Don’t Drink too Much: Bubbles, Capital, and Staying Scrappy
September 21, 2011 2 Comments
There has been no shortage of writing and discussion in recent months about the ‘maybe-bubble’ that the startup/VC world is currently experiencing. I’ve pledged, for your benefit, not to enter that discussion here, and I intend to honor that pledge. For those interested, you can get all you need on the “not a bubble” side of the debate by Googling Mark Andreesen and bubble – he’s commented widely. As for the “it is a bubble” argument, try Mark Suster.
Bubble or no, it is a simple fact that there is more money flowing right now than there has been at any point in the past ten years. More money is flowing, and more deals are getting done, than at any point since Internet Bubble v1.0, back in ‘97-‘00. The chart below shows quarterly dollars invested and deals done for “First Round Financings.” This represents the number of new companies being funded by VCs, and the dollars associated. These are what I believe to be the most relevant metrics of the frothiness of the environment.
First Round Financings – Deals and Dollars Invested, Q3 2001 – Q2 2011
source: National Venture Capital Association
This environment is enabling a fabulously exciting wave of innovation. But an inevitable, unintended consequence of this environment is that we’ve lost something of the ruthless Darwinism that I think characterizes, at the micro level of any individual company, the healthiest environments for innovation and disruption. In a world of freely flowing cash, companies are able to raise more, hire more, and spend more. The bloated balance sheets of so many startups obfuscates a lot of sins and inefficiencies. That readily available cash enables managers to dodge tough choices, and to abandon a focus on efficiency in favor of an unbridled race for growth.
This all came into renewed focus for me last week when I ran into John Roland, co-founder and CEO of ExtremeReach, on the Acela from NYC to Boston. John’s company is without question one of the most exciting companies in the Boston scene right now. ExtremeReach is the emerging leader in management and distribution for both offline and online video advertising. It’s been a rocket ship since raising its series A three years ago, and is finally getting the attention it deserves. In just a few short years, John has built a business with revenue that is well into the eight figures, and he’s wildly profitable (think Google-style operating margins).
I passed on leading John’s Series A a few years back, and I’ve since tracked the company closely (painful as that has become!). As John and I were catching up I said to him, “I want you to know, John, that I’m well aware of how wrong I was to have passed on this business.”
John’s response was interesting. He said, “You weren’t wrong, Brad. When we were talking we were so early, and we didn’t have our model figured out yet. We were too hardware focused. You were right that our business was too capital intensive, and that our implementation model was going to make it harder to sell.”
He continued, “Looking back, in many ways the best thing that happened to us was failing to raise capital early on. It made for a very painful year, but it forced us to completely reexamine the business, and we came out in a much better place. I don’t know if we would’ve ever gotten to this point if we’d had the luxury of a lot of capital early on.”
John’s a very bright and reflective guy, and it was interesting (and somewhat comforting) to hear him think back on that transition. While it’s nice to hear him acknowledge that maybe I wasn’t completely wrong, that’s cold consolation when I consider that I did not stick with him and work with his team through the transition to the model that is currently kicking butt. C’est la vie. . .
John’s story is a great example of why, bubble or no bubble, I worry about the ease with which capital is flowing these days. If ExtremeReach were to launch into today’s financing environment, John and his team would no doubt have an embarrassment of options on their hands, even the story they were selling was that original, hardware-intensive model.
And as John recognizes, that’s not a good thing. The availability of capital would have encouraged the pursuit of a suboptimal strategy for some time before realizing how wrong it was. They would have lost valuable time in a competitive marketplace, and likely had to take on more dilution to keep themselves going.
It would be foolhardy, of course, to suggest that every company is somehow better off with less capital. No doubt some great companies would have failed if they hadn’t been able to access abundant early resources. But I am a fan of the discipline and scrappiness that is bred of limited resources, and John’s story is a great example why. Limited cash has a way of focusing managers on what is truly essential, of exposing and rewarding only what really works in an emerging business model.
While the capital continues to flow, I’ll certainly be encouraging most of our companies to eat when served. But not in every case. And even with those that do build big balance sheets, we’ll be aggressively coaching against the sloppy decision-making those resources can enable.
Regardless what your balance sheet looks like, I’d encourage every company to go through the exercise of imagining “what would we do if we had less?” You might be surprised by what you conclude. You might even decide to do it.