Tales From The Main

Snapshots of small town life - zany characters and our neverending poker game.

Friday, March 17, 2006

Deja Vu all over again

I had a conversation with some friends last weekend where I mentioned that the valley was undergoing a venture capital boom akin to that seen in the dot com bubble. Now these friends are sophisticated professionals heavily involved in the technology business, and I could tell that they either didn’t quite believe me or choose not to believe me. Yet I worry that this wave could come crashing down on our heads much the same way the last one did – pessimist that I can be.

Here’s a tidbit of data to support my thesis from Peter Thiel at Founders Fund who was recently quoted as saying, “Early-state, first-round venture capital valuations are close to where they were in 1999 and 2000.”

Let’s think about this for a second. At a high level what is a VC thinking when he gives money to some uber-nerd with an business plan? The VC is not a noble creature out to create shiny new toys for the betterment of the universe – he’s looking to make money – and lots of it – for some hardnosed investors in his fund. The amount of money the nerd is able to get from the VC is driven by two things – the expected rate of return on the invested money, often a very fuzzy calculation, and the herd mentality of multiple investors clamoring to give money to the same nerd, allowing said nerd to demand more money in exchange for giving up less of his baby. What we are seeing right now is not investment based on rational expectations of positive returns but rather irrational investments by lemmings with bloated funds desparate not to miss out on the next MySpace.com. Yes I agree that this time around the general size of the investment is much smaller - no longer are we dealing with funding the building of the infrastructure with its huge capital requirements - but also the exits are equally smaller. I seriously doubt we will see more than one or two new Googles spring out of the class of 2005-06 - most exits will be more along the lines of a Flickr. A nice return but hardly the creation of billions of dollars in completely new value.

Some may argue that the tidal wave of cash flowing into early stage companies these days is a boon to innovation. I take a contrarian view and feel that an excess of cash at an early stage in a company’s existence is a negative thing. I have found through my career that people work best under two conditions; a) they really believe in what they are building, and b) they are under desperate financial and time constraints. Adding a lot of cash to the mix reinforces a) but removes a lot of the intensity. Having cash in the bank also allows the executive team the feeling that they can buy their way out of strategic or operational blunders and/or allows them to explore and develop variations on their original ideas. Branching out into complentary spaces might seem like a risk reduction strategy but ultimately it is most likely to remove focus from the organization and result in the creation of several mediocre products or services rather than one highly focused and stellar offering. I do agree that starving an operation is equally wrong but a lean and efficient group is far more likely to be successful than a bloated team with a sense of entitlement.

My current gig finds me at a wildly profitable company - and one that certainly struggles with employees feeling that they should be able to take advantage of the organization's success. Case in point is one of my engineers who decided that he would not travel unless he stayed at a 4 or 5 star hotel. Too bad! I stay at a $39.00 motor in in Sunnyvale - everyone else can too. The $150 a night savings times 6 or 700 hotel nights starts to add up to real money after a while.

Who knows? Perhaps this time things will really be different. I just get the feeling that 3 or 4 years from now we are going to see and awful lot of Web 2.0 writeoffs and be listening to stories about how you could get a social networking idea funded with a cocktail napkin business plan way back in the good old days of 2006.



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