Tuesday, October 30, 2007

“Worth What You Pay For It?” Musings on Entrepreneurism without a clear economic goal…

A couple of postings back, I noted on how web startups could get going on much less invested capital, and how startup investing had to adapt. Well here’s another way of looking at it, that isn’t so sanguine.

I’m stimulated by a posting I read recently by Paul Graham of y-Combinator fame (http://www.paulgraham.com/webstartups.html). He is hitting on many of the same points, i.e. that startups can be launched much more efficiently now, that capital needs are lower and time to market is shorter. I couldn’t agree more. He also makes a number of sweeping generalizations that my 7th grade teacher would have nailed me for. I don’t buy the whole message.

But my point here is to say it isn’t all good. Along with a blossoming of inexpensive web startups, there are also a lot of cool apps with hopelessly non-existent business models … if we build it they will come. There seems to be a growing divide between things you can do that will have a big impact on the world, and things you can do that will have a large economic return on investment. I often find myself in a presentation on a new startup idea, where I could definitely use the product, but can’t figure out how they will make a business out of it. I can see clear value in it, but no way to extract that value.

It feels like we are in an Oklahoma Land Rush world. A couple of major paradigm-shifting changes have occurred (the Internet, the cellphone, ubiquitous computers, mapping the Human Genome…), and now we have this whole generation of bright people rushing across the newly opened landscape, seeking homesteading sites to stake a claim on. Some people are doing a good job finding economically valuable homestead sites. Others are just trying to sell wagons and provisions to the incoming flood of homesteaders. Yet others are trying to stake out beautiful view lots that won’t be economically valuable but give a great view (and someday may therefore become valuable). And others are simply enjoying the run in the countryside, and are admiring their beautiful running form.

Many startups I see today are simply not venture investible. That doesn’t make them bad, just not good vehicles for VCs to invest in and get a return from. VCs have to return money to their investors. Hence they can only invest in a subset of the new ideas brewing out there, i.e. the ones that have the potential for a steep increase in economic value over a short period of time. And not likely to help the entrepreneur put food on the table.

But what happens if you can start a company with practically no money and no hassle pitching angels. My fear is that entrepreneurs will expend an enormous amount of effort launching a startup that can never become self sustaining. They have become enamored with their own idea and it’s novelty, and haven’t tested it outside of their narrow circle. And because they haven’t had to go out there and convince others that it’s a good idea --- and pitch the idea over and over again to investors --- adapt the idea to what seems to stick to the wall --- they will ultimately be wasting their time. It may be very worthwhile meaningful work, which makes a difference and draws huge traffic and changes the flow of homesteaders across the prairie, but doesn’t end up making the entrepreneur or their investors any return. In the end, it’s possible the entrepreneur will look back on these years as wasted --- benefiting others but not themselves.

What’s happening on the web is frequently cultural, and not necessarily economic. Great revolutionary businesses are being created, and great cultural changes are happening, but they don’t always overlap. And the test of a good idea is not that it is neat, or that it can be implemented simply and elegantly, or that it can draw many other’s curiosity and interest. The test of a good idea is the value others will place on it, and a good proxy for that value is the money they will pay for it. A good predictor of that value is whether others find it investible, be they angels or VCs.

So I think it is a good thing for entrepreneurs to have to pitch their ideas and convince others to put a value on it. I found in my own entrepreneurial career that my business models and even my technical ideas benefited from being pitched and explained to others. They became more focused and distinct. I recall A-HA moments that happened in front of prospective investors.

I worry about a world where doing things, making a big impact, affecting our culture in a big way, has such a very low cost of implementation. And even pitching some small investors isn’t necessary. I think it is bad even for the entrepreneurs who might seemingly benefit from it.


Elia said...

I'm enjoying your blog. As an entrepreneur and individual who works with start-ups at an incubator here in Portland, Ore., I partially agree with your comments: "A good predictor of that value is whether others find it investible, be they angels or VCs."

There is another predictor of value, and one I could argue in the long run is more important than invest-ability by VCs and Angels. And that's sales. If a business can be created quickly and easily and begin generating sales, than it goes an awful long way to "proving" the business model.

Now, don't get me wrong: VC and angel investing is important. Nor am I making a comment about all the advertising businesses out there that will never generate real dollars because there aren't enough ad dollars to go around. But if a company truly has a product/service that people will pay for and the entrepreneur can develop and sell that product without requiring angel or VC money, more power to him or her. It doesn't mean that the business is any less valuable. After all, customers make an "investment" decision as well.

Elia Freedman

easydjr said...

I heartily agree. Sales is the best valuation a startup can get. The long tail implies that almost any reasonable idea can get "some" revenue in this frictionless new world. But clearly, broad market adoption by paying customers is a real business.

I just worry about the entrepreneurs and deals that are more lifestyle choices, where they avoid outside criticism and thereby fool themselves and waste Friends and Family money.

Thanks for your comment.


Amy Jenson said...

Interesting post. I'm a budding entrepreneur, so this is very helpful. I'd love to buy a business, but having enough capital to support myself during the beginning would be great. I've been looking for businesses, but I haven't found any that truly interest me. Do you have any suggestions? Thanks

Monica Kermani said...


I suggest looking into any small business groups in your area. They should be able to help you, and it's always nice to network.

I also highly recommend checking out BizTrader.com, which is an online global marketplace. You can invest in, buy, and sell a business there. There are other professional services, in case you need to, say, find a lender. There a bunch of different businesses, so it'll be good. Check it out and good luck!