Disruptions: With No Revenue, an Illusion of Value

So founders and would-be founders, beware. This article is full of mistakes. In particular this one:

  most venture capitalists... are not interested in 
  building viable long-term businesses

His list of startups that got acquired before they had significant revenues refutes rather than supports his point. It's a short list, and even so, many of the startups on it generated only modest returns for VCs.

YC knows as well as anyone what VCs want, and any founder we've funded can tell you that we tell startups the best thing they can have on Demo Day is a hyperlinear revenue graph.

That's still mostly true, but looking at it some more, it's more of a Burger King problem.

When Burger King started out, presumably, it made a lot of money and expanded quite a bit. But what they found out (along with other fast food businesses) is that customers are fickle. Unless you mix it up now and then your customer base will slowly melt away to go to Five Guys Burgers, or some other new fast food place that everybody thinks is cool this week.

So what they and other restaurants started doing was launching these short-lived, heavily advertised changes to the menus. Miniature burgers. Mexican burgers. Burgers on a stick. Whatever. They kept a bunch of ideas on the back burner, rigorously A/B tested and used trial markets, then launched something new every now and then. There was always something new and different enough to keep folks from drifting off to the shack down the street.

Startups are now forming a somewhat similar function for these huge tech giants. A startup has some catchy idea, gains millions of addictively faithful users, then sell out to McGoogle (as an example)

Works great for everybody. Google gets new talent with a proven record of coming up with ideas that capture eyeballs, they get an instant boost in eyeballs for their services, and, better still, later on these features can be rolled into the code base. Maybe. Maybe they just buy a startup up to keep the other guy from having it. Works the same way.

I'd also note that this is at a much higher level than the "lifts" restaurants get. It's entirely possible that the next eyeball catcher has no kind of long-term value at all; but is still worth tens of billion in lift to some acquirer over a period of a decade.

So articles like this get it wrong. There's absolutely real innovation and value, but at least to me it doesn't seem like the same kind of innovation and value you get when you cure the common cold. It's more like making a cool new kind of french fry.

Look at YouTube. It seems to be doing pretty well for Google now, with more intrusive pre-roll video ads and popups during videos. Google also gets strategic benefits, good placement on iPhones, a better seat at the table for its so far not very successful TV products.

If YouTube had started off with those annoying ads, would it have seen off the competition?

A lot of digital startups are in winner-take-all markets. The conventional wisdom is, push for revenue if it helps you deliver a better product, through revenue relationships that also bring content, users, and lock out competitors.

If the market doesn't value revenue, but values users and the aura of hypergrowth and the next big thing, and it can be fatal to allow space for imitators and competitors, entrepreneurs are being strategic and rational to push for growth at all costs.

It's a perfectly valid strategy to build an innovative product that may be a proverbially two-legged horse that doesn't stand on its own, seize a dominant position, and sell to one of the massively cash-generating platform companies, Google, Apple, Facebook, Amazon, Microsoft, that need to maintain their position.

Or if you're in the right place at the right time, that's how Facebook and Amazon became platform companies.

Where would Facebook be today if Zuck had pushed for revenue and organic growth, instead of charging for growth and dominance at all costs?

And that hothouse atmosphere is why the US startup ecosystem is dynamic, and beats competitors around the world flat.

That's one reason to not try and squeeze nickels out of a growing business when you know you'll get quarters or dollars later from greater opportunities that were previously unavailable.

Had Instagram focused on trying to be ramen-profitable early on, it's possible it would have impacted their meteoric growth and successful Android launch. Moreover, at massive scale, their revenue potential and avenues to generate revenue change dramatically compared to what they could do when small.

I think the article made this claim:

Innovation is risky business but hyping a social CRUD app is less so. Hence a disproportionate amount of the money and (VC manufactured) media is focusing on the latter. And these less/non-innovative companies can only match the returns of a successful innovation based business in a bubble/greater-fool environment. So both the lack of innovation and the bubble are being caused by these financial firms.

This seems plausible to me (as an outsider). I would say more that we are seeing this as a direct result of the money looking for returns post real-estate bubble burst. Smart money doesn't seem to chase bubbles, but create them.

The lack of innovation becomes simply the opportunity cost of an investment bubble.

What's unfortunate is that I bet there are 10's maybe 100's of people like Elon Musk looking to get funding for their ideas but are being over looked by these same firms.

Come on NYT!

And also if you have profit/revenue very early you are immediately marked as lifestyle business.

So the entire system is pushed toward wild and big bets without any space for relatively small things.

But I don't think this is bad ...

If a successful company with massive earning potential decides to pay what seems like too much for another company with no visible revenue and it doesn't make sense to you, it's probably not a great idea to flaunt your ignorance by writing an article for a major publication.

From the perspective of a potential acquirer, a feature might be a more valuable acquisition than a new product (especially one that might compete with it's current product). The problem with building a feature company rather than a product company is that your only real chance for an exit is to get acquired.

There's 2 different routes to the finish line. A product could be acquired or go public, but a feature probably can only be acquired. If a company is building a feature, it probably needs to grab as many eyeballs as possible to increase it's valuation. If a company is looking to go public, it's ability to generate profit is a much more meaningful metric.

Turns out I had it all backwards. Several investors, declining, confirmed to me that the amount I was asking for was frighteningly low. I showed breakdowns of what would go to hiring and equipment, what would go to advertising, and what was the emergency fund - ($100k) - and how we really wouldn't need more because it would start paying for itself quickly. That wasn't satisfying to them.

What I also didn't know was that turning a profit was the last thing on their minds. It took me awhile to piece that together. I have to thank HN for opening my eyes to it.

The problem with speculative investors is that they aren't producing anything of value. They aren't building the software, they aren't in the trenches trying to acquire users or running customer service.

So I launched with a couple of friends who threw in some very, very small investments of a few grand, rented the equipment I would have wanted to buy, and ran it myself. And I haven't been able to grow it nearly as fast as I would have wanted to. But y'know what? It's making a profit. I just paid a 12.4% dividend on investments for the first quarter. Average time on the site is 45 minutes. We convert 1.5% of users at an average of $75 each. And I hold 81.5% of the company.

So... are investors looking for massively overhyped, vaporous, disruptive monster-IPOs wrong? No, but it's kind of like going to the track and only betting on the longest-shot horses you can find. The whole game would cease to function if a majority of cooler heads weren't making wiser investments with better chances of pretty-good payouts, in companies that actually turn a profit. Of course, the whole game might cease to function pretty soon; things right now look an awful lot like 1998. But people with good ideas and a shoestring budget will keep finding ways to turn a profit that keeps the lights on; and for that I'm glad I didn't find an investor, and did it my way.

The rest is just "try". This is acceptable because outcome is unpredictable and expectations are reasonably low. It's a gamble, and anyone contributing funding knows it.

If you can make money for your clients, great. If not, you are liable for nothing.

It's a good feeling for VC if they can make money for their clients. But VC still make good money either way. That is just how it is.

This is true to some extent in other professions as well. For instance, lawyers, on whom VC closely depend.

If lawyers advising startups can help their clients, it's great. But even if they don't, they still make good money.

And like with VC, clients recognise little is "guaranteed". Often they do not even know what to expect. Expectations are reasonably low.

What matters here is reputation. If someone's reputation is enough to convince others to give them money, with little expectation of "results", then that's abusiness.

There was an op-ed in the NYT a month or so ago called "The Zuckerberg Tax" written by a tax lawyer.

Read it.

Consider that the question it raises may not be how much the kid is "worth" (and his accompanying tax liability), but how much others are willing to give him, with no real expectation of return. Be they Microsoft, Russian investors, advertisers, ..., or his bank.

He no doubt has great "credit". He, through the popularity of Facebook, has a reputation. He may not be able to produce a billion dollars in cash, or even a fraction of it, but he surely can borrow it, the act of which amounts only to a change in a bank's computer database somewhere. We need not see the cash itself. People are willing to give him money. With no expectation of return.

And that my friends - "credit" - is the cause of most of America's economic problems. Spending money we don't have. And assigning large dollar values to things when it's unlikely the physical currency itself could ever be produced. "Show me the money." The real money, that I can hold in my hand. Not the funny stuff that is just the subject of talk... and op-eds.