Posted on December 12, 2007
Filed Under VC Insanity |
The auction of classified listing service Edgeio provides an interesting look into the world of VC-financed startups. Edgeio received $1.5 million in an angel round and $5 million from Intel Capital and Transcosmos Investments in a series A round. Edgeio’s demise, and the fact that the assets of a company that raised $6.5 million are now being auctioned with a $250,000 starting bid, have unsurprisingly sparked a lot of negative commentary, including some directed at Edgeio’s co-founder Michael Arrington, editor of TechCrunch.
But the failure of Edgeio doesn’t reflect poorly on Edgeio’s founders or management team because the majority of new businesses fail. The failure of Edgeio instead reflects poorly on the VC model for building companies, which I believe is, for many companies, significantly flawed. The wiki set up for prospective bidders provides a detailed insight into what is fairly reflective of a prototypical VC-funded technology startup and makes for interesting reading (I enjoyed looking over the balance sheet the most).
Edgeio had lofty goals and invested its funding heavily in technology development and infrastructure. In announcing Edgeio’s entrance into the deadpool, Michael Arrington wrote:
The company burned through that money according to plan, meaning they ran out this month. The product roadmap was fulfilled, meaning development lags didn’t hurt the company. But the revenues didn’t come in and user/partner milestones weren’t met. And that meant no one else was going to put more money into the company.
Keith Teare, the CEO of Edgeio, showed some cojones by posting a response to some of the comments and questions left by TechCrunch readers. The portion of his response that I find most telling is:
edgeio was a pre-revenue company. That was entirely within plan. We are building an Internet scale classified ad platform for ALL publishers. That is a big effort. We had 11 full time employees, almost all engineers. No sales or biz dev staff yet. Our costs ($6m over 3 years) are well within normal limits for a venture backed company with a big idea and plan. Despite that we had begun to get revenue (I would characterize it as early stage accidental revenue).
Our plan for 2008 was $1.6m and for 2009 about $16m. Last Thursday we pushed the first part of our publisher facing revenue platform. Check out http://www.edgeio.com/cb-intro to see it. By mid January this was to include a CPC and CPA component. This platform is all but finished. A buyer would own it for a fraction of the $6m it cost to build, and without needing the 3 years it took to build it.
The words of Michael and Keith demonstrate a fundamental flaw in the VC model for building a business: generating revenue early on isn’t nearly as important a priority as it should be. A VC might argue that a company like Edgeio needs to make a significant investment in product development before revenues can realistically be generated and that given the size and potential of the market Edgeio was going after, the risk in providing capital for product development during a pre-revenue phase was acceptable. This isn’t necessarily a completely asinine argument as more often than not it’s hard to make bigger money without big money (especially in the relatively short period of time VCs are looking to exit their investments).
I still, however, believe that the VC model for building a business is flawed for most companies. Startups should be encouraged to generate revenues as soon as possible. Having a “plan” to burn through millions of dollars before any real revenues are expected to be generated is insanity no matter how you justify it. In Bubble 2.0, not only has the importance of revenues been devalued, but in many cases, the importance of even having some clue as to how revenues can be generated has been devalued. Web 2.0 darling Twitter, for instance, raised $5.4 million without any semblance of a coherent business model coming into focus.
Every company needs a business model and revenues. The lack of these things may be acceptable to VCs because it only takes a small number of big hits to “make” a fund, but entrepreneurs should consider that because the majority of VC-funded startups fail, the odds of succeeding by following the VC model for building a company aren’t that great. And while the VC only really invests his limited partners’ money, the entrepreneur invests his time and energy. For a true entrepreneur, those two things are probably more valuable than the VC-subsidized salary he gets.
In the end, Edgeio is the poster child for the importance of revenue (and its even more important friend, cashflow). While it is necessary for some startups to eventually raise capital from VCs or institutional investors, don’t listen to anybody that will write you a $5 million check for a “plan” that has you spending all of it during some “pre-revenue phase.” As I noted in my 10 rules for startups, cash is king. At the end of the day, businesses are started to make money. Start a business that makes money and your chances of success are higher; start a business that doesn’t make money and pray that somebody buys you. Which is more sensible?Print This Post