Generated Transcript

David Hornik

[00:00:00]
Howdy. Welcome to VentureCast. This is the VentureCast Edition while I drive up Highway 101 heading to a board meeting. And I did think that it was probably an opportune time to address my blog post on Venture Blog Built to be Bought. I can’t figure out whether it was the built to be bought part that’s upsetting people or the bubble 2.0 thing that’s upsetting people.

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But I’m guessing It’s the bubble 2.0 thing.

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So I just figured I would take this chance as I sit in my car heading up the beautiful Silicon Valley freeway to sort of clarify what I was saying, what I wasn’t saying, particularly as smart people who I respect are basically calling me a bonehead. The folks at 37signals called me an idiot, sort of. Dave McClure called me misguided, I think. And Dick Costello told me that I was calling the bubble prematurely because either nobody had made enough money and gotten public or Dick hadn’t made enough money and gone public. I can’t figure out which.

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But in any event, I do think that the interesting thing is I wasn’t really calling a bubble, I was calling a warning sign. It’s sort of like when you see the clouds forming off the coast and it looks like, gee, maybe we should watch this one because we may be hitting interesting times with a hurricane to come. But in any event, I mean, that’s sort of quibbling. The truth is that I sort of view it the same way, which is that there are a lot of companies that are being built out there that don’t have neither presently have nor have a vision for a self sustaining business plan. Self sustaining business model.

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Their plan is essentially to build a feature that will be useful to a potential acquirer and therefore hopefully be acquired in a relatively short order. And you know, frankly, I’m not speaking out against the idea that such a, such a company is a reasonable idea. As Dave McClure rightfully points out, there is an opportunity for people to spend a relatively small amount of money and build a company that can grow in user base, grow in value to potential third party and be acquired for some number of millions of dollars and make the founders make the found there’s a reasonable amount of money in the process. And I have no problem with that, frankly. I think those are great opportunities.

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I do think that frankly the infrastructure of Web 2.0 makes those things possible. And that’s a great thing for technology. It pushes things forward. It pushes the ability to on a couple of hundred thousand dollars build something that gets traction with a group of people or with a set of technologies that is meaningful. So I was in any way rallying against that.

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But the distinction that I think is worth making is that there are companies that can grow based on cash flow and small amount of angel investing. And then there are companies that traditionally have grown by virtue of venture financing. And venture backable businesses are just different than those businesses. 37 signals guys are building a great business. I think that they’ve done a great job, that they are self sustaining, that they’ve built something that is a product, it isn’t a feature.

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People are using it, people are appreciating it and that they will continue to grow and they can grow their business based on the cash flow that they have. So I’m not suggesting for a second that what they are doing is somehow bubblish, but it is certainly the case that if they at some point decided that they wanted to accelerate their growth curve or expand the set of products that they could build based on the amount of money they’re bring in from sales, then they would need to raise financing. And if they were to do that, then they would enter the realm of this sort of venture backed businesses, which obviously as a venture capitalist I think is a meaningful set of companies. I think that over time venture capital has really driven the growth of the tech sector, helped build the biggest technology businesses that are out there today. And so venture capital has a role to play.

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It doesn’t have a role to play in every business. I’m not suggesting that. So I’m not suggesting that if people don’t appreciate the nature of, if people don’t sort of appreciate the nature of venture capital, that they can’t grow an interesting business. They certainly can. There have been businesses that have been built on cash flow alone that have grown into interestingly large businesses.

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But by and large, the businesses that are built in Silicon Valley and built elsewhere that become big interesting businesses, the Yahoos and ebays, the Microsofts and Suns and Symantecs and intuits of this world at some point take venture capital so that they can grow at a faster rate, or expand the nature of their product development, or expand the nature of their sales force or whatever those things are that cost more money than cash flow will allow, and that those businesses then have the capacity to expand and become larger businesses by virtue of taking capital. And so that’s my business. My job is to try and help those folks who think that they have a larger business that can be accelerated by Infusion in capital of capital to grow more quickly.

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What I raised a bit of a red flag about in my built to be bought venture blog post was this idea that there were businesses that assuredly need venture capital to grow and accelerate, but don’t necessarily have an end goal where they can be self sustaining businesses. And that is a very slippery slope. Because if the only outcome, the only potential outcome in the foreseeable future for a company is to be bought, then when you are running out of money, you need to raise additional venture financing sort of forever in the foreseeable future. And that is a precarious position to be in. And it tends not to build the most interesting and sustainable businesses, the sorts of things that venture capitalists like to fund, because the end game is really a hard thing to predict, and the amount of capital that it takes to get there is an equally hard thing to predict.

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And so companies that have no foreseeable self sustaining business then have to sort of be on the money trail at any given time. And so therein lies the challenge, I think, for businesses that are, as I say, built to be bought, rather than built to be independent standalone businesses. And as a venture capitalist, I think the thing that interests me are businesses that I look at and say, even if they have a relatively small scope today, that they have a path towards something that’s larger and interesting and above all else makes more money than it costs. And so I can point to dozens of examples back in the web 1.0 world of quote unquote, companies that were being built with the express intention of being purchased. And many of those then went down in bankruptcy because ultimately once the acquisition window closed, there was no other alternative.

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And with venture investors not seeing the future of those sorts of investment opportunities, they found it hard to invest because like I say, it could be good money after bad until either the thing’s acquired or ultimately people grow impatient or tired and the company has to be shut down. And those are not the sorts of things that I think are valuable long term, sustainable businesses and the sorts of things that Sandhill Road should be looking at and thinking about investing in. So perhaps the quibble is what constitutes a long term self sustaining business. And I think that’s a perfectly fair debate, right? I mean, I think ultimately there are lots of businesses that do not today make money that one can foresee making money in the future, making more money than they cost to produce in the future, and therefore will be self sustaining businesses.

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And I think frankly, to a large extent, venture investors in this space, folks who are looking at these Web 2.0 businesses. That is the big biggest thing with which we wrestle, which is betting ahead of the curve, finding things that look interesting, that have interesting growth curves, that are getting the right sorts of markets or hitting the right sort of product strategy. And we think in the long run we’ll be able to make sufficient money to be large and interesting and not need further investment. Those things are fabulous businesses and difficult to spot when it’s three people in a business business plan. But that’s the stuff that we’re looking at these days.

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So I raised the sort of warning flag to say that I see a lot of investments that are happening now, venture investments that are happening now that look to me like pieces of something bigger, but don’t have the future necessarily of being independent and self sustaining businesses where they won’t require additional financing to move forward. And I just think that those are indicative of a time where people think there’s an opportunity to put in money, to grow something quickly on a curve and sell them off to someone who will then put them to use in a bigger company. And while there’s money being made there, that is a very tricky gamble and not a gamble that I think makes sense and a gamble that I think a lot of people made during the bubble. And when the acquisition bubble, as it were, deflated, they were left sort of holding the bag on a bunch of companies that didn’t really have a home and didn’t have a path to profitability and ultimately had to be closed down. And I think, you know, I don’t mean to suggest that this is only a problem for venture capitalists.

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It’s not by any stretch. It is. It’s a problem also for entrepreneurs who pour their hearts and souls into companies and, and have the same desire for an outcome where their technology is meaningful and part of the future and profitable and makes them money and all of that. So as an early stage investor, one of the things that I like the most is that I have the opportunity to invest early and then stand alongside entrepreneurs, sort of looking at the future from the exact same position, which is the value to both the entrepreneur and the early stage investor is growing a meaningful company, being able to drive future financings or future relationships and grow a business into something meaningful. And so I think this is not just an investor problem, it’s an entrepreneur problem.

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It’s a question for folks as they start pouring their hearts and souls and lives and days and money and effort into an idea to say to them themselves, what is the long term value of this thing. What is the long term opportunity here? And if there is a vision for something that is large and meaningful and has the opportunity to sort of change the playing field, then I think that that is not only a great opportunity for an entrepreneur, but it’s a great opportunity for venture investment. And if it isn’t those things, then the question is, is this something that’s but can be built on a relatively contained amount of money and therefore won’t be constrained by the same sorts of requirements of venture backed businesses won’t have to grow at the same pace, won’t have to look for the same sort of ultimate outcome. And therefore there’s a smaller but still interesting to the entrepreneur business to build.

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And in those cases I think those are fantastic businesses and I’ve talked with plenty of folks I’ve encouraged to build those sorts of businesses and not take venture investment.

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Not all businesses are venture backable businesses. Not all businesses need nor require venture capital. And those businesses should be built accordingly. They should be grown at a pace commensurate with the cash flow of the company with the means of the entrepreneurs. And then the outcome, while it may be more contained than in a larger sort of platform like technology, could still be not only a great outcome for the entrepreneur, but could be a great home for the technology, could help the technology be meaningful, those sorts of things.

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So like I say, I’m not for a second meaning to suggest that all businesses require venture investment, nor that because a business may, you know only, and I say that in quotes only be worth some number of tens of millions of dollars. Therefore it’s not an interesting business. All I’m suggesting is that venture capitalists have a particular focus on businesses that have long term opportunities, that are large, that have the tendency to change the playing field and grow the market, expand an existing market or change the nature of a set of markets or those sorts of things order to do that require capital to invest ahead of the profitability of the company. And when that’s the case, those things are great opportunities for venture capitalists and can result in great interesting outcomes.

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But if venture investors are putting money to work in things that where the outcome is grow the user base to some number of millions of people and sell it to an existing portal because they can put it to good use. If that doesn’t come to pass, then their investment is in a sort of precarious position of needing to figure out how to get to that self sustaining nature. And not all businesses have that in their future. So all Right. Enough said.

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I think I’ve. I hope I’m not sounding too defensive. I don’t intend to. I mean, I didn’t intend to stir things up quite the way it seems to have with my venture blog post, and I remain incredibly enthusiastic about the things that are happening in and around this web 2.0 world. I look at businesses every day that strike me as interesting long term businesses that deserve a capital infusion to help them grow and see if they can work.

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And I’ve invested in a number of companies in and around this space that I think have the opportunity to be interesting large businesses and I look forward to helping helping them grow. So again, I didn’t mean for a second to suggest that the web 2.0 world was not a worthy world and didn’t deserve sort of the focus that it’s received. I just meant to raise the sort of cautionary flag that there are businesses that strike me as appropriate venture investable businesses and there are businesses that strike me as less so. And as I see more and more of those businesses that strike me as less venture backable, receiving venture funding and therefore sending them on a certain trajectory, it does remind me of the sort of bubble 1.0 when everything was working great so long as the acquisition gravy train kept on chugging along. And when that train stopped, boy there were a lot of folks left holding the bag, entrepreneurs and venture capitalists alike.

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So I for one am keeping an eye on the landscape to try not to find myself in that position position to find myself working with companies that regardless of the IPO window or the acquisition window or any of those other things, are marching towards self sustaining businesses that grow by the strength of their own cash flow.

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And those are the businesses on which Silicon Valley has been built. And I am hopeful that I can help be part of building the next generation of those businesses. So there you have it. And I guess that’s it for this driving along 101 edition of VentureCast and have a good one. Bye.