Yes, VC May Be Irrelevant if it Continues Focusing on Weekend Projects

Where are Web 2.0's Amazon.com, PayPal, Google, or Travelocity? They were never funded.

Paul Graham and now Eric Schonfeld are extending the several-year-old "VCs don't know what to do with Web 2.0's super-low-cost startups" meme. The extension has to do with the recession, arguing that it will accelerate the decline of VC relevance, as VCs become more reluctant to fund these shoestring startups, and more entrepreneurs pull a DIY anyway and ignore VC.

Well... maybe. The VC problem with micro-cap micro-startups is real, in the sense that it's a real math problem where the VC fund size divided by the proposed investment size equals too many portfolio companies to interact with, and a kind of interaction that is a big break away from the old model.

But the easiest fix is for VCs to simply invest in more expensive businesses. The current predicament is a classic chicken/egg: after the dot-com crash, VC money was hard or impossible to get, so the businesses people started were these undergraduate-level 1 man-year (or couple-of-weekends!) efforts.

Small product, small team, small money. We got things like 'Remember the Milk.' Cute, sure. Useful, sure. But nothing too hard or too ambitious. Nothing a tiny shop -- or a bored college student -- couldn't hack out in their spare time. Indeed many were spare time or side projects.

Some of these apps got a lot of users, especially where network effects were involved, and eventually VC wanted nothing that wasn't viral, network-effect, social. Never mind that there was never big challenge or big value in those. Facebook is the biggest thing in Web 2.0 at the moment, and it's nothing but network effect and questionable monetization. "Not that there's anything wrong with that..." It's a fine, useful application. But in the absence of any real substance the model became more Hollywoodesque, more personality- and connection-dominated than it should have.

So where is the Amazon? PayPal? Google? Travelocity? Ariba? Netflix? Danger (maker of the Sidekick devices)? Those big projects that take tens of man-years, maybe hundreds? The projects that can't "launch in beta" after a few months and acquire tens of thousands of fanatical users because they're more than a glossy AJAX UI on a local database?

Where are the startups that drag whole industries whining and screaming into the 21st century and liberate billions in value, trapped in transactions that real people make every day?

Those big projects haven't been A-round darlings for a long, long time. VCs, terrified of risk, moving in a tight pack, loved the new ethos: let the entrepreneur build a product, get it launched ("beta"), get customers, get mirror-hall PR (blogosphere), then later drop in a few bucks. Less risk. But not easy money. Count the exits.  And the ad-only valuation has no more magic today than it did in 1998.

And no one even notices when hundreds or thousands of these little pownces and iwantsandys hit the deadpool.

It's no coincidence that many of the step-by-step tutorials for new frameworks and tools teach you to clone a blogger, a flickr, or a wiki farm in a sitting. After all, those are trivial undertakings, lacking only for a network-effect mob signing on. And we'd all have a good laugh about widgets one day... if we weren't laughing so hard already.

Can you imagine a tool vendor of the dot-com era giving an hour tutorial that produces a working Travelocity clone? a working PayPal clone? It's sketch comedy, or something sadder and more disturbing. Frankly, the most ambitious projects in all of web 2.0 are the tooling and infrastructure plays that are largely open source.

Investors, entrepreneurs, engineers and end users might all do well by hunting some bigger game.

On the Knocking at the Gate, VCs, and a Math Problem

Bang!

This economy may be the wakeup to VCs (and CEOs alike) that their future isn't what they want. But the murder happened years ago, and the "I don't want yes men, but strangely I don't listen to much else'" hivemind has just woken up.

The IPO window isn't shutting or recently shut -- it never re-opened after the dot-com meltdown. A handful of IPOs (including a Google) doesn't make a "window." Whether you blame SarbOx, or a trend of investing in companies with a wink-wink style of sustainable competitive advantage, that could not produce high enough valuations to warrant a public offering, there were to be few IPOs.

The startup and VC world started getting this idea a couple of years ago, when they realized that at the smaller exit values (for the exits that were to be had), in order to get a high multiple return, the initial investments would have to be so small that the venture fund couldn't afford to service the quantity of investments. That is, the investment would have to be too small to be worth the firm's time. Uh-oh. A few innovative programs came out of that realization. But for the most part everyone acted like this was just a bad dream.

Moreover, the vaunted "get acquired" exit that appeared to be the next-best exit option, has been rather overrated. The real acquisition numbers for the most part are not what investors (or founders) would like. Not to mention the acquisition could well mean the end of the road for the business (Google is the most famous for this) which is the opposite of what founders should want, and so produces some strange incentives. Yes, YouTube and Skype ... but the curve falls off quickly.

The bad news is that this pile of trouble has been sitting in the corner stinking up the room for years.

The good news is that it's not a sudden crisis, and may well be correctable by VCs who are willing to, um, take some risk (this means getting out of their comfort zone in terms of rituals and assumptions, or expanding said zone) which is, ironically, what they are supposed to be doing for their investors.

But what about all of that advertising? Isn't there money in all of those targeted ads? Or, at least, wasn't there supposed to be until the advertising market started downhill?

In the short term, maybe ... but in the long term, the model doesn't work at the macro level and here is some math that suggests why.

Showing ads is kind of like printing money. You can show as many as you like up to a function of your pageviews. In order for the ad-economy to grow, the attention economy has to grow. That is, the aggregate amount of attention-hours spent against ad-supported pages needs to grow. Ok, there's definitely evidence for that (GMail, etc.)

But what about the ratio of the ad growth rates to attention growth? Attention growth has real-world limits (number of people, amount of time, ad-blockers, desensitization to ads) while theoretical ad supply does not. The limit on attention growth does not limit real-world ad growth. For example, if I view 50 GMail pages where I used to view 15, it's entirely possible that the same amount of attention is now divided across more ads -- or that the total spent attention is even smaller.

In the long run, the ad-value growth is smaller than the application-value growth. So the deficit of uncaptured value for businesses relying on ad revenue grows larger over time.

We can check this analysis by looking at the numbers from another point of view. Start with the raw resource itself -- a piece of a data center that includes a unit of compute power, storage, bandwidth, and hosting.

Hosting and displaying ads is relatively less expensive (in units of the resource) than hosting application functionality. So the very resource which makes the ad-supported model plausible will supports growth on the ad side that is at least as strong as growth in hosted functionality, which is the attention-harnessing product. That is, the resource availability supports growing the supply of units for spending attention as fast or faster than the supply of units for capturing attention. Again, over time, in the aggregate, more ads are powering less features. The value of each ad goes down.

This has nothing to do with the overall economy, consumer spending, etc. It's simply a side-effect of the coupling between the monetization mechanism and the product.

If, at the same time, the "real-world" spending that is driven by even successful ads is flat or in decline, you have an even bigger problem.

Post-structuralism for Dollars in Silicon Valley

On the eve of one of our grand theatrical spectacles, featuring one of our industry's undisputed showmen as emcee, let's pause for a minute and imagine that we've got our mental map of the tech world all wrong. We've been drawing lines not just in the wrong places, but where the model isn't about lines at all. As a result, we're misunderstanding ourselves and a lot of other stuff. And, since the economy doesn't care about our degree of self-awareness, it means we all -- entrepreneurs, investors, engineers, designers, marketers, journalists -- are leaving big money on the table.

I'm hoping that last sentence might catch someone's attention, especially that of the VCs who have a lot to gain or to lose based on their understandings or misunderstandings.

Where do we draw lines by mistake? We live in a structuralist mythology that we make up because it's easy and it's a shared set of beliefs that we can use to argue (in circles sometimes):

• The "new" versus the "old" is of course the big daddy duality
• How about Client / server, Startup / enterprise
• Geek / management, Engineering / marketing
• East Coast / West Coast, Stanford / Berkeley
• Open source / proprietary
• Content / code
• NorCal / SoCal, Hollywood / Silicon Valley
• Entertaining / Functional

These just scratch the surface -- you can probably think of fifty pairs of your own now, along with examples of how they are convenient, self-reinforcing, and yet ultimately invalid.

They are a cliche, but they own the conversation. I want to talk about the last few pairs: think of the narratives we make and live inside, as regards Northern California vs. Southern California, Hollywood vs. Silicon Valley, and Entertaining vs. Functional.

Now look at Steve Jobs, an entertainer who could get his fans to poke out their own eyes and get in line for an iPatch. Apple is theater, the Apple store a set, a Disney experience for people who feel superior making snarky comments about Disney. Do you really think computer geniuses work at the Genius Bar? "Space may be the final frontier / But it's made in a Hollywood basement" -- and in this case the fans have already reserved tickets to the sequel.

But, wait! I'm not bashing Apple or Steve -- that would be buying into the very dualism I'm pointing up here...

Now consider also: we have another award show, the Crunchies, coming up. Before you laugh, remember this event isn't intended as a joke. And donating money to charity doesn't make you serious, just generous.

We have our gossip writers, our A-lists and even our stunts that get a third of the Valley looking self-consciously at the floor, embarrassed at having to wonder whether Carly Fiorina or Leah Culver has set feminism back further, a third watching our great-standup-with-the-dirty-mouth pretending they all get the joke, and another third just saying the heck with it and jumping on.

Ya know, maybe we're not so far away from our SoCal cousins as we think. And just to keep it clear: I'm not saying there's a middle position, a compromise, where we're all gonna end up. I'm saying that the duality itself is a fiction. So there is no middle. Until we get this, we're going to continue to have a heck of a time getting some things right. Or making money with them!

Like what? Like things that aren't quite code and aren't quite content. We never got SVG right, because it didn't fit into the categories we thought made up the world.

Is a Flash media code or content? When my mom gets an e-card, she thinks it's content, not an app.

We don't have a cross-platform vector graphics standard in 2008 (!) ... because practical vector graphics in the real world means some logic as well as geometry.

Why can music acts sell (via the carriers) all manner of wallpapers and ringtones for cold hard cash to technically unsophisticated folks, and we still can't get the average person to install or run a mobile app on their phone for free? We're playing that game wrong and we can't see it.

We have every manner of "media center" -- hardware, software, open, closed, expensive, free. Even Microsoft has been in on the act for five years now. And I still don't know any regular folks at all who use any of them.

We have tons of great ideas on the shelves because we can't understand 'the other' well enough to make the deals we need on content licensing. (They don't understand us either.)

Three quarters of "Web 2.0" is not about any kind of functionality at all; it's not even about interaction design. It's about the glossiest thinnest veneer of user experience. It's about buttons and realistic smoke ... the kind of thing that some folks refer to as "production values." Moreover, three quarters of it is free and ad-supported. Not unlike most radio and television. Unlike radio and television, its reach is minimal. Ask your aunt in Duluth what del.icio.us is. Before we spend another session making fun of the studios for not realizing where their business really is, we might think about what an adjustment in ad rates will do to our own.

One last time for the folks in the cheap seats: it's not about right or wrong, steak or sizzle. We're just not where we like to think we are. We're somewhere else. To get a better idea where we are, we need to do some demolition on our usual Monday morning narratives. It's uncomfortable. The good news is, there's a ton of opportunity. And eventually it feels good to realize we've outgrown the notion that the world is flat.

Now go to Macworld and enjoy the, uh, show.

How Bay Area Subprime Mortgages Relate to High-Tech Startups

Earlier this week, Tom Campbell, Dean of Berkeley's Haas School of Business, gave a long interview about "the mortgage crisis" on KCBS' in-depth segment [MP3]. At one point, the conversation turns to the general paucity of housing in the Bay Area (relative to demand, anyway), and the notion that landlords may be beneficiaries as folks suddenly discover that (1) they can't afford $975,000 for that 3-bedroom house and (2) it isn't worth $975,000 anymore either.

But aren't these b-school types the ones who are always telling us to "think outside the box"? The best Tom can come up with is a kind of housing trust or co-op, that lets you own, say, 25% of an expensive house, while you still get to live in it (an investor group owns the rest).

That's a really cute way of pumping up housing prices and speculation even further, by letting investors who would never do the real-estate transaction themselves pool their investments and then spread them across a bunch of properties (doesn't this sound a little like the mortgage problem we just saw?), while leaning on loan guarantees to cover their downside.

The cost of housing and difficult commutes are a big brake on the tech industry; they consistently rank at or near the top of Silicon Valley business leaders' concerns about the growth of their companies and the success of the region.

In the positions I've held over the last 4 years or so, I've been responsible for hiring engineers. Not just punch-the-clock engineers, but wicked smart, willing-to-build-it-from-scratch-but-wise-enough-not-to startup-minded engineers. But it is brutally hard. Even with robust salaries, it is difficult to get applicants in the door, let alone hired. And, no, it's not due to a shortage of U.S. geeks. Housing costs and impractical commutes seem to be the primary limit on the realistic pool of applicants.

Over time, if we don't do something about it, we'll only have the old-guard geeks (who bought homes a long time ago or live in rent-controlled places in SF or Berkeley) and immediate college grads (who are up for an adventure and happy to have roommates).

The problem is, when your only tool is sprawl, and you run out of farmland to sprawl on, you either throw in the towel (Silicon Valley) or you sprawl farther away (American Canyon, Fairfield, Tracy, even Monterey). When your only tool for traffic congestion is building more lanes, that's what you try to do, even though latent demand means that more freeway creates more traffic in the long run, not less.

If I'm so clever, what am I suggesting? We need to use a different tool, namely smart growth.

Among other things, we need significantly higher density, infill development, and more mixed-use development (residential, commercial, and light-industrial uses in the same or nearby buildings). This isn't a speculative proposal: where it has happened locally, it has been popular. Look at Santana Row, San Mateo, downtown San Rafael, even South of Market/Mission Bay SF (although arguably the planning there didn't go nearly far enough, leaving too few housing units to make any dent in affordability).

Luckily, the Bay Area does not share America's poorly grounded prejudice against living in towns. So communities like the ones I propose, on the peninsula and in the East Bay (Hayward, anyone?) would likely be embraced. And infill opportunities abound: Every time you see a big-box store in the Bay Area, whether you love them or hate them, imagine a few stories of residences on top and additional businesses lining the enormous "blank" sides of the store at street level.

Will this generate so much housing that no one will be tempted to take on debt at crazy terms they can't afford? Of course not. But if it can help keep that housing-cost-to-salary ratio from growing quite so fast for the folks we want (and need!) to work with, while bringing the ancillary benefits of denser communities, it seems like a no-brainer.

Hazardous Attitudes: Disregarding VC Due Diligence

The FAA identifies five "hazardous attitudes" that have proven so dangerous to pilot decision making over the years that they are explained in the FAA "Pilot's Handbook of Aeronautical Knowledge" and included by reference in exams and regulations. These attitudes are Anti-authority ("Don't tell me."), Impulsivity ("Do it quickly."), Invulnerability ("It won't happen to me."), Macho ("I can do it."), and Resignation ("What's the use?").

Working with startups, I've seen entrepreneurs exhibit all of those attitudes when trying to convince others (and themselves!) that they needn't worry about VC due diligence.

I would advise those entrepreneurs -- and any wannabe entrepreneurs -- to read Rick Segal's fabulous post on due diligence. In addition to giving advice, Rick explodes a commonly held notion that VC due diligence is just a formality and that, if you get to the d.d. stage with a VC, you're all set, you can just wait for the wire transfer to hit your bank account.

Due diligence is real -- Rick suggests that one or more of three deals he's currently looking at will not close because of problems at the due diligence stage. Read that sentence until you believe it. Then, before you tell yourself that it doesn't matter because you're going to bootstrap, you'll never need a VC or a corporate investor, go back and read the five hazardous attitudes again. If you think success means believing in Plan A so much that you don't bother preparing a Plan B, the odds are you'll be laughing about this failure some time down the line over a beer.

Now that we've got that out of the way...

A couple of Rick's points that deserve emphasis:

• Financial Forecasts. Of course they'll be rosy. What's important are the assumptions. Where did you get your data? How hard did you try to get good data? Is the logic that ties the data together sound?
• Business Thesis and Assumptions. "... [W]hat do I have to believe?  What do you believe?  And, of course, what are the assumptions behind those beliefs. ... You have to have the same story, metrics, thesis, etc, from day one." If you change your execution plan a few times, that's to be expected. If your fundamental beliefs about the space are changing faster than you can execute, you have little chance.

At some point between the kitchen table stage of your startup, and the time when you walk into a VC meeting, the following things will become relevant. Plan accordingly:

• "Understandings" or "Gentlemens' Agreements" with investors or employees. Unusual terms can be changed or dealt with at VC time, but I wish I had a buck for every time a CEO told me these issues would just melt away because everyone would be so pleased at the prospect of making a big deal or closing a round.
• Questionable expenditures. This can either be a few big items or systematic spending that adds up. Don't do it, and if you do, don't try to hide it or hand-wave. I've seen a VC identify a six-figure sum missing from the books, and still make the investment. The firm identified the issue and decided they would arrange the deal so as to handle it and get it under control. It wasn't a showstopper for the company, but it was the end of the line for the guy who tried to cover it up.
• Team issues. Although Rick says that not every VC would talk to all the employees in a small company (he would), it's a good bet that your core exec team -- and probably everyone in your first 8 people -- will get a good grilling regardless of the VC. The team has to be a team, and you won't be able to fake it. This doesn't mean everyone needs to agree or be buddies, but they need to function properly as a group. If you don't have a team, the VC will figure this out, and your funding is unlikely.
• Product. Ok, this should be obvious. You can spin the marketing claims ("a better way to manage your contacts" could be anything) but you can't fake the technical claims ("syncs up to 5,000 contacts to any device" is either true or it's not).
• Customers. Although some VCs seem to be trying to get all the risk out of their portfolios by investing only in companies with a solid customer base, that is their problem, not your excuse to pretend you have customers that are fictional, occasional, or just plain unlikely.

If you still think this is all hypothetical, or won't affect you, then take another look at the five hazardous attitudes and ask yourself: are you really planning for success? just closing your eyes and hoping? or fooling around and enjoying the ride?

Lifecasting will be Prevalent, and has a Down-To-Earth Future

Lifecasting is one of those things that is interesting on a theoretical, academic, political, and artistic level. Yet, right now, it's pretty boring in "real life."

But there is a big bourgeois, commercial opportunity coming for lifecasting, and with that will come low prices, ubiquity, and all sorts of new content also relevant to the avant-garde. In the same way that cellphone cameras now catch politicians off guard and police beating protesters, the surveillance (sousveillance?) society will take a quantum leap forward.

Walgreen's sells a low-end USB web cam for $14.99 today, and for well under $100 one can get a higher-end unit. I predict that in 2-5 years, I'll be able to drop $40 in Walgreen's and get a wearable cam/mic with an 8-ounce belt-clip battery that will plug in to my cell phone ... and I'm in the game with justin.tv.

This is not live-without-a-net futurism here, either. I'm making a modest argument by extrapolation on the hardware side. The original justin.tv rig was a hassle to put together with today's technology. The biggest challenges involved upstream mobile bandwidth, battery power, and data compression.

With EVDO Rev B, HSUPA, and WiMAX, bandwidth looks to be less of a problem than giving customers a reason to buy it. As MPEG-2 fades away in favor of MPEG-4 flavors like H.264 and 3GP, cheap hardware compression is already becoming less of an issue. In fact, many of today's low-end smartphones are most of the way there in terms of a basic lifecasting rig. Battery power will remain an issue for anyone wanting to go live 24/7. But for a few hours at a time, several ounces of lithium-ion will keep the camera, compressor, and radio humming.

So what are the bourgeois, commercial applications?

• Conferences: organizers won't love broadcasts of the content, but, at least in tech, they are desperate to find some way to keep the shows compelling. I can see a lot of organizations sending one delegate to lifecast while others back home watch and interact, including talking to vendors, visiting hospitality suites, etc.
• Meetings: an interactive lifecast of a remote meeting would be a more productive way to participate than just a conference call or even a traditional web/videoconference.
• Social events: suppose your school reunion is far away and not nearly exciting enough to make the trek. But a friend who lives in the area goes, and you can ride along via lifecast? That could be a riot. And if it isn't, just close the browser.
• Education: how cool would it be sit in on some virtual flight lessons, tuned in to a lifecast from a CFI giving a real student a real lesson.
• Remote Personal Assistant: Instead of a worrying about wearable computers with smarts, you go about your business while a remote assistant tracks your lifecast. Need directions? a pickup line? a reservation? instant info on anything? Your assistant, sitting somewhere comfortable with easy access to all things cyber can do the virtual legwork and send you what you need in real time.

The monetization platform is already here, as early adopters have jumped out ahead. Phone hardware (which will serve as the workhorse for the system, just as it does now for millions of phone-cam snapshots, videos, and mms messages) is moving at a rapid pace. That just leaves a few more parts to design and sell to complete the picture. With the amounts of VC money flowing today, I don't see that last part as a problem.

LifeLock: More Shenanigans, Now Featuring Radio Jingle

I almost feel bad piling on LifeLock at this point... after all, I passed on writing when I first had an inkling something was up, at the beginning of April.

It was curious that they ignored a polite email where I articulated that I might be interested in their service, and that I understand no system is perfect, so I would like to know their views on some potential security vulnerabilities. After all, they purport to close some ID theft gaps, but they create some new weak links in the process. My friend Andy, who knows more about security and financial fraud than I, wrote this post about my concerns.

The rest is history ... Kleiner gave them $6 million a couple of weeks later. And perhaps skimped on the due diligence, since Wired has been following the company and turning up gems like

• LifeLock Founder Resigns Amid Controversy (such as identity theft and fraud ... hmmm ...) in May, and more recently
  
• Police Say LifeLock Coerced Unusable Confession from Identity Theft Suspect (a mentally disabled man who managed to partially thwart the CEO's own LifeLock protection plan)

Like I said, I almost feel bad piling on at this point (and wasting your time, since if you're interested in LifeLock you've almost certainly seen the latest already).

Why only "almost"? Because, as I wrote earlier this week, "the money has to go somewhere." In particular, Kleiner Perkins' money, and Bessemer's if there's any left, is now buying radio spots in the San Francisco area for these guys. Argh. On the other hand, if tracking down and threatening crooks becomes part of that ad campaign, I might not be so quick to change stations.

The Money Has to Go Somewhere: Ads as Boom Barometer

During the dot-com boom, it seemed as though every advertisement on the radio was for one dot-com or another. Some campaigns paid off (amazon.com had a big radio spend); some didn't.

This morning I heard a radio commercial for "pinger" ... which appears to be a voicemail site for when you want to leave a message and really don't want the other person to pick up the phone. Or when you want to spam a whole bunch of people with voicemail. I just don't buy it. I had heard of it before and it doesn't sound any more sensible now.

The commercial was on KCBS, an all-news watt-monster in the Bay Area that is not cheap to advertise on. Especially during morning commute hours. In poker, this is what they call "buying the pot" -- and pinger is lucky enough to be buying with Kleiner's money.

Having recently seen VC-backed mobile-YouTube-play Zannel placing large ads at art events in SF neighborhoods where the only dot-com you expect to see is laughingsquid.com, I realized the ripple effect is underway.

I was hesitant to promote anecdotal evidence as economics data, but my confidence was bolstered by the coincidental publication this morning that "VC Investment Hits Highest Level Since 2001"

The money has to go somewhere. Like free movie tickets just for applying for a job:

Scamalicious, Bubblicious, or the Next Transistor?

It's a multiple choice test for this venture investment in Stirling engines as solar power collectors. Stirling engines are of course very real. But so is fusion.

Is this brilliant risk-taking and the green investment that'll lead to breakthroughs? or another dangerous sign of too much money chasing too few ideas?

TechCrunch vs. The Maker Faire

Mike Arrington wrote one of those shot-heard-round-the-world posts today. It wasn't news, but Mike Arrington writing it on TechCrunch was the news. The Valley in a troubling state? Indeed.

It would bum me out a lot more if I hadn't spent this weekend at the Maker Faire. The fair was a beautiful thing. The people and projects looked great; the companies mostly silly. The bigger they tried to look (Yahoo!) the sillier they looked. The more they focused on doing cool stuff (Microsoft... sorta kinda) the better they looked. But really it was DIY anything and everything. The essence of the geek thought process was there, the thought process that makes Silicon Valley work decade after decade: one part science, one part "I bet if I monkeyed with this a little more, it would be really damn cool," and one part "that is really damn cool -- you need a hand with that?"

Robert Scoble already made this connection. But I want to hammer on it a little more. Spend 15 minutes browsing this flickr stream and you'll feel right as rain. It's meatspace stuff, mostly, some fire and robots and yarn along with the software. But the idea is the same, and the membrane between online and offline has never been thinner.

On Saturday, we spent 20 minutes looking for parking and ended up in the far reaches of a dirt lot where some cargo trailers were parked. The event was well attended.

The peninsula has its own cash-driven strain of lycanthropy, never more than a full moon away, but a lot of people here always want to sit down with a soldering iron or scissors or a blank text editor window and put something new and cool into the world.