What Does It Take to Scale A Web 2.0 Startup?
Last year, the meme of “you can start a company for minimal capital” made the rounds. This is still true. But – it’s not trivial to scale a company for minimal capital (it’s possible, but an exception, not the norm.) This meme is starting to make the rounds – Heather Green at BusinessWeek just wrote an article titled Make-or-Break Time For The Net Newbies.
Heather interviewed me for the article. Since I only do interviews by email, I asked her if I could post our email exchange as further background to the article. She kindly agreed as long as I waited until the article came out. Here is the actual interview we did. The questions Helen asked me are in italics.
Are we seeing companies getting wound down and why? (I.E. Is something deliberate going on rather than just observers making something out of nothing). This is all totally normal. There should be plenty of mortality among young, venture backed companies. If there’s not, something weird is going on. At this point, there were a lot of Series A investments in “Web 2.0” stuff done in 2006 – those companies are now running out of money and need to raise a Series B. Some non-trivial percentage of these companies should not be able to raise a Series B for a variety of reasons, including (a) poor performance, (b) overly crowded segment where the companies are “me too” companies, (c) difficulties between management and the investors, and (d) “stuff just didn’t work.” There’s nothing special going on here – it’s just the normal VC-backed company cycle.
Do you think that entrepreneurs and VCs are finding that though it is much much cheaper to start up companies these days, because of the rising competition with more companies getting funded, you now need to put in more money to make your company stand out? Any ballpark estimate of how much more? It’s much less expensive to get started – that’s been well documented. However, at some point you have to go from a web-based prototype to a business. Many of the companies that were acquired by Google and Yahoo in the past 18 months were in this zone and they ended up getting bought before the moment of truth came. This prompted lots and lots of me too companies – none of which will be bought by Google, Yahoo, or anyone else. So – once these companies get a prototype up and running (their “beta”), the probably will need some money to get to the next level. We’re now in that zone – where the rapid prototypes have flooded the market – and the companies that emerge will actually need to build out infrastructure (that costs money), a team (that costs money), a salesforce or channel (that costs money), deeper technical capability to scale the business (that costs money), and so on. Fortunately, this time around, most rational people realize that it doesn’t take $75m to build a web-based software company – the number is more like $15m – $25m. So – the money is spent slower and more intelligently in the success cases.
If that’s the case, how do you spend that money? What can work to help you stand out? (Examples would be great). “Build it and they will come” happens rarely (e.g. Youtube). However, when they come, you’ve got to put together a bunch of infrastructure and that costs money. Most of the money is being spent on three things: (1) distribution, (2) engineering, and (3) infrastructure. Distribution is the tricky one – it’s a combination of marketing, sales, and business development and you’ve got to get the mix right. Many early stage companies don’t really know who their customer is, what their channel is, or how they are going to get to it, so the spend here is inefficient.
What lessons can be learned from the companies that are getting wound down? If you aren’t going to make it, take your medicine gracefully and move on. Life is long and most successful entrepreneurs (and investors) have plenty of failures in their past.
Are any companies you’re involved with going through this? Not right now, but it’s inevitable that some will.
Do you expect more companies shut down either soon or later this year? What kind of companies? (IE are there areas where there simply are too many companies?) I think there will be a steady stream of failures. That’s normal and should be no surprise to anyone.