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Start-up companies in Silicon Valley face harsh financial realities as venture capital disapppears

Silicon Valley start-ups must grow up and start making some real money, entrepreneurs, venture capitalists and company chiefs were told at the Web 2.0 Summit this week.

The economic downturn has begun to bite hard and young start-ups looking for the traditional “free” venture capital (VC) money to develop their projects are being turned down. Better-established firms are being told that only the fittest will survive. The tone was set by a sobering analysis by Mary Meeker, a managing director of Morgan Stanley and leader of its global technology research team.

In a series of slides, she showed how America’s GDP had plummeted, the market capitalisation of technology companies in the United States had fallen through the floor and how advertising revenue growth, even online, may go negative.

A further stark illustration of the problems now facing the technology sector was the “layoff tracker” on the authoritative Techcrunch blog. It is not a scientific poll, but the total number of tech job losses announced globally since September stands at more than 44,000. The worst-hit companies have been the small and medium-sized start-ups that began with the traditional plan – that is to say no plan – on how to make money. Normally they would look to billion-dollar IPOs or to sell out to Google for pots of money. Neither is now possible and the VC money to keep going while they wait for the good times to return is not available.

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John Doerr, one of the leading venture capitalists in tech, told the conference that VC investment peaked in 2007 at $37 billion. This year such investment was likely to be about $15 billion or $16 billion and next year it was predicted to be in the order of $5 billion to $10 billion.

Mr Doerr, of Kleiner Perkins Cau-field & Byers, said: “We might not see very much liquidity for the next three or four years. Google is just not going to buy all these or even a lot of the internet-related start-ups. You have to hunker down, take the long view, don’t cut with a meat axe, and focus on your core.”

Companies are going to have to make money for themselves. One of the best recent examples has been Zynga, an online gaming company that is making waves with its applications for social networks. The company raised $29 million in VC funding this year but has yet to touch a cent of it despite having a staff of 80. Its free online games, including Dragon Wars and Scramble, have proved huge hits on both MySpace and Facebook. The company makes money primarily from virtual goods or currencies that are purchased with real credit cards by players who have been drawn in by the games. Its business is said to be doubling every 90 days.

Chris DeWolfe, the co-founder and chief executive of MySpace, who was at the summit to talk about the launch of MySpace Music, said that concentrating on growing a real business was crucial in an economic downturn. For more established companies, diversifying revenue streams was similarly vital. MySpace is attempting to do that with MySpace Music, a joint venture with the four major music labels. The move is a recognition that it is not possible to force people to buy music because there is so much pirated material available. MySpace, which is owned by News Corporation, the parent company of The Times, will make money through advertising and charging for downloads if users want to keep tracks on their computers or MP3 players.

Mr DeWolfe told The Times: “We had to get away from the idea that every media company is stupid and is going to fail and start doing partnerships with them.” He said that consumers had streamed music more than 1 billion times in the first few days and have created 80 million playlists since the launch. Five million bands had uploaded their music to the site.

Earlier in the day another co-founder and chief executive had a little more trouble answering the question of how to make money. Evan Williams, head of the hip microblogging site Twitter, was celebrating a particularly successful US election, which saw traffic and membership soar.

Asked how this was going to be turned into dollars, Mr Williams was able to say only that they were thinking of charging corporate customers to use the site. Advertising, he implied, was not a route he wanted to go down. “It’s still very early for Twitter,” he said. Despite the downturn, hope springs eternal in the Valley.

New secrets of company survival

John Doerr, on the board of Amazon and Google, has developed an 11-point plan on how to survive the downturn:

1 Act now, and act with speed

2 Protect the vital core of the business. Cut once, and cut deeper than you need to

3 Make sure you have 18 months’ worth of cash. Make sure you know where you stand with your investors

4 Do not spend money on facilities or technical infrastructure or even software you do not need to run your business

5 Reevaluate research and development priorities

6 Renegotiate all contracts

7 Make sure everybody in the company, from the receptionist to the engineers, is selling the company’s value proposition

8 Offer people equity instead of a cash bonus

9 Secure your cash reserves

10 Figure out what your lead indicators for revenue are

11 Overcommunicate with all your staff. Make sure employees and their families know where they stand

About 401k plans (Perma):

Is there anyone here that is knowledgeable about the behind-the-scenes workings of 401k plans?

Specifically, based on previous experience, I have been concerned that sometimes the assets of a 401k plan are not always held at the proper arms-length distance from the assets of the mother company.

Any lawyers here that can explain how it is supposed to work, in that respect?

I am not knowledgeable about the inner workings of 401K, but my instinct disallowed me from owning one even with "obvious" financial benefits. The same instinct convinced me not to buy a house in 2005.

Not investment advice.

Is there anyone here that is knowledgeable about the behind-the-scenes workings of 401k plans?

This is how a 401k plan usually works.

You contribute a dollar to your 401k, which your employer matches.

The two dollars is given to a management firm, which takes their fees then invests in the market. Say, buy purchasing futures on one of the common indexes.

Then, they lend the newly purchased shares to someone like me. I sell them back to them after they've lost two dollars and pocket you and your companies money. Your financial services company keeps their fees.

PermaRenter Says:
November 8th, 2008 at 12:19 pm
"Today I had to fill full tank of my Toyota Land Cruiser with premium. I thought something was wrong when the bill was less than $58. Then I realized gas price as 2.599 … this is great!

How are Prius owners feeling now?"

Fine, especially those of us who only leased one and have less than a year left on it and are waiting for the full plug in hybrids. $2.59 is still not cheap though, but I think it is going to keep falling. Prius owners are part of the reason prices are falling, people found alternatives to the high prices, they didn're really expect that. Also, keep in mind, saving money is just one component for people who hate the idea of funding enemies with foreign oil.

justme Says:
November 8th, 2008 at 7:14 am
"Malcolm,
It was a little difficult for me to follow what you said: Let me see if you agree.

Provider1; $5200 total, although you used Blue Cross insurance

Procider2: $1900 total , but you got money back later because they said 1900 > BlueCross

Correct?"

Correct, the numbers were much smaller, but the guy who did the exact same thing and charged less ended up sending me back $150. What pisses me off is when the BC bill comes in and it says, non qualifying not applied to out of pocket maximum or deductible. That sort of crap pisses me off.

"didn't" in the Prius post.

One other thought, while there is some smuggness that comes with the notion of being insulated from inflating oil prices, my household's gasoline bill is dropping as well. I don't want to pay more just to feel good about the savings, I'm happy to be paying less just like anyone else.

justme Says:
November 7th, 2008 at 12:36 pm
"What are the conditions under which the patient is exposed to the inner workings of the system?"

The patient isn't, that's why if feels like you are getting fucked. I'm glad my deal was very small but the idea of doing something without knowing what the cost is going to be because "it is determined by the provider and insurance company" who isn't actually paying anything under a PPO and ends up excluding it from the annual deductible anyway. So in essence someone else who isn't paying anything is negotiating the price after the fact for you.

BAP,

That's the redevelopment department hard at work. It's not just Merced County. It's Stanislaus, Contra Costa, and just about every other county that has access to the funds. It's just that they have more to whine about now so it makes the news.

Look at the bright side. As long as lending institutions don't make ridiculous loans, people cannot afford to buy the houses and prices will stay low.

"Prius owners are part of the reason [gasoline] prices are falling..."

Yes, and perhaps just a little is also due to the anticipated slow down in global demand. In particular, China's inability to decouple from the US economy played a big role in this. Peak oil is just not as imminent as speculators thought it was.

Deflation,
Agreed.

Kewp,

I liked your tongue-in-cheek answer, but I was actually being serious.

I'm quite well acquainted with how the 401k works on a day-to-day basis. My question really was about something else. I'll try to paraphrase:

"who holds title to the assets while they are in the 401k plan, and can the company and/or plan trustees under any circumstances divert the assets for other purposes, either on a temporary or semi-permanent basis?"

This is the gist of my original question. And I am talking about MY contribution, and not potentially un-vested matching funds.

@deflation,

Well, if oil consumption, and therefore production, is falling and never again reaches 2007 levels, then by definition, peak oil occurred in 2007. So peak oil indeed perhaps it is not imminent, but rather past.

One can hope.

Alright, I'm starting to get a little freaked out by the articles I'm reading about the need for an "international overhaul of the financial system". With the "free market dogma of the past has been shown not to work" kind of statements.

Christ. As if the market was anything close to free. If the market was free, the failing corporations would be allowed to fail. Lo and behold, it would solve the problem.

I think what they really mean is that the "free market dogma" has shown not to consistently produce fantasy profits forever and ever. Fucking morons.

I think Ron Paul had it right when he said the result of all this would be a new World Central Bank and some unified currency. God we are so fucked. They are taking a housing downturn and turning it into the end of the free world.

The only thing to fear at this point is our own government.

@justme,

I believe the highs we saw were caused by speculators blowing the Chinese growth engine out of proportion with respect to oil consumption (not to mention the Prius owners:).

I may be wrong, but I always considered peak oil to be the maximum rate at which they are able to pump (irrespective of demand) and implied a depletion of oil from the source.

We can have "peak oil" and falling prices at the same time. But it may take a supply shock to send prices up again.

Do not blame the speculators. Without them, price shocks will still be there, price discovery will be slower, and liquidity will be less readily available.

Yet here we are, at 1/2 the price and dropping while OPEC is decreasing production. I'm not arguing that we shouldn't have speculators.

Just that they were very wrong this time as happens at times.

Justme,

The assets in a 401(k) are generally held in trust by a fiduciary for the benefit of the plan members. The fiduciary's duties are specified under ERISA, and breach of fiduciary responsibility is a serious crime - up to 1 year in jail and a big fine. Second occurance is a felony.

Did anyone ever answer Charles' (the original poster's) question?

See for example www.dol.gov/ebsa/publications/fiduciaryresponsibility.html

TOB, democrats do not tolerate liberty because free-minded people are impervious to their populist claims.

YES WE CAN!

When those young people were chanting, they failed to realized that the word 'WE' was referring to populist elites.

I still think Ron Paul was the only good candidate.

BTW, I prefer Ronald Reagan's "It CAN be done."

Deflation,

>>I may be wrong, but I always considered peak oil to be the maximum rate at which they are able to pump (irrespective of demand) and implied a depletion of oil from the source.

Good point, and this is exactly the distinction I was trying to make.

From Wikipedia:

Peak oil is the point in time when the maximum rate of global petroleum extraction is reached, after which the rate of production enters terminal decline.

Since this definition uses the word *extraction*, it does not refer to peak pumping capacity (per day or month or year), but rather the peak volume actually getting pumped.

The peak volume getting pumped will occur at some point in time where the current price combined with current demand causes a never-to-be-exceeded (daily, monthly, yearly) production numeric value.

Another way of saying the same thing: It is likely that peak oil will occur because of higher price pushing the demand down rather than a constant or falling price and hitting a hard limit on pumping capacity. Oil price has a way of soaring instantly once demand gets even close to the supply capacity.

I agree that the difference can perhaps be called somewhat subtle or technical, but also think that it means that peak oil *production* will be reached sooner rather than later. The reason simply being that oil production will peak at the point of maximum oil affordability, as determined by oil price and expendable income (or macro-economic equivalent).

DennisN,

I should have thought of you right away, thanks for the lawyerly answer.

hmm, did someone say socia1ised medicine? too late, thread's over...

obama rules...