrepreneur.
If I'm right, we'll all be better off in such an environment.
Of course, if I'm wrong, we'll all be unemployed and be forced to turn to dairy farming.
Follow me on Twitter @mjasay.
If you were looking to create a start-up, and particularly an open-source start-up, you could hardly do better than to stumble upon a pre-existing open-source project with millions of downloads, widespread adoption by some of the biggest names in the industry, and a fast-growing enterprise need.
Take Lucene, for example, as CMS Watch's Kas Thomas noted on Monday. It is a hugely popular project with one big failing: no enterprise support. Writes Thomas:
Lucene has a lot going for it...(It's) one of the safest (open-source projects) around, in terms of governance and oversight (through the Apache Foundation), the maturity of the code, the amount of active development going on, the size and vitality of the user ecosystem, and the number of high-traffic Web sites that have validated the technology in real-world applications (some better-known examples being Monster.com, Netflix, and Wikipedia).
Perhaps reflective of all this, Lucene has become a top-five Apache project, with 7,000 downloads a day.
But one thing Lucene is not is an out-of-the-box solution...To go from Lucene to a ready-to-deploy solution requires programming (and lots of it). And when you have a problem, there's no phone number to dial in the middle of the night. It's just you, the source code, and the community.
Enter Lucid Imagination, a commercial Lucene company that on Monday announced a $6 million Series A round of venture financing from Granite Ventures and Walden International, which also invested in SugarCRM.
Started by Eric Gries in 2007, the company already has a full roster of customers that includes Netflix, Hewlett-Packard, FedEx, Orbitz, AOL, Apple, Comcast, and Zappos, which sets it apart from Gries' former venture, Levanta (formerly Linuxcare), where he was CEO.
In fact, in talking with Gries several times over the past few months as a member of Lucid's advisory board, it became apparent to me that the Levanta experience may well prove to be one of the best reasons to be optimistic about Lucid, in addition to its stellar roster of engineers and Doug Cutting, the founder of Lucene, as an adviser.
Enterprise search is a growing market, and Lucene (and its more commercially friendly Solr brother) is keeping the pace. The question then becomes whether Lucid and Gries can provide enough value around Lucene to warrant companies such as Netflix spending big with Lucid rather than rolling their own Lucene-based search solution.
I think it can, because it's being run by people that have learned the hard way how to ensure open-source success. As an adviser to Lucid, I'm somewhat biased, and doubly so because my own company uses Lucene as part of our content management solution, so I've felt the power and pain of Lucene firsthand. But I believe that this is a space to watch and a company worth watching.
The Guardian probes an interesting dilemma for startups: Should you flip or float (an IPO)?
The truth is that innovation blackmail [Starting an industry-changing company] and selling out is becoming an increasingly attractive option. With the world's financial outlook so torrid that even the most strapping City magnates are being shrivelled up by paranoia and turned into tiny human prunes, we can't expect much different.
Nobody gets into the startup business just to be average. You've got to have big ambitions: change the world, make a fortune, get famous - or perhaps all three. The scrutiny that young dotcoms are under means very few entrepreneurs are simply hoodlums who think they'll blackmail their way to a retirement fund. But there are two real exit strategies for a startup founder: to flip or float. Option two is disappearing fast....
The post comes in response to Tom Foremski's post about disruptive startups selling out to the very companies they should be putting out of business. Foremski's is a fair critique, but as The Guardian notes, it may be that startups have little choice but to succumb. Entrepreneurs like cash, too.
As for open-source startups, Tim O'Reilly posited a year ago that open-source disruptors would mostly end up feeding the hands that they had been biting: "I will predict that virtually every open-source company (including Red Hat) will eventually be acquired by a big proprietary software company."
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I was having this conversation with my good friend (and O'Reilly Alpha Tech Ventures managing partner) Bryce Roberts this morning:
Matt Asay (9:34)
Was just reading about Bebo's $850M AOL acquisition
I want to come up with nothing and have someone overpay for it, tooBryce Roberts (9:35)
I like that idea a lotMatt Asay (9:35)
Yes, but too many people are already doing it. It's a crowded market. :-)
To think that we were on to the Next Big Thing (Come up with a weak product and have someone overpay for it), and too many people are already doing it. But if anyone wants to buy the business from me, I'll sell it at a fire sale price: $100 million.
No? Well, guess I'd better get back to working on a real business. :-)
The Wall Street Journal recently asked a highly poignant question: "Who's going to fund the next Steve Jobs?" The Journal asks the question in light of a startling piece of trivia: The second quarter of 2008 marked the first time in 30 years that no venture-backed companies went public. Not a single one.
Why? Through punitive regulations like Sarbanes-Oxley, we may have dried up the appetite for public exits, given that a private buyer means less red tape:
This is bad news for the U.S. economy. Does anyone think that we would be better off if Bill Gates and Michael Dell had sold out to corporate behemoths early in their careers, instead of leading their firms for years as public companies? Would consumers enjoy the same vibrant market in Web services if Yahoo had gobbled up a nascent Google? How powerful would our computers be if Intel had become an IBM subsidiary, instead of going public in 1971?...
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Larry Dignan asks a potent question: Which startup will topple the giants of today, Microsoft and Google?
As I've written, I believe Google will cut Microsoft off from its future, leaving it to dwindle into its past. It will take some time (Microsoft has more cash than the US federal government), but Microsoft's every effort to become relevant in tomorrow's most important markets have met with resistance and, ultimately, futility. Google is the death of Microsoft on the web.
But what about Google? I had suggested that mobile may be the answer, but in reality I suspect Google has several more years of dominance. We won't know who will challenge it until it's at the very height of its hubris, just as with Microsoft. It's when we're strongest that the cracks start to show.
... Read moreThere were a slew of new open-source companies launched (or still getting first looks) at last week's Open Source Business Conference. A few sites (Socialized Software and ZDNet, to name two of them)have been pointing to some of the more promising ones.
Here are a few to watch:
- Acquia - Drupal-based social/web content management company
- Ringside Networks - Social networking platform/application server
- Loopfuse - Marketing automation (Disclosure: I'm an advisor to Loopfuse)
- Projity - Microsoft Project competitor
And more. Check out the sites above to see who else caught the eye. Interestingly, JBoss executives sit on the management teams of several of them. As the market grows, there will be more cross-breeding between commercial open-source projects. This is a Very Good Thing.
It will be a few years, but I can't wait until Zimbra and MySQL have loosed their golden handcuffs so that they can start new companies, too. That's how the open-source business market will be enriched and grow.
There was a time when working at a start-up meant scrimping and saving one's way to untold wealth...or simply a self-inflicted pink slip. No more.
With all the VC money washing entrepreneurs' cars these days, it's hard to find much frugality in the Silicon Valley start-up.
As it turns out, however, there are great ways to save money without being an obnoxious miser, and Jason Calacanis, CEO of Maholo, has listed 18 of them. Here are a few of my favorites:
1. Buy Macintosh computers, save money on an IT department....
16. Don't waste money on recruiters. Get inside of LinkedIn and Facebook and start looking for people--it works better anyway...
18. Outsource to middle America: There are tons of brilliant people living between San Francisco, Los Angeles, and New York who don't live in a $4,000 one-bedroom apartment and pay $8 to dry clean a shirt--hire them!
The other tips are good, too, but I find these three above highly pertinent to my own experience managing Alfresco's U.S. operations. We're a highly distributed bunch, and so the only way to measure success is through actual productivity, not face time or the number of e-mails sent back and forth. We don't have office space, though we're thinking of getting some here in the "near shoring" capital of the world, Utah--want to sublet some space to us?). We don't have a phone system. We don't have a coffee machine. Well, I don't. :-).
With all that we don't have, we're forced to, well, work. Since we spend a lot of time working, we get the best machines for people (Macs, of course, tricked out) and good mobile devices (iPhone, Blackberry, etc.).
I guess this is what I'd add to Jason's list:
19. Don't bother trying to hire everyone in the same place. Hire the best people you can find...wherever you happen to find them. Development is no longer something that has to be done within the same office. In fact, there are plenty of reasons to disperse developers. (It tends to lead to more modular architectures, for one.) And open source is a classic demonstration of the power of distributed development. The rest is sales and marketing, which should be as close to the customer as possible.
What are your top tips to add to Jason's list?
