As the French say, plus a change, plus 'est la meme chose ("the more things change, the more they stay the same"). In 1988, when I wrote my first treatise on venture capital, I mentioned a phenomenon which had been apparent to me and other experienced players in this space over the years... the "too much money" problem. Yet again, the pigeons have come home to roost. The dotcom/NASDAQ melt-down, plus the failure of a number of high flying venture-backed public and private companies in the last 15 months following the market break in March of 2000, has been attributed by various pundits to a variety of factors. Among those often cited is that all the failures were the product of flawed business models. I strongly disagree with this assessment. While some companies with flawed business models were funded, many of these companies represented solid and sound business opportunities. Where the model got off the track is a function of the delirium in the public and private markets in late 1999 and early 2000. What happened was that many companies got too much money, too soon. The thinking was that `first mover' would own the niche market at which the business model was aimed, and the conventional wisdom was that only one player would survive in each internet-related niche. Awash in money from the VCs and from the public stock markets, and started spending at a heroic "burn rate" (monthly cash outflow) on the theory that the current market conditions would continue indefinitely. Thus, they could seize the "first mover" advantage, get to be the "category killer" or the "killer application" at "internet speed." Therefore, the race was to the swift, and swiftness implied significant spending on people, marketing, infrastructure, etc., even though cash flow (let alone profits) was not projected to start becoming respectable until some future date. The entrepreneurs took the money for one reason, and in many cases only one: It was available. And, they spent it on the theory that it would always be available. When the market broke, of course, the money dried up. The companies in trouble were incapable, despite the soundness of their original model, of scaling back economically. One cannot, as they say, put the toothpaste back in the tube. The firms were not sufficiently mature so that it could forecast to investors a solid and reliable date on which cash flow breakeven would be reached. In short, they took the money before they were ready for it. They did so because they were beguiled by the `first mover' advantage and on the theory that then-current market conditions would continue indefinitely. It is almost as if the VCs were the parents and had spoiled their children by giving them a lavish life style which, upon attaining maturity, the kids could not maintain. The dirty shame is that the failure of many of these companies (not all, of course) is purely a financial failure. It is a failure showing a lack of discipline and an imprudent and overly lavish deployment of resources. Some of these companies will survive by scaling down either in bankruptcy or by virtue of salvage operations (including compulsory mergers) which reduce the employee census. They will compromise with their creditors in a transaction representing what is known as a `restart.' Again, a dirty shame because restarts are tough. The wind has gone out of employee morale, customers are often disappointed and the overall company mood is sour. Companies which were lucky enough not to be lucky (i.e., not to have solicited and accepted lavish venture funding) are the true survivors, based on the "back to basics" model. These are the companies that are doing it the good old-fashioned way. They are existing hand-to-mouth, funded by founders, friends and family and selected angels during their immature stage. This is a deliberate technique, one that has been time-tested. Thus, we propose to add the following to our rules for startups:
Rule No. 1 (and 2 and 3): Do not take the money until you are ready to spend it productively.
In the interim, keep your burn rate as low as possible. Scrimp, save, start working your plan as if every dollar was your last one and get the company to a stage where a venture round of financing makes sense. Timing is everything, in other words. If the company has enough periods under its belt, enough pain, strain, energy and testing of the business model in the beta stages, then it makes sense to go out and look for big bucks. And, in my opinion, those big dollars are still available. There is an enormous amount of liquidity in the system. However, it is being invested on the `back to basics' model, in companies which have gone through the agonizing, exhilarating process of testing the business model, attracting customers, approaching the market and penetrating the same to the point where it appears the start up has a real future. These are companies that have early indications that cash flow breakeven is within sight. The managers have taken a very careful look at what is going on around them, they have been in constant communication with customers and potential customers, and they have been paying attention to customer reactions. This is the `launch, listen and learn' theory, and it is a tried and true method. They have been consulting their advisers and are thinking long and hard about the advice they are getting. They have tweaked the business model and are ready for what is called the "second mover" advantage. In the jargon of the business, they have avoided the "LST effect" (a reference to the fact that the first soldiers out of the LSTs on D-Day were the ones that caught the brunt of enemy fire; the survivors generally were those who hit the beach in the second wave). The `back to basics' companies, or many of them, are coming into their prime and are ripe for venture funding. The pricing is back to what it was three or four years ago and, indeed, what it was 15 to 20 years ago. The VCs are hard bargainers, as they have always been (or at least almost always) and are extracting their pound of flesh in terms of valuation and deal terms. However, they are coming out of their traumas (at least some of them are) and ready to write checks for the appropriate opportunities.