Tonight We're Going to Party Like It's 1999

(originally published on March 27, 2011 on the Launching Tech Ventures course blog)

Are we in a new bubble, as Steve Blank recently wrote, or do current high valuations for early- and late-stage consumer Internet companies reflect sound fundamentals, as argued by Ben Horowitz?

From an academic's perspective, this is a difficult question, and I won't tackle it here. Instead, I'll share some data on the performance of Internet startups launched during in the late-1990s boom.

The table below compares the market value at the end of 2001—the trough of the valuation cycle that began in the mid-1990s—to total capital raised since inception (private and public) for all 2,121 U.S-based Internet companies that had ever got funding from VCs or public markets (see appendix below for my definitions and methods). The firms had an aggregate market value of $99 billion at the end of 2001, and they had raised $85 billion of capital. This doesn't imply an attractive return for someone who invested pro rata in all rounds, especially if you consider the time value of money and the fact that investors had to share part of the $99 billion with company founders. But it's not a wipe-out, either.

Of course, focusing on sector-level, aggregate results may mask serious problems with overinvestment in individual markets, for example, online pet supply retailing—where four rivals burned through over $500 million and all failed.  Also, it's important to note that returns from individual companies were very skewed. As the table below indicates, only 139 (7%) of the 2,121 Internet companies completed an IPO. Among these public companies, only 37 had a market value at the end of 2001 that exceed the total capital they had raised historically. A full 42% of the sector's $99 billion in yearend 2001 market value was accounted for by just five companies: Amazon, eBay, E*Trade, Yahoo!, and WebMD.

In summary, if the Internet sector had been subject to grossly excessive rates of entry and investment during the last bubble, as conventional wisdom holds, we would have expected a significant sector-level capital loss, rather than a shoulder shrug, "got-my-money-back" aggregate return. Conventional wisdom exaggerates the economic damage wrought by the late-1990s bubble. In considering the impact of valuation bubbles, it's important to separate stock market gains and losses—transfers of wealth between traders—from poor long-term returns on the capital invested directly in companies. It is also important not to conflate the high business failure rates that result from excessive rates of entry with the high failure rates we would normally expect to observe in new markets with “winners-take-most” potential and low entry barriers—like those targeted by many Internet companies. Given lottery-style payoffs, high rates of entry and failure are consistent with rational economic behavior.

As a new bubble emerges around social media startups, we should expect to see similar performance patterns.

APPENDIX

Definitions. The table above includes all U.S.-based Internet companies that raised capital from professional investors prior to 2002. Internet companies were defined as firms that relied on the Web as their principal channel for delivering products or services to consumers or businesses. This definition excludes: 1) companies that earned most of their revenue by providing professional services, software, or hardware to Internet companies; 2) firms that provided Internet access or hosting services; and 3) the online units of established, brick-and-mortar corporations. Professional investors were defined as venture capital firms (including corporate venture funds) and institutions that purchased public securities. Firms funded exclusively by angels or by strategic investments from non-Internet companies were excluded, although strategic investments were included in estimates of total capital raised by VC-backed firms.

Valuations. Enterprise values were estimated as of December 31, 2001. Valuations for private Internet companies reflect only the market value of equity; few such firms had any debt. Enterprise values for public firms reflect the market value of their equity as of yearend 2001, plus the book value of any debt.

For active, private Internet companies that raised funds sometime during 2001, yearend 2001 equity market value was assumed to equal 98% of total capital raised historically, based on average post-round valuations for funding transactions completed during the second half of 2001. For active private firms that did not raise funds during 2001, yearend 2001 equity market value was assumed to equal 49% of total capital raised historically, based on analysis of performance for VC funds launched during 1999.

For merged firms, valuations reflect their contribution to the yearend 2001 market values of the companies that acquired them, rather than proceeds realized by the merged firms’ shareholders. For mergers involving two Internet companies, the acquired company’s value is included in the acquiring company’s yearend 2001 market capitalization. Capital raised by the acquired company is added to the capital raised by the acquiring firm. 

For acquisitions of Internet companies by non-Internet companies completed during 2001, yearend 2001 market value was assumed to equal announced merger transaction proceeds, which averaged 76% of total equity capital raised historically by the acquired companies. For such firms acquired prior to 2001, yearend 2001 market value was conservatively assumed to equal the total capital they raised historically.  

Source: Eisenmann, "Valuation bubbles and broadband deployment," Ch. 4 in The Broadband Explosion, edited by Austin & Bradley, HBS Press, 2005

No Regrets (Mostly): Reflections from HBS MBA '99 Entrepreneurs

(originally published on March 28, 2011 on the Launching Tech Ventures course blog)

MBA students who are debating whether to launch a startup upon graduation often ask me, "What are the career consequences if my business fails? What do MBAs who founded failed firms do now?  Do they regret their decision to launch a business right out of school?"

We have plenty of experience with student entrepreneurship at HBS. Over the past 15 years, an average of 3-4% of students in each class of 900 HBS MBAs have founded firms upon graduation, and another 4-5% have joined startups in non-founder roles. [author's note, 2/26/14: the comparable statistics for the HBS MBA Class of 2013 were 7% founding and 4% joining startups.]

At the dot com bubble's peak in 2000, 11% of our MBA class founded firms upon graduation. To determine whether we're in another bubble, I'll track this figure for the Class of 2011. Interest in entrepreneurship has been rising at HBS, but so far, it lags 1999/2000 levels.

To respond to my students' questions, I assembled some data on career outcomes for a sample of a dozen MBAs who founded firms upon graduation in 1999 or 2000. I also asked these alums whether they had any regrets about their decision to follow an entrepreneurial path. Most of the startups in my sample failed. A pattern of highly skewed outcomes—with just a few big winners, a modest fraction of firms that earned back their investment, and many failures—is just what we'd expect from any portfolio of VC-backed tech startups.

Specifically, in my sample, one firm is still a going concern; one was sold at a price that roughly yielded a breakeven return to early investors; two were sold at prices that returned only a small fraction of capital invested; and the rest were complete wipeouts. So, most of the alumni I contacted can comment from direct personal experience about the career consequences of startup failure.

What are these alums doing now? One is still CEO of the firm he cofounded upon graduation. Three are serial entrepreneurs who have been successful—so far—with a second startup. Three are partners in VC firms. Two are presidents of medium-sized businesses, having stepped in as professional managers to replace founders. One is at Boston Consulting Group. One is planning to launch another startup after holding a senior marketing job in a public Internet company. One is searching for a role in a new venture after a hiatus to start a family. As a group, the alums are in impressive positions. Those whose first startups failed do not seem to have suffered negative career consequences.

Do the alums regret their decisions to found firms upon graduation? Eight of nine who answered my email query said "no." Here's a sample of their comments:

• No: There is no substitute for the sense of pride and accomplishment that comes with starting a business. 
• No: But you need realism, an understanding of drawbacks and most importantly, to be passionately entrepreneurial. Starting a business is not for the timid. You need to be resilient, optimistic, able to deal with uncertainty, and strong-willed.
• No: The lessons learned have applied to my subsequent businesses. Each has been less stressful, because the experience provides groundwork for doing a better job the next time.
• No: Right after graduation is a great time to get start a business. You have amazing drive, focus and a smaller personal overhead. 
• No: I got to participate in every aspect of my company as a true general manager. I never would have that opportunity in a large, established company.
• No: The Internet boom was a unique moment and I could not pass up that opportunity.

One alum did voice regrets:

Yes. But I have no regrets about launching another business later. For me, it was just a matter of timing. Coming out of HBS, I had blind spots. I was an engineer undergrad, and even after HBS, a couple years with McKinsey or on Wall Street would have made a world of difference in developing structured thinking and hardcore analytics. I also needed more experience in areas like partner selection and more maturity in dealing with negotiations and employees. These blind spots introduced founder risk and reduced the likelihood of our success. The smart investment would have been to spend 2-5 years doing other stuff, getting paid while addressing blind spots.

More Advice from HBS MBA '99 Entrepreneurs

(originally published on March 28, 2011 on Launching Tech Ventures course blog)

I recently wrote some former students from the HBS MBA classes of 1999 and 2000, asking what advice they'd give to current students considering an entrepreneurial path. In a prior post, I shared their responses to the question, "Do you have any regrets about founding a firm upon graduation?" Below, I present their advice to current students.

In 2000, Rod Harl co-founded GiftwareExchange, an online B2B marketplace that connected gift stores with product suppliers. The business never gained traction, and after several career twists and turns, Rod is now President of Alene Candles, a business he and a partner purchased in 2008 that manufactures custom candles. Rod shared this advice:

Ample low-cost funding can compensate for founders’ weaknesses. In such periods I might endorse aggressively pursuing new businesses regardless of your experience or the quality of your idea. Playing musical chairs, you can make a lot of money. But outside those periods, entrepreneurship is about creating value for your customers before yourself.

HBS doesn't teach about handling failures, which represent a very large proportion of outcomes. Be aware of the personal risks associated with starting a business. Many of my classmates attached themselves so strongly to their startups that it cost them their life savings, marriages, or years of their professional lives. This should not dissuade a true entrepreneur, but it is rarely discussed. 

When Guy Miasnik co-founded AtHoc in 1999, the company provided a browser toolbar that presented alerts and updates from online content companies — akin to today's RSS. After some early pivots, AtHoc identified an attractive opportunity in emergency mass notification systems. Guy, still AtHoc's CEO, shared this advice about founding a firm:

The decision is not so much a matter of timing or financial upside. It is about the passion to create something new, to shape the world in ways you believe it should be, and to lead those around you — co-founders, investors, employees, customers, business partners, and media — to accept and adopt your vision. It is about incredibly positive thinking despite many rational negatives. It is about willingness to work extremely hard; to be relentless and persistent while still being flexible as you listen and learn.

As you go down the entrepreneurial path, you should build skills in two areas. The first is sales. Getting a customer to buy your product means you’ve learned how to gain trust, convey value, and extract commitment. The second is product management. 

As you embark on this path, don’t forget your family. Your partner’s buy-in to an entrepreneurial life style is crucial, and your family will help you keep things in perspective in good times and bad.

In 1999, Joel Silver launched SalesDriver.com, which provided incentive programs for sales reps. After Joel sold SalesDriver in 2001 to a larger marketing services firm, he served as President of Indigo Books & Music, a leading Canadian retail chain founded by other entrepreneurs in 1996. Joel offered this advice to current students:

Entrepreneurship is life changing. It is exhausting. Every decision is yours. There is no "down" time. It takes smarts and tenacity. It will test every relationship you have.

Be conservative and raise more money than you think you need. 

Know your customer cold. Customer insight — not being first with technology — will carry you to success. 

You will meet a lot of smart people who will give you advice. Take it. But don't assume anybody, despite their pedigree, knows your business better than you do. 

You will attract people who want to be part of a great team and work really hard. That is the best currency you have.

Dispense money from an eye dropper. Find the ugliest, cheapest space. Go to Goodwill for furniture. Use chipped coffee cups. You will gain investors’ respect. 

Just ship! Your first product needs to do one thing well, but it can suck in other ways. Version 2 will be good. Version 3 needs to be great

In 1999, Nikitas Koutoupes, co-founded eBricks.com, an online B2B marketplace for construction supplies which was absorbed through a series of mergers into Sword CTSpace. Nikitas, now a Managing Director at Insight Venture Partners, shared this advice: "Ambition and humility are not mutually exclusive. You don’t know what you don’t know, so hire well."

In 1999, Sasha Novakovich co-founded GetConnected.com, which provided advice for consumers shopping for voice, internet access, and video services. GetConnected successfully morphed its business model from a destination site into a private label service for brick-and-mortar giants like BestBuy, then sold its technology to a rival after eight years in operation. Sasha, now planning her next move, said, "Make sure that you have the best possible founding team: people with relevant, non-overlapping skills and experiences, who you trust and respect. Make sure there is a clear reporting structure and division of responsibility. A great team can take an okay idea and turn it into something phenomenal. A weak team can kill a phenomenal opportunity."

Returning to Argentina after graduation in 1999, Alex Abad co-founded Certant, which provided website development services. The firm failed in the recession that followed, and Alex is now the founder of Advanced Organic Materials. He said, "Entrepreneurship is a long and sometimes painful process. To succeed you need to have a passion. This has been the difference between my two startups. The second company I started is a chemical manufacturing company. I am a Chemical Engineer. Now, I enjoy everything I do."

In 2000, Richard de Silva co-founded Siteburst, which hosted and distributed online video for content companies. The service failed after online video emerged more slowly than expected, and Richard is now a partner at Highland Capital. He offered the following advice to aspiring MBA entrepreneurs:  "It’s important to be honest with yourself. If you feel compelled to start a business because it seems fashionable or you have seen others having fun, you should join a young company or a fast-growing bigger company and develop functional expertise — until you feel compelled by a market need."

One former student, who asked to remain anonymous, launched a failed consumer Internet venture that was truly ten years ahead of its time: a successful variant of his idea exists today. He offered this advice to current MBAs debating whether to launch a firm upon graduation:

Recruiters like to see big names on your resume: Google, Facebook, Amazon, eBay. Getting a job at these companies is a lot easier while you are at HBS than it will be after you graduate. Today these companies are courting you. A year from now you may be explaining what you ‘learned’ from your failed startup experience. 

Back in the web 1.0 era, the goal was to raise a huge first round and spend it quickly, acquiring users via large portal deals and banner ads. In the web 2.0 era, product is marketing. Now, with low technology costs, the goal is to do a lean start-up and get breakout user traction before raising serious VC money. After all, great products sell themselves, right? Just look at foursquare and Twitter. It’s easy!

In fact, one could argue that it is harder today than it was back in 1999. Back then, you had a fighting chance to get to scale using your VC war chest. Today, you’re expected to have product pixie dust that magically spawns a million users through spontaneous virality based on your insanely great product. 

So what would I do if I were graduating this year? Taking these two points together, I would take a job at Facebook, and do my start-up on the side. At Facebook — or Twitter or Zynga or a similar company — you will learn about product management, and you will meet the developers and UX people you’ll need to know if your start-up takes off. You can build your business at night and on the weekends, and see if it gets traction. And if it doesn’t take off, so what? You work at Facebook. You’re a stud. When you are ready to move on, recruiters will be calling you, and magically you’re on the HR buy side again!

To be clear, I’m not saying don’t start your business. Life is short. I’m just saying you should think about doing it in this less risky way.

Finally, Craig Carroll co-founded eGrad, which provided on online channel for established brands to market goods and services to college graduates. After morphing eGrad's model and selling the company to a larger student marketing firm, Craig is now founder and CEO of Rezolve Group, which provides services that help families secure financial aid for college. Craig shared this advice:

As a founder, you don’t have much control over exit timing. You take on responsibilities to investors, employees, and clients. If things aren’t going well or you aren’t enjoying it, you just can’t just extricate yourself. Understand the ramifications for your personal and family life. 

There are real benefits to being entrepreneurial when you are young. It is easier to deal with the stresses while you still have energy and no children. Sure, you may be less experienced, but energy, optimism and a touch of naivety can more than make up for that.

There is no formal career path. You truly make your own destiny, but I have seen many friends struggle with the transition from a failed venture and the uncertainty of “What do I do next?” 

The best entrepreneurs have an indomitable spirit and are resilient in the face of adversity. Every new venture really is a rollercoaster of successes and setbacks that test your emotional fortitude. Aspiring entrepreneurs need to ask themselves if their personality and mental strength is really suited to this.

The HBS definition of entrepreneurship as “the pursuit of opportunities beyond resources currently controlled” is more than just a platitude. For me, it sums up perfectly what I do day-to-day. You need to be inventive, creative, opportunistic, persuasive because you rarely have enough resources. Embracing this definition helps me in my role.

Startup Management 101: World's Longest Syllabus

I've compiled lists of blog posts, articles, and books that offer insights and practical advice about various startup functions, including product design, product management, business development, marketing, and sales. In addition, I've aggregated readings on lean startup logic and methods and key factors for success with the SaaS business model.

The catalyst for creating these lists was an MBA elective course, Launching Tech Ventures, which Flybridge Capital GP/HBS Senior Lecturer Jeff Bussgang and I co-teach. The course focuses on functional management challenges in early- and later-stage tech startups. We assign lots of readings by entrepreneurs and investors. Instead of a final exam, students complete a "learning-by-doing" project which applies one of the tools/techniques used by startup managers, for example, customer discovery interviews, A/B tests, or usability tests. The lists I've compiled contain terrific guidance for our students. Thanks to all who've contributed their insights!