I just got back from a week in Israel having spent some time in Jerusalem for an Answers board meeting and then making my way to the Ohalo Resort on the Sea of Galilee for Kinnernet 2006. Kinnernet is a techie geek camp organized and run by Yossi Vardi (cofounder of ICQ). At Kinnernet, I had the privilege to spend time with some great people from Israel, Europe, and the US. I suggest checking out Jeff Pulver's blog and going to Flickr and searching for Kinnernet2006 for pictures and more thoughts on Kinnernet. There were lots of robots, aerial shows with model planes and helicopters, great discussions on current technology trends, and of course, plenty of beer and laughs.
One of the discussion groups that I led with Simon Levene (heads up Corp Dev in Europe for Yahoo and Yair Goldfinger (founder and CTO of ICQ and Dotomi) was titled "Are Internet VCs Dead." You know the backdrop - it costs less to get a company started and to generate users and Google and Yahoo are agressively snapping up companies before VC rounds. Google's expertise seems to be buying engineers, many times before a product is even launched. Yahoo, on the other hand, prefers to buy companies that have some nice user base, maybe no revenue model yet, but also before a VC round. The last point is that companies are now more capital efficient (see an earlier blog post) where $10-15mm can get a company to cash flow breakeven vs. $30mm. So what do VCs that invest in Internet companies do? Before I go there, I would flip the question and ask what do entrepreneurs do? From my perspective, I wouldn't take in more than $1-2mm to get my company started with a developed product and an idea of what usage will look like. At that point, as Yair suggests, it is decision time. Some of the questions to ask include:
1. Do I have a product or feature or can I build a real company (i.e., a growing cash flow sustaining business)?
2. What is the risk I face in building a company for the long term vs. selling today.
3. And finally, do the math - if I take in VC money I will clearly have to sell for alot more tomorrow than what I sell for today in order to generate the same or greater value.
4. Do I want to do it?
As a VC, I truly would not want to invest in a company that has not thought about all of the above with a founding team that is fully behind building out the company for a longer term play. All that being said, the numbers are still against the entrepreneur. While there have been a number of acquisitions in the past year, it is still a fraction of the number of companies started. Since it is so cheap to start a business, you can have anywhere from 5-10 companies out there in each category. In addition, it is not clear that many of the acqusitions during the past year could have built real businesses rather than being a feature of a much larger entity. While the math worked for a number of enterpreneurs that sold, one of the decisions you need to make is the likelihood and timing of being crushed by a larger player if you decide to go alone and raise VC funding. Whatever you start, I would suggest thinking about what your potential revenue model is from day 1 and thinking through the economics. Hell, it may change a couple of times, but building a company with the sole purpose of flipping is the wrong idea as your odds of success are very low.
Despite this, the opportunity for entrepeneurs and VCs could not be greater. There are clearly more users globally, broadband is everywhere, users are more educated, companies can target more, capital efficiency has increased, and there are real business models out there generating tons of profits. I do not think that Internet VCs are dead, but rather, need to reinvent themselves. It is also clear that the VC model is broken and needs to change. As you can see this is slowly starting to happen as smaller funds ($200mm vs $750mm) are being raised, VCs are doing less new deals per year and sitting on less boards, and many are trying to get in earlier. Having a smaller, more focused fund allows a VC to make some investments during the Angel round ($500k-$1mm), watch the company closely, and give VCs the opportunity to lead the first real institutional round. If the company has the chance to flip, then great, everyone wins. If the company want to take the next step, then we can be there to lead or co-lead the next funding round. It is imperative for VCs to get in early and structure their funds around this because in the Internet space companies can build momentum quite quickly which also means that valuations tend to move quickly as well. That is also why the Googles and Yahoos of the world are trying to identify the emerging opportunities before the VCs get involved.
All in all, it was a wonderful time, and I feel honored to have been one of Yossi's guests and for having had the opportunity to network and participate with Israel's tech elite. Unfortunately, I had to head home on a redye Saturday night, but many of the attendees ventured to the Marker Tech Conference where 3500 people were expected to attend and hear panel discussions led by many of the participants at Yossi's Kinnernet. Kinnernet was great and I had a blast, made many new friends, and came away clearly impressed with Israel's thriving and talented startup community.