Edgeio: An Interesting Look into the World of VC-Financed Startups

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?

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9 Responses to “Edgeio: An Interesting Look into the World of VC-Financed Startups”

  1. jamboree on December 12th, 2007 2:30 am

    Edgeio failed because they didn’t burn cash fast enough. Look at Youtube… 1M/month just in bandwith alone with 0 revenues… Result? $1.6 BILLION valuation!

  2. Keith Teare on December 12th, 2007 11:21 am

    I don’t think it is possible to generalize like you do. Many many companies have raised cash and used it to build a revenue generating company, often a huge one. Google (raised $25m before revenue) eBay ($15m) YAHOO (IPO’d when not proftable_ as did Netscape, etc etc.

    On the other hand many many companies bootstrap and grow from revenue. My first startup, Easynet Group plc (UK) did that. We went IPO without VC funding.

    It is really about the market, it’s size, what is needed to attack it.

    edgeio was attacking a $50 billion US market ($200 bn worldwide).

    My analysis is that a smart investor would have funded the next stage, even up to $15-20m raise, to go after that, and would probably get a 100 x return.

    However, today’s VCs are heavily metric focused, perhaps due to bubble shock from 2000. They do not look for big ideas that are not yet profitable.

    There are exceptions, and clean tech is one, where they put huge amounts to work in drives, acting like sheep. Classified Advertising is not one of those. It should be.

    Keith Teare

  3. Mike Rundle on December 12th, 2007 11:25 am

    I don’t have any relation to the Edgeio founders, but I think one of their biggest problems is that they were spending all their money and time creating the platform that would allow them to do something, rather than on building a definable product or service off the bat. Keith defended the server purchases by saying how much number crunching and processing was going on so they could pull listings down from the cloud and process them for usage elsewhere. I understand the concept of a distributed listing system but the immediate value to users I cannot see.

    Look at the most well-known exits we’ve had in the “Web 2.0″ industry — YouTube, MySpace, Flickr, LiveJournal — you can explain each of them in just a few words and everyone will understand. Easy video sharing. Customizable social networking. Easy photo sharing. Edgeio was… a platform for allowing websites to list auction entries and make micro-revenue from them. Their value proposition just didn’t hit the mainstream of Internet users, which is essentially what you need if you want to gear up as quickly as your investors want you to. If you target a niche audience then growth is flatter, if you target the largest of audiences then growth can be more exponential.

    The problem with drinking the “Web 2.0″ koolaid and building software for others in the web industry is that you’re missing out on the 99.9% of people. MySpace, Flickr, and YouTube provided interesting services for everyone, regardless of technical knowledge, and they took off rapidly. That’s the key difference.

  4. Drama 2.0 on December 12th, 2007 12:06 pm

    Keith: thanks for your comment. If it isn’t obvious, I’m a fan of the bootstrap model. As I mentioned in the post, VCs do use the “this is a big market and we need to invest big money to attack it” rationale to justify many of their investments but the real problem for the entrepreneur is that for every eBay, Yahoo, Google, etc. there are 100 failures. The fact that most VC-funded startups fail despite the fact that they do not lack sufficient capital to get a proper start would seem to indicate that there’s probably something flawed with the model and I think the fact that generating early revenue isn’t always a priority has a lot to do with it. The support of exorbitant burn rates that don’t correlate with near and medium-term cashflow is also flawed.

    There may be times when such a model makes sense and is necessary, but I simply think that it’s never a good idea for any startup to devalue the importance of revenues. VCs often allow, and encourage, that (although as you know, this doesn’t last forever). When bootstrapping, the entrepreneur has a significant incentive to think about ways to make money as soon as possible and for the majority of Internet startups I think this is more conducive to success.

  5. Alex Linhares on December 12th, 2007 5:26 pm

    Drama 2.0: you win.

    I’m now bearish, because of you! Darn Prophet… The apocalypse is really coming.

    I’m doing an youTube video stating my arguments; can I use some of your thoughts (with attribution, of course)?

  6. Drama 2.0 on December 12th, 2007 11:14 pm

    Go ahead Alex. My thoughts are free.

    Since I’ve officially been called a prophet now, I figure it’s time to start a cult. Do you want to be the first member?

  7. Drama 2.0 on December 12th, 2007 11:17 pm

    PS: I noticed you’re from Brazil. I love your women. Which reminds me that there’s a Brazilian woman I met recently who I need to call. :)

    Bring a few beautiful women from the Copacabana beaches into my cult and I’ll make you a lifetime member!

  8. Drama 2.0’s Predictions for 2008 : The Drama 2.0 Show on December 21st, 2007 1:01 am

    […] now that a new year is upon us and I’ve already been hailed as a prophet by a Drama 2.0 Show reader, it’s time that I make my predictions for […]

  9. The Top Mistakes Entrepreneurs Make : The Drama 2.0 Show on January 9th, 2008 2:23 pm

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