Sean Parker thinks Silicon Valley is in trouble | Digital Media - CNET News

Sean Parker this week at Techonomy

(Credit: Techonony)

Tucson, Ariz.—Sean Parker, a big reason for Facebook’s success (remember Justin Timberlake) and a now a partner with Founders Fund, thinks Silicon Valley is in big trouble. His beef: Too many angel investors are throwing way too much money—albeit in little drips—at aspiring entrepreneurs who aren’t up to the task of building a company.

The subject came up during a panel Parker was on at Techonomy 2011, a conference that took place this week in Tucson, Ariz. It’s a hot-button issue -every young coder in the Valley, it seems, is either doing a startup or toying with the idea.

I talked with Parker to drill down on the issue.

Q: What’s the problem with the assembly line model of rapid-fire investing that’s going on now?
Parker: This is a model that works well in a bubble—the model of making a large number of investments very rapidly and outsourcing your due diligence to members of your network. Obviously in a market where everything goes up, this works extremely well. And that’s a bubble environment.

Q: How’d we get here?
Parker: There was a huge inefficiency in the market six or eight years ago, where there wasn’t enough early stage capital. It was that opportunity that allowed Founders Fund, my venture fund, to enter the market to fill that void because angels had become very skittish and started to believe they could never get their money out.

Now we’ve seen this explosion in angel investing. There are lots of angels coming out of Google and Facebook investing very rapidly and wanting to be players. I think that’s some of the motivation—wanting to be players, to stay close to the game and wanting to have a seat at the table.

And they’re making tons of investments often in companies that aren’t fully baked—either the team isn’t fully baked or the product isn’t fully baked or there’s no conceivable revenue model.

Q: You talk a lot about the importance of the right team.
Parker: A lot of the best talent in a particular domain is not necessarily the correct talent to be starting a company. So there’s a lot of fantastic engineers who really shouldn’t be product people, really shouldn’t be founders, and there’s a lot of founder product people who really shouldn’t be engineers. Understanding your place in the ecosystem and the value you’re able to bring gets lost and distorted when there’s so much money sloshing around, and everyone you know is pushing you to go and start a company.

There’s a sense of entitlement that I’ve never seen before in Silicon Valley among people who work for a big company for a while and make a lot of money. They think the next step for them is to start a company. That’s often exactly the wrong thing for them to do. They will likely squander their own fortune or waste someone else’s money.

Q: Sounds like funding can end up being a disservice.
Parker: Any great engineer these days, who has a good pedigree, can go and get a $250,000 or $500,000 check and start a business and they’re probably not qualified to do so.

They think they’re going to build a prototype and that’s enough. They need to be focused on building a team, and it doesn’t have to be a team of seasoned execs. It needs to be team of people who can perform all the functions necessary to run a business. I learned that the hard way—by starting companies that didn’t necessarily have a complete team.

Q: But sometimes good businesses come out of these small ventures. Few become Facebook or Google.
Parker: I think that the lesson in all this is that while this can sometimes work, it much more closely resembles gambling than it does investing. The result is going to be a lot of lost capital, but the most deleterious affects is the dispersion of human talent, human capital. The dispersion of human talent to a huge number of startups—none of which is executing with the right product or have the right team members to really succeed.

And the good businesses find themselves competing not just against Facebook and Google and Dropbox and Groupon for talent. They’re competing against literally thousands of startups, most of which will never succeed.

Q: How does this all play out?
Parker: I think that when the large established players are done going public, you’ll see a few companies that are not ready to go public try. And if the market gets frothy enough, a few of those companies, which are too dependent on bubble economics, will go public and you’ll start to see those companies going terribly wrong and then you’ll see a lot of losses. And when those losses start to accumulate, you’re going to see the public markets for technology shut down again.

Q: But the public markets aren’t the only option. Google bought 27 companies just in the last quarter.
Parker: Google bought 27 companies last quarter and a lot of them are talent acquisitions, in some cases paying $1 million an engineer. That can’t last forever. There’s way more startups getting founded now than there are companies than Google and Facebook want to buy.

Q: The bubble bursting would obviously help the talent crunch.
Parker: The only countervailing force in that analysis is that Google and Facebook and Dropbox and Groupon, which are willing to pay exorbitant prices for talent, will stop having to do so.

Q: Yup. That has to have a ceiling.
Parker: And then you’ll probably see a lot of these companies shutting down, and I guess this is where it really ends—when way more of these companies are shutting down then are getting bought. Then that causes this million-dollar price per head thing to drop, and the scarcity in the market goes away.

Then there aren’t VCs willing to keep funding these companies; therefore they’re forced to sell in a fire sale. So they essentially stop being mergers and acquisitions plays and they start being recruiting opportunities.

I see these deals now where Facebook or Google makes an offer not to buy the assets but to acquire the right to hire. They’ll pay the company a certain amount of money and the investors a certain amount of money. It’s a talent acquisition where you don’t even buy the company. You’ll probably see more of that, where companies just get rolled in or talent gets picked over and there’s limited to no return back to the investors. At that point the whole system grinds to a halt.

Q: What’s the time frame for all this doom and gloom?
Parker: I don’t know how many more years of this we have—maybe it’s a year a year or two, max. But eventually this graveyard of dead young companies is going to dramatically exceed the number of companies that Google and Faceook want to buy, at which point that gravy train is over.

via news.cnet.com

Stock Market Drops. VCs Hold Partner Meetings. What Happens Next? | TechCrunch

Frustrated VC

This is a guest post by Mark Suster, a 2x entrepreneur turned VC with GRP Partners where he focuses on early-stage technology companies. Read more about Suster on his startup blog and on Twitter at @msuster.

Venture Capitalists typically have partners’ meetings on Mondays. Why is that? Who knows. But probably because as a group we travel a lot. So the industry formed around a day of the week when all partners could avoid having company board meetings or traveling.

Yesterday was a Monday. And not a pleasant one.

Rewind. When I first got into the industry it was 2007. Valuations were enormous relative to progress in companies. Web 2.0 was still a term being bandied about. Companies with less than $2 million in revenue were asking for $50-60 million valuations and getting them. My partnership was pretty bearish and scratched our heads a bit at price tags.

It was a great learning time for me. I spent my days meeting companies, figuring out what areas of the market interested me and trying to get a sense for how VCs thought about fair valuations. I thought about things I never had to as an entrepreneur: check size, ownership percentage, deal stage, portfolio construction and risk.

2008

By 2008 I had gotten more serious about championing companies through our investment process. I started showing my partners more deals that I found interesting and doing loads of analysis on the future of markets I thought were ripe for disruption.

I have always believed that TV was ripe for disruption. The parallels to the music industry are too obvious even though the industry players, the medium and the cost structures are different. US TV advertising is $60 billion in its own right. I had found my industry and a deal I really liked in it.

I introduced my partners, we spent weeks with the team and felt good rapport. And just when I thought I had the deal that was worthy of bringing to the investment committee the world changed. It was September 2008. The market had tanked. Lehman Brothers had filed for bankruptcy. It was many events that led to the crash but perhaps this was the pin that pricked the market.

The following is a 2-week graph of the end-of-week price of the Dow Jones Industrial Average (DJIA) in Autumn 2008.

And while the market was off 24% in two weeks, it’s worth remembering 2 other things

  • The market was actually off 40% from its Oct ’07 peak
  • The market wouldn’t bottom until Mar ’09. On Mar-6 it hit 6,626 or 53% off its peak

We thought the following:

  • No new deals close until we figure out WTF is going on with the market. We need some visibility.
  • Let’s review all of our existing investments. Let’s make sure each has enough cash. Cut where needed. Finance where needed. Anyone not going to make it?
  • Who has deals in process? Let’s help get their funding get finalized or the company sold if it’s already in play.
  • Fawk, man. This is really bad. Depressing. Harrumph.

It felt awful. Kind of like you felt as personal investors, no doubt.

My deal got dragged out and eventually never happened. Mostly we got to see the team operate in stressful times and that changed my perspective on the deal. I need leaders who manage in good times and bad. To build a large company you need to manage through economic cycles.

2009

Come 2009 we felt really bullish about the future for startups because the froth was gone and so, too, were wantrapreneurs. The people left standing had a compelling vision to build companies and we backed many in 2009.

When this period was fresh in September  2009, I wrote a very detailed assessment of what I thought had just happened.

tl;dr summary

  • Companies raised too much money in 2005-08 and had high burn rates
  • VCs were very active in this period
  • When the market tanked they had the “triage problem” – which portfolio companies to save, which to kill
  • So no new deals got done. Everybody focused inwardly
  • And VCs scrambled to raise their own funds. Making even less time for new deals
  • VCs hate downrounds to even good companies struggled to raise money

But by late 2009 life had started to return to normal

  • Eventually you have to invest. It’s your job. You don’t get paid to sit on the sidelines. So when the market started showing good signs (iPhone, Facebook, Zynga, Twitter, stock market growth) it was happy days again
  • M&A returned. For the same reasons. You would think it would be better for M&A to be more active when the markets are down – better prices. But I guess you could say the same about VC.

So I encouraged entrepreneurs to think about raising their funds as quickly as they could because

  • Consumer spending 70% of the economy and vulnerable (wealth effect, build up debts)
  • Unemployment likely to rise
  • Risks of these two factors to the stock market
  • Stock market declines would bring back dog days of VC

The full articles are linked below. If you want a comprehensive summary of the industry in this era it’s worth a read:

VC Ice Age Part 1 – What Happens When a Market Comes to a Standstill?
VC Ice Age Part 2 – Why the Market Started Moving Again?
VC Ice Age Part 3 – What The Future Holds

In particular part three talked about what happened if we saw a double dip in 2010-11 or a “lost decade.”

2010

We did not see a double dip or the drying up of VC funding. In fact, fundings boomed as you know. 2010 was the year of the “super angel” and 2011 has to date been the year of unbelievably highly priced B,C & D rounds of venture capital. The so-called “billion dollar club.”

Fast forward a year to September 2010 and I wrote my treatise on the 2010 economy. It has some detailed charts you may appreciate if you’re wanting to understand the current economic situation. I show charts on housing, structural unemployment, home equity re-financings that we spent meaning less spending power post crash, new housing sales, debt-to-income ratios, public-sector job problems that will cause crises in cities and states across the US.

Summary version? No chart was good.

At least you can’t accuse me of being inconsistent. My year-over-year summary sounds very similar upon re-reading them.

2011

I have a young entrepreneur friend who IMs me a lot. He was working on a VC round in the early Summer. He pinged me for advice. I told him (verbatim), “close your round by August 2nd. After that, all bets are off.” He’s literally on IM right now in my other browser tab saying, “you called it.” I can’t say his name yet because he hasn’t announced funding. But he got it done. Maybe he’ll reveal our conversation when he announced.

I told another friend the same. He’s still optimizing on price and hasn’t accepted his term sheet. It expires this Friday. I wonder what will happen. I guess in part we’ll see how the stock market plays out this week.

August 2011. What’s happening?

The fundamentals in our economy are mostly not on more solid footing than when I wrote the posts in 2009 and 2010. On the positive side, corporate profits are up, their balance sheets have been repaired and they have recapitalized themselves to have lower amounts of debt relative to equity. Not just tech companies but industrials, too.

But you’d have to be a pretty heads-down coder to not have noticed the past 2+ weeks in the DJIA.

Most of the informed people I know are telling me that the sharp sell-off has more to do with European national debt (PIGS as it is called: Portugal, Italy, Greece & Spain) than the current US dilemma of a S&P downgrade of the US government debt. But it must also be on the minds of investors that perhaps the flu will end up on our shores, too.

I know that investors must also be aware of the civil unrest in the UK. Yes, it seems to largely be thugs. But social unrest is created in harsh economic times and we’ve seen this in Greece before. Expect it to spread. It does weigh on the mind.

And while I cannot tell you for sure what was going on in VC partner meetings across the world today – I’m a data point of exactly one – I think I have a pretty informed guess. And depending on which way that economy heads I can tell you what the story in entrepreneur land *might* be in 60 days, “funding is getting harder, valuations are slipping, companies are running out of cash, M&A is slowing down.”

So let me give you the news 2 months early. If the economy and the stock market continue to languish that’s exactly what’s going to happen.

I’ll bet most partners’ meetings this week consisted of looking just a little bit closer at the cash needs of their portfolio companies – making sure they’re “fully funded.” I’ll bet many of them did a review of their “investment pace” as in – how quickly should we be investing. I’ll bet many did a slow roll on deals that might have gotten approved today. Not a “no” but not yet a “yes.”

It’s impossible to sit in a partners’ meeting on a day like today without having an iPhone on watching the stock market free fall and no matter how much of a public tech cheerleader you are – privately I guarantee there was much concern.

If we do head South it will take a few weeks or months until the memos to portfolio companies get published and the Powerpoint presentations get sent out. But the internal conversation started today – trust me. VCs will take a “wait and see” approach right now. Don’t want to call it either way. It’s too early.

Me? I feel confident telling you to, “Watch your pennies. Raise your money. Don’t spend like it’s 1999. If we’re not heading for a double dip recession at least you’re still being prudent.”

Maybe we’ll bounce right back? Anybody who says they know for sure one way or the other is a bit of a shaman. But I have to imagine the speed and severity of the stock market decline and political instability will likely weigh on investors for some time to come – even if we rebound.

And I’ll tell you what worries me: Jobs, growth & political malaise. And don’t think tech will remain immune.

I guess that’s why I encouraged people to raise money while the getting’s good (PPT slides & video).

My prognosis?

1. Jobs
I’ve been parroting this for 2 years. We have a two-track economy. We have the inability to hire engineering in Silicon Valley or brand sales people in NYC but the country still has very high structural long-term unemployment. Check out the graph below from the Economist magazine. It plots employment changes from the peak GDP quarter of the previous boom. What you’ll see is that it takes about 2 years to recover jobs from the normal recessions of the past 50 years (as if there was a “normal.”)

This recession?  We’re 2.5 years in and still down 5% from the peak.

What gives? I’m guessing many of these jobs ain’t coming back any time soon. The last big recession was in the early 90′s where IT and globalization were in their infancy in terms of impact. We need a plan to replace these jobs long term. That can only come through education, training and investment in regions of the country that are not IT centers.  There’s no band-aid solution and no quick fix.

Whatever you think about tax policy, I’m certain that it’s not driver one way or the other to fixing this problem. Anyone who says it is a driver is selling you political malarky.

We gotta fix jobs.

2. Growth
The story here is no different.

My message to entrepreneurs has been, “It’s coming soon to a theater near you.” You know – the “butterfly effect” on a local and tangible basis. Consumers hurting in Detroit or Biloxi will not continue to spend money they don’t have and income they’re not earning. It will impact retail. It will impact brands. These companies advertise. On your tech platforms. These consumers buy iPads, iPhones, Androids. You’re counting on them for up-sells to your app. For buying virtual goods. You need consumers – they’re 70% of the economy.

Trouble is – they don’t have jobs. Those that do still have too much debt. Their 401k ain’t what it once was and it just got whacked again. They still have too much personal debt. And the equity in their house isn’t rising. They’re doing what economists call “de-leveraging,” which means spending less, saving more.

And you don’t see it. You don’t see it because the world you likely live in if you’re reading this has been booming. And even if you’re not physically in a booming tech market you’re likely in the market spiritually, metaphorically. You’re reading TechCrunch, aren’t you?

3. Political Malaise
I think here I’ll just quote myself from my analysis a year ago to avoid sounding like I’m jumping on the bandwagon of this week’s quarterback analysis:

“While there was a momentary unity in the US government for bailouts & stimulus spending that were initiated in the Bush administration (many people conveniently forget this now) and continued under Obama, it is clear that this era of consensus is over.  Keynesians will argue that this is a bad thing and fiscal conservatives will argue that it is a necessary discipline. 

Either way, the gridlock that is now the US congress will prevent any real economic responses and it seems likely that this political malaise will last beyond the 2012 election as the Republicans look to make big gains in the 2010 mid-term elections.”

Maybe the stock market drop will bring some clarity to congress. Maybe it will bring some bi-partisan spirit to solving the nations problems. Maybe. But evidence seems to the contrary. Right now people seem to be angling more around November 2012. And that sure sounds a long way away to me.

What does this mean for the tech and VC markets?

I’m characteristically still bullish on our long-term trends for companies who get through the toughest times. Here’s what I know:

  • Television will be consumed dramatically differently in 10 years from now than it is today. Creative destruction will continue to create opportunities for people who understand the deflationary economics of the Internet. I’m long.
  • Cash will continue to become less relevant in 10 years as electronic & mobile commerce continue to proliferate and new technologies like NFC drive change. I’m long on payment technologies.
  • Computing will be an order of magnitude more mobile 10 years from now, changing the way applications are delivered and the way we interact with our real social networks. I’m long Mobile. And Social.
  • Businesses will continue to realize that the Internet is one big information utility and will continue to move operations to the cloud. This will create whole new segments of the tech market for databases, data-as-a-service, real-time information processing, cloud mapping & visualization technology, etc. I’m long the cloud.

Venture capital is an industry best served up from 7-year aged casks. As many people have said, “We over-estimate the impact of technology in 3 years and under-estimate the impact in 10 years.”

Make sure you’re still here in 10 years. Get yours. Then go build your companies.

Top image courtesy of Fotolia.

via techcrunch.com