To Survive, Net Start-Ups Slow Their Metabolism
Silicon Valley has always been a land of big, bold dreams. In the first Internet boom its start-ups either grew fast or died trying, sometimes spectacularly. The casualties of the bust, like Pets.com and Webvan, became legendary.
In this downturn, say investors and entrepreneurs, start-ups are adopting a strategy that they hope will let them hang on instead of flame out.
To preserve cash, many tech start-ups are rushing to lay off employees and cut expenses. They are shelving their dreams of Google-size riches and getting small, humble and thrifty, all with the more modest goal of surviving the coming economic winter.
Once upon a time, an unprofitable Internet start-up like Zivity, a social site that revolves around photos of models, might have turned into just another dot-bomb. Though it has paltry revenues and just 20,000 registered users, the company pays only $8,000 a month to rent its offices in San Francisco and has received $8 million from investors. This month it laid off 8 of its 22 employees — saving enough money to stay alive through 2011 and survive even a prolonged recession.
“We think we have a valuable product,” said Cyan Banister, Zivity’s co-founder. “We should be able to weather the storm.”
Even in normal economic times, a majority of start-ups fail. But the same factors that have made it so easy to create Web 2.0-style start-ups — low fixed costs, access to inexpensive overseas programmers and cheap ways to advertise online — also make it relatively easy for even faltering companies to cut back their operations to the bare minimum and hang on through a slump.
Web start-ups “don’t fail in the same way they used to fail,” said Brad Burnham, a partner at the venture capital firm Union Square Ventures, adding that the previous generation of Internet companies lived hard and died young. Knowing when to pull the plug on the current crop of more frugal companies is now “different, more subtle, more problematic,” he said. “They don’t run into a wall.”
The Web companies in this new generation are so efficient with capital that venture capitalists “may not have the plug in our hand,” Mr. Burnham said.
The only certainty in Silicon Valley is that survival is quickly becoming more challenging. The growth in online display advertising, which helps fuel the new Internet ecosystem, is declining. Venture capitalists and other investors in start-ups, like hedge funds, are cutting back. The market for initial public offerings remains closed and potential acquirers — Google, Yahoo and the rest — are deep in their own problems. Many entrepreneurs and deal makers agree that a shake-out is indeed coming.
Venture capitalists have begun preaching frugality, urging the start-ups they have invested in to cut costs and get profitable. Their advice shares themes: cut employees, do not count on raising more money and move quickly.
The entrepreneurs appear to be listening. AdBrite, an online advertising network in San Francisco that raised $35 million in venture capital, recently laid off one-third of its staff, or 40 employees, to get to profitability next year. The company’s chief executive, Iggy Fanlo, ran the e-commerce site Shopping.com during the first dot-com bust, and he said he recalled how wave after wave of layoffs sank morale.
“I had gone through this before and we had death by a thousand cuts,” Mr. Fanlo said. “I wanted to credibly look people in the eye this time and say we are profitable.”
Every day seems to bring a new round of layoffs. In the last two weeks, the music site Imeem, the social search site Mahalo, the visual search engine Searchme, the real estate site Zillow, the Internet radio site Pandora and the social network Hi5 all cut as much as a quarter of their employees.
For many entrepreneurs, the lone goal has become survival. At Seesmic, a video blogging service, the day of reckoning — when it runs out of the $6 million it raised in May — will come in three years. To make the money last, Loïc Le Meur, the chief executive, recently laid off seven employees, or one-third of his staff, and cut all projects not directly related to the video service.
“If I can’t make this work in three years it will be a failure,” Mr. Le Meur said. “If I can and I get through this, it will be much stronger.”
Even companies with less than stellar track records and revenues say they can live through a protracted slump.
Lala, a music site based in Palo Alto, Calif., has scrapped two music services and recently began a third site in conjunction with the major labels. The company raised $35 million three years ago and, thanks to financial prudence, has $20 million in the bank. It recently delayed plans to double its staff and it put its excess office space up for sublet.
Lala’s founder, Bill Nguyen, expressed a measure of relief at the chill in the Valley. “This whole economic crisis allows me not to have to grow,” he said. “I view this as a free hall pass.”
That wholesale resetting of expectations might be the biggest change to settle over Silicon Valley. Instead of aiming for blockbuster public offerings or market-shaking acquisitions, most entrepreneurs now just want to endure. But if not enough people use these start-ups’ services and revenue does not grow fast enough to attract potential acquirers, mere survival may not look so good.
At Faraday Media, a Palo Alto start-up that is trying to create a personalized version of the Internet for its users, there is no revenue, no office space (the five employees work from their homes) and little chance of raising any capital from the newly miserly angel investors who would otherwise support a start-up of its size.
Chris Saad, Faraday Media’s founder, said the company saw no reason to give up. “We are committed to the idea that the company and technology we are building is fundamentally going to reshape the Web,” he said. “We are committed to investing our time into this for as long as it takes.”
If these skeletal start-ups do succumb to the downturn, firms like Sherwood Partners, which specializes in bankruptcy consulting and shutting down companies, will be waiting. Sherwood Partners has not yet had the kind of activity it witnessed during the last bust, but Martin D. Pichinson, a partner at the company, is preparing for a burst of new business as many start-ups acknowledge that just because they can survive does not mean they should.
Failing start-ups “are already out there, and we are starting to close some of them, when investors say it needs to be done,” Mr. Pichinson said.
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