The tech twilight zone, where Yahoo aimlessly spins

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There is a dimension of tech beyond that which is cherished by investors.

It is the middle ground between failure and success, between innovation and stagnation, and it lies between the pit of man’s fears and the summit of man’s knowledge. This is the dimension where activist investors and private equity firms prey. It is an area which we call the twilight zone.

And this twilight zone is where Yahoo has been stuck for nearly a decade now. The company’s core operations have been struggling to stay relevant in an online-ad market that was dominated by first Google, and now Facebook. The harder Yahoo raced to catch up, the further it found itself slipping further back in the race – a mythic, archetypal nightmare played out in real time on the stock market.

Yahoo’s reality, for a while now, has been this: In tech, there have been three tiers all along. The clear winners, that is, the Googles and Facebooks, which write the rules others must follow. The clear losers, that is, the incumbents and me-too startups that can’t adapt to or abide by the new rules and fall by the wayside. And the very, very unclear middle tier – the companies that are clearly not winning but can’t be labeled clear losers either because they still see some profit growth and, in a good quarter, some decent revenue growth.

The tech press and most tech investors love the top tier and even the bottom tier. They are coherent narratives you can fit into a headline, or even better, a cell in a spreadsheet. But nobody wants to deal with the middle-tier, which always involves too messy a narrative. The company won’t die. But it won’t thrive either. It aspires to innovate, doing so in intermittent flashes. Yet things never quite gel, nor do they quite fall apart. And so on…

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The frustrating, no-win “Goldilocks Zone” of seed deals

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There is so much cruel irony to the startup game.

Unless you are one of the five to ten companies that just explodes with usage and hype, the easiest money you will ever raise is your seed round. And in recent years, all kinds of hacks, trends, and innovations —  accelerators, series seed rounds, convertible notes, seed funds, AngelList — have come into being to make that process of early cash in the door quicker, cheaper, and easier than ever before.

Woo hoo! Move even faster and break even more things, right?

Maybe not.

Even though the seed round is a time when many entrepreneurs can move the fastest, it doesn’t mean it’s a great idea. From Series A on, the startup world is so intensely competitive that the seed round– when you have nothing to show, no data, and nothing to lose– is when you could make some of the biggest mistakes that could tank your company in the long run. It’s also when you have the most optionality to avoid making those mistakes. Once you hit A, it all changes. In markets like Silicon Valley, if you are remotely connected with a remotely good idea, you’ll never have more options than you do at your seed round. (It’s the exact opposite in cities with more nascent ecosystems, where investors want to back companies with real revenues and not ideas.)

That’s fucked up, because some of the best companies are started by entrepreneurs who just don’t know any better, don’t have huge piles of cash from previous wins, and just want to get money in the door to start building.

The latest wisdom on the subject comes from CB Insights. They’ve looked at the data anew and essentially reversed a conclusion they came to in 2013 about whether or not entrepreneurs should raise seed money from VCs.

The debate has to do with the so-called “signalling risk” of raising seed money from prominent VCs. TL;DR version: Large VC firms may do lots of seed deals but each partner will only do one to two Series A deals a year. So basic math tells you it’s a game of survivor. Most of the seed deals will not get a Series A from that firm. The concern is if you don’t quite make the cut, is the signal so bad to other VCs that you are worse off than if you never raised that, say, $ 200k from a big name VC to begin with?

Some VCs have told me that they have absolutely passed on companies because of these signals. Others have told me it’s wildly overstated and that VCs cite a negative signal from another VC in order to let a startup down gently, essentially passing the buck on why they didn’t invest, instead of just saying no.

Back in 2013, CB Insights studied this and found that startups taking seed money from VC firms were more likely to raise a Series A. In other words, they called bullshit on the whole signalling thing. The problem with that theory is that there are so many anecdotal accounts from VCs saying the opposite. In fact, several big VC firms were backing away from seed altogether, acknowledging they may have done more harm than good.

So CB Insights looked at the data again– only in a different way…

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