Dead 3.0

It’s refreshing to see someone else thinking the same things I am. “Drama 2.0″ (no link, unfortunately) wrote about the Web 2.0 “Summer of Love.” The comment is reproduced in full below:

“Andy, It isn’t about the money, not at all. It’s pretty easy to get money. It’s about the opportunity, the connections, the mentoring, the camaraderie with the other teams and the ability for us to leave our full time jobs to bootstrap for 3 months.”

Andy: how is giving up 2-10% of your company to an angel for $5,000 base plus $5,000 per founder bootstrapping? The typical definition of a boostrapped business is a business that is started without external investors. See:

http://en.wikip…_%28business%29

As I’ve said before, from an investor standpoint, companies whose founders show an ability to make the most of limited resources are very appealing. If a guy comes to you and says that he was able to build his product without taking on any outside investment by using credit cards, home equity loans, creative deals with third parties, etc., that shows some real business savvy and determination. It also shows that he has enough confidence in what he’s doing to put his own arse on the line before asking me to put my money on the line. It doesn’t guarantee success, but if somebody is eager to give me 2-10% of their business for a low five-figure amount, I’m probably a bit underwhelmed. A huge part of success in business is being able to deal with challenges. If a founder is successfully able to deal with the challenge of not initially having easy access to the money he needs to get his product built or business off the ground, he’s proven some ability to deal with a major challenge, and that puts him above founders that can’t scrap together $10-$20K themselves.

I will not argue that the connections, mentoring, camaraderie, etc. you might find with a TechStars or YCombinator have no value whatsoever, but I frankly I think there’s too much back patting and ego-stroking going on with startups these days. In my opinion, when done to the excess we’re seeing today, it’s not healthy and distracts from the real purpose of a legitimate startup: creating a product that a viable business can be built around. Mentoring and camaraderie are fine up to a point, but you don’t build a company for social purposes and it seems like there’s a “Summer of Love” mentality to a lot of the Web 2.0 stuff that’s going on today.

“That is VC’s, angels, people that have made it already… These things cannot be priced. Also on top of that we all know how clique VC’s are and as such when VC’s and angels like those running the start-up schools give your startup some lovin’ then they’re all the more interested in you.”

The question is whether you really want or need loving from VCs. I think the biggest mistake young entrepreneurs make is thinking that VCs will lead them to the promised land. Many young entrepreneurs look at investors who have money and individiuals who have achieved success and are easily hypnotized. These people have one goal when they invest in your company: to make money and maximize their returns. Don’t forget that. If you are only capable of seeing the potential benefits of that and can’t see the potential problems it creates, you shouldn’t take their money.

In addition to capital, investors do supply you with advice, connections, etc., but at the end of the day they cannot guarantee the success of your business. If your business model isn’t solid, you’re not able to execute, etc., all their money, connections and past success are very unlikely to do you any good. As Guy Kawasaki says, everything he touches does NOT turn to gold - “If it’s gold, Guy will touch it.”

Additionally, when it comes to connections, don’t expect that your investors are just going to shower you with introductions to their most trusted contacts. Just because Sequoia invested in your company doesn’t mean that you can get a lunch meeting with Sergey Brin and Larry Page. I think many founders overestimate the extent to which investors can or will provide them with connections, and many investors oversell their “network” and how it will benefit portfolio companies. The bigger truth is that you can develop a network of key contacts on your own. Build a product that really takes off and you’ll find that important people will take your calls and may even call you.

“Your supposed to at the end of 3 months / have something to show for a bigger round of VC funding”

Pallet Jack: therein lies the problem. I think young founders are often seduced by the lure of VC and believe that it’s a requirement for building a successful technology company. Therefore getting locked into subsequent rounds of institutional funding when you participate in a program like TechStars or YCombinator doesn’t seem like a big deal. But it’s probably the biggest decision these founders will make when it comes to their startups. How you decide to finance your company dictates how the company is built, the timeframes for execution, the control founders have, the available exits, etc. Going the equity financing route is almost a requirement for some types of technology businesses, and it’s often a good route, but I think far too many founders think it’s the only route. They don’t realize that it can lead to failure just as often as it can lead to success.

(Editor’s note: I did apply to TechStars and was not selected. I think the TechStars business model is sound… but maybe not their judgment.)

TechStars, the Y-Combinator-like startup incubator, selected its first round of ten companies, according to TechCrunch. I cannot find a list of all ten companies but the post lists two startups: (1) Intense Debate and (2) socialthing (by digitalsoap). Also absent is any notice on the TechStars blog.

The majority of comments focus on the amount of equity being given up but that’s a non-issue. If you sell your idea cheaply, it’s your own fault. And I would argue that the valuations reflect the very high risk of funding people without a track record. Entrepreneurs and investors are on the same page. It was the first comment that made me cringe though:

This is what I love about web 2.0..everybody who is smart has an equal chance…well almost equal chance..it would be exciting to see if these companies become the next “it” thing

I completely disagree. Not everyone has the same chance. There are hundreds of smart people out there. The majority are not good at entrepreneurship, just like the majority don’t play pro baseball. Web 2.0 has not changed the equation. Entrepreneurial success takes intelligence but it also takes passion, capacity to execute, timing, risk management, personal work/life balance, a great idea, sales skills, networking skills, a bit of luck and a thousand other things I’m not thinking of at the moment. Not everyone has those. It’s scary if people believe stuff like the above comment. A good idea isn’t a good business necessarily.

In my opinion, the funding TechStars offers is not the most important part–its the connections and networking opportunities. But with 70 percent of the companies being B2C, I am leery. Think about it: the key to consumer-facing social applications is achieving scale. There are thousands of networks out there, only a few have really hit it big–why? The MySpaces and Facebooks of the world did so by either: (1) being there first or (2) defining a niche. Timing and niche building aren’t easy. I wish all companies selected the best of luck. I’m sure they’ll be developing truly interesting ideas. But what I worry about is if those amazing ideas will make amazing businesses. Some ideas are too innovative–the world just isn’t ready for them yet. I am interested to follow the progress of these ventures in the coming months.

Here’s my prediction on Web 3.0… Veteran software execs leverage their own personal connections and a new generation of entrepreneurs (who grew up with the internet and truly know it). Some equity funding to start initial development. Mentoring and networking around follow-on funding. Connections to experienced developers, designers and project managers. Execs (now investors) sit on the Board of Directors (or an Advisory Board) and do a lot of the selling. Teach the founders how to pitch, how to sell, what clients look for in a presentation and then get their foot in the door. It’s a recipe for success for everyone involved. I would even go so far as to say the specific execs who sit on the Board of any given company should be given a direct financial interest in the company (as opposed to the incubator as a whole) to encourage active participation. Students do the legwork for very cheap, execs talk to their contacts, everyone cashes out, everyone wins.

Update: priceless comment via TechCrunch in a follow-up post.

Via Mashable, Facebook is surveying users on a proposed classifieds system. Free to post on your network and a small price to post on other networks ($0.50 to $5.00 in the the survey). Smart move to test the price elasticity pre-launch. This is another way Facebook is reaching out to users, something I recently talked about here and on VentureBeat.

I read an interesting article on OnoTech on the need for craigslist to innovate. It’s all the more important given this announcement. Facebook is the site for a healthy portion of America’s youth. If this service achieves a critical mass, craigslist (of which I am a huge fan) is no longer the classifieds site. Smart move by Facebook to keep users coming back. It makes perfect sense to slowly roll out services with real value to users.

More as it develops.

For the most complete information, see Virginia Tech’s Collegiate Times. It’s been all over the news but it’s still shocking. Watching MSNBC yesterday morning, I couldn’t believe my ears when the fatality count rose from one to 20 in the blink of an eye. The final count of 32 struck close to home. Charlottesville, VA is a short two-hour drive from Blacksburg, VA and more than a few good friends from high school attend Tech. Thank God they’re all safe. In the moment after the shooting, the outpouring of grief from fellow students across the county was immense. I got multiple invites to join Facebook groups reaching out to support our peers at Tech. The group I am in at UVA already has over 2K members. The Collegiate Times has a piece on the Facebook outreach related to the shooting. Students are using Facebook to support our friends and family at Tech, organizing vigils and expressing sympathy. I rarely run out of words, but there really isn’t much else to say–yesterday was a sad day for all students, Virginians and Americans. Please take a moment of silence to pray for those affected, their friends and families.

Update: see my post at VentureBeat on the same topic.

(Editor’s note: I didn’t think about it at the time of writing, but the title of this blog (Dead 3.0) is somewhat ominous given the topic of this post. The title has nothing to do with the shooting, instead referring to another blog (Dead 2.0) which covered the myriad of foolish startups currently being launched (and their subsequent demise). Oversight on my part, apologies.)

I wrote about Aggregate Knowledge (AK) last week after they raised a $20M round of financing. Chris Law–an AK founder–gave some background on why they decided to raise capital versus grow it organically. I agree with his analysis and have several additional points.

First, he points out that AK was wrong in its estimation that discovery services would not come into the limelight until 2008. On the heels of rumors that AK boosted Overstock.com sales by $100M last year, 2007 begins to look like more of a coming-out year. Raising a large second round allows AK to cement its position. The size of the round serves a barrier to entry to potential startups–going up against an established venture with non-trivial funding now looks much less attractive.

Second, the financing allows AK to expand its sales and marketing in its two verticals. They currently target two sectors: (1) Discovery for Retail and (2) Discovery for Media. What I see here is the beginning of a successful segmentation strategy. By slicing up the market vertically, AK can demonstrate success in a particular niche. By being the experts in Retail and Media discovery, AK can get the big deals. This compares to one-size-fits-all providers with generic solutions. The biggest enterprise customers want a solution that meets their exact needs. They demand specialized (and proven) solutions to justify large expenditures. Look for AK to not only expand in these two verticals but to also replicate their success in new niches.

Third, AK needs to finance infrastructure and capex. AK’s Collective Discovery Network (CDN) is currently in beta testing. The CDN correlates data across seemingly unrelated sites. According to AK, their technology is built on a “sophisticated, super computing architecture.” The complexity of the AK system is daunting–they’re aggregating and correlating billions of data points across multiple sites. The computational requirements make my head spin. AK would be smart to invest a healthy portion of this latest round into their data center(s). Look at Google–their competitive advantage in large part stems from the massive economies of scale they leverage.

Fourth, AK is expanding its product portfolio and stretching its platform. AK offers two supplemental services: (1) Discovery for Email and (2) Discovery for Mobile. Personalized emails were popularized by companies like Amazon. The Discovery for Mobile interests me a lot more. Mobile is a platform that no one owns yet. There are a lot of companies doing interesting stuff in the space, that’s for sure. But no one has found the right formula. Someone is going to break mobile open, will AK be the platform that makes that happen? Google did it with text ads, targeted mobile ads are the next step.

Finally, I read an interesting post at VC Ratings about Web 3.0’s fast approach. According to the article, Randy Komisar, a general partner at Kleiner Perkins Caufield & Byers (an AK investor) “dismissively defined Web 2.0 startups as those that rely on an advertising business model to build their business.” That statement is one of the reasons I started writing this blog. I see too many consumer-facing, advertising-driven startups without any serious business model. Some types of sites, like media, entertainment or very targeted content, fit well with this model. But advertising isn’t applicable, viable or sustainable in many cases. Great ideas aren’t necessarily great business models. Until you generate cash flows or someone writes you a check (either funding or acquisition), the value of your venture is $0. KPCB (or at least Mr. Komisar) seem to understand that. Actions speak louder than words and this recent round of financing is another vote of confidence for AK.

See my post at VentureBeat about Facebook’s new design and changing direction.

Aggregate Knowledge (AK) has closed a $20M Series B financing round. The company tracks user behavior and provides personalized “discovery” features to boost top-line revenue growth for its customers.

VentureBeat confirms a post-money valuation of over $70M. This latest round brings total financing to $25M. VentureBeat also notes that AK has secured the right to use behavioral data across sites (competitor Omniture does not currently have this right, according to CEO Paul Martino.). This is a very smart move. By tracking users across different sites, AK can develop a more complete picture of a user. With more information, targeted information becomes more accurate and relevant, driving revenue. TechCrunch reports AK has aggregated information on over 50M users through its 15 customers.

AK is a poster child of a movement that has been overshadowed. While the consumer-facing side of Web 2.0 applications has received a lot of press, the business applications that are being developed operate behind the scenes. In my opinion, the new titans of the software industry will come from this segment. AK provides real value to its customers. For a business to be sustainable, it needs to generate revenues not buzz.

Not too long ago, Facebook posted some interesting graphs on its blog. Ashkan at HipMojo posted an interesting valuation of Craigslist that got me thinking about Facebook’s value. Ashkan derived advertising revenue by multiplying pageviews by click through rate (CTR) by cost per click (CPC). Although Facebook is nothing like Craigslist, a quick, back-of-the-napkin look at Facebook through a similar lens is interesting. View the Google Spreadsheet I put together.

The first sheet (PAGEVIEWS) is based on the aforementioned graphs. Pageviews and registered accounts are growing 18.9% and 13.9% per month, respectively. Note the December drop in pageviews, but not registered accounts. Is this due to students being on winter break? I wonder if the site experiences a similar drop during the summer months?

The second sheet (CPC-VALUATION) is based on February pageviews (other assumptions are noted). CTRs among the Facebook demographic are likely below average. According to ValleyWag, one advertiser pegged the CTR at 0.04%. There’s a column for 0.04%, but I’ve highlighted the CPC range $1.00 to $1.50 and CTR range 1.00% to 1.50%. Why? These are the same numbers HipMojo assumes for Craigslist and I think they are achievable. As a (very) active Facebook user, I do not think they are fully utilizing their advertising platform. CTR could be raised by increasing the value and relevancy of the advertisements–more on that later.

I don’t think Facebook is worth as much as the highlighted cells show. A 35% profit margin and a 30 P/E is logical and relatively conservative though. HipMojo values the company at a little over $2B based on a social networking market size of $2.15B. I’m inclined to think this is much closer to the truth.

The third sheet (FB-REVENUE) is based on a ValleyWag-obtained screenshot of a company forecast. According to ValleyWag, rumor says Facebook is on-track to make $150M in FY07, a little below estimated. Of the estimated $172M in revenue, we see $139 derived from advertisements. We can back into this number using eCPM and impressions generated (eCPM/1000*impressions = 139M). MSNBC quotes a lower number of $100M.

Now my opinion: Facebook is a more powerful platform than MySpace. It’s because the Facebook community is really a thousand smaller walled-in communities (versus the chaotic MySpace). I remember using Facebook when it was still a group of elite schools. Not much has changed since then. Facebook has been careful to not commercialize the site and alienate loyal users. They’ve taken steps to solicit user feedback. They’ve implemented privacy controls and strict divisions between local networks that have fostered a greater sense of community.

While Facebook’s decision to outsource banner and search advertising to Microsoft guarantees them $200M through 2008, there’s an opportunity cost. Facebook recently (via PaidContent) extended the contract till 2011, a smart move if they’re thinking about pursuing an IPO, as HipMojo suggests. Yet there are two factors that make Facebook a powerful ad platform: (1) user data and (2) local communities.

First, Facebook users have willingly provided billions of data points to the company. Everything from Greek affiliation to favorite movies to interests and activities. So far, Facebook has not extensively leveraged this data to target advertisements. They are making moves to increase the amount of content though. New “sharing” features reveal Facebook’s plan (Andy Kessler, WSJ interview with Zuckerberg) to take advantage of user-generated content.

Second, Facebook needs to start thinking like college students. Local communities are based on local information-there are a thousand possibilities. Why not coupons from local restaurants? “Click here right now and get $1 off your pizza!” There are already some local advertisers posting flyers on the site, but Facebook hasn’t reached out to this segment of marketers yet. When it’s all said and done, Facebook’s users are worth more than MySpace users, in my opinion.

Sooner or later, investors such as Greylock, Accel and Peter Thiel are going to push for a harvest of their investment. Whether Zuckerburg and the VCs opt for an IPO or a big acquisition is an open question. At the same time, there’s no question Facebook represents an attractive target for companies looking to secure a well-established toehold in the social networking market–despite Facebook’s penchant for turning down buyout offers.

Check out my post on the newly launched StreetAdvisor over at VentureBeat.

Quick off-topic opinion post… You can’t turn on any of the news networks without hearing constantly about Legislative v. Executive. Regardless of your political orientation or personal opinion of George W. Bush and his administration, he has remained continuous on one point. Throughout his tenure, Bush has always attempted to assume the moral high ground. Yesterday, I was surprised to hear the restrictions being placed on White House personnel testifying before Congress. The no-transcript requirement seems somewhat logical to me. But the no-oath requirement flies in the face of Bush’s previous behavior. As a man of faith and character, George Bush is honor bound to tell the truth. Without an oath, he seems to be endorsing or at least allowing his administration to lie–it seems to me that Bush is folding is last card, the moral one.