I spend a lot of time with internet consumer services startups. Currently, a meme circulating in this area is whether something fundamental has changed in the paths to liquidity open to startups in this space – a fundamental change that is foreboding to VC’s. A number of recent stories in magazines and newspapers have made the “sky is falling” claim that the internet consumer services world has fundamentally changed, and that VC’s who work in the area are yesterday’s news. Angel investors now rule the roost and are best positioned to take advantage of this new evolutionary niche.
The truth, of course, is more nuanced.
The argument typically goes like this: a titanic battle over the future of the web is shaping up among the major “new media” companies: Google , Yahoo! , Microsoft (MSN) , TimeWarner (AOL) , IAC/Interactive , News Corp. , etc. As the arms race among them accelerates, they will add features to their offerings by buying small start-ups (Flickr, de.licio.us, Pyra Labs, Oddpost, Picasa, et al.) who can innovate “around the edges” faster than they can.
Because most of these small companies have a cool feature,
but not a lot of users (until they can access the massive distribution of one
of the major players), they sell for a range of values between $10 million -
$30 million. But they also don’t need to
raise much money to build their cool feature. Accordingly, a $10 million - $30 million sale price can be a terrific
outcome for the founders and angel investors – but terrible for a VC (who
depends on a few grand slam home runs to stay in business).
Implicit in this argument is the assertion that internet
consumer services company can no longer go public, and that the only liquidity
outlet for any such company is (1) to build a cool feature and a small (but
fast-growing) user base of early-adopters and (2) sell to one of the major
Offered as compelling evidence of this is the current dearth
of internet consumer services IPO’s……
And, no question, the IPO market is down from
historical levels. On page 113 of the
February issue of Wired (just out), Chris Anderson notes (“The New Boom”) that
about 50 technology companies went public in 2005, compared to more than 300 in
1999. While 1999 was obviously the peak
of the IPO market, each of the 10 years prior had more than 50 tech IPO’s.
So things could be said to look bleak for VC’s and the companies they typically have financed.
But here’s an alternative view from the VC trenches.
We’re already starting to forget that almost no internet consumer services start-ups were funded in the “nuclear winter” between mid-2000 and mid-2003 (dates not precise). Only in the second half of 2003 did VC and start-up activity in this area start to revive.
Because we still remember the quick-hit, fly-by-night IPO successes of 1999-2000, we have forgotten that, in the 35 year history of Silicon Valley, it has always taken 4-6 years to build a successful and enduring start-up. And, it still does.
Therefore, it should surprise no one that there isn’t a crop
of internet consumer services start-ups currently popping out the IPO chute. In fact, given that most startups in this
space were founded after mid-2003, it would actually be a surprise if there
were. I predict that we’ll start seeing
an increasing number of IPO’s in this area in Q1 2007 (going public off 2006
financials), and accelerating through 2007-2008 -- back to historical norms.
If I’m wrong, then I think it is fair to examine whether
something fundamental has changed.
End note: the actions
by the Federal Government (Congress, the President and the SEC) aimed at the
financial scandals of 2000 – 2001 (Enron, WorldCom, Tyco, et al.) have
dramatically increased the costs of being a public company. This will have a depressing effect on
technology IPO’s even when the crop of 2003-2004 companies matures. I think these actions have been entirely
misguided, and have redounded almost entirely to the benefit of lawyers
(disclosure: I used to be one) and
accountants -- with no benefit to investors. More on this in a future post, but consider that (as far as I know) all
of the convictions of the 2000-2001 fraudsters were won under laws that
pre-dated Sarbanes-Oxley and related laws and regulations. The pre-existing laws worked fine; we just
needed to enforce them.
Write your Congressman.