Silicon Valley has come a long way since the days of Net-savvy entrepreneurs who could do no wrong. With dot-coms dead, dying or applying for witness protection, new tech start-ups are following a completely different blueprint, one that goes far beyond the pithy declaration that “profits matter.” Three-word business plans (“selling dogfood online”) are passe; technologically complex products and business models are in. An IPO is still the goal, but it’s not expected to happen for three to five years. And the value of a company is calculated not by questionable metrics like revenue potential or the number of visitors to a Web site, but by actual profits and gross margins. A new austerity has swept the Valley, and cash is now fiercely conserved (no Super Bowl ads or foosball tables). It signals a wholesale return to how the Valley used to do business way back before 1997 and an attempt to avoid the sweeping pessimism that investors are applying to all new tech businesses in the wake of the dot-com crash.
In other words, you don’t have to be jealous of brash, twentysomething Internet millionaires anymore. Doors at venture-capital firms on Sand Hill Road are routinely closed in the faces of Stanford M.B.A.s and other Young Turks. Experience is fashionable again. Most execs who have been successful in raising capital for new ventures this year have at least one previous start-up under their belts. Even the exceptions, like Voxeo’s Gary Reback, are exceptional. As a lawyer, Reback worked with Netscape and sparked the federal antitrust case against Microsoft with letters to the Justice Department.
Typical of Silicon Valley’s new start-ups, Voxeo isn’t a simple Web scheme but an ambitious high-tech company. It helps companies create applications for the telephone using Internet technology. For example, using Voxeo’s programming tools and host computers, an airline could create a program that automatically places telephone calls to every scheduled passenger if a flight is canceled. It’s a plan that requires a white board and 30 minutes to fully explain–something the early dot-coms never needed. “The whole notion that something is quick and easy and you can make a lot of money real fast–that’s just not a message that anybody is interested in hearing anymore,” Reback says.
New start-ups also have to demonstrate financial viability, not just technological ambition, to get funding. The portfolios of venture capitalists today are springing more leaks than the Mir space station. When VCs aren’t busy trying to save the wounded companies they invested in during the boom years, they ask entrepreneurs tough questions: what are your revenues and profit margins and–the big one–how long until you break even? “We weren’t even asking that question two years ago,” says Larry Cheng of Boston-based Battery Ventures.
Entrepreneurs are building their plans around these requirements. In the old days, capital was plentiful, and entrepreneurs could visit the private markets several times before they went public. Now, to reduce their risk, tightfisted investors want more equity for their dollars. John Peters, CEO of Sigma Networks (himself a veteran of six start-ups), set out nearly a year ago to raise a first round of $50 million to launch his company. Sigma aims to build broadband connections between local Internet providers in major cities and backbone Internet companies (you need two white boards to explain this one). Then he realized $50 million would not get his company very far and changed course. Sigma is now among the fortunate: last month, after nearly a year of fund-raising and one week before he couldn’t make the payroll, Peters announced a massive $435 million round of funding–the third largest financing in Silicon Valley history. “You cannot assume you will be able to raise additional capital” in this environment, he says. He had to give up a larger percentage of the company in the process, but in the shaky new world, he says, it’s worth it to have the cash in hand.
Since new entrepreneurs want to limit the number of times they go looking for funds, they’re concentrating on making the cash last. That’s where the belt-tightening comes in. Gone are the masseuses, designer pizza parties on Fridays and Las Vegas retreats. Tours and parties heralding the launch of a start-up have also been toned down (journalists who based their diets on the free chicken sate at such events have lost weight). “It’s all about making your money go a whole lot farther than it used to,” says Craig Janik, cofounder of Simple Devices, which makes Net software for appliances like phones and stereos.
In the days of bubbledom, start-ups would eat through several million dollars a month. Today most companies want to maintain their “burn rate” at half a million a month. They’re hoping to make it to positive cash flow as soon as possible, and an eventual IPO. But that’s not easy–the IPO markets have a big closed sign on the window. So the three- to five-year plans of many start-up CEOs are speculative. The one thing they’re sure of is that the days of companies like Akamai and Pets.com going public after 12 months are over.
The new austerity has also translated into differences in the way start-ups are managed. In the bubble years, there was a big emphasis on the department of business development, which was responsible for forging partnerships with other companies. Those relationships, proclaimed proudly in public, often were a start-up’s primary assets, but did little to bring in revenues. Now, says Gary Reback, there are only two positions in the company: “You either make something or you sell it.”
There are a few things that haven’t changed in the Silicon Valley start-up community in the past year. Net companies are still being founded and funded in herds–the B2C and B2B crazes have been succeeded by peer-to-peer and “infrastructure” companies. There’s also as much thirst as ever among Valley tech types to work at start-ups–despite the recent shakeout. On the day it closed its $435 million round of funding, for example, Sigma Networks got 315 resumes. And Voxeo recently lured several executives from East Coast companies out to sedate Scotts Valley. Reback says Valley entrepreneurs still see dollar signs at the end of the rainbow; they’re just less expectant about the amount of money they may make and how soon they’ll make it, and acutely aware of the risks involved.
