For years, this is how companies built value: They identified a need in a market, sized the opportunity, developed a viable solution for that need, ran the numbers and defined potential. Establishing value was a market-driven process, pure and simple. Investors calculated their ROI based on the market opportunity and an ability to scale, then gauged risk factors and plunked down the bucks.
Then along came the promise of technology and the internet. That mystifying thing that promised vast and sudden riches. The siren song of undefined potential. Venture capital companies threw billions at .coms. Forbes and the Wall Street Journal encouraged the public to invest in risky companies, despite their disregard for basic financial best practices. The markets exploded.
At the end of that rainbow the bubble burst. The resulting crash lasted years and generated a loss of $5 trillion in market value from March 2000 to October 2002. NASDQ lost 78% of its value. Many .coms ran out of capital and were acquired or liquidated. Where is Boo.com? Broadcast.com? Or FreeInternet.com? And a ton of others. In 2001 AOL acquired Time Warner in what has since been described “the worst deal in history”. Those were tough times.
Lesson learned, right? Ah,.. not so fast. If we went to school on the first bubble, why are millions, even billions being invested in companies with no revenue models, and no defined market? Simple – investors have learned they don’t need companies with revenue to get rich.
The propagators of this mentality? The venture community itself. In Silicone Valley they’re brushing off the notion of another bubble. And they’re financially motivated to do so. See, they sell what might be; a dream of found opportunity. Startups are often advised not to make money too quickly. Obviously counterintuitive, yet for investors, open-ended hypothetical projections inspire a get-rich-quick mentality.
Paul Kedrosky, a venture investor said it well, “It serves the interest of the investors who can come up with whatever valuation they want when there are no revenues. Once there is no revenue, there is no science, and it all just becomes finger in the wind valuations.” When small startups do make money, they often find it difficult to raise new investment as many VC’s know it’s not feasible to build a viable long-term business. Instead they see their ROI in the get-out-quick model. They’re interested in pumping up enough hype and valuation in an attempt to find a quick exit through an acquisition, merger or IPO, and at fantastic returns.
In this short-term, rags-to-riches mentality lessons have been lost. The truth is, 90% of tech startups fail today. Dreams of these riches are born of relatively few, but admittedly spectacular successes. From the 90‘s, eBay, Google, and Amazon all more than survived and today have significant market valuations. Facebook, LinkedIn, You Tube, Twitter all thrive today. Last year, Instagram, which had zero in revenue was acquired by Facebook for $1 billion. And there have been dozens of multimillion-dollar acquisitions of startups that made no money whatsoever. FriendFeed, Zite, Hot Potato, Beluga, GroupMe, TweetDeck and Dodgeball are just a few examples of well funded ventures with little to no revenue. But look deeper and things begin to break down. Hot Potato has been shuttered. Beluga, after raising $10MM in investment, sold to Facebook and now can’t be found.
As you would expect, picking a winner can be a crap shoot. The saturated social space is particularly precarious. Years ago AOL purchased Bebo for $850 million, while News Corp. acquired MySpace for $580 million. Both reported annual revenue in the eight figures. Yeah, that worked out well. AOL later sold off Bebo for $10 million, while News Corp. flipped MySpace for $35 million. After millions in investor dollars, Second Life has barely 1 million monthly visitors. It never lived up to its media-fueled hype and, today people mostly forget it exists. In 2009, two location-sharing services, Gowalla and Foursquare, went to battle. Gowalla raised $12M in 2009. Today, only Foursquare remains. Gowalla closed its doors in 2012. Remember Plaxo? The company launched on November 12, 2002 and was funded by venture capital including funds from Sequoia Capital. Plaxo was then sold to Comcast in May of 2008. Today, Plaxo is an also-ran in the professional networking space. And while it exists today, I’m not really sure what it is.
It’s happened in search. In 2009, an upstart tech company, Cuil, went after Google. Cuil CEO Tom Costello invested in a team that included former Google employees and went on to raise $33 million in VC funding from big dreamers. By September 2010, Cuil was no more than a footnote in the history of the Internet, with its servers shut down for good.
Acquiring purely for capability has its place. These tend to be good bets if you spot them early. Skype acquired GroupMe for a reported $85 million though the group messaging service had no revenue. Founders and investors did very well. GroupMe gave Skype a smart solution for group chats, excellent social data and increased synergy with Microsoft. Other examples? Zite, a personalized-news service CNN acquired for $20 million despite having no revenue and no clear business model. CNN got a mobile technology for content distribution, and recommendation technology that may allow CNN to personalize and target its own content. And take Siri, the voice recognition platform that Apple reportedly acquired for $200 million. A significant return on $24M investment for Siri’s investors. What Apple bought was a capability, a competitive advantage, and a driver for market share.
When will technology stop blinding us with its golden promise? How do you invest in something that people don’t know exists or know that they need? Will traditional, stable and scalable investment opportunities grounded in financial best-practices ever be in vogue again? Sorry, silly question. As long as there’s promise for astronomical return, there will always be high-risk gamblers investors. Maybe this fuels innovation, I don’t know. But I do know that in the end, it’s big-time gambling. A kind of Russian roulette. And the variables for success lie with the fickle mind of the consumer – never a safe bet. So get ahead, grab your dice. Have a roll.