More on the “Seed Fund Crash”

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Following up on the “seed fund crash” meme that I commented on last week, Chris Dixon wrote a thoughtful blog post.  His main point:

It’s not the seed investors who are smarter – it’s the entrepreneurs

He makes a fine argument about how entrepreneurs today are more informed, with new seed funding options available.  And he cites a key seed fund advantage:  they’re in early, at lower valuations, before the VCs.

However, my issue is not about entrepreneurs (or investors!) being “smarter”, it’s about the overall ecosystem.  From a macro viewpoint, I’m feeling a replay of Bubble 1.0:

  • Many new investment entities and professionals (e.g. new angel investors, new seed funds, existing VCs that want to do seed investing, etc.)
  • Excess of capital (most investors will tell you there are too few projects, and the ones that are investable, are too competitive)
  • Follow-on financing rounds driven by bid-ups, not by business fundamentals

Capital efficiency amplifies these issues, because small amounts of capital quickly make things very crowded.  I’ve written before about the “weedy ecosystem”.  Being just smart is not sufficient, because entrepreneurship is ultimately zero-sum:  a dumb, poorly funded set of competitors will still steal mind-share, confuse customers, confuse investors, dilute your brand, and make it harder to build your business.   I see evidence of this every day:   ever narrower ideas, because it’s just so insanely crowded.

In the limit, the ecosystem becomes a lottery.   We’ll see a few nice exits, I’m sure, but it will be (mostly) because of luck, not skill.  For an entrepreneur, that’s a very tough game to play, I prefer the Slotzo games.

(Note:  these comments apply to the most crowded, most capital-efficient technology projects:  such as software pure-plays, consumer Internet, “new” mobile, etc.   For ideas that have real technology, real IP, or some other non-replicable component, things get a lot more interesting, for both entrepreneurs and investors).

Coming Seed Crash?

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In a recent blog post, Paul Kedrosky wrote:

[T]he super-seed crash is coming. We have silly numbers of companies being seeded — I had someone at a well-known, larger venture fund tell me yesterday in San Francisco that they were seeing dozens of Series A-seeking newly angel-funded companies a week. Valuations are escalating as super-seeding angels compete against one another, while fourth-quartile incumbent VCs jack prices to buy deals through dint of having more money to put to work.

I think he’s spot on.

Between angel friends, friend starting seed funds, VC friends doing seed investments, and VC friends starting seed funds out of their venture funds, it’s getting a little absurd.   This hasn’t felt right for a while, and I think Paul nailed it.

Some argue this supply of capital is nothing but good for entrepreneurs.  I disagree, and Paul touches on this as well:

[M]ore companies seeded means more full-cycle money required to break through the noise and competition, which while drive dilution of seed investors who can’t follow-on in subsequent larger rounds

Easy and excess capital creates a “weedy ecosystem”, which makes it harder for everyone.  Even if you’re the best idea in that ecosystem, the bar is raised by those around you.

I Have A Few Questions

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A quick note to folks that email me unsolicited investment decks and business plans, asking for meetings.  I love to meet as many people as I can, but (unfortunately) I do not have the VC-firm army of associates to screen things that are the best fit.

Please don’t be offended if you email me to meet, and I reply with a bunch of questions first.  I won’t waste your time; I’ll think about what you’re working on and ask the key, probing questions (e.g. they don’t come from a canned list).

And then, if it makes sense to meet, we’re already that much further ahead in the discussion!

(And an interesting side comment:  you’d be surprised how many times someone sends me a cold email, I send questions back, then I never hear from them again.  Not even, “Good questions!  Let us do some work and get back to you.”)

Emotional vs Rational Thinking

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We’re all emotional creatures, and even though business is business, it’s impossible not to bring emotions into the work we do.  The key is to recognize when emotions are overriding your rational thinking about a business issue.

If you (or your boss, peer, investor, co-founder, or negotiating counter-part) is “hung up” on something, that’s a big clue that there’s probably some emotions at play.

Some examples of emotional issues I’ve seen in startups:

  • New employee B shouldn’t have more stock than employee A, who started much earlier (or more stock than a co-founder)
  • The first venture investor doesn’t want to pay more per share than the initial angel investors.
  • An entrepreneur doesn’t want to give up “control”, even when involving new investors and managers will greatly increase the chances of success.
  • An investor doesn’t want founders or managers to cash out (even partially) before they do.

Identifying an issue as an “emotional issue” can go a long way to resolving it.

Stock Market- Startup Investing: “Growth” vs “Value”

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Individual stock investing can be divided into “growth” & “value” strategies.  Growth investors as well as every stock picking service find companies that will grow at an above-average rate.  Value investors try to find deals:  companies that are trading below their intrinsic value.

I’ve found venture investors can be categorized among similar lines.

“Growth” investors focus on the idea:  the team, market, and product.  They want investments that can be run-away successes.  In contrast, value investors focus on the “deal”:  investor rights & protections, aggressive preferred stock elements, etc.  They want the biggest slice of the outcome, for the smallest investment amount.

In practice, it’s not really this black and white.  As Warren Buffet has pointed out, growth and value strategies are not mutually exclusive, and successful investors use a combination of both.

As an entrepreneur, I love working with growth-focused investors.   The value or “deal”-focused VCs are a drag.  I respect investors wanting fair terms, but getting overly clever or aggressive just complicates things for follow-on capital, disincents management, and most importantly, time spent negotiating those terms is time NOT spent on making the company valuable. Check this Investors Underground Review to learn more about stock market investment options.

My message to VCs:  you’ll make your LPs happy by finding the right projects and doing everything to make them successful, not by cranking your average ownership & deal terms across your portfolio.  Keep your eye on the right ball.

Angel Investor Referrals

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A quick protocol note for entrepreneurs raising money from angel investors:   asking for referrals from one angel to another can be tricky.

If you ask angel investor A for a referral to investor B, the first question B is going to ask of A is:  “are you investing?”

If A’s answer is “no”, it is unlikely the referral is going to go anywhere.

Have We Gone Meta?

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Is it me, or does it feel like many entrepreneurial discussions today aren’t about new ideas, but are about the “meta” stuff (processes, methods, groups, etc.) around entrepreneurship?   Everyone seems to be talking about seed stage funds, how to get funding, how to start companies, the latest Y-combinator clone, organizing meetups, incubators/hatcheries, etc.

To use an analogy I saw fly by somewhere (and can’t fully credit, sorry):  it seems like the action has moved from making money on foreclosures, to infomercials and books about making money on foreclosures.

Are ideas so plentiful they’re not the focus anymore?

Am I hanging out with the wrong crowd?

The SparkFun Story

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A few weeks ago, I heard Nathan Seidle talk at MIT about founding and growing SparkFun Electronics (an on-line supplier of microcontollers and related electronics prototyping and hacking items).

He was smart, funny and engaging, and it was very inspiring.

Interesting bits:

  • He started in 2003 to provide a better on-line ordering experience for certain parts (moral:  good UI + UX can win)
  • They had 65 employees and did $10m in 2009, will be close to doubling revenues this year.
  • They’ve been very scrappy, opting (for example) for developing their own solder-mask and reflow techniques, instead of buying expensive machines.
  • They don’t compete on selection (with Digikey, Mouser, Jameco, etc.)  Instead, they research the “best of X” and sell that one product.  Their customers are usually building small quantities (like one).

It was a reminder that you can build an interesting and meaningful company (a) doing what you love, and (b) without venture capital (he started with about $6-7,000).

The Internet Used to be Flat

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The Internet used to be a lot “flatter”.

Last decade, there really weren’t any major points of control.  If you had an idea for a new app or content site, it was pretty much a level playing field, and you could largely control your destiny.  The browser was a major point of control, but that was very “horizontal” — few Internet companies worried about bumping into Netscape or Microsoft as a competitor.

Now, the world is quite different.

Google emerged as the first gorilla, becoming the “starting point” for many Web sessions.  Most Internet companies are now hugely dependent on Google, directly or indirectly.   SEO-dependent companies can find their fortunes change overnight, and Google’s “quality score” manipulations can materially affect an SEM budget (and usually not in the favorable direction).

Facebook is the next gorilla, especially with their recently announced strategy to own the social fabric for the Internet.  They’re a major “attention point” for many users, and it’s hard to consider a new Internet idea without a Facebook strategy.

Twitter is a gorilla-wannabe, but it’s not clear if they’ll win (long-term) over Facebook status updates.  But the Twitter ecosystem got a splash of cold water with the news of Tweetie’s acquisition.  Many app developers are now wondering if they’ll end up competing with Twitter.

And finally, Apple is emerging as a gorilla wildcard.  They don’t have leading market share overall, but their mobile devices (iPhone, iPod, and now the iPad) are dominating and defining their categories.  The App Store is a huge improvement over the carrier’s closed systems, but it’s hardly open.  Apps are approved at Apple’s pleasure, and can be un-approved at any time, without reason or notice.

The Internet’s Darwinian era seems to be over.

iPad Quirks

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For all the hype, the iPad still has a few quirks/drawbacks.  My list:

  • No camera. What doesn’t have a camera these days?
  • Can’t charge from most USB ports. They don’t put out enough power, you have to use a wall-charger.  This means that you’ve got to manage two distinct things:  syncing and charging.
  • iTunes umbilical cord. The iPad is nearly a laptop; why do I need to tether it to iTunes to do key operations (like unbox it)?  Also, why can’t I sync with iTunes via Wifi?
  • No printing.  (built-in support, anyway)
  • Limited app selection. Expected, but improving.  iPad apps can be much more complex, so the ramp may be slower than it was for the iPhone.

Given how Apple iterated on the first iPhone, I’d expect the same thing to happen here.  I love my iPad, but I’d expect iPad 3.0 to be even more impressive.