posted on December 15, 2006 11:22
Unlike the dot com era of the nineties, Web 2.0 enables entrepreneurs the ability to engage in two very different paths:
• Create a traditional nineties-style, high-growth, venture-funded technology business.
• The second option for starting a business that has burgeoned is the rebirth of the traditional entrepreneur’s self-funded small business. The Web 2.0 era affords entrepreneurs the ability to have a technology business that rapidly develops product, with that product being sold to meet clients’ needs.
Although these two options are laid out as extremes and are both worth discussion, I am going to discuss the underlined nuances of the second option.
Building a business: First, I am defining a business as a revenue-generating, profit making entity. Although this definition may seem pretty obvious, there are plenty of businesses today that break that model – YouTube.com, FaceBook.com, MySpace.com – you get the idea. In spite of these examples, the beauty of a Web 2.0 era business is that the level of capital required to build a technology-related business has declined to rival the capital requirements of starting ANY small business in the pre-dot com days. And contrary to the above Web 2.0 examples, entrepreneurs can immediately engage on a path toward profitability.
Unfortunately, the message of this new reality hasn’t gotten the wide-spread distribution it deserves. Entrepreneurs are still making their rounds to the VCs looking for bubble-level cash investments in hopes of being on next year’s cover of Business Week. And VCs are still funding business plans without clearly-defined paths to profitability, in hopes of landing the company that ends up on next year’s cover of Business Week. The model from the nineties that you can build a business AND lose money should have burst with the dropping of the year 2000 Waterford crystal ball in Time Square. My all-time favorite quote from the nineties is “we’ll make up for the loss on volume” – which they did a few months later by shutting their doors.
As recently as the past month, I heard advice given by a VC to a Web 2.0 start-up was to defer actual sales opportunities and focus on building product and brand. This scenario results in a cycle of dependency, where the entrepreneur becomes ever more dependent on funders to keep their lights on. And the funding partners, instead of having a portfolio of businesses, has a portfolio of products. This may not be a bad deal for the investor if they are looking to roll up product, but it can be a risky play for the entrepreneur.
Therefore, in starting a business, I recommend that entrepreneurs have clearly defined personal and business profitability goals that they model and make sure that these goals are in alignment with their funding partners’ goals. Worse case scenario, if they don’t hit it big on the cover of Business Week, they end up with a profitable business.
Rapidly developing product: Secondly, the era of Web 2.0 enables entrepreneurs to rapidly develop and market new products. In the Dot Com era, at a minimum, it took over $500,000 to develop prototype products. Nowadays, with combination of Web 2.0 technologies, open source, and off-shoring, entrepreneurs can develop mature product for a fraction of that price. Gone are the days of the big bang product launch – we are seeing more and more businesses rolling out as “Beta”, thereby setting low expectations, and getting preliminary reaction from the user community, and ultimately paying customers.
After an initial beta, or proof of concept, it is desirable to then build what you can sell. It is amazing how many entrepreneurs have great ideas and begin developing their beta product – without ever having put a design prototype in front of a potential client. Some entrepreneurs have told me that they would like it to be closer to final before showing; others are afraid that they will be giving away their intellectual property. Nonetheless, my experience is that there is nothing like good old fashioned client feedback to help speed a product to market and to ensure that entrepreneurs build what they can sell.
Sold to Meet Clients’ Needs: Finally, selling a product that meets immediate clients’ needs is perhaps the most important aspect of starting a Wed 2.0 business. If you have 1) committed to making a profit and 2) committed to a rapid, client-centric development cycle, then 3) the entrepreneur needs to sell the product to the clients that informed the development cycle.
These three integrated steps makes it possible to start a web 2.0 business via bootstrapping your way to profitability. As an investor and entrepreneur, I am not making a judgment between bootstrapping versus outside funding. I am simply drawing the distinction between the two extremes.
In thinking about the options as extreme examples, the main issue that comes up through this process is the entrepreneur’s desired growth rate and perceived risk tolerance. Taking this organic, methodical path generally means a slower growth rate, but also minimizes the amount of outside capital requirements and medium-term risk. I consider the organic growth route to be less risky since more of the control is in the hands of the entrepreneur and the decision to keep the lights on is a decision made between the entrepreneur and the customers.
If the entrepreneur takes outside capital, even if the business is going according to plan, the plan could include another round of funding. And if that is the case, and the funding dries up, due to circumstances outside of the entrepreneur and their current funding partners’ control, the business shuts down, or at least goes through a significant, uncomfortable transition.
The pros and cons of bootstrapping versus outside seed funding is a topic that spans many critical areas in starting and running a small technology business (and keeps many entrepreneurs and investors up at night). Therefore, I will be spending some more time on this issue in future blogs and sharing with you my discussion with other investors and entrepreneurs.