Web 2.0 Disrupting VCs? Clavier Thinks Not

Web 2.0 changes a great deal for companies and people in general. But the question has recently evolved as to whether or not it changes the fundamentals of venture financing as our friend Rick Segal has been contending. Rick has some ideas in the formative stages that he says will disrupt the venture community’s status quo. So far, we’ve found his thinking stimulating—but to date we’ve only taken a small sip of Segal’s blended KoolAid.

We thought it was time to ask around to see what people more knowledgeable than ourselves might think, so we turned to our friend Jeff Clavier, one of the Web 2.0 mavens who seems to us to best understand venture investment from the perspective of multiple views.

In 200, Jeff became a general partner in the Reuters Greenhouse Fund, the corporate venture arm of Reuters. He eventually moved to California to run the US office of the London-based fund.

In 2004, he left to start SoftTech VC, a venture consulting firm that focuses on seed-stage Web 2.0 companies, where he earned respect for his sharp eye in picking a long and generally impressive list of promising companies at the seed stage.  The list includes Edgeio, Kaboodle, Loomia, Buzznet, Feedster, Userplane, Glenbrook Networks, and Truveo, which was recently sold to AOL.

We asked Jeff a few questions regarding Web 2.0, investment and Segal’s envisioned opportunity for disruption.  The two are apparently not joined hip-to-hip in agreement. Here are his answers as he gave them:

1. Do VCs “get” Web 2.0?

Yes, most VCs with prior experience investing in consumer/Internet startups get Web 2.0. What is less clear is whether/when/how they should get involved in these companies that will often achieve a lot with minimal/no financing, and will then be expensive to invest in.

2.How have today’s startups changed from five years ago?

They are cheaper to start (open source infrastructure, low cost hardware/bandwidth, off shoring), hence cheaper to operate. Online advertising has developed to a point that allows small companies to get to profitability provided that they address a specific demographic that can be effectively targeted with relevant advertising.

3. Everyone seems to agree that Web 2.0 has generated a lot of noise. Do you think there is a boom or bubble forming?

No bubble, because only small amounts have been invested in the space - and therefore even if all Web 2.0 companies were to go bankrupt, the loss would only represent a few percentage points of the yearly VC invested total (roughly $22/24B). It is however true that there is a lot of activity in founding startups and early stage financing.

4. Some Web 2.0 companies seem to require very little funding to get moving. Is this a challenge for a Venture fund that has raised say a $100 million?

It is true that startups do not need much capital to get going. However capital might be required for the company to scale to hundred of thousands or even millions of users, especially if the company is dealing with audio or video content. Only a small percentage of companies will be able to scale on their cash flows, or be taken out early as Flickr, Del.icio.us or Truveo were. An early stage VC fund of $100 million will actually do well in that context, the issue is more for funds of several hundred million dollars that can not only invest early stage.

5. Is there a way for a VC today to make a micro investment?

They can and some are actually doing it - investing a few hundred of thousands seeding startups to help them prove their concepts before investing additional dollars in subsequent rounds if the idea is worth it (and cutting their loss if it is not). The question is whether a fund can justify the opportunity cost of making small investments, and actively support these companies. Certain Tier 1 funds will claim they do, while others will wait to be able to invest their stated minimum of $3 to $5M to engage - which might mean they will be unable to get a seat on the table, or will pay dearly for them.

6. Rick Segal, as you know, is making a lot of noise about disrupting traditional VCs with a new, low investment, fast-transaction game plan. What are your thoughts on the wisdom or foolishness of his thinking?

What I have read from Rick seems very similar to what angel investors do when they invest through an equity round as opposed to debt. The real issue of the industry though is the very limited number of exit avenues for software/Internet startups - where only a handful of companies are potential M&A suitors and IPO markets are virtually shut. Coming back to the question: helping the industry evolve maybe, disrupting I don't see it - just because the number of companies for which Rick's hypotheses apply is too limited to generalize them.

7. What is the future of the current crop of Web 2.0 startups. Will the best all get scoffed up by Yahoo, Microsoft and Google?

A small number of companies will be acquired early before they reach scale or revenues (as opposed to the current fantasy that GEMAYANI will acquire them by the dozen). Another small number will reach profitability and will have their options open, and the majority will either hit the wall or operate small enough that their founders will be able to keep them running alongside  their regular day job.

The best companies will most likely be approached by a number of large players at different stages of their development, and it will be up to the founders and their stakeholders (employees, investors, families) to decide what is the right number/time to sell.

8. Is there an IPO climate forming for today’s Web 2.0 startups?

Nope, except if companies have $80M in revenues, profits, growth, etc. Not that many companies satisfy these requirements, and if they do, a private equity buyout might be an alternative.

Comments

[/pd]

Not sure if I agree with the IPO part of it.."except if companies have $80M in revenues, profits, growth, etc." - lets me specific here !! Profits of $80M wit the marging rate beihng 20%, then its pretty simple maths to let me know if the IPO is worth it or not.

But if its Revenue of $80M, then the chances of Market capitlization is very slim...

classic e.g of Web2.0 company is riya, iotum both cutting edge, not been snatch up by the other players.. ripe of VC fund management and risk taking... yet IPO status is dicy !!

[Jeff Clavier]

Peter> I threw revenues of $80M just to indicate that companies had to show serious revenues/profits before thinking of going out, and you could argue that it has to be even higher. There was a time when $40M in revenues was enough to consider filing an S1.

[/pd]

I agree, Jeff. Maybe I kinda took the figure literally and it went against my grain.... As an indicator of "health" for risk investment, I'll conceed the point. you are bang on-- either its serious revenue and/or profit..

[Jack Krupansky]

One of the things an entrepreneur gets from even a modest investment from a big-name VC firm is their networking potential, that your average neighborhood angel investor usually will not have.

Even if a grand Web 2.0 concept is actually just a collection of features of interest to a GEMAYANI, the "connected" VC will stand a fairly good chance at being able to flip a Web 2.0 venture to one of the major players for at least a little more than the idle cash would earn in T-bills.

And, although Yahoo, et al *could* develop some Web 2.0 features in-house, they most probably wouldn't be as far out, cool, and edgy as what may come from an entrepreneurial venture.

And, in today's ultra-tight IT market, a lot of VC's with an information technology interest are probably sitting on much more cash and time than they would like anyway, so a little cash and a little management attention actually could go a long way with a Web 2.0 venture. Especially compared to doing nothing, or even worse, investing in some mediocre IT venture that will probably turn into a vast sinkhole of cash and management attention anyway.

At least with your average Web 2.0 venture the downside for both cash and attention is rather modest and somewhat a no-brainer.

Personally, I don't think the big VCs should be going after most Web 2.0 opportunities, but the opportunity cost is probably quite low given the dead-zone of traditional IT opportunities at this juncture.

I wouldn't view Web 2.0 so much as a major disruption for the VC sector, as simply the only "fun" game in town while the VC wait for the IT sector to truly come back to life.

-- Jack Krupansky

[Shel Israel]

Jack,

All good points. But if you can get to customers, partners, prospects and even future hires through blogging, the question becomes--is the VC Rolodex as important as it used to be?

[Jack Krupansky]

Shel: That's certainly a good point as well, but "get to" raises the issue of the quality of the connection and the reputation of the "caller". Essentially, how likely is it that your contact will in fact lead to a desired or acceptable deal.

Sure, you can blog about an opportunity, email specific "targets", meet them at a conference, even call them up on the phone, but there will be a somewhat tedious vetting process if they've never dealt with or heard of you before.

So, if you have a new Web 2.0 venture and you're anxious to do deals with key strategic partners, I *think* you really want that VC who already has strong ties to your desired stategic partners.

Sure, blog away, but unless you are an A-lister, how likely is it that the key GEMAYANI execs are really listening to your blog?

A little test: Are any of you GEMAYANI execs who are hot to do Web 2.0 deals actually reading this blog? Even if so, are you reading Z-list blogs as well?

Incidentally, I'm amazed that there are actually Web 2.0 startups that *don't* have blogs right up front on their web sites.

-- Jack Krupansky

[Jeff Clavier]

I agree with Jack: blogging provides reach, real rollodexes provide actionability.

[Graeme Thickins]

right - tough to compare VC rolodexes to what startups could ever do with blogging...