Over the past few years the startup scene has experienced another golden age, reminiscent of the late 90s. Once again amazingly innovative companies are creating new markets and radically altering existing ones. And once again behind those innovators there is a growing list of also-rans, hoping to cash out before the bubble pops.
This is, of course, a bubble.
We are now at a fascinating inflection point in the startup ecosystem that runs from hype to cautious optimism to fear to despair and back to hype. We are somewhere between cautious optimism and fear. With Web 2.0 darlings Facebook and Groupon now public, we can now assess just what the market thinks of these companies, and what the judgment of the equities markets could mean for the prospects of many other startups.
- Facebook: Mark Zuckerberg heads an amazing and innovative company, but perhaps shareholders are now wishing that he had limited his innovation to product offerings, and not stretched the bounds of corporate governance. When $50 billion of market capitalisation evaporates, shareholders might expect to pressure management changes, but with Facebook’s dual-class structure, they are stuck.
- Groupon: The outrageous growth story that is Groupon has shown itself to be susceptible to severe execution risk. CEO Andrew Mason’s troubling comments on the company’s under-investment in technology and pricing issues were the lowlights of Groupon’s Q2 earnings call. And recently the company announced that it would take further steps to address persistent challenges in its financial reporting and systems by the hiring of Brian Stevens, formerly of KPMG.
It could be that the liquidity offered by a robust secondary market, as well as the migration of significant venture funding to late-stage investments, simply consumed all of the upside (and then some) that would, in earlier times, have been available to retail investors willing to roll the dice on an IPO. The market has spoken, and it is signaling a need to retrench.
The next stage of this retrenchment will be fascinating, and should be marked by three key trends:
- Proof, Not Promise: As investors at all stages become more discerning, companies will increasingly be pushed to demonstrate not only user enthusiasm but revenue and profits.
- The Funding Desert: I expect that over the next year early stage startups will begin to experience a chill in the fundraising climate, as they spend through their seed and series A funding and find themselves too small to be of interest to later-stage venture capital investors. We have termed this the “Funding Desert”, and in our own firm we have seen a considerable uptick in startups facing exactly this challenge.
- VC Shakeout: Not all businesses scale, and it is notable to me that even successful venture capitalists such as Fred Wilson see issues with the current makeup of the VC landscape.
Change is coming, and the shakeout will be real. But for those startups that are focused on building durable companies, the shakeout will be an opportunity to rise above the competition. As the tide goes out, we will get to see who has been naked all along.
About the author:
David Johnson is a partner with ACM Partners, a boutique financial advisory firm providing due diligence, performance improvement, restructuring and turnaround services. He can be reached at 312-505-7238 or at [email protected].
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