Comments on: Q&A: VC Economics – Web 2.0

By: Lucinda

Lucinda — Tue, 28 Feb 2006 02:24:14 +0000

As the CEO of several successful (and not) venture-backed companies, I think that the question starts with a mistaken premise. I’m in the thick of a Web 2.0 start-up and I don’t see a typical large fund as a natural investor. $100m exits will be hard to find for most 2.0 companies; most 2.0 companies can be built with only a few $million. So neither the need nor the exit will be there for a typical large fund.
More importantly, though, funding shouldn’t drive “what the entrepreneur is shooting for”, rather “what the entrepreneur is shooting for” should drive funding strategy. At some point during the bubble people shifted to seeing funding as the key to success. The key to success is providing huge value to customers profitably. As long as you do that, you’ll be able to attract funding. Funding from whom will be based on the business – its capital needs and its exit potential. Venture capital is extraordinarily expensive and should be used only when the dynamics of the business require it.

By: Simon Brocklehurst

Simon Brocklehurst — Tue, 28 Feb 2006 01:06:52 +0000

“they are typically looking for are both higher multiples and higher absolute returns”

Might be nice to put some more flesh on this for people – even though there’s no one-size-fits-all. For what it’s worth, my rule of thumb, from an entrepreneur’s perspective, is: if a VC’s fund is $300M – $500M, then they will be looking to invest $30M-$40M over the life-time of an investment; and they would regard an exit in the low hundreds of millions of dollars as success (say $250M). You can scale these numbers down for smaller funds.

In terms of multiples the VC will achieve on these numbers, the critical phrase in the above is: “over the life-time of the investment”. That is, the investment will need to be staged in order that the VC gets the kind of stake in the business they need, at exit. The Series A isn’t what counts here. Rather, it’s the later rounds that matter. After the Series B, entrepreneurs should expect the VCs to have a controlling stake in the business (unless they have a really super-hot company). Nothing particularly wrong with that. People just need to be aware of it.

The other thing that makes an investment an attractive proposition is if there are lots of options for exits along the path to building a multi-billion-dollar company. This lets the investors take advantage of any peaks in the asset value cycle as well as building for maximum long-term value. Entrepreneurs need, thereore, to understand exactly what drives the value of their company (which many seem not to do).

By: Alan Warms

Alan Warms — Mon, 27 Feb 2006 23:04:33 +0000

I have a different question — why in the world do you need $2- $6MM to build a web 2.0 company? The stack is basically free, you can outsource development if need be, and there are plenty of ad networks to avail yourself of (yes i know bad English). As an entrepreneur, if you raise that kind of cash, you’re going to go hire a bunch of people, and then be in a position where you have to be top 1% of top 1% to breakeven and start to cash flow. Why not set yourself up where your burn is only 20-30k a month (easily done with this technology IMHO), get to cash flow positive, and then decide why you need so much money. Think about nice it would be to sell a $1MM cash flow business for $10MM and you own all of it. If you raise 2-6, forget it. This isn’t software, where you need to hire all these developers and sales and marketing ahead of revenue. These are generally consumer services that can be bootstrapped very very effectively. My advice to most entrepreneurs has been: take less! Take much less! Nothing against VCs — just be sure you are raising money for the right reason; ie your business REALLY needs that much cash NOW and without it your business will not succeed

By: Jack Krupansky

Jack Krupansky — Mon, 27 Feb 2006 22:34:26 +0000

As the question author…

Implicit in the moniker “Web 2.0″ is the implication that eventually there will be a “Web 3.0″. Three years is a dog’s age in Internet time, not to mention the fact that hardware will probably have advanced very significantly in those 3 years as well, particularly for handheld computing devices and wireless connectivity options. Computes, storage, bandwidth, devices, etc., will all be… quite awesome in 3 years.

To put it more simply, can anybody offer any really solid reasons why the market won’t have moved on from Web 2.0 to Web 3.0 or even beyond by 2009?

I’m really trying to ask this in the context of venture capital investment decisions. If you’re “building to flip”, then three years should be plenty of time and there would be no reason to look beyond the current Web 2.0 feature set and current hardware and software platforms.

But, if you’re investing in what you think may be the next Microsoft or Google, presumably you’re much more interested in the quality and depth and flexibility of the team, so that you have confidence that they really will be able to pull off “the second product” that is radically different from their initial product vision and that will be able to exploit the next generation of hardware and software beyond Web 2.0.

I agree with the overall thesis that we’re in the early days of the overall Internet evolution. My question related only to the Web 2.0 phase and how venture capitalists think about short-term opportunities versus longer-term vision and capabilities.

One of my pet peeves is that I read descriptions of current “Web 2.0″ businesses and they offer no clue as to the overall corporate vision. If you’re investing in such an outfit, surely you must expect a little more “vision” of the future than simply the current Web 2.0 feature-set. Unless of course your only goal is the flip.

So, I’ll turn this into a new question: What qualities should a VC look for in the entrepreneurial team to ensure that the investment is for the long-term (Web 3.0, 4.0, and beyond) and not a one-shot, flash-in-the-pan, one-trick-pony “hit” that has a higher probability of being a flip than the next Microsoft or Google?

– Jack Krupansky

By: Brad Feld

Brad Feld — Mon, 27 Feb 2006 17:17:53 +0000

I fixed the insure / ensure typo.

Re: the question – I don’t know what possible situation this would be true. As an investor in Internet-related stuff since 1994, with the exception of a period between the fall of 2000 and the winter of 2002, I’ve enjoyed every millisecond and see no end in sight.

By: Jason J

Jason J — Mon, 27 Feb 2006 17:03:48 +0000

Two comments: first one is a minor pet peeve–you used the word “insure” in the second to the last paragraph where the word “ensure” was probably more akin to your intended meaning.
The second is far more interesting to me: Under what possible scenario would the window for web 2.0 opportunities close in three years? Is the author proposing that all the possible internet businesses will be used up in that time frame? It seems to me as though we are still at the beginning of the great internet “land rush”, so I am truly curious.

By: Marc

Marc — Mon, 27 Feb 2006 16:46:13 +0000

Others would answer that if the entrepreneur has no better carrier plan than inserting himself in the payroll of a behemoth, he’d better start by scanning job postings. Such a plan hardly makes it for a vision and a strategy. It also relies on the assumption that the behemoth is too dumb to think of it by itself. Big mistake (although I know some of these beasts that are brain dead for a while).

Moreover, there is a fundamental flaw in the question: you should ALWAYS aim at the largest company value at term. For one because you can’t predict what it will be (if you’re that gifted, better start a consulting business on Sand Hill Road). Second, because considering a trade sale at some point in time during the life of the venture, is a plan-B strategy. It means that you’re no longer considering that you’re able to grow the business by yourselves. Then it’s time to dress-up the fianc�e, ring the doors and call it synergies.

And if you meet a VC that smiles when strategizing with you about how short it will take to reach a $20M sale, run. Because that VC will very very soon quick your ass out of your own company and put some “suit” in your chair.