Growth Times

Tired of the Social Media Hype? Me Too.

A connection of mine just directed me, by good ol’ email, to a new book on social media. My friend knows I am thinking about the topic these days. This yet-to-be-released book puts marketing and social media in opposition, asserting that businesses must stop marketing and start engaging. The author positions himself as the “world’s authority on the topic”.

Yawn.

Here we have it, ladies and gentlemen, yet another guru surfing on the social media hype wave, with thoughts as deep as a Celine Dion’s song. Unsurprisingly, his website also is a bunch of platitudes alongside eloquent quotes from other gurus. You know, that type of quotes that has the word “period” fully spelled out, as in “he’s the interplanetary guru on social media, period.” – and that type of gurus that has published a get-rich-quick book.

Social media is here to stay, no question. I use it every day, and it does occasionally help shape my impression on brands. But let’s curb the enthusiasm and keep our feet on the ground, as its impact is blown largely out of proportion:

#1  – Remember the 2000 bubble. The laws of economics didn’t apply anymore, if you listened to gurus. And now social media is going to revolutionize business and marketing. Sure, social media has a transformational impact, but gurus overstate it because it feeds their purpose: profits – for themselves, not their clients. And by the way, the economic fundamentals haven’t changed. Social media companies need to turn a profit sooner or later to stay in business. So far, none yet does. Sure, Facebook reached cash-flow positivity … What that really means is that they cover all costs except for operational expenditures and one-time costs. Like personnel and new acquisitions, for example. You know, minor ones…

#2 – Social media affects marketing, but its effect on business is not as wide-ranging, radical and fast as gurus predict. While it is great to connect with friends, the influence of social media on purchase decisions is quite limited: according to a 2009 study (referred in http://www.mediapost.com/publications/?fa=Articles.showArticle&art_aid=106445 – It also compares social media to TiVo – I recommend the read) , less than 5% of social media users regularly turn to these social networks for “guidance on purchase decisions”, and only 16% of social media users say they are more likely to buy from companies that advertise on social sites (some even say they are less likely!). How many purchases did you make last year because of ads or product recommendations on social networks?

#3 – Good luck establishing a new commercial brand through social media. I can’t think of any that did, beside a Facebook game like Farmville that is, built by social media for social media and part of the bubble. Social media helps with conversion, much less with awareness. Social media does not suppress marketing channels, it adds new ones to the mix. To build awareness, there will always be room for one-way communication channels like TV, radio (and podcasts), and billboards, as well as for face-to-face channels like events, presentations. Often, people want to learn stuff without having to “engage”. People need to really care to engage, and that’s why they want to engage with friends, not with the makers of the hundreds of products they consume. Sure, some brand with cult-like status such as Apple can communicate effectively through social media, but it’s as a one-way channel, not much better than TV and other traditional media which Apple still primarily uses to reach the masses.

#4 –Embracing social media too fast may lead businesses to neglect traditional channels, counterproductively. Fancypants marketing heads love to do social media, because it’s new, more fun and attention-grabbing. You would be surprised by how often they’ll spend loads of cash on something just because it’s “cool” and “we have to do this”, although any levelheaded employee could tell them this is not going to generate a cent for the company. Let me say it again to those Silicon Valley marketers: you live in a bubble. The time people spend watching TV, reading papers, and surfing classic web portals dwarfs that spent on social networks – if those even were comparable metrics. 350 millions of active users on Facebook is great, but there are billions of phone users and yet to make money phone companies still have to charge them for usage.

#5 – Social media is currently subsidized. Expect normalization and the end of social media subsidization. The main reason the growth in social media users is impressive is that almost all social media companies have focused entirely on growing social media users. At the expense of making money. Now, imagine that TV channels tomorrow could spend tons of money on great programs while getting ads out of the way. It wouldn’t be interactive but surely it would be way more attractive than it is today to most of us, the TiVo-less majority (note: you have to pay a subscription to get TiVo, which makes up for the lack of ad revenues). I suspect that ultimately social media apps are going to have to be commercially more aggressive, and guess what will happen then? The user experience will progressively deteriorate like it did on TV. And hype will be gone. Social media is subsidized, that’s why it seems attractive. Note #2: subsidizing to gain market share is a traditional marketing technique. Those still work.

What is a Business to Do, Then?

#1 – Don’t embrace the hype. When planning your marketing program, start with your target audience and think how they use each channel. The social media rush will open up opportunities for companies that haven’t been so fast at embracing the hype. Of the marketing programs I designed with clients in the past two years, none included a major social media component – that is, more than 5% of spend (half our programs included some sort of small and targeted social media component). The reason for it was quite simply because none of our target segments, mostly B2B decision-makers, made much use of social media or relied on it to make decisions. Some didn’t use computers much beyond email and basic websurfing, others used social media but relied much more heavily on other channels when it came to keeping abreast in their field and making purchase decisions.

#2 – Know what social media is good for, and what it isn’t. Marketing fundamentals haven’t changed, it is still to grow awareness, generate leads, convert them and build repeat business; and when it comes to doing that, lots of potential actions still beat social media hands-down. Social media is useful to build a dialog with users in certain segments. It can work well in conjunction with other channels to seed it. It also has increased the reputational risk as it created a new platform for unhappy consumers, so it is important for businesses to monitor it. All those usages are far from covering the whole marketing spectrum.

#3 – Remember the cost and the risk of social media. The medium might be free, but time isn’t. It takes a lot of time to participate in social media, and lots of that time can often be put to much better uses. Then, the chances of a viral success with social media are also slim, and the risk of backlash is higher than most channels. Run a traditional cost-benefit analysis and give it a test-run before you commit hard currency to it.

#4 – Finally, do kill the messengers (just not physically). Those self-proclaimed gurus by definition tend to be very good at riding waves, but very poor at offering any substance, let alone good advice beyond plagiarized clichés. Somehow, being smart and calling oneself a guru just seems incompatible. A recommended read on this is Social Media Experts Don’t Exist, by Toronto-based Mark Evans. Sure, if you’re in it for the fun only, as some are, then gurus can be more fun than people actually interested in your business’s success. But do your part to clear up the air and help social media reach the end of its hype cycle: refuse to drink the Kool Aid, don’t attend their events or buy their books, and never, never expect actual results from one-inch-thick gurus.

By no means am I collectively discarding social networks. They are game-changing in many ways, and can be very valuable, if used intelligently. But common sense still applies and always will. Period.

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Market awareness, branding, Business, buzz, Communication, engagement, Facebook, hype, hype cycle, Marketing, marketing mix, Mass media, new marketing, social media, social networking, social networks

Karen Mazurkewich, Financial Post, in an interesting article on Monday entitled “The new uber-angels” comparing the VC-fund approaches of Ontario and Quebec, declares on the Ontario Venture Capital Fund that “What Ontario didn’t — or couldn’t — predict was the lack of potential co-investors for these funds.”

Karen, I would invite you and Ontario’s decision-makers to step up your due diligence and review Growth Times’s August 4th, 2009 blog post entitled “Who Will Match Ontario’s $250M Emerging Technologies Matching Fund?”……………..

Really, was it that hard to anticipate? Ontario could have predicted this, but there were political and financial forces at play and incompetence at the top. Let me guess that the persons in charge will actually get rewarded with more assignments and rewards for their mistakes, while the rest of us in the private sector get to work harder to actually make innovation happen.

[Addition to the post following subsequent inputs I received: the setup of the Ontario Venture Capital Fund remains such that Business Angels can barely play. The restrictions pretty much rule it out ($1MM min investment, full net worth disclosure, etc.). They should reduce the barriers for Angels to participate, given they are one of the few true sources of capital these days.]

As a rule, I am starting to realize that the public institutions in this province, and that includes a lot of the nonprofit hubs, are not quite designed to really encourage innovation. Except in rare cases, they are designed to grab taxpayer’s money and redistribute it to their supporters based on loyalty, not performance.

One thing Ontario and Canada really needs to get urgently, is that smart regulation has much more leverage than direct intervention. If Ontario really wants investments, it should work to repel section 116 to get American capital flowing here.

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Canadian entrepreneurs, Fund Due diligence, Financial Post, Financial Services, innovation, Investment, Karen Mazurkewich, Ontario, venture capital

In my experience helping entrepreneurs, the most important success driver of any business founder is the capacity:

1. to know their success drivers,
2. and to keep everything they do tied to those.

So being able to keep one’s eyes on the prize and not get lost in the weeds is the top quality any good entrepreneur should cultivate. In this age of information overload, however, requests are being thrown at us from every direction, and in the midst of that flood it can quickly become difficult to discern what matters from the rest.

Luckily, whatever problems technology throws at us, the human brain can still solve.

One method I recommend to solve the focus problem is to create two living documents to keep you on track:

• A Masterplan, that lists both the overall goals for your business and the immediate milestones you are pursuing. Think of each as, respectively, your cardinal direction (I find that concept more flexible than a “destination”, which sets things a bit too much in stone), and the first island your boat should be headed to (in that same direction!)
• A To-Do List, prioritized roughly

A few implementation tips:

• Keep it simple. Both documents don’t have to be fancy. In fact, they really shouldn’t be. Try to keep them as concise and as clear as possible. The longer and fancier – as in feature creep - both documents become, the least chances you’ll use them and the more chances you’ll get lost on the way
• Use standard software. For the masterplan, use a text editor like MS Word. For the to-do list, use a spreadsheet program like Excel, with 2 columns: Task, and “Done” (and if you’re good at excel, you can add an automatic timestamp for the Done entry). If you want my excel template for the to-do list, email me at gregboutin “AT” growthroute.com
• Keep one version only. This one is obvious, but you should have only one version of each document. If you spread the information over more than one version, you’ll have version control issues, have conflicting objectives across the versions and won’t be able to assess the priority of tasks against each other as easily, so avoid that. Yes, even if you work on more than one business. If you want to create similar documents for your personal life, however, I recommend keeping those separate.
• Update them every time. Very important: always, always keep both of the documents updated. Those should be working documents. Remember, they should be the unique source of truth for your business goals and your tasks. Captains use maps, compasses and task lists for the same reason. Yes, captains have task lists too. Or they should, in any case.
• Start small. Iterate, completing each document over time, especially after each shower when you finally got some strategic thinking time!
• Prioritize to-dos intelligently. I suggest a prioritization based on a loose combined factor of importance and urgency as perceived by the entrepreneur. Some like to separate both, thinking what’s urgent is not necessarily important. I disagree. First, it complicates your list. Second, the more important it is, the more urgent it should be, and vice-versa. But sure, some things are very important and can’t be done today, due to some dependency. Then either list the dependency, if that’s an action you should do soon, or downgrade the to-do, or move it to the Masterplan and make it part of your ”first island”: it might be important but it’s not actionable immediately, which is the key criteria for a working list. What’s top of list is what you should do next.
• Align both documents. Check whether the actions you’re pursuing – which should be listed in your to-do list – further the goals in your masterplan. If not, or not much, scrap them. Understanding why some actions you listed do not align with the goals you expressed in the Masterplan may also lead you to revise those goals.
• Share, but own. You are welcome and even invited to share your masterplan with your trusted partner(s), and to ask them for inputs. But remember, you are the Captain, and for as long as you are, you continue to own and be responsible for those documents.

What’s your system? Have recommendations? Please share.

Lead building a business, business creation, commercialization, Entrepreneur, entrepreneurship, focus, innovation, masterplan, Start Up, tech venture, Technology, to do list

Last month I gave a presentation at the Research Innovation Center in Mississauga, looking at the topics I discussed in my last post, and presenting some implementation of a CRM system, which I did for a client.

The video of this presentation is now available at http://www.youtube.com/user/RICCentre and the slides are here: http://www.riccentre.com/images/Greg_Boutin.pdf 

Canadian entrepreneurs, Market, Scale Angel investor, Customer relationship management, Mississauga, sales process

If you still read magazines… you might have seen GotoMeeting’s “Do the Math” ad, comparing the cost of their service to that of a business trip. Brilliant.

Companies too have noticed and, in virtually every sector, they are leveraging ubiquitous electronic connectivity to chomp the cost of sales and improve lead generation and conversion rates.

Always be (electronically?) closing

A good way to do that is to map the sales process, slice it into different pieces, and hand each over to specialized sales “agents” – be it a piece of software, an inside sales person or a road warrior. With new online capabilities, it is now possible to keep it all synchronized without losing information between each agent. Additionally, ideal sales paths are created for different types of prospects to maximize the ratio of “sales outcome” over “cost of sales”. The sales outcome is roughly based on the “probability of success” times “sale payout”, over the anticipated life cycle of each prospect.

Over time, by tracking wins and losses electronically, companies develop a nice database that can be mined to create predictive models and used to enhance the sales process.

Of course, the business payoff is in improved efficiency, by getting the most expensive agents (road warriors – in general) to spend more time on what they do best – and having the rest completed both effectively and cost-effectively. At last, road warriors can “always be closing” rather than sourcing and nurturing leads.

For the company, that also means that less field sales reps are needed. Expensive road warriors – where they are still required – are becoming one small part of the process, more the exception than the rule. Most transactional sales can be completed over the web, and consultative sales are greatly facilitated through web support. According to a recent survey by Dr. James Oldroyd, a professor at the Kellogg School of Management, hiring of outside sales reps is almost flat, while hiring of inside sales reps is growing healthily at 7.5%. The recession plays a role in this, but I have no doubt the change we are undergoing is deeper, and will continue to amplify as the web gets smarter and our world gets smaller.

Develop your sales process as you would develop a product

Funneling prospects and clients is nothing new. But the web has taken it to a whole new level, making the entire process cheaper and more precise. And with the bar being constantly raised, a focus on the “whole sales process” is increasingly decisive: established companies must further invest in updating and refining theirs, and early-stage ventures in nailing it through deliberate design and rapid testing.

The sales process needs as much attention as your product – and sometimes more. The sewers of history are filled with dead companies that got their product right but their sales process wrong. Poorly managing the sales process is a sure recipe for disaster. Think of it this way: the sales process really is about creating a “product” around the product.

What we call the product, ultimately, is just a mechanism enticing customers to give us money in exchange for value. But there is generally much more to delivering this value than the product. Apple, for instance, offers quality products, but not just that: it provides excellent support, an intelligent approach to sales by staffing its stores with lots of relatively well-paid and relatively smart attendants, a brand that makes you “cool” by association, an integrated online store, a higher price point that reinforces the impression of quality – and overall, a controlled, consistent, reassuring purchase experience. A lot of the sales process is even built into the product itself, when you think of it (especially for the iPod).

Still, it’s not perfect. There is no follow-up on purchases (or is there?), or little that makes it possible for them to capture expression of interest and categorize them by probability of sales (or is there?), and failed attempts at capturing a more mainstream audience in computers – largely attributable to the narrow reach of their sales process in my opinion.

If engineering the right sales process is tough in B2C, it’s even harder in B2B, because of the cheer range of options available to a company there. Just think about the many different ways one can market a knowledge management solution, for example: pricing (subscription, one-time fee, freemium+consulting),  , delivery model (cloud, on-site, hybrid), market (legal, medical, etc…), audience, lead generation (wherefrom?), follow-up (when, how, what?) etc… Surely getting it right and keeping it right is going to take quite a bit of trial-and-errors. Like developing the product did.

So why have dedicated product development and management people, and not a sales process development and management function in your company? The only reason I see for that is that most tech ventures are started by product-oriented people. So the solution is simple: think about the sales process in terms of a product and have it managed likewise. Ultimately, you need sales process experts in your company, and functionally those are not much different from product experts. It’s just the subject of their attention that differs.

Illustration with some sales process innovations

At a small, fast-growing cleantech venture I worked with recently, we introduced changes and innovations to improve their sales process.  We developed a Lead Generation and Client Satisfaction Manager role to qualify and learn about prospects prior to handing them over to a sales rep, created an online CRM system with Lead Scoring, added automatic Google Mapping (when completed, all prospects will be visible on the map – reducing the cost of visiting a particular area) as well as a “Nurture Marketing” capability (grouping leads and customers into different clusters based on precise criteria, each going through a different sales path). They’re even creating a demo video that – together with an inside sales phone call – will replace sales rep visits to low-potential prospects.

(This is the complete version of a post published on the RIC Mississauga blog)

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Develop, Market Customer relationship management, lead conversion, Lead generation, Marketing, Marketing and Advertising, sales funnel, sales lifecycle, sales process

Josh Kopelman, Managing Director of First Round Capital, wrote a great post today building on Fred Wilson’s VC math problem, and call Why VC Performance Has Fallen Off A Cliff.

I argued in a recent post that in parallel to the “moonshot” approach Josh rightly describes as the norm for VCs,  there must be a model that focuses on extracting revenues from a portfolio of tech companies with lesser risk.

Overall, it’s pretty clear to me that what we call VC companies should cover the entire risk-return frontier for any early-stage tech company, because that would allow large investors to place their bet as they like in this category. I’m not suggesting VCs turn into bankers or private equity investors, but there is a clear case for filling the early-stage funding gap towards tech ventures that hold less risk and more proven revenue models than moonshots.

For all the analytical firepower of VCs, it feels a lot like playing this field is still an art not a science. If really, VCs take a classic portfolio approach to early-stage returns, like I’d argue they should, then risk-return is a continuum and the industry ought to cover it entirely to offer interesting options to large-fund investors.

Which brings me to this: the expectation of a 20% return yearly is completely unrealistic, when the average growth rate for the world economy is 2-3%  (tidbits from my finance classes at Stanford – I don’t think our average growth rate has gone much above that since I finished my degree there…) If VCs as an industry grows faster than that rate, then by definition it will have to return to the mean (back from the moon) sooner or later, hence the cliff. Risk has nothing to do with this, since we are talking about a risk-return continuum in a vast portfolio managed by the entire VC industry – over time the failed companies bring you back to that 3% mean.

If you can do better than 2-3%, or say 5% to be a bit more optimistic about the growth capacity of our system, then you’ve nailed some distortion in the market and/or you’re taking more risks than you should. It’s hard but possible to do that as an investor, but impossible to do it sustainably as a large industry. Sooner or later, the industry will lose big, just like gamblers. Keep in mind again that I am talking about the VC industry as a whole, not individual players here – there is much variability there.

The problem with promoting those 20% rates is that it fuels hype and bubbles – the only viable mechanism to achieve those returns for the entire VC industry, if not a sustainable one. So I think it would be great if VC as an industry could stop pretending it can do much better than the mean, and focus instead on offering a decent continuum of risk-return options to their investors based on early-stage plays. From that angle, VCs are just expanding the range of investment options available and that, I think, would be good enough for everyone.

Unfortunately, the current system is set up to create monopolies of sorts by maintaining a complete imbalance between money pools and money needs. VCs are encouraged to bet on moonshots because that’s how, individually, they can make it and retire (with that feeling of intellectual superiority one gets for betting on the right horse at the tracks). They don’t lose much money on failed investments, but they make tons on successful ones, so of course they swing for the fences. The first thing VC firms should do is take a good look at their compensation system and rehaul that.

As things go well and returns grow, a few investors that actually beat the mean quite consistently (there will always be some – they are the right dots in the normal distribution of investors) make everyone hope over time that they can too – and thus the system as a whole progressively takes more risk without realizing it.

Meanwhile, companies with a lower risk-return ratio – but not low enough to warrant a bank loan – have a heck of a time finding money. Angels fill some of that gap, but while they’ve structured themselves greatly in the past few years, they don’t have the discipline a VC firm could bring, which only would attract the big money from the big funds.

Unlike what some observers think, I’m convinced the VC system is here to stay. But not without adjustments – either angels will structure themselves more and more to fill the void VCs left, or VCs will get back in there as they should. The overall lesson as a VC is that you can shoot for the moon if you wish, but keep your feet on the ground, because your industry will go back to the mean sooner or later.

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Fund Financial Services, First Round Capital, Fred Wilson, Fundraising links, Josh Kopelman, Private equity, start-ups, tech venture, venture capital

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To any current or would-be entrepreneur, I highly recommend the following video of a presentation this month by Aaron Patzer, CEO of Mint, which was recently sold to Intuit for $170 million.

At first I thought it was a bit long, at 22 minutes, and so I figured I’d only watch the first few minutes. 23 minutes later, I am writing this blog post. Aaron goes over the start-up creation and growth process in practical details, even presenting slides from his own original pitch.

One thing, I’m not a fan of the first advice he gives, about focusing entirely on the product and hiring only engineers when you start, which has some truth to it in a number of situations but can lead to complete trainwrecks in others. Someone on the team needs to tie your development to a market need and a winning revenue model – it may not have to be a business person, and a well-atuned engineer can do that as Aaron shows, but it’s got to be someone with a certain ability to think ”market”. Leaving that detail aside, his advice is a gem.

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Develop, Fund, Market, Scale Aaron Patzer, entrepreneurship, Fundraising links, growth stages, Mint.com, Start Up

A great post today by Suzanne Dingwall Williams of Venture Law Associates LLP in Toronto, regarding the recent considerations by the U.S. to increase the number of H1B visas for skilled foreign workers, apparently thanks to a push by venture capitalists.

The stats she quotes are startling: 

“A recently released study by the NVCA notes that (a) immigrants have started more than 25% of U.S. public companies that were formerly venture backed, and (b) more than 50% of the employment generated by U.S. public venture-backed companies has come from immigrant-founded companies like Intel, eBay, Yahoo!, and Sun.

The New York Times has also taken note, citing Harvard Law professor Vivek Wadhwa’s claim that 52.4% of today’s Silicon Valley startups have at least one foreign founder. US VCs are figuring that, to expand domestic deal flow, they need to expand the immigrant entrepreneur base.”

Having lived in six countries including the U.S., I can tell for a fact that the amount of energy I deployed to learn about and obtain the visas and other administrative passes giving me the right to stay and to work is stupendous. In volume, it easily equals the time required to launch the operations of a start-up. This truly is wasted time. If the U.S. had made it easier for me to stay after my years at Stanford, I’d likely be there. I truly love Canada and Toronto is my favorite city in the world – but on a professional level, for tech entrepreneurs the environment is just not comparable to California. So the main advantage of Canada over the U.S., as Suzie points out, is that it is easier to immigrate as a skilled worker here.

But if that advantage diminishes, what’s left to retain immigrant tech entrepreneurs in Canada?

Better public support for start-ups? More grants? Sure, that’s one thing we have over the U.S. But it’s also a double-edged sword: in the previous years and months, the government and semi-public/nonprofit bodies have rapidly enriched their offering to better support the local tissue of tech entrepreneurs. That part is great. But a problem that’s not often raised -no one wants to publicly irk the hands that feed them, I guess- is the increasing institutionalization of venture commercialization actitivities that came with it: internal competition between agencies and “nonprofits” (whose employees clearly profited from this boom) are now leading some of them to expand into the private sector’s realm, for example by offering free market research and consulting services for start-ups. That move even goes against the public service mandate, as those services are generally only available to handpicked “clients”.

Even though it is motivated by a will to better support start-ups, it troubles me that the government and the bodies it supports increasingly choose to nationalize this activity as opposed to supporting the private providers already present. I didn’t leave the most successful communist country in the world – I’m talking of France – to land back in a growingly soviet-like environment, and have to make a living by begging for public grants! Hubs and catalysts are much needed. But it is to complement and promote, not replace, our private entrepreneurial ecosystem.

Sure, there is a lot of good work done hand-in-hand by private, public and publicly subsidized nonprofit organizations here, but when it comes to actual commercialization projects, it’s been my experience again and again that someone with a guaranteed salary and an institutional job simply doesn’t deliver as much value as a private sector provider whose next job depends on the quality of the one at hand. But unfortunately for us, it’s hard to compete with free. ”Free” also creates the wrong culture up north, with start-ups getting used to focusing on the technology and not investing much in commercialization and marketing, which obviously comes back to bite them. The higher valuation Americans place on commercialization activities, in my opinion, is another characteristic of the U.S. entrepreneurial ecosystem that still makes it more compelling than the Canadian one. With higher quotas for H1B visas, it won’t just attract better entrepreneurs , it will also attract better professionals to support those entrepreneurs.

As for VCs in Canada, there are few left, and so companies here are forced to look south or reduce their fundraising expectations and go after angels (who have done a tremendous job filling the gap left by VCs in early stages, but simply don’t have the same financial firepower). Interestingly, the VCs that are left also tend to only provide small amounts and thus really start looking more like angels with extra overheads. Among the Canadian clients I helped this year, and other start-ups I know here that received term sheets from Canadian VCs, not one accepted them. They went for local angels or U.S. VCs. Canadian VCs are stuck in the middle.

Luckily for Canada, U.S. H1Bs are not as compelling as the permanent residence our country is handing over to skilled workers, since they are tied to employment – it’s E visas and green cards the U.S. should make easier for entrepreneurs to obtain (and perhaps they are working on that too, I haven’t checked). But if the great Canadian advantage in facilitating entry and residence of skilled workers goes away, there will be little left here for immigrant entrepreneurs. A Canadian spouse and public healthcare (also something the U.S. may address) as the main reasons for most of them to stay here doesn’t make for great headlines about the state of our entrepreneurial system.

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Canadian entrepreneurs canada, Entrepreneur, h1b, immigration, permanent resident, Silicon Valley, skilled workers, Start Up, tech venture, toronto, US, venture capital, visa

Varun Mathur, the Techvibes Community Manager, who I just learnt is based in Toronto (I look forward to meeting you, Varun), made an excellent point yesterday in his Techvibes post on What Separates 37signals And Twitter ? 

For all the talk about “getting to revenue” as fast as possible, VCs are still valuing companies based on hype and unproven potential for exponential revenues. You can build valuations based on traffic, but if you can’t attach a realistic average $ amount to a visitor, and if you are going to hemorrhage your traffic as soon as you offer ads, then your valuation is built on shaky grounds – which in finance means you should likely be extremely conservative or discount it.

I don’t say there is never a case for giving high valuation to companies that have great brand awareness and usage even if they haven’t made a buck yet, but my thesis is that the risk of this revenue never materializing should lead to discounting valuations more heavily than they currently are. VCs should put their valuation through a simple risk-based, probabilistic tree analysis, contemplating the likelihood of 3 basic scenarios:

1. will never get to revenue and can’t sell or IPO company
2. can never get to revenue but can get company acquired
3. can get to revenue (and then look at the different types of revenue to differentiate linear from exponential in particular)

The problem, which ultimately has to do with the probability and payoff you attribute to each scenario, is especially with number 2. Even in this market, founders and VCs can rely on overpriced acquisitions to unload a company to an unsuspecting acquirer (hello eBay).  And so, with the right connections, the probability of scenario 2 is still implicitly weighted higher than it should likely be in VC valuation models.

My theory is that the Silicon Valley is an echo chamber for tech venture hype (just like Wall Street for blue chips), and a lot of founders and investors are masters at amplifying and riding this wave – rather than focusing on actually creating a revenue engine. In other words, ladies and gentlemen, yes, there are a lot of respectable-looking scammers in that business, and very successful ones too.  VCs won’t tell you this but lots of them love embracing irrational exuberance, because bubbles is how they get rich quick. 

Right now the real-time web is where this exuberance can be found. To Varun’s point questioning whether 37signals didn’t get Twitter-type valuation because of its Chicago location, I would add that perhaps the main reason why a valley-based Twitter will get a higher valuation than a Chicago-based or Canada-based twitter is that irrational exuberance dies off quickly when you have to take a 5h flight to close an acquisition -  reality-distortion fields don’t work well that far from the epicenter of the tech mecca. Locations that can turn perception into reality have a clear edge in businesses that rely on hypothesis for their valuation. So, yes, if 37signals want to reach astronomical values, it would do well to move to Mountain View or Palo Alto, drop any source of revenue, and change its name to reduce the likelihood their past revenue figures will constrain their future valuation.

However, that’s not all. In all fairness, one must point out that the potential for exponential revenues by 37signals as a platform developer targeting, well, application developers, is lower than a Twitter that can be used by potentially anyone. There is a lesson here for business models. Based on whether you target revenue or fundraising, your runway and product mix looks very different. In the first case (seeking revenues), you often need to diversify across a small range of products to test and create multiple sources of revenues – alpha, beta and subsequent market iterations are less dangerous because they don’t impact your long-term success as badly as a highly hyped flop from a VC-funded venture. You can fix things, there is less pressure to grow to $100M in 5 years, and quite often the decision to give you money is distributed across many potential users as opposed to concentrated on just a few VCs (who know and speak to each other).

In the second case (seeking capital), you often have only one chance to build buzz, and if it fails to support your story, it’s unlikely you’ll raise a round, and it’s likely you’ll die of capital thirst. So you want to bet the farm on one-single make-or-break application. It’s a different discipline. But still, the problem remains in the fundraising model, that it doesn’t encourage you to build your product with a revenue model in mind, until often too late in the game.

All in all, that’s a real problem for venture consultants like me as we generally encourage start-ups to get to revenue asap, and then a Twitter investment by VCs reactivates pipe dreams that all you need to do is a cool app and you’ll be a millionaire. If you are after VC money, it’s better not to make revenues if those are going to disprove the revenue potential of your model… Maybe that’s why new VCs need to emerge that don’t take a “winners take all” approach to investment, and instead focus on growing real revenues across their portfolio. Mmm, sounds like a hybrid of VC and management consultant… Did I just evolve my model? Thanks Varun!

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