Warren Buffet enlightened us to the fact that the stock market is governed by fear and greed. But then he said people should actually be fearful when the market is greedy and greedy when the market is fearful. Similar opposing forces apply to the software industry. Technology is driven by reality and hype. People should look for hype when everyone is based in reality. During a boom, companies should come to reality quickly if they want to survive the bust.
Some very lucky people were at technology startups around 1995. Companies going public prior to 1995 were forced into a strict reality of profitability. The general rule of thumb was several quarters of profits before you IPO. Then Netscape went public in 1995 with no profits and based on the hope, or should I say the hype, of the emerging Web. Look what they started by offering hype above reality. Their success changed the game for what was required by companies to create value in the market.
Imagine what may have happened to you if you believed in hype back then. Development of Hotmail started around 1994 and Microsoft bought it for $400 million in 1997. The product was just email in a browser which is something most developers could create in a weekend with PHP and the mail API. Broadcast.com was started in 1992 as online radio. In 1998, it went IPO and a year later was bought for $5.7 billion. The founders of Netscape, Hotmail and Broadcast.com were looking for the next great thing when most of the industry was stuck in reality.
Then the boom hit.
Everyone came flocking to the Internet and companies were starting all over the place. Idealab!, an Internet incubator, was working on creating a company a month. A company a month! How could that possibly lead to success? It takes years to build a great company. Yet, in 1999, 457 companies went public and a quarter of those doubled in the first day. If you define success by a liquidity event, then clearly success was to be had by many.
One of the most discussed business models was the land grab, a.k.a. the Amazon.com model. Don’t worry about profits or debt, just get as many eyes on your site as possible and stake your claim. Amazon incurred what felt like mountains of debt, and in the end out spent their competitors to success, though I don’t mean to trivialize the other aspects of their impressive execution. While some companies succeeded in this great California gold rush, like eBay and Amazon, many more did not. Why?
The bottom fell out.
In 2001, the stock market took a nose dive and the money dried up. A mere 76 companies went IPO that year. Most of the companies started during the boom went out of business or were gobbled up at bargain basement prices. What happened?
Companies were so focused on the hype and the land grab that they ignored one of the fundamental realities of business. When you don’t have any money, the doors close. Watch the movie Startup.com if you want to see this played out in real life.
Notables like WebVan, eToys, and Beyond.com floundered because they were caught up in the hype and expected the investor community to keep funding them. Had they paid attention to the reality of running a business that must pay expenses and do marketing to get customers, they could have weathered the storm and been the last man standing in a wide open field. Talk about a land grab. When hype implodes, the companies who come to their senses first will have the best chance of surviving.
History is repeating itself right now. The Web 2.0 movement emerged from the dust of the previous fire. The economy rebounded and money started flowing. Look at how many new companies are riding this wave, and as an aside, what’s up with those names???
Facebook is worth billions. MySpace sold for $580 million in 2005. YouTube sold for $1.65 billion in 2006. While many of us were just trying to stay employed, and others were switching back to their former careers, the savvy entrepreneurs remained dedicated to innovation and chance. Being at Google in 1999-2003, forgeddaboutit!
The movement was still hitting stride when some very notable investors in the valley revealed this presentation to the industry earlier this year. OK, to be fair, the economy was already in a funk. But yet again, those companies who were living on hype suddenly found themselves needing to preserve every dollar hoping they can reach cash flow positive before the lights go out. How many of these companies do you think will be around in a year or two?
What does this tell us?
If you believe Warren Buffet, then soon will be the time for hype again as everyone has just been forced back into the reality of trying to get through the crunch. Companies that have identified successful markets or products may run out of cash leaving a door wide open. Investors are preserving cash in case they need it to protect investments they have already made. How long do you think they’ll do that before they start looking for the next MySpace or Facebook?
Even more important, the companies that survive this contraction will be forced to become well-run businesses that effectively manage their bottom line. That in turn makes them attractive to investors provided the hockey stick growth is possible in their market. The money will flow again, that much is sure, if you believe Warren Buffet.
My advice to you is to let the market thin out for a year or so. Spend the time working in a stable job while you enhance your skills and brainstorm ideas. Then, when you have your next idea, a feeling you should definitely validate with all the smart people you trust, get started so that you will have a solid offering when money becomes more available again. That’s what I’ll be doing. I predict by 2010, the seed money will be flowing again. The best founders will not forget the lessons of economic down turn and opposing forces.
If you don’t think there are still great ideas out there, let me say that I still can’t check my voice mail when walking in my front door by just saying “What’s new?” I still don’t know how energy efficient my house is from reading a meter on my wall. I still haven’t worked on the product for my sister that I uncover in this post. And don’t even get me started about how many small businesses are still using desktop software.