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I Don't See No Startup Bubble

Over the last three months, there have been many posts from investors about how startup funding is in a bubble. Since December 2010, the Yesware team has been in the fundraising weeds raising our seed round. We recently signed a term sheet (details to come), and based on this experience, I’m confident that the general startup community is not in the midst of a funding bubble. I raised money and sold companies in 1999. I worked at CMGI through the first internet bust (historical chart below).What we have here just ain’t no stinking bubble. cmgi stock price
Here’s how I reached this conclusion and what it means for you.

Disclaimer #1: I’m not an economist, I’m a startup guy.

There are many eloquent and technical definitions of what is and isn’t a bubble. My working definition of a bubble requires two things -
1. Investors are funding deals without regard to fundamentals that hold in “normal” or “familiar” businesses and
2. Entrepreneurs are seizing on this behavior to drive up valuations based on fear and greed instead of on demonstrable/logical/considered fundamentals.

Disclaimer #2: My sample size is n=1.

In the course of pursuing this one deal, I’ve been in touch with 44 angels, super-angels/micro-VCs and VCs. Most, but not all, of these people have been on the east coast. Maybe my small dataset is too small to reveal a west-coast Startup Financing bubble, but we’ve been turned down by several west-coast investors who were not behaving “bubbliciously” (subject to irrational bubbly decision making) so I believe I’ve gotten a decent perspective on at least the US startup financing situation.

Yesware Investment Background:

To evaluate whether our experience is subject to a possible “Bubble Valuation”, here’s a quick summary of the strengths and weaknesses that any investor considering our deal would consider.
  • Team – The two original founders have successfully started, run and sold a business, but it was not VC-backed. Subsequently, the team brought in a founder with significant experience in this area.
  • Opportunity – Professional Email Users is a huge market. Yesware is addressing a real pain point in the market. Both companies and individuals have demonstrated behavior of paying for business tools that help them generate additional revenue and provide additional visibility into enterprise activity.
  • Customers – The company has signed agreements with a small number of senior sales executives at market-leading companies to trial their proposed solution.
  • Competition – Email is not a new, untested application. Microsoft Outlook is the dominant application among prospective users. Although Outlook users indicate significant dissatisfaction with their existing solution, for at least some (unknown) percentage of them, switching inertia is high.
  • Technology – There is low technology risk with the Yesware approach. No significant research or technology development is required to successfully deliver the proposed solution. Operational challenges are real.
  • Distribution – Channels and tactics for distributing SaaS solutions are well established and well understood. Not sure if CoCA can be reduced enough over the medium term to build a profitable business.
  • Exit opportunities – Many and varied across the value chain.
So it’s not a bulletproof story. The team (at least as originally formed) hadn’t made big multiples for VCs already. There is real competition in the space we’re attacking. Cost of Customer Acquisition might be prohibitive at the initially contemplated pricing levels. We could have more proven customer demand (but that’s literally always true). On the positive side, we’ve got some past indication of ability. We’re making something that people who can pay generally want. And we don’t have a tremendous technology execution risk hanging out there. Executing on this particular opportunity is always a risk, but that has nothing to do with a funding bubble.

Investors That Passed on Funding Yesware

Among the many investors that decided not to fund us (at least in this round) the most common reasons they gave were:
  • Psychological switching costs are too high: Can Yesware make email work well enough to get professionals off of Outlook?
  • Market size: There are plenty of professional email users, but how big is the addressable market of salespeople who are dissatisfied with their current solution, will search out alternatives, and will pay out of their own pocket?
  • CoCA too high: If we can’t charge much for Yesware, can we really attract users cheaply?
I fully recognize that these might not be the real reasons that these folks decided not to invest. For the purposes of this discussion, it doesn’t matter. If we had been subject to a bubble in our fundraising, neither the declared nor the undeclared reasons would have been enough to stop investors from funding us. We would have had a greater number of competing term sheets offered to us. We would have had investors working against each other to invest at higher valuations. Investors would have tried to push more money than we needed for our stage so they could “put more money to work.”
None of that happened.

Investors that Are Funding Yesware

The firms and angels that are investing in Yesware are doing so not because they are irrationally chasing the next big thing. They aren’t writing checks out of fear or greed. They see the risks of our business as clearly (and in some cases, much more clearly) than investors who turned us down. They just made a different assessment of the opportunity, their ability to help us, and our ability to execute. They believe that we can build an application that will attract real user traction. They believe, as we do, that achieving these goals will translate directly into revenue and profit.

Maybe Micro-bubbles?

There’s data from the UNH Center for Venture Research that startup valuations overall fell in the first half of 2010 from the previous year. But maybe there’s a little bubble – only for companies in Silicon Valley founded by entrepreneurs who have already generated outsized returns for professional investors in a similar opportunity space and only fed by investors who are irrationally chasing the next big thing without regard to business fundamentals. Our maybe there’s a bubble in startup incubators. But those are pretty small groups of companies compared to the number of startups these days.
If you are one of those very successful entrepreneurs, you will have less trouble getting a comparatively high valuation compared to historic averages. But that’s always been true – that’s not a sign of a bubble. Perhaps there’s a late-stage bubble, but again, that doesn’t really apply to us normal startup people. With all due respect, there’s a self-serving aspect to the bubble talk from investors.
If entrepreneurs hear that investors are concerned about high valuations, we’ll go into funding negotiations with that consideration as an implicit anchor. I’ve heard of several angels who will look at seed deals only if they are of the “700 on 700″ variety – buying half the company equity for $700,000. I’m not at all saying that many angels take this approach. And I don’t begrudge those investors who do. They have a right to their investment strategy just like everyone else does. But that strategy is contra-indicative of a bubble, just like everything else we’ve experienced in our fundraising process.

What This Means for You

Keep building your business. Don’t get discouraged when you get turned down – you aren’t the only company that’s not subject to the supposed bubble. Do consider raising money now, but don’t expect an easy go of it, and don’t expect sky-high valuations unless you fall into the tiny category of entrepreneurs I’ve already called out.
As in almost every fundraising effort (except from 1997 to 2000 for internet and telecoms companies), the normal rules apply. Investors haven’t had the wool pulled over their eyes. They have tremendous benchmarks for what you are trying to do. They might mis-apply them or be overly skeptical about your ability to defy their perceived pattern recognition. But if they are any good at all, they won’t be fooled into investing in your company at stratospheric levels. Any why would you want those few investors on your cap table anyway? Their mistakes are bound to be corrected when you try to raise the next round.
Let me know your thoughts on this. In particular, I’d love to see some data showing how wrong I am.
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