When a great product hits the funding crunch

http://andrewchen.co/2013/11/05/when-a-great-product-hits-the-funding-crunch

by _pius • 13 years ago

84 41 13 years ago

anatari• 13 years ago

If this trend continues, the implication will be that venture capital will cease to exist as we know it, but instead will resemble traditional private equity where capital is mostly allocated to established viable businesses.

brador• 13 years ago

Or maybe we're just getting better at identifying viable businesses from earlier metrics.

akbar5014• 13 years ago

venture capital will cease to exist

There is a general consensus that venture capital as we know it will not continue indefinitely.

1.) AWS and it's ilk virtually eliminated the high cost of hardware/hosting from the previous era.

2.) Open source software has eliminated server software expenses. The contribution of OSS to lowering startup expenses cannot be understated. I still remember flying from SF to LA will a million dollars worth of software in my backpack in the 90's. Server software was a big cost that's been nearly eliminated.

3.) Development. Given that #1 and #2 are now close to zero, it follows that entrepreneurs should be responsible for hacking out a prototype, if not a 1.0 release. Obviously, this cost will remain high as a business scales and venture capital will continue to play a role in helping startup founders scale development team. But, there is no reason outside capital should be wasted on building a prototype (with a few exceptions).

4.) Marketing. This will be one of the last vestiges of high cost. Winning in the market is expensive. Venture capital adds value in scaling marketing faster than a company can organically generate cash. It follows that it is fair and reasonable for VC to demand that their financing be used for growth capital, not search capital (i.e. searching for P/M fit)

5.) Management. Building and running a business will continue to be expensive. As with #4, VC will continue to add value here when a company can grow bigger and/or faster with outside capital than it can with organically generated cash flow.

However, there are new models emerging. Capital, at least in a capitalist economy, will move to its most profitable use. If venture capital for technology startups is a profitable use of capital, then VC will continue in one form or another. If not, then it'll die, and the world will be no worse off.

AznHisoka• 13 years ago

I disagree with #1. Did you see how much they spent per month on AWS? If a normal bootstrapped startup was spending that much, they wouldn't last more than a couple of months.

not_that_noob• 13 years ago

The number of small and midsize venture firms unable to either raise a fund or raise a fund comparable in size to their prior fund is growing. There are now many ex-partners from several firms, who have been discarded because the new fund is too small to support them.

On the other end of the spectrum, large funds which supply capital for rocketship companies have been doing well and raising more. These funds are akin to PE, and are primarily supplying the money to keep companies private long after they could have IPO'd. Hence the large valuations for dropbox, etc.

austenallred• 13 years ago

"You can see that other than the top-line metric of total signups, the other metrics are quite solid."

Try as you might, I don't think it's possible to downplay that statistic. The overall numbers of signups need to be higher than they were in 2003, but anecdotally it seems like the percentage of the market you need to capture (and percentages of the market the startup will reasonably capture) haven't changed drastically. 1,000,000 users used to be almost the entire iOS App Store market - now it's a small sliver. Everpix was the rare scenario in which there's a solid product, solid team, and traction that seems like great traction, but casts too much doubt on its ability to grow to where it needs to to justify investment.

After the exception (that will always exist), your seed round says, "Alright, I think this could have potential. Let's try an experiment." Your Series A says, "Experiment successful. Let's grow this thing." There are more experiments being tried, but if you take those same ratios into 2003 (user adoption would be much slower, and the numbers would be lower), and Everpix would still be a failed experiment. It's harder to hit x users than x/2 users, surely, but it's easier than ever to get x users. I would argue easier than it used to be to get x/2 users.

The ratios of companies not getting a Series A is different, but that's largely because more experiments (seed rounds) are tried than ever. It seems like you can raise a seed round (<$50K) on almost nothing. Raising a Series A is still hard.

The target is moving, but so is the consumer. Comparing numbers today vs. numbers 5 years ago isn't a testament to the investment scenario changing, it's a testament to the Internet and the world changing.

carsongross2• 13 years ago

At some point many entrepreneurs need to ask themselves WTF they need the venture money for anyway. If you are going to have to go ahead and build a viable product to get any money... why not just keep on keepin' on, and keep the upside? You can scale costs with the success of your business anyway, and, if you aren't insane, you are billing recurring, so you've got a pretty good idea where minimal revs will be for the next year.

Sure, there are perpetually money-losing ideas, like twitter, that still need the old model, but most startups I see these days don't have to be built that way.

A modern startup’s costs are all people costs

Very true. And one of the things that startup founders can arbitrage.

And, let me say again, thank you everpix team. You've done the startup community a huge service by being so open about things.

phillmv• 13 years ago

Because making a successful living heading a $10-20 million company that took 5-10 years to build isn't the lottery ticket we've all been sold on.

untog• 13 years ago

A $10-20 million company you own all of, though. The VCs don't just give you cash for free.

carsongross2• 13 years ago

Right, but note that the VCs are effectively asking you to bootstrap anyway before you get any real VC, and absorb all that risk yourself, regardless of whether or not the lottery ticket story is true.

That's not to say there aren't ideas that really scream for VC: enterprise sales take a long ass time and require expensive sales-bots to get done, for example. But for a lot of SAAS type stuff, that isn't the case.

jmduke• 13 years ago

While I don't think this is a particularly bad analysis, I think its a short-sighted look of what happened with Everpix. Yes, human capital is a massive sinkhole, but this article seems to be focused on the funding/HR side of finances as opposed to the reality of running a business with non-trivial variable costs.

Andrew argues that "Monetization won’t save you if it’s not combined with growth". I'd argue that monetization won't save you if its not combined with a sane business model in which marginal revenue is larger than marginal cost.

I prefer this analysis, posted by an HN user on one of the previous Everpix discussions:

http://research.ivanplenty.com/2014-economics-everpix-shutdo...

malyk• 13 years ago

I think that analysis is also short sited. Yes, they where upside down on their marginal costs right now, but that's because they went the minimal engineering effort way and used AWS to get things started. By raising a large(r) round they, presumably, could have hired an infrastructure engineer or three and moved away from the higher costs of amazon.

If they had gone that route from the beginning they would have had to sacrifice some other part of their business because they would have had to hire for that role...and that could have been more expensive than just paying Amazon to get things off the ground.

So yes, they could have saved on operations, but either at the expense of product or at the cost of another engineer or two...thus increasing depth of the human capital sinkhole.

smoyer• 13 years ago

"My question is, in 2016, will the bar be even higher? Maybe angel investors will expect a working product, reasonable traction, and product/market fit all before they put in the first $1M? How much can market-risk be proved out before any professional money is raised?"

At some point, the start-up founders have done all the work and bootstrapped themselves into a thriving business. If the VCs (or Angels) delay the funding too long, there's no value for them to add between those rounds and an acquisition.

jtbigwoo• 13 years ago

It's basically a game of chicken where VC's try to get in as late as possible but the investment terms get less and less attractive to both parties as they wait.

rpedela3• 13 years ago

With yearly revenue of $340K, why couldn't they keep going? I realize that is smaller than their costs, but $340K is enough to pay 2-3 employees and the other costs (hosting, etc). Didn't they only have seven employees? Why are the total office expenses $128K? Why $565K for legal fees? Seems like they wasted a lot of that $2.3 million investment.

akbar5014• 13 years ago

The reason is that $340k is not worth their time.

dhoulb• 13 years ago

Exactly!

It's kinda sad that unless a company has crazy hockey stick growth, it's not worth it.

Everyone: the founders, the early employees and the venture people, we're all in it to make tens of millions, so while it was a viable business in every other sense, no-body involved cared.

But, why should they? All of those people are probably capable of making loads more money in other places. The early employees can get $100k at an established company, the venture people can invest in some other flash-in-the-pan venture with a better chance of an exit, and the founders believe their next idea can stand a better chance of making them millions.

I don't really have a side here, I just think it's weird when a business with revenue shuts down and doesn't continue in any capacity. Surely one or two guys could've maintained it and made $150,000 each - a pretty good income! The founders could've had it running on autopilot for a few years to give them an income while they started their next project.

rpedela3• 13 years ago

The assumption is that the business would continue to grow but slower than they would like. I don't think $340K was the ceiling.

thatthatis3• 13 years ago

No. The reason is that 340 was revenue, and COGS was higher than 340.

A 340k per year profit machine is easily worth a few million.

Revenue != profit.

jonathanjaeger• 13 years ago

Someone posted an in-depth overview about why their business model was flawed. If you're selling something for less than it costs you, you can generate a ton of revenue, but it's still at a loss. This is why they couldn't keep it going: http://research.ivanplenty.com/2014-economics-everpix-shutdo...

rpedela3• 13 years ago

Interesting. Thanks.

georgeecollins• 13 years ago

That post on the economics was great, and it offers a convincing explanation of why they shut down.

The funny thing is that the author often thanks the team for making their numbers public. But he also calls them reckless and irresponsible. I think people's judgement looks worse in hindsight. And if you are benefiting from someone's candor it would be smart to speak of them more charitably, if only to encourage future candor.

But that link is a great analysis.

ChuckMcM• 13 years ago

This is a good read. Clearly if the series A type people get too risk averse they will lose out on winners, if they are not risk averse enough they sink a lot of capital into non-winners. Greed and Fear the eternal balance.

What is interesting to me about the analysis is the people vs infrastructure costs. 15% of their costs went to the product, most everything else was people cost. Inverting that number suggests to me that you have to have 85% gross margins just to break even[1], and you're looking at "growing" the business on one or two points of margin better than that. Ouch. Mitigating legal and office costs might help.

[1] I understand that at their current subscription level vs new subscribers and lifetime value of the subscribers they get, but as gross measure breaking down the costs and separating the people costs from the 'product' costs it is pretty sobering.

codegeek• 13 years ago

"6 FTEs plus operations costs about $100k/month"

Genuinely interested in understanding this. If we divide 100k by 6, it is about 17K (rounded). Other than Salary,Payroll,benefits etc, what comes under "operations". Rent ? hardware cost ? datacenter/hosting ? Would really like some details in general on this because on the surface, 17K /employee/month seems very high for a startup.

greghinch• 13 years ago

To hire good devs in the Bay Area, particularly mobile, you'll easily start approaching $150k/yr. in salary. Couple in employment taxes, benefits, etc. and you are easily in that neighborhood

saturdayplace• 13 years ago

Seems like an argument in favor of a bootstrapped companies which intentionally keep costs low and intend to go for slow growth instead of a spectacular flameout. Because infrastructure costs have come down so much, it now feels like companies are more likely to remain viable as bootstrapped concerns than shoot-for-the-moon operations.

ig1• 13 years ago

The milestones have definitely moved, but so have the underlying costs. It costs far less to build a solution, deploy it and acquire users. Modern languages, frameworks and API services save man-years of time, cloud hosting means you can get on demand for pennies what would have cost thousands in upfront server costs.

The milestones for user numbers have also inflated, because simply the number of people on the internet has exploded as has the amount of time they spend online across multiple devices. It's also become much cheaper to acquire users due to the collapse of ad prices and virality of modern distribution platforms.

Seed rounds are also much bigger, a seed round of $1m would have been exceptional in 2004. Now people wouldn't batter an eyelid. You've also seen VCs who were previously Series A investors now doing seed investment as well.

mathattack• 13 years ago

"A modern startups costs are all people costs."

This one sticks with me a lot. All the cloud/virtualization/thisandthat/outsourcing really puts the people at the center. It makes fighting for sustainable competitive advantage that much harder.

dasil0032• 13 years ago

Total tangent, but this really jumped out at me:

The secrecy that’s so deeply embedded in the organization facilitates their distribution strategy- can you imagine building your company culture around your marketing strategy? That’s what Apple’s done, though it’s not often talked about.

I've never thought about Apple that way at all. To me Apple was always about the product first, and the secrecy and marketing was built around that. They don't announce a product until it's ready to ship because it's stupid to talk about something that's not finished yet (unless you're Microsoft and you need to do it to keep your long-term enterprise customers on the hook). Jobs greatest strength may arguably have been as a pitchman, but wasn't his greatest passion the product itself? At the very least, Apple could not hire a retain the level of technical talent they have had based on being marketing first.

jonnathanson2• 13 years ago

I don't think Apple's success can be isolated cleanly to one pivotal variable. Steve Jobs was obsessed with product and obsessed with product marketing. Apple doesn't see product and product marketing as two wholly distinct functions, either. Most companies do -- and the fact that Apple doesn't is, in itself, a corporate strength.

People could probably quibble for days about whether Apple is a "marketing first" company, or what that phrase actually means. I think it's more apropos to say that Apple is a company that understands both product and marketing. And it understands the "full stack" of marketing in a way most tech companies do not. Apple is phenomenal at brand marketing, for instance -- not just MarCom, or advertising, or conversion optimization. A lot of its competitors relegate marketing to a series of discrete, necessary-but-evil functions, and not a pillar of corporate culture.

dasil0032• 13 years ago

That's fair, I don't think you can tease apart the product and the marketing. But the reason I find the quote strange is that the marketing depends on the product, not the other way around.

smackfu• 13 years ago

Notice that this article is from November at the time of the shutdown, and Everpix has released a lot more data now.

https://github.com/everpix/Everpix-Intelligence

clamchowderz• 13 years ago

he makes a lead gen pop up come up when you visit...not a fan.

thatthatis3• 13 years ago

Everpix failed to achieve basic unit economics: https://news.ycombinator.com/item?id=6678135

It's a nice story and all to say that they failed even though they were successful. But that's not the truth. They failed as a business, and thus their business wasn't funded further.

When you can't cover your COGS as an Internet company, your business model is what sucks, not the funding environment.

amirmc• 13 years ago

"When you can't cover your COGS as an Internet company, your business model is what sucks, not the funding environment."

There are plenty of examples of SV companies with no revenue and no business model in sight who are still able to get huge amounts of funding. Typically, these companies have focused on (and achieved) huge growth rates.

thatthatis3• 13 years ago

Sure, there are plenty of examples of zero revenue, hundred million dollar valuation. Fb, pinterest, snapchat, instagram come immediately to mind. These businesses though are all building networks and social graphs.

Everpix's business was reselling storage and bandwidth with value added software, but they resold at a marginal loss. There is no "if we get a billion users our value per user goes throug the roof" payoff like when you build a social graph.

I don't know of any high valuation zero revenue companies that are essentially resellers.

AndrewKemendo• 13 years ago

My question is, in 2016, will the bar be even higher? Maybe angel investors will expect a working product, reasonable traction, and product/market fit all before they put in the first $1M?

Try 2013/14.

Just as an example using our company, we have a well rounded team with experience in the industry, working beta (nothing scalable), letters of intent from large industry players and several beta users. Every Angel I have talked to says they can't invest (even low 6 figures) without significant traction, on the order of thousands of monthly paying customers.

By that time I won't need their money.

The problem is, for leading edge technology and people with families working part time its that extra layer of difficult to move quickly with iterations and improvements, so that slows our entire dev cycle down SIGNIFICANTLY.

I have spoken to others in our region (D.C.) who say the same thing, so its not unique.

mgkimsal• 13 years ago

"If anything, this trend will only continue. San Francisco housing costs continue the rise, while computing infrastructure only gets cheaper and more flexible."

So... don't do this in SF. One of the primary arguments I've heard for moving to SF is "that's where the money is". Well... if they're not handing out the money like they did in 99, or 2004... there's one less reason to relocate yourself (or a team) there.

Yes, there are certainly other benefits to SF, but if you're expected to have built a product/service, marketed it, and begun building a customer base before you get useful angel or VC funding... you can at least attempt to do that from many less expensive locations.

When a great product hits the funding crunch

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