Nov 21, 2008

Internet Startups Face a Change of Plan

Internet firms are looking down the barrel, in terms of the financial crisis. Yahoo Inc. (Nasdaq: YHOO), for instance, faces a 64 percent drop in net profits, as 1,500 employees are scheduled to lose jobs and the stock price touches $12. (Some investors think Jerry Yang’s decision to turn down Microsoft for $33 was a huge mistake.) Even Google (Nasdaq: GOOG) stock has fallen (in spite of strong financial performance) from a 52-week high of $747 to a recent new low of $310.

As the overall bailout and new stimulus packages from the U.S. Fed take effect, the scene will get tighter for Silicon Valley firms of all sizes, including startups, as VCs revise their investment plans.

So, how does the situation affect the lifecycle of an Internet startup?

Up to now, the philosophy for new companies has been: Get an idea, bootstrap a company, show that your model works, get seed funding, show some scaling in terms of traffic, and then get proper VC funding to build the traffic. Revenue will come once the traffic is there (the Google way). Funding is based largely on revenue “potential.”

This philosophy will be tested in the worldwide severe economic downturn. “R.I.P. Good Times” is Sequoia Capital 's response to the current situation, in a leaked presentation that is proof -- if any were needed -- that startups should expect a lifecyle plan more like: Get an idea, bootstrap a company, show that your model works, make some money in a short amount of time, demonstrate your viability, then seek VC funding with some running cashflow at decent burn rates.

It hasn’t helped that a lot of funding for the Web 2.0 bandwagon has been quite unworthy. There are tons of social networks and video publishing sites that have been funded in arenas where even leading lights don't have revenue plans. Example: Twitter is still undecided on revenue channels. Bijan Sabet, board member of Twitter, says: “Stay tuned, they are working on it.”

Startups interested in making it in the present environment could benefit from the following tips:

  • Get costs down. Burn rates must get lower in order to justify startup expenses, period. “Time is money," after all.
  • Get cashflows higher. Don’t expect to get funding unless you can generate revenue.
  • “Get Real or Go Home.” This admonition from the Sequoia Capital presentation tells it like it is -- and will be -- for those seeking VC funds. Companies without a demonstrable product or service with a robust revenue model can’t expect much in the way of financial assistance.
  • Expect high expectations. In today’s startup market, VCs will focus on better apples in the portfolio and quickly drop the rotten ones. A viable exit is the way VCs and angels make money, and in these tough times, it’s going to be difficult. Startups will need solid key metrics to keep themselves saleable.

There is some good news: Since this isn’t the first economic crisis Internet startups have faced, some firms are better prepared this time with lessons from the dotcom bust eight years back. Also, Internet penetration is far higher than it was in the year 2000. Web sites today have solid traffic with high user involvement -- giving TV viewership a run for advertising dollars. The SME segment and other ROI advertisers are getting more direct purchases from the Internet than from any other medium. Vertical startups have strong niche traffic, which is useful in targeted advertising.

Still, most funding will dry up for the next two or three quarters -- during which time robust business models will be promoted, while frivolous copycats will meet their demise.

Written by Sandeep Amar

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