Bubble, bubble, bubble – In Private Equity not Web 2.0 (Classic)

This is the first in an ongoing “Venture Files Classics” written by former Venture Files Editor Steven Fisher. The selections are chosen for historical reference as well as a notorious ability to be right. The original post from January 12 of 2007 can be found here

Being a serial entrepreneur I have been through many business cycles, but the Internet boom of the late 1990′s was an extremely heady time. People were so enamored with what the Internet could do, every one really believed that the old rules didn’t apply.

The reality was that those rules applied more than ever and with the crash in the early part of the century we have tried to learn our lesson.

With these new companies deemed Web 2.0, everyone is expecting another bubble. So many of the same types of companies have been funded so there are bound to be consolidation and just plain failure.

According to Michael Arrington, his entry “Bubble, Bubble, Bubble“, the despite the fact that some companies are failing, the sky is not falling.

In fact I would call this time around the ol’ startup track “saner, saner, saner”.

Despite many of these companies basing their success on being an aftermarket for Google, the smart ones I think many people know that you have to be in this to create a real enterprise and one that makes money. It is not so much about the VC’s but about the ability to use the low cost and barrier of entry to innovate.

But the Dead Pool is not cool

I think that the blog A VC gets it right his counter points on “Building It Up and Then Knocking It Down” are right. He says “over hyping young companies where people are working their butts off and then throwing them overboard quickly into a “dead pool” when they fail is not healthy.

I believe it is dead wrong to put this up there. It just feeds the fire for the chicken little’s of the world. Mike Arrington has known successes when he co-founded helped flip Achex and sold it to First data. I don’t know if he has experienced building a company from scratch and having it fail, many times from circumstances out of your control.

But there is a bubble developing and not where you think…..

The bubble is not with companies it is in the private equity market itself. The model of funding and the way people are evaluating companies is changing. The way investors look at companies is not based on a fast IPO but aligning it to be a sweet acquisition target.

This is helped in no small part since most VC’s invest like they are teenage girls. “Oooo, you invested in a video sharing site, I want one too! You put $5 million into social networking for eco-friendly baby boomers? Find me one so I can get one too!!

Here is how I got there:

  1. The amount of money chasing deals have lightening strike twice to find that repeat of unrepeatable past returns is growing rapidly
  2. The number of opportunities are declining and there are too many copycats plus the cheap money is pouring out to fund them.
  3. Not enough VC’s to serve on boards effectively and make the existing investments get to a proper exit
  4. IPO market is still not there and there is and there are only so many acquisition partners
  5. Higher prices of entry and lower returns

What I don’t know:

  1. When the IPO market might be friendly to tech stocks
  2. If investors will broaden their portfolio choices to get their money working in unique ways
  3. If funds might start giving their money back

Only time will tell if this comes to pass. If you have a good idea, the money is out there but might not be for very much longer.

Crystal Ball? 2-3 years or mid-2008 this is gonna come to a head. Only time will prove me right or wrong.

Editors Note: At the end of 2008, we do now know that the economy has imploded, not simply from web valuations. In fact, web valuations hardly played any part like they did in 1999-2000.

In fact, the web sector has seen much less damage, than the rest of the economy. In fact, there are still investments taking place, if devalued. A series investments for web companies typically range in the $1-2M range which in the larger picture is fairly small. Biotech companies, for instance, typically pull in around $20M for a Series A round.

That does not make the web sector immune, and in fact, Steve is correct in recognizing that there would be a bubble coming, and that it has arrived.

5 Things I Learned from Nuclear Winter

picture-11.png

Nuclear Winter. It’s the time period after a holocaust that can last for hundreds of years, making the surrounding landscape around ground zero uninhabitable due to radiation.

It is the death of life and the birth of a new holocaustic life. We’ve never actually had an actual nuclear winter on a global scale, though the threat is there as more and more nuclear weapons proliferate the globe. Many science fiction stories have been built around the concept of a nuclear holocaust and life after.

Although it’s a dark time, sometimes proverbial nuclear winters are necessary. They are the times when you throw away everything you know and begin from scratch. A chance at a new life. A rebirth. It’s a time to correct all that is wrong and hopefully get on the right path over the long haul. Economists call it “corrections”. Historians call it the “end of an era” or the “decline of an Empire” – depending on the context.

As someone who is not experienced in an actual nuclear winter, let me describe a few things that I’ve learned from proverbial “nuclear winter”

42497244_77eee59002.jpg
Photo by nogoodreason

1. All Assumptions are False

In a nuclear winter, life is not as you expect. Landmarks are gone. People you know are no longer in your world. You can no longer go to the grocery store and instead have to live off the land.

If you’re in a business that is facing massive layoffs, you cannot assume that the way things always have been will still exist in the world post-layoffs. You cannot assume that, even if you retain your job, your “new” job will remain as it was. You will likely end up giving up responsibilities due to business strategy objective shifts and maybe doing some new work due to the need to backfill for laid off colleagues.

You cannot assume that, because we’ve lived in a world of thriving internet startups, that you the lay of that land will remain the same in an economic holocaust. You can’t. It’s just not a safe assumption. Ask Seesmic.

2. Live Off the Land

In a nuclear winter, as described earlier, you simply can’t go to your Whole Foods and buy your hipster organic food. The reality is is that even if you could go buy organic food, it’s likely tainted from the fallout in the water, ground and air. No, you live off the land. You find the bugs and plants that carry an innate immunity to radioactivity or that have evolved enough to live and thrive in a nuclear landscape. Because you have to survive, and that’s more important than getting your Venti Soy Chai at Starbucks (that don’t exist).

More and more companies that continue to emerge these days are bootstrapping. Companies like AwayFind, who launched the other day, are bootstrapping and not taking angel investing or venture capital to stay alive. They are not taking a devaluation just for the infusion of cash. They are succeeding the old-fashioned way – a method that might take a lot more runway, but that ensures that 100% of the value of the company is retained by the principals. If you can live off the land, do it. It might be awhile before you find yourself a Starbucks in the nuclear wasteland.

3. There is Always a Remnant

During any nuclear winter in any story, you’ll always find a remnant. It might just be a small village of survivors that are doing their best to build a community and survive. They may have built a wall of scrap metal around their community to keep raiders away, but they are surviving.

At critical times where the status quo is challenged, the companies that are the hardiest and most cost-efficient are the ones that survive. While companies like AIG require an infusion of cash (or, as I call it, a crutch) to stay afloat they continue to splurge on non-necessities. Companies like this are doomed to failure.

While the auto-industry, built around an inefficient union mentality that, at one end, limits innovation because it de-incentivizes that innovation, and at the other hand overpays under-qualified individuals to do jobs that are worth half of their paychecks, struggles to figure themselves out, they will eventually have to declare bankruptcy. During that bankruptcy, they will be forced to cut, by some estimates, 50% of their workforce while updating their approach to union labor to ensure survival. There will be a remnant, and that remnant will figure out what needs to happen to survive the wasteland.

4. That Bridge Used to be the 14th Street Bridge

Picture 11.png
I’ve been playing Fallout 3 recently, which is set 200 years after a nuclear war between the United States and China. The setting is a region called “The Capital Wasteland” and is, in essence, the Washington, D.C. metropolitan region.

Throughout the game, you can find indications of what used to be. I recognized, in my wandering around the Capital Wasteland, a landmark that could only be the 14th Street Bridge. I would not have recognized it from anything other than geographical position. There were no distinguishing features and it was largely destroyed and falling into the isotope-filled Potomac River, but I knew it was the bridge.

Practices will change throughout life, but principles and patterns remain the same. It is the essence of the Chaos Theory which states that though the universe appears to be full of chaos and disorganization, it is entirely made up of fractals and patterns at an atomic and sub-atomic level. More simply, there are patterns and principles that remain true, though practice, execution and manifestation of those principles change.

In the communications, newspaper, and television industries, as well as many large businesses, people are wrestling with how to do business in a world that is dominated by the internet and then, only recently. They see chaos, where they should see patterns. The principles of public relations is to communicate effectively with the public. The practices of public relations, however, are shifting and the ones that adjust are the ones that will survive that nuclear winter.

5. Know Your Immune System

In a nuclear winter, there’s no one looking out for survivors except the survivors themselves. If there are doctors, they are few and far between. If there is a support community, you have to look hard and not trust anyone. It’s the nature of the new dog eat dog world that such a holocaust causes.

Companies right now are scrambling to figure out “what’s up”. They are looking at their profit margins, cash in hand and extending their runways as far as they can extend them. Investors are reassuring their portfolio companies that there should be a way to survive if they are smart and proactive, but the reality is that in a nuclear winter, no one really knows.

Even if a portfolio company manages to get that C-round and the $15M investment they need, it will be on a down valuation. In layman speak, that means it becomes, in essence, a high-interest loan where the company gets the cash they need but give up a larger stake in the company to make it happen.

The big banks are getting bailout money, but giving up controlling stakes in their companies in some cases. Rollups are likely with smaller companies needing an infusion of cash. People are being reassured that they will retain their jobs, and being laid off the week after. You can trust no one in a winter except yourself. I reiterate my recommendation from a few weeks ago, though. If you have a stable job, stay in it. If you are an entrepreneur, don’t seek shelter in a stable job. Survive, survive, survive…. then rebuild.