A Scarcity of Fools

I recently read an article on The Huffington Post ("Web Start-Ups Strapped for Cash") that talked about how more web start-ups are having a hard time getting capital from investors. It seems as though, because of the credit crisis, investors are more cautious with their cash. And they are starting to demand unreasonable things from web start-ups. Unreasonable things like -- revenue.

The demands are unreasonable because the ROIs of some of these web start-ups would be great if their businesses were lemonade stands.

I co-founded an online career site about ten years ago. I started it with a buddy of mine from college. We met in the local diner and sketched out our plans on napkins. We eventually got funding from one of the top advertising firms in our state. Sometimes I wonder if we would have gotten more money if, instead of using a napkin, we had sketched out our plans on paper towel.

Before we got funding, my partner and I operated on a shoestring budget for nearly two years. Many of today's web entrepreneurs need a hell of a lot of money just to operate on a shoestring budget. What kind of shoes are they wearing -- Jimmy Choos?

One entrepreneur mentioned in the article had raised $3.5 million in 2006. At that time, his business was valued at $18 million. He was surprised last summer when he found out that investors no longer thought his business was worth that amount. To me, what's surprising is that he really thought that his business was worth $18 million in the first place.

One problem mentioned in the article is that many web entrepreneurs only have a vague idea of how they are going to generate revenue. Even a kid with a lemonade stand can tell you - clearly - how she is going to generate revenue. (Then again, a lemonade stand does have a clear revenue model, which is, apparently, more than what many of these web start-ups have.)

Doing something without serious thought about how you're going to generate revenue isn't a business; it's a hobby. Or collecting.

Under this definition, my daughter's don't have a Barbie doll collection; they have a Barbie doll business. And my wife and I are the lead investors. Every Christmas, we do another round of funding. This year will make our ninth round. (Actually, this example is not a fair comparison because I'm sure that when my daughters outgrow their Barbie business, we can have a garage sale and recoup some of our investment -- which is more than can be said about many web start-ups.)

Then again, giving millions to a business that has no clearly defined revenue stream also isn't collecting or having a hobby. Let's just call it what it is: gambling. By calling it gambling, we can then make investing in web start-ups a fun form of entertainment, like horseracing. We can even have odds. This way, gamblers -- I mean investors -- will know that they are actually betting on a long-shot. We can also give the businesses names like, No Chance in Hell, Inc. and Pete's Pipedream, Inc.

After I sold my equity to my partners, entrepreneurs starting talking to me about their start-ups. If I wanted to give money to someone with no hope of ever getting it back I'd give it to my kids.

Don't get me wrong, I do like gambling. I just don't like taking chances.

Back when I started the online career site, every career site said it was going to be the next Monster, which, to my mind, clearly wasn't true because it was obvious that my partner and I had the next Monster.

I can just imagine what the web entrepreneurs are saying today:

"Our business is the next Google. In fact, we're more like Google than Google."

Google was incorporated in 1998. My partners and I got funding in 2001. I could have said that our dotcom was going to be the next Google -- but not with a straight face.

To be fair, some of the fault does lie with the investors; they could do a better job at due diligence when investing in start-ups. To say that you'd have to be stupid to invest in some of these start-ups just might be an insult to stupid people.

A former boss of mine sold his technology company for about $100 gazillion dollars and became a venture capitalist. I remember talking to him about my dotcom. I wouldn't say that he was extremely thorough, but before we had our conversation I disrobed and put on a gown.

My message to web start-ups: You can't make people invest in your business. All you can do is tell them that if they don't, you'll never bring the kids by to see grandma and grandpa again.

Comments

[cylindar]

Good Article!! My wife and I started our web business about eight years ago. We borrowed money from no one. We are currently deriving our sole income from our web business. Now that is a big deal. People think that they can make a gazzillion dollars overnight. That is not the way the real world works for most of us. Making big money and getting overblown prices for websites is about as common as winning the lottery. But the fact is there is real money to be made that can provide a comfortable living for those who want to work. We work from our home which is great for flexibility. We live in a very rural area but we service the world, as fifty percent of our business is foreign. We can work stark naked or dress up depending on our moods. We do not have to spend money on clothes to look the part, nor do we have to spend big sums on gas and car maintenance. These are only a few of the benefits available for web startup types. My one and only piece of advice for any web startup is to never take any offers of investment and never borrow money for your business. In this way if it grows you will know that it is a real business and has a solid worth. Anything else is indeed gambling. Gambling can be fun, but most people lose as the house always holds the winning card.

[Henry]

You know, of course, that in Lake Wobegone... all the children are above average.