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?
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.
