A while back I remember having a conversation with a friend about the state of web business and how it seems that no one wants to build a business that they ever intend to make into a long lasting proposition. It is all about building to be bought rather than building a business intended to last beyond the first serious offer from a larger company.

YouTube is probably the most famous of these buy-out that made waves when Google bought the video service. However they are not alone as the web is littered with absorbed companies of which Zappos was the newest member.

When Amazon bought Zappos for $1.6 billion of Amazon stock many wondered what would happen to the company. While predictions may have varied it seems that at this point in time all is well with the Amazon-Zappos marriage and with Zappos becoming the poster child of successful big company – small company buy-outs.

So it was interesting to read the excerpt of Tony Hsieh’s, founder and CEO of Zappos, book Delivering Happiness on the Inc.com site and hear how; and why, the sale to Amazon came about. As it turns out there were actually two offers from Amazon with the first being made when Zappos was still just getting its feet wet in the start-up world but ended up turning down.

In the intervening years Zappos grew into being a successful business with profit just around the corner and changing the whole landscape of what customer service meant. The problem was that the venture capitalists backing the company didn’t see the company ethos the same way as the people running, and working for, the company. There was a conflict brewing and one that could have changed the company.

Some board members had always viewed our company culture as a pet project — “Tony’s social experiments,” they called it. I disagreed. I believe that getting the culture right is the most important thing a company can do. But the board took the conventional view — namely, that a business should focus on profitability first and then use the profits to do nice things for its employees. The board’s attitude was that my “social experiments” might make for good PR but that they didn’t move the overall business forward. The board wanted me, or whoever was CEO, to spend less time on worrying about employee happiness and more time selling shoes.

The main thing to remember here is that Hsieh didn’t want to sell the company but instead of taking Zappos public and remaining independent he realized that the only way to keep the company unique was to find a buyer.

It was a stressful time for me and Alfred. But we’d gotten through much tougher times before, and this seemed like just another challenge we needed to figure out. We began brainstorming ways that we could get out from under the board. We certainly didn’t want to sell the company and move on to something else. To us, Zappos wasn’t just a job — it was a calling. So we came up with a plan: We would buy out our board of directors.

We figured to do so would cost about $200 million. As we were talking to potential investors, Amazon approached Alfred about buying Zappos outright. Although that still didn’t seem like the best option to me, Alfred sensed that Amazon would be more open than last time to the idea of letting Zappos continue to operate as an independent entity. And we felt that the price Amazon was talking about was too large for us to ignore without potentially violating our fiduciary duty to our shareholders.

Therein lies the big problem of venture capital – they aren’t in for the long haul, especially in complicated financial times. They want to see a return on their investments as quickly as they can and don’t get me wrong, there is nothing wrong with this but it provides little incentive for long term business strategy.

Where Zappos wanted to remain independent and wholly owned by the people who had founded it they were put in a position where they had to sell. It was either that or potentially lose their business.

While venture capital might be the greatest thing to happen to people with a dream it the same doesn’t always apply to people who want to create a business for the long term. Sure it is great to see all the innovation that these start-ups are bringing to our world but at the same time there is way too many me-too ideas getting funded by VCs. It is because of this crap shoot in funding that venture capitalists find themselves thinking in the short term which means take the best and soonest buy-out offer that comes along.

It leaves one wonder just how many of these absorbed companies could have gone on to continue to innovate instead of becoming a nameless entity that once showed promise.

image courtesy of Jake Chessum/Inc.com

Zappos: the poster child for why start-up VCs suck is a post from: The Inquisitr

Like Mark I don’t mean to pick on specific companies like Seesmic or Twitter but the fact is they are the poster children of this faux web business that keeps seeing larger and larger valuations. Valuations that are based on nothing more that highly questionable pageviews and possible membership counts that can supposedly be translated into eyeballs pointed towards ads. Sure there are profitable Web 2.0 companies but they are companies that came into this with their eyes wide open and a business plan in hand. These types of companies are also few and far between in a web landscape that is predominately free models supported by VC dollars.

The idea that companies like Seesmic, Twitter and countless number of Web 2.0 startups can even be considered as real viable businesses because their main source of income comes from VCs is ludicrous. The thing is even VCs expect to be paid back at some point and how can a company like Seesmic; who recently took another VC payday of $6million, expect to pay those investors back when they aren’t even concerned with having a true viable source of income. Even Facebook has said that they are not concerned about making money at this point and don’t expect to need a monetization plan for another three years. Then there is Twitter who just recently got handed $15million but still no business plan in sight.

How much more of a hot air bubble example do we need to have in order to understand Web 2.0 can’t be sustainable with this current model of VC supported free businesses. Again pointing back Mark’s post I agree when he said

Not to pull a Robert Scoble and suddenly go doom and gloom but maybe we got suckered again. All the lessons learned seven or eight years about crazy schemes, companies raising lots of capital without a plan on how sell stuff, and the hype/euphoria surrounding the Web’s Next, Great growth phase were mostly forgotten.

The interesting thing is that due to the ongoing economic problems VC are saying that things have to change if Web 2.0 business want to succeed. Even though they might be saying this there are still startups with no business plans getting funding right now so I guess we’ll see how much change actually takes place.

However one interesting I had as I thought this post through is that this currently economic instability and uncertainty could have been the saving grace of Web 2.0. With the way that Web 2.0 was going with this utter reliance of VC money and a total lack of real business plans that we were on the road to a repeat of the Web 1.0 crash and burn. This time around though it was a totally different segment of financial market that was the cause of the meltdown it could have very well been the bursting of the Web 2.0 bubble that once again sent us into a downward spiral.

Under the current sircumstances Web 2.0 has been given a chance to gently deflate and give us all a chance to re-evaluate and regroup. It has given us a chance to take a deep breath and get a grip on what basic business principals are and bring them back into the realm of Web 2.0 where they are in short supply.

Could This Economic Downturn Be The Best Thing To Happen To Web 2.0? is a post from: The Inquisitr

The biggest hit in the web 2.0 space is going to be for unfunded startups who need money, and existing startups who need more money to survive.

The money is going to run out.

Not entirely, it never does. But the buoyant days of venture capital funding for all, typical of the second great web boom are about to end.

The cash crisis

Fundamental to the still developing economic situation today is a crisis in cash, ignoring the problems that have led to this point. Banks have either completely stopped lending, or have stopped lending to other banks, restricting the flow of debt based finance (banks lend money from other banks for lending purposed). Barack Obama described it in the last Presidential Debate well:

Right now, the credit markets are frozen up and what that means, as a practical matter, is that small businesses and some large businesses just can’t get loans. If they can’t get a loan, that means that they can’t make payroll. If they can’t make payroll, then they may end up having to shut their doors and lay people off.

Debt based finance isn’t a typical situation in most startups, although it’s not unheard of. But that contraction in finance does have flow on affects. The money coming into venture capital funds has to come from somewhere, and typically that’s been a combination of direct investment, banks and funds. Each take a hit:

• Direct investment presumes availability of funds from direct investors. While some of that includes the VC’s themselves, it also includes “sophisticated” investors who have surplus cash and are looking for high returns. These investors will have exposure to the broader market (in multiple ways) so may simply end up with less cash at hand to invest, or become more risk adverse, choosing to hold onto their cash or invest it in safer investments
• Funds: funds management arms are taking a huge hit at the moment, from reduced share prices, to debt restrictions (debt can often be a financing vehicle in investment arms). One example: pension funds are said to have dropped 20%, or 1 trillion dollars in the US in the last 12 months. There is now less money under management, and what is left will be looking for safe havens, not high risk investments. There will still be money for VC’s here, but there will be a reduction.
• Banks: finance can and is regularly used as an instrument by VC’s, and some banks are direct investors themselves (Lehman Brothers was a big investor for example). If banks are struggling to fund their own liabilities, the risk component becomes more conservative.

The common factor is that we don’t know how much this is going to hurt venture capital in the web industry, we just know that it will. The scenarios range from a small impact: many venture capital firms are already sitting on funds, and may have enough to ride out the worst of it until things pick up; to serious impact: VC’s cannot raise new rounds at all, or in such volume that the funding market for web based companies completely dries up. If I was to bet, I’d say it’s likely going to be some where in the middle of the two.

Profit or die

The contraction in venture capital for existing companies will present one simple outcome: the days of not having a business plan and not making a profit will soon be over, and the longer the economic crisis continues, the more so this will be. Some companies will have cash reserves and will be able to ride out the crisis at least for the short term, but those on the edge now are in big trouble. The only way to survive an economic downturn is profitability, because profit pays the wages, and gives any business a future.

Better startups?

The scarcity in venture capital will fundamentally change what gets funded, if anyone gets funding at all. Nat Torkington at O’Reilly thinks that lack of funding will be a good thing for innovation:

this recession will be good for innovation because recessions generally are. During boom times, companies direct development and occupy great talent with at best evolutionary improvements over the state of the art. Companies are great chasers of new things, but aren’t great at making new things. A recession means technologists cease to be paid vast amounts to duplicate the work of others. The Great Tech Bust of Ought Two gave us 37Signals, Flickr, and del.icio.us and there’s a strong argument to be made that many companies spent the next six years chasing what they created.

Certainly he has a point: in a funding scarce environment, it will be startups who stand out from the crowd who get funded, and most definitely being different and innovative will be an important factor.

Conclusion (or simply the end perhaps?)

I’m a little torn on this. I hate to think that venture capital will be harder to come by when for anyone outside the United States (and particularly the Valley) it already is. There will be companies that die along the way that may have made it with another round, and good people will suffer.

And yet, the excess was always going to come to an end eventually. The second web boom wasn’t as overboard as the first one: we’ve not seen the ridiculous rounds and valuations that led to the first crash. And yet the problem isn’t one of too much cash for companies this time, it was one of too many companies getting cash without either a proven business model, or as is the case with Twitter and some others, any business model at all. That many startups will fail is not the fault of the economic crisis, even if it may bring forward their deaths, it is a failure of startups to focus on business fundamentals, such as making money. Those with solid businesses, making a profit or close there to it, will ride this out, and what’s left standing may in the long term be beneficial to us all.

Now for the bad news: less investment money for startups is a post from: The Inquisitr