When Things Don't Work Out
avc.com
avc.com
YC has proven that startup incubators can be phenomenally effective... who wants to launch the first startup hospice?
However, I do think there is scope for a sort of holding pool for products that are acquihired and then shut down. Eg. Posterous would be a good candidate. Let the staff go to their new homes, but build a team whose specialist skillset is in taking an already built product, putting it into stasis and dropping ongoing costs, and then monetising that existing tech/content/audience/userbase. Perhaps in the hope that some later startup can use the existing product to build-off in return for equity.
This, in a nutshell, explains the problem with uniformly applying the VC model to all tech startups. Some tech startups -- often the ones involving creation of substantive new technology with deep intrinsic value -- require many years of slogging. There's nothing wrong with startups like that as long as there is a way to fund them to completion. But how to do that?
The problem is that the standard VC model doesn't really fit well for these startups, because the VCs by necessity have fixed, relatively short time horizons.
The VC-funded startups that do work well despite involving slogging and deep innovation generally seem to hit some vein of gold along the way -- e.g., Google "discovering" the psychological fact that consumer click-through rates are vastly higher for search ads than for other online ads, despite initially targeting enterprise search sales. This "gold strike" propels these companies to very rapid, hockey-stick growth that funds the vast investment required to build the new technology. But they seem a priori unpredictable, which is troubling if you're looking for a repeatable model of success.
At ITA Software we "slogged it out" from ~1997 to 2010 and created $700M of value for shareholders; in contrast to the typical scenario Fred describes, it did very well for both entrepreneurs and the VCs (as well as for many of the employees). But we'd likely have exhausted the patience of our VCs had we raised money in 1997 rather than in 2006, and come to a rather different end. (We actually did look into raising from VCs circa 2000, but the terms offered were so bad we declined.)
Likewise, imagine trying to make what ultimately became Siri with a VC partner. SRI spent tens of millions of dollars on that project over a very long period of time. (I remember seeing a talk on it at AAAI in 2007, at which point it was already pretty mature, and had cost -- if I recall correctly -- $40M, but was still years away from being acquired by Apple.)
To be clear: I'm not saying the VC model is bad; I'm just saying it's not universally applicable. And I honestly don't know what to tell entrepreneurs who want to create companies that don't fit the model well, unless they are already rich enough to self-fund, in which case I ask if I can invest. :)
THANK YOU. I am not one to usually use caps (normally, what I say is bombastic enough) but I am so fucking glad you said that.
It's not even "slogging". It's growth at a rate (10-40%/year) that is (a) extraordinarily fast by pre-technological standards, but (b) fails to deliver immediate liquidity/gratification.
The problem is that the standard VC model doesn't really fit well for these startups, because the VCs by necessity have fixed, relatively short time horizons.
VCs deride everything designed for lesser-than-50% annual growth as a "lifestyle business", which is why they end up funding so much get-big-or-die social media bullshit and so little Real Technology. Real Technology enables rapid (50+ percent per year) growth in applications (often discovered by external parties with important but non-technological knowledge) but it almost never, itself, grows at such a rate. Instead, 10 to 40 percent per year is fairly typical. Reliable, genuine improvement is hard and requires a certain sobriety-- don't load up on technical debt, get the basics down as well as you can before building applications-- that's incompatible with the "triple-up the sprinters, kill the laggards" climate of current "technology" financing.
To be clear: I'm not saying the VC model is bad; I'm just saying it's not universally applicable. And I honestly don't know what to tell entrepreneurs who want to create companies that don't fit the model well, unless they are already rich enough to self-fund, in which case I ask if I can invest. :)
I'm writing a long series on the causes of organizational malfunction (specifically software engineering, but probably more applicable) and the conclusion I've come to is that VC-istan's mandatory rapid growth (in headcount; 100+ percent revenue growth is fine if you can do it) is just incompatible with stable, long-term cultural integrity. We need to find a way to finance mid-growth "lifestyle" businesses that optimize for genuine technological contribution and cultural health, but don't double their headcount every 12 months.
I wrote about the financial/trust problems here: http://michaelochurch.wordpress.com/2013/03/26/gervais-macle... . It's the 17th in a ~21 part series on how to unfuck Corporate America. The short version is that we need to come up with a way to connect passive capital with a Fleet of 50,000 mid-growth (10-30% per year; moderate failure risk) businesses, focused on long-term goals and therefore more able to mentor talent and serve specialized niches, that are currently underbanked. The solution I come up with is a profit-sharing-heavy compensation mechanism that is extremely transparent and kicks back dividends to (passive) equity-holders.
http://www.sri.com/work/timeline/siri SRI spun off Siri from SRI in 2007 and Siri was acquired by Apple in 2010.
There are a lot of governmental, or government-associated organizations which tend to work with a high level of long-term technical depth. Granted, those organizations generally show less/varying ability to quickly get technologies out for public use than VCs.
In an ideal world, it would be nice to imagine that these long term organizations could operate on the downstream income from products benefitting from their focus. However, I think the typically the closing of that loop is through the relatively disconnected path of gov't funding: if that gov't/society benefits, and that organization can claim a link with past successes, then more gov't funding follows...
If anything it reinforces how powerful it is to be a high profile company. Then your company doesn't just die, it either salvages its resources as an acqui-hire/firesale (which clearly isn't good but it's something) or survives unglamorously. There are companies out there that cannot say they were "fortunate" enough for either of those things to occur.
Alternatively maybe the language he's using and what goes unstated is actually masking serious financial losses. But I think most startup failures actually result in founders' and investors' time & money up in smoke.
It sounds like he means that they're profitable enough to keep surviving and growing somewhat but not to the point where someone wants to acquire the business.
Due the emotional investment in the business the entrepreneur slogs it out hoping they'll stumble upon something that will give them the growth curve they need to get the acquisition / IPO / other exit opportunity.
I'm in the photography space and I know of companies who raised rounds years ago (2006-09). They are still around but it's clear they won't be a huge win for the investors.
In the past, VCs used to say about the portfolio: "3 go north, 3 go south, and 4 turn into the living dead."
I think Fred is saying that 3 go north, 5 go south, 1 turns into the living dead, and then there's another that we just will agree to ignore.
These two sentences seem contradictory. Why admire an entrepreneurial Don Quixote?
As an entrepreneur, growing a "runt" company is basically wasting your talent, and that of anyone else you have working for you. Your own skillset, and all the company's other assets, are locked away doing something that's not making anyone--especially you!--nearly as much money as you could if you tossed the current company out and rolled the dice again. If a larger company was responsible for the project you were managing, they'd shut it down and move you to something else where you could make them more money (see: Google Reader.)
In economic theory, this is why layoffs and recessions are good: they kill companies that were just getting by, and release the human capital "stored up" there to move to newer, brighter ventures.
I mean, it's fine if all you really wanted was a lifestyle business--but lifestyle businesses don't take investment.
By comparison, creating a company that will both make money and do good in the world is not nearly as efficient for actually doing good in the world.
Further reading:
* http://lesswrong.com/lw/65/money_the_unit_of_caring/
* http://lesswrong.com/lw/6z/purchase_fuzzies_and_utilons_sepa...
Are you saying that if my "meaning" is derived from, say, extending the human lifespan, then starting a company that tries to do that--and fails (because extending the human lifespan is a public good nobody wants to pay for)--is more meaningful than creating some kind of SocialMobileLocal juggernaut, and then spending the money it generates to fix the problem for real?
To me, that just sounds like impatience and an unwillingness to look at the big picture. A startup itself can be a schlep, to achieve something greater.
So VCs learn to respect people who are determined, and truly believe in what they are doing. The entrepreneurs who stick it out are therefore demonstrating that they are people the VCs should respect, even though the relationship is not working out well for anyone. On top of that working together through shared hardships tend to create bonds - and these are people who work together with the VCs through shared hardships.
Moving on to the second half of the equation, what about the VC? It may be tempting to quickly abandon all of your failures. But doing so means making worse returns than you could otherwise. Furthermore developing a reputation for abandoning too easily hurts your reputation as a VC, and therefore hurts your ability to find good future deals. So a VC is stuck with their bad decisions as well as their good.
And a final fact for you. The bigger the investment that you take, the harder it becomes to win big. There are many reasons for this. One is that too much money makes people complacent. Another is that there are more potential markets out there that are worth $50 million than are worth $250 million, so it is more likely that someone you invested $2 million at a $10 million valuation can earn 5x returns than someone you invested $10 million at a $50 million valuation can. Therefore VCs are on the lookout for opportunities that are big enough to be worth their time, but want to invest as little as they can in each one.
You'd just fire everyone, walk away, and hope to hit bigger next time? Your investors are unlikely to agree that this is the best way to use your talents...
Less admirable to jump ship from a going concern because there's no rocket ship payday and let the VC and everyone else try to salvage as much as possible.
Think about something like Next... was a struggle and had to be scaled back... Steve Jobs could have just let it go and moved on to the next big thing.
A VC would much rather give you 1mil five times and have you kill four of those companies and make a 100x return on the fifth one. Sitting around forever on the first one trying to eek out a 2x return means you never build the fifth one, and that's a much lower aggregate return.
It's not quixotry. Quixotry is when you're delusional about it. You're quixotic if you think you still have a chance despite overwhelmingly bad odds.
There's a lot of ugly work involved in shutting down a business: deciding whether to give severance packages when resources are very thin-- if no one else gets one, which is common, you shouldn't take one-- communicating painful messages, delivering what one can while morale goes to zero, managing reputations (yours and others), and then firing people who don't deserve it.
There are people out there who just bolt and make it someone else's problem. Failing gracefully is very hard.
The idea is that extreme transparency in profit sharing and compensation makes it possible for the mid-growth businesses to kick back dividends to investors while still growing-- instead of several years later at a liquidity event that may never happen. Thus, investors are fairly treated and get to participate, financially, in a space of business (mid-growth) that's currently underbanked.
The VC ecosystem is pretty abominable, and I don't think it's because VCs are bad people. They're not. I think it has a lot more to do with the fact that these red-ocean gambits require huge, fast-growing companies, so it's a natural oligarchy. It requires businesses to swell to 100+ people before they have the cultural readiness to grow to that size while maintaining a decent culture (hence, most turn into cutthroat, horrid messes).
It seems like if we could come up with a structure that enables the financing of mid-growth businesses-- equity financing for the 10-30%/year growth companies with less risk of total failure, that could also use their slower growth to optimize for creative innovation and cultural health-- then everyone would win.