The Trouble with Bubbles (talent, angel & incubators… oh my!)

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The bubble is back, baby!


Let’s raise lots of money… Aeron chairs for everyone!

Oh wait, I’m angel investing now….  higher valuations means I get a smaller percentage!


Bubbles are bad!

Bad bubble, bad bubble!

If you read the blogs, you’ve been hearing intelligent venture capitalists like Fred Wilson and Bill Gurley lament the bubbly conditions they’re facing.

[ Side Note: If you’re reading this and not Fred Wilson and Bill Gurley’s blogs, you need to free up five hours and read everything they’ve written in the past six months. These are two venture capitalists in the prime of their careers who are operating at a very high level. Seriously, go subscribe: + –> I’ll be waiting right here. OK. Welcome back, let’s continue. ]

Everyone at the Web 2.0 conference, which I am lobby crashing during the LAUNCH conference announcement, is asking me if there’s a bubble, when it’s going to pop and what they should do.

There are four distinct bubbles right now:

1. The Angel Bubble (huge)
2. The Talent Bubble (unprecedented)
3. The Incubator Bubble (large)
4. The Stock Market Bubble (modest)

Based on these I have four pieces of advice for startup founders:

a) Close Your Angel Round — NOW!
b) Close Your Series A — NOW!
c) Move out of Silicon Valley
d) Join a Quality Incubator and Work It!
e) Focus on the Waves

1. The Angel Bubble
Ten short months ago, the valuations at Open Angel Forum were in the $1-3M “pre-money” range. In October and November valuations for angel deals at the Forum, and that I’ve seen personally, were in the $3-6M pre-money valuation range.

In fact, almost all of the angel investments I was excited to do in the last three months gave me the new angel standard, “We’re thinking a $6M pre.”

Part of the reason for the angel bubble is that events like incubator demo days and servies like Angel List (and, yes, even Open Angel Forum — guilty as charged!) have made the process of finding and pitching angels transparent, free and merit-based.

It used to take a month to find an angel, now you can pitch a dozen in one day–online or in person! It’s wonderful, unprecedented and probably unsustainable.

A second reason is that so many folks are cashing in Zynga, Facebook, Groupon, Twitter and LinkedIn shares on SecondMarket.

The third reason for the angel bubble is that most folks are not excited about putting their savings into the stock market or real estate — where most high net-worth individuals typically park their money.

Said another way, the thrill and reward of angel investing combined with a good chance of getting a 5-10% return — with the lottery-ticket possibility of investing in a Facebook, Zynga or Twitter — is more appealing than giving your money to Goldman Sachs or a hedge fund.

While the logic I’ve outlined above seems valid to me, I’ve learned that with money, people don’t do logical things too often.

Frankly, I would have done three more deals this year if the valuations were lower. However, I’ve been learning from my angel and VC mentors that the valuations you invest at do, shockingly, matter. When I look at a company these days, I say to myself, if I were running AOL, Google or Yahoo, what would I pay for this company two or three years from now?

In many cases the answer is $10-25M. If you’re investing at a $2M or $6M valuation, you’re talking about the difference between a 12x vs. 4x return. If you only get a return on one in five investments, then the 4x puts you at basically breakeven.

Being an angel investor is easy, being a profitable one is hard.

Bubble Size: Huge

Winner: Startups; Savviest/Luckiest Angel Investors

Losers: 80% of Angel investors

2. Talent Bubble
Venture capitalist Fred Wilson blogged that things like Google paying a reported $3.5M to retain a single developer headed to Facebook were signs of an unsustainable environment.

Paying $3.5M to retain any employee is probably absurd — let alone one of thousands of your developers.

However, without knowing the developer, it is impossible to say.

What if this developer is a Mark Zuckerberg, Bill Gates, Steve Wozniak or Ray Ozzie-level talent? The $3.5M is NOT a lot of stock to pay them over four years, is it?

If you’re a game-changing developer at Google, you now have the option of raising money from the angel bubble (see #1 above), or getting accepted to the TechStars, Founders Institute or yCombinator bubble (see #3 below).

If you’re going to give up starting your own company, which you might own 10-20% of on exit (assuming you have a partner), then $3.5M seems to be the perfect number for Google to “float.”

Bubble Size: Large

Winner: Worker bees who would be Queen

Loser: Suckers who invest in anything but the top three incubators

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Where will you be February 23rd and 24th?
The LAUNCH Conference, Hosted by @Jason
San Francisco, Tickets start @ $400


3. The Incubator Bubble
The old-school way of becoming an entrepreneur was kicking down the door and saying “I’m here.” Then you made a ton of mistakes, got your ass kicked, and begged, borrowed and stole every nugget of how to run a business you could.

The test to see if you were worthy of being invested in was if you could figure out how the startup business worked. There were no blogs explaining term sheets, or podcasts about startups.

Certainly there were no schools for entrepreneurship like TechStars, yCombinator and the Founders Institute.

Today you can literally learn how to code, build a basic website proof of concept — heck even mockups — and apply to go to a three-month class in which you build your startup!

Oh yeah, the best entrepreneurs in the world mentor at these “schools,” and oh yeah, they pay you $15,000 in living expenses. The downside? They take 5-6% of your common stock.

If teaching you how to build a company wasn’t enough, at the end of these events you go to a demo day where you show your work to angel investors and raise $500K (or more).

There are now dozens of these programs operating in cities around the world — and many more will follow. Every VC firm and government economic development group is studying the TechStars and ycombinator models and saying “We need that.”

As these programs have expanded, I’ve found that the level of intensity and savvy of the founders has come down a notch. Basically, there are a lot of open seats in these programs, so some of the B-level students are getting in.

With the addition of more programs will come the placement of C-level founders, which are basically in the category of “not fundable.”

In the worst case, I think we’re going to reach the point where people who shouldn’t be teaching entrepreneurship are going to start teaching folks who are not qualified to be entrepreneurs how to start companies!

The delusional leading the incompetent!

Bubble Size: Medium
Winner: Founders
Loser: B-level incubators

4. Stock Market Bubble
Is there a stock market bubble? I actually have no idea. Half the people I talk to tell me “at these PEs I’m buying all day,” while the bears lament, “We haven’t solved the fundamental problems in the economy and printing money is going to cause [INSERT DISASTER HERE]!”

However, I can tell you that the phenomenon I’ve observed with many bubbles and busts is that great startups grow independently of the stock market.

Let me repeat that: great startups grow independently of the stock market.

The fact is, the public markets rarely have much effect on a startup at all.

Perhaps if your clients are publicly traded you can make an argument that their spending might raise or fall with the stock market. Perhaps the number of engineers available in the market might track with valuations (but doubtful).

Great startups put their heads down and build during stock market bubbles, and if given the opportunity, they exit or raise capital via an IPO.  Most companies are not IPO ready (i.e., they have less than $100M in revenue).

Bubble Size: Medium
Winner: Bankers
Loser: Consumers dumb enough to buy stocks

Bubble Advice

Given the four bubbles, here is some advice:

a) Close Your Angel Round
If you’re raising an angel round and can get anything above a $2M pre-money valuation, you should immediately raise money because my gut tells me these large angel valuations are going to end after the holidays.

Angels are running out of powder to invest, and they are going to get a lot of bad news next year when the companies they invested in this year run out of capital and do flat or down rounds. It is highly likely that a number of these startups that raised at the higher end of valuations will start to run out of capital before they’ve made meaningful products and revenue progress.

New and existing investors will look at these 18-month-old companies and say “Well, you spent $1M and you haven’t gotten significant traction, so I’m only going to invest at the valuation of the last round.” Or, they may ask for 25-50% less!

When the new breed of inexperienced angels — of which I am one — experience the reality of sideway startups, they are simply going to stop investing at $4M+ valuations. Angels will get more disciplined and look for $1-3M valuations.

b) Close Your Series A
============== recently took down millions at a $35M valuation a couple of months after closing an angel round someone told me was in the $3M range. 10x increase in value in four months, with no revenue and tiny adoption for a product that has been done with only modest success five times already (upoc any one?!). Oh yeah, one person around the company told me they lose money on every transaction due to SMS fees they ship to Twilio I’m guessing.

If you’ve closed an angel round in the past six to 12 months, I highly recommend visiting 10 VCs over the next three weeks asking them “for advice on how to scale your business.” Scale is code for taking yourself out of the minor leagues of angel investing and into the major leagues and pulling down $3-4M series A.

Don’t wait. Don’t overthink it.

Take. The. Money.

Don’t waste your time thinking of reasons your A-round can’t happen, think of all the reasons it can happen. I hear folks say all the time, “We just did our angel round, it’s too soon to raise another round.”

You know when smart entrepreneurs raise money?

Answer: “Any time they can at an increased valuation.”

Rarely does a company with large cash reserves shut down, but 100% of startups that run out of cash do!

c) Move out of the Valley
The talent wars are out of control. Folks like Facebook will not only match Google’s brilliant “10% raise, effective immediately,” they will probably exceed it!

With Twitter, Zynga, Facebook and Google in the ultimate game of one-upmanship, small startups are simply not going to be able to compete for talent in the Valley.

Moments after you land a great developer, product manager or sysadmin for your startup, recruiters will be whispering in their ear how foolish your new star is for ignoring the fact that they could make much more and have “free money” in the form of Facebook, Twitter or Zynga shares.

Smart companies are thriving OUTSIDE of Silicon Valley. They are scaling in markets that are not as cut-throat and competitive. Living Social is in D.C., Groupon is in Chicago, my company Mahalo is in Los Angeles and Zappos is in Las Vegas.

Even my beloved Silicon Alley is hard to recommend as a startup location due to the brewing developer battle between startups with tens of millions of dollars in funding like FourSquare, SquareSpace, and tumblr, who will face Google and AOL’s absurd offers!

If you’re a great developer in New York City looking for a cool job with max cash and massive upside, you’re going to have your choice of one of the six companies — not to mention John Borthwick from Betaworks and David Cohen from TechStars lobbying you to forgo short-term cash in order to start your own company.

Your tiny start doesn’t have a chance against that lineup, and you’ll be forced to settle for the B or C-team talent. You will then lose.

If you’re in one of the non-Valley and non-Alley cities, your team will have a lower cost of living, a better quality of life and less distraction from recruiters. You’ll have the time to build an authentic culture, based on a four-year plan and loyal team members (loyal to *each* other).

Note: I don’t blame any talented individual from getting a pay day. I mean, we all need to eat — and many of us like money and what it enables (i.e., freedom).

However, the talent bubble is obviously out of control, and short-term gain is keeping teams from making the next Facebook, Zynga, Twitter or Google. In fact, today’s talent war is unlike anything that came before–certainly a magnitude more intense than even the dotcom bubble.

Clearly Facebook and Google are buying all the talent in the market to not just service their needs but to keep great people from creating great competitors. If you have billions of dollars available to you via earnings (Google, Microsoft) or via investment (Facebook, Zynga), why wouldn’t you block the best talent from becoming your next competitor?

Said another way, if Facebook wastes a billion dollars on salaries over the next three years, and one of those salaries comes from a developer who would have built a better Facebook, well it was cost-effective insurance wasn’t it?

If you leave the Valley, you and your team will forget about the Facebook and Google talent war — it will become an abstraction that you read about on TechMeme, as opposed to a conversation you have online at Starbucks.

d) Join an Incubator, But Demand a Half-Price Deal
If you’re a first-time founder and you’re considering joining an incubator program, I highly recommend TechStars, The Founder Institute and especially ycombinator. These programs are all game changers for newbies, and there is zero downside to donking off 6% of your startup to one of these fine programs.

However, if you’re joining a new incubator, I suggest negotiating very hard and playing angels off of the incubators.

If an accepted ycombinator company came to a group of angels and said, “I’m giving 6% to ycombinator for $15K or I will skip ycombinator if you give me $50K for the 6%,” what do you think the angels would say?

Angels are so drunk on ycombinator —  with good reason — since the quality level is stunning. They would literally outbid ycombinator 5-10x. If you’re a startup, you should always be trying to get a better deal for yourself and your team, within reason.

If ycombinator is overvalued right now, why not leverage that into a preemptive angel round at a juicy valuation?

e) Ride Waves, Not Bubbles
Bubbles are a lot of fun for folks to speculate on, and humans are conditioned to rubber neck.

For a year the media obsessed over the financial crisis, which while very real and intense, had absolutely no impact on great startups. For fracks sake, I even got distracted for a little bit and laid off a dozen folks and wrote that half of startups were going to fold/go into hybernation mode (it was probably half or 1/3rd).

Twitter, FourSquare and Groupon all added billions of dollars in value while CNBC shat the bed daily. If you’re working at a startup you have no business watching the stock market or CNBC. Every minute you waste on that garbage is a minute you could have been talking to your customers and iterating on your product. Focus people!

[ Note: I’m talking to myself mainly in that last sentence. ]

Sure, a lot of startups quietly waded into the dead pool with “merger” announcements, but the truth is that during all these bubbles, the swell kept growing!

Six waves are more important than any bubble the pundits can obsess over:

I. Online Advertising
II. Mobile/Smartphone/iPad Adoption
III. Globalization
IV. Absurd Software Efficiency & Innovation
V. Plummeting CSB (Computing, Storage and Bandwidth) Costs
VI. Internet-enabled TV/Video

These six have grown to the “big wave” category, and some are about to reach tsunami levels.

As an entrepreneur, you need to let the bloggers and blogging VCs sweat the bubbles while you focus on the waves!

Surf’s up dudes! Let’s do this my peoples!

best, JCAL

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Where will you be February 23rd and 24th?
The LAUNCH Conference, Hosted by @Jason
San Francisco, Tickets start @ $400

Suggested reading

Chris Dixon’s blog ( <— Angel, blogger & entrepreneur )
It’s not that seed investors are smarter – it’s that entrepreneurs are

Mark Suster’s blog ( <— VC, former entrepreneur, blogger and podcaster )
What Angel Investing & Florida Condos Have in Common

Fred Wilson’s blog ( <— Blogger, long-time VC & an old friend of mine )
Storm Clouds

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