Throwing Rocks at the Google Bus: How Growth Became the Enemy of Prosperity (25 page)

His investors taught him what my friend Ruby figured out on her own: that creating a company for acquisition or IPO is different from building a profitable enterprise; it’s about building a
sellable
enterprise. Startups are not trying to earn revenue (which is a liability); they are setting themselves up to win more capital. They are not part of the real economy or even the real world but part of the process through which working assets are converted into new stockpiles of dead ones. That’s all they have really accomplished with whatever digital fad they’ve foisted onto the market or sold to yesterday’s tech winners. They thought they were engineering a new technology, when they were actually engineering a reallocation of capital.

That’s why digital entrepreneurs who do win often end up becoming the next generation of venture capitalists. Everyone from Marc Andreessen
(Netscape) to Sean Parker (Napster) to Peter Thiel (PayPal) to Jack Dorsey (Twitter) now runs venture funds of his own. Facebook and Google, once startups themselves, now acquire more businesses than they incubate internally. With each new generation, firms and investors leverage the startup economy more deliberately, or even cynically. After all, a win is a win.

Take OMGPop, a gaming Web site startup that won a spot in the Y Combinator incubator to build social games. It soon enjoyed moderate success with a Facebook game but then couldn’t seem to get any traction. With good advice from its venture-savvy mentors—all former startup founders themselves—the company pivoted from one sector to another, looking for a sweet spot. It picked up another cohort of mentors, including the famed startup studio Betaworks, who helped steer the company toward a trending yet underserved market segment: mobile social gaming. The company came up with a free social gaming app called Draw Something, in which users draw little pictures for one another. In just a week, the game proved a hit, so the developers began to create add-on utilities and features that the most ardent users were willing to pay for.

One month after its iPhone/Android launch, the game had earned fifty million downloads and fifteen million active daily users.
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Without any real sense of how durable this new customer base might be, OMGPop put itself up for sale. It received an acquisition offer from Zynga, the social gaming company responsible for an earlier megahit, the Facebook-based virtual farmer game, FarmVille.

Zynga, for its part, had managed to earn about $30 million in 2011 selling in-game virtual goods to players for their farms. Its success captured the attention of investors, who were desperate for a way to bet on social media. The company figured it was a good enough proxy for the whole sector and rushed to IPO in December of that year, ahead of Facebook and Twitter. By the end of its first day of trading, Zynga was worth about $7 billion.
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But FarmVille eventually began to tank, and the company had no compelling follow-up game to replace it. Revenue tanked. Zynga proved better at gaming the market than at making games. Making
matters worse, once Facebook had its own IPO, people interested in social media companies sold their Zynga stock to buy Facebook’s, further eroding its share price.
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Zynga had to do something with its capital before it was gone. Besides, social networking was moving to smartphones, and gaming had to follow. Draw Something had to be purchased or cloned—but simply copying the other company’s product might make Zynga look even less innovative in the long run.

So, in March 2012, Zynga went and bought OMGPop for its Draw Something franchise and the promise of a mobile future. It paid over $200 million for the company,
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a little more than ten dollars per active user. Almost immediately, however, the user base of Draw Something began to decline—from fifteen million to ten million daily users the very next month,
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and down from there. Oops. Draw Something was less the gateway to a new population of users than a short-lived fad. Zynga thought it was buying a ready-made pivot for itself to a new market, but it had really purchased a single mobile game product, itself retrofitted to a market moment. And it did so at the absolute top.

For weeks after that, no one knew quite what to say about all this. The founders of OMGPop were good, hard workers. They weren’t pulling an intentional con, even if their company had been used by one group of billionaires to extract a few hundred million from a different group of billionaires. Yet when I went to a Betaworks event that month, OMGPop’s founders and advisors were all there with strange grins on their faces. There was a palpable sense of giddiness in the air. They sold the company on the exact day it had the most users it ever would. It was a perfect win. A year later, the OMGPop division of Zynga shut down.
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Luckily, OMGPop was never intended to save the world, so its founders got what they were after. They wanted to have fun, but their ultimate intention was to have a spectacular exit. That’s why they welcomed the intervention of investors who could coach them to hit the home run. To those who see their startup as having some enduring purpose beyond a market hack, such calls to pivot are less welcome. But they soon learn they are powerless against venture capitalists who insist that there’s only one objective and that
any goal beyond IPO or acquisition is a distraction. By this point, most founders have taken on far too much investment to refuse.

For some developers, this is the moment when all the venture capital they managed to raise during countless roadshows and pitches begins to feel less like capital than a curse. Slowly, they come to realize that their original vision for serving people with a new technology has been lost amid a series of compromising pivots toward an outlandishly improbable megahit. Succeeding in the new world of platform monopolies doesn’t even leave room for whatever the company was first created to do. Gone is the technology company that meant for users to be able to create value for themselves or for other developers to take advantage of some terrific new feat of engineering. These openings for distributed prosperity are now recognized as obstacles to market dominance and sealed shut like potential leaks in a battleship.

For most, such misgivings occur too late, only after the deals are signed, the checks are cashed, and the founders’ fiduciary responsibility to shareholders trumps their dedication to their vision. In many cases, the financial payoff offsets the personal pain. Becoming a multimillionaire in one’s twenties can be a powerful positive reinforcement for playing by the venture capitalists’ rules. But for a few, the compromises become incentives to look for alternatives—for an even more fundamental hack: rather than retrofitting one’s company to the existing venture funding model, how about using a company to change it?

In their own run-up to IPO, Google’s founders still had enough gumption to challenge Wall Street’s power brokers. They insisted on pricing their shares through a bottom-up auction that mirrored the way their search engine came up with results. Traditionally, companies hoping to list on the stock exchange hire investment bankers to pitch them to investors and to calculate the highest valuation and share price that those investors will pay. In return, the bankers get a significant piece of the whole deal—usually around 7 percent—as well as the bragging rights for having been chosen to execute it.

Google figured it had enough name recognition and a clear enough value proposition for its potential investors. Plus, it wanted to demonstrate a more democratic style by offering the very first shares to the general public instead of just to the insiders at Goldman Sachs and Morgan Stanley. They did a Dutch auction, through which anyone with a brokerage account could bid on any amount of shares, at any price. After the bidding, the highest price at which every available share could be sold became the price for all the shares—in this case, $85 per share, or a total of $23 billion.
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Investment bankers called the auction a “disaster” and claimed they could have gotten Google a much higher price had they been allowed to offer the shares to their usual clients in the traditional, closed fashion.
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Then those clients could have sold shares to the hungry public on the open exchange and reaped even more. But the only disaster was for investment banking itself. Google had not only bypassed the bankers but also given the general public first crack at its shares. This was an Internet company at the height of its ability to “do no evil.” It took the short-term gains away from elite investors who formerly enjoyed exclusive access to IPO shares, and gave a sense of privilege and ownership to the millions of Google users who were actually responsible for the search engine’s rise from dorm-room experiment to technology giant.

Unfortunately, it didn’t set a trend. Facebook, Twitter, and every other major subsequent tech IPO went the traditional route, letting investment bankers handle their sales to the public markets. Sure, the IPO prices end up being unsupportable, at least in the short term, but that doesn’t matter to the venture capitalists, who are less interested in the future of the company than they are in getting the heck out of their investments. The IPO is their exit, not their entrance. Investors and venture capitalists are not about to let the companies in their stables blow 20 or 30 percent of potential opening-day market cap on some idealistic hacker ethos. From what I’ve learned in the conversations I’ve had with the founders of some of these companies, they never had a real choice in the matter.

Still, those who have lived through a painful but profitable soul-sucking home run are the best equipped to do it differently the next time out. My good friend Scott Heiferman made millions on his first company, a Web advertising technology firm called i-traffic that he sold to Agency.com at the height of the dot-com boom. But he felt pretty empty afterward and went on a multiyear walkabout that included a stint working at McDonald’s, as well as posting a photo a day on a site he created called Fotolog (which has since garnered over a billion photos from thirty million users, mostly in South America).

As if to counteract some of the Internet’s ills, Heiferman founded a new company he called Meetup—a simple Web site through which people can convene meetings in the real world, about anything they’re interested in. There are Meetups for pug owners of Memphis, knitters of West Boca Raton, and furries of Houston. Meetups gained traction during the Howard Dean presidential campaign of 2000, when they were used as a primary organizational tool, and they have remained popular with organizers of all kinds ever since.

Heiferman took in some venture capital—but only as much as he needed, and mostly from people he knew would be patient. Today, the company is profitable; it funds its operations by collecting small fees from thousands of group organizers and can do so indefinitely. It’s just not the path to a home run. Heiferman regularly fields offers from brands wanting to pay the company to sponsor various Meetups, send targeted ads, or give conveners samples of products; the company is sitting on a gold mine of consumer data, too. But Heiferman rejects them all because he aims for Meetup to be a civic platform rather than a platform monopoly. “We’re not trying to vertically/horizontally integrate or get into new businesses or invent self-driving space elevators. We know what business we want to be in, it’s a big opportunity, and we don’t see ourselves as empire-building imperialists.”
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Most of his investors are wealthy enough and intrigued enough with his
mission to let Heiferman keep Meetup on the slow and steady path. As for those who aren’t, Heiferman says, “I’m telling investors the truth: we want to generate good profits and get to a point of paying dividends for many, many years. That’s not their business model, but that’s not my problem.” Still, he is exploring ways for impatient investors to sell their shares to others who will be more content with a long-term dividend generator.

Don’t mistake Heiferman for an enemy of the market. He’s not running a nonprofit, and he believes his company’s mission is to accomplish what “government could or should do but won’t do because government is broken and they couldn’t assemble the talent and energy to do it. This talent is very valuable in the marketplace.” And only a market solution can solve the social ills Heiferman means to address.

Rejecting the rules of late-stage tech-bubble venture-capital madness is a better, more resilient, and durable approach to business in a digital landscape. Who better to affirm this than one of the digital industry’s most trusted news and analysis sources, PandoDaily. Generally accepted as the “site of record for Silicon Valley,”
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PandoDaily raised just over $4 million in capital, granting no single investor more than 8 percent of the company and giving up no board seats to venture capitalists. If the investors had control, they would push the publication to grow faster and bulk up its staff. They would force it to use its capital to hire away name writers from other business publications, both for the appearance of dominance and to make the company more attractive as a potential acqui-hire. This hiring would, in turn, increase the company’s burn rate, forcing a new round of investment, wresting more control of the publication from its founders, and shedding more of their personal mission.

But Pando’s founder, tech writer Sarah Lacy, had seen all that before—many times—and wanted to steer PandoDaily on a longer, ultimately more profitable path. “Pando could raise more money and spend double
our burn rate and I’m not convinced we’d get to our goals any faster,” she explained in a letter to readers. “What we would risk doing is building the company at an unsustainable cost structure, give up our lock on control, and one day be forced to pivot to a tech platform—like so many other venture funding content companies that have come before us.”
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She’s not even certain there would be a home run waiting for them at the end of that path. “I’m not sure how much this venture capital fervor for content will continue,” she admits. In other words, if the sort of company she is creating goes out of style by the time she’s ready for an acquisition or IPO, then she will have compromised her company’s value and integrity for nothing. Even the
odds
are against selling out.

Lacy is content to become a big, old-style content company instead of a platform of content platforms, or whatever the latest venture capital thesis would have her do. And she’s okay with this “even if it means we all never sell a single share.” In the current climate, that’s taken as a radical statement. It shouldn’t be. PandoDaily, Meetup, and other mission-driven companies like them see the value in owning a real company instead of selling a fake one. Their second- or third-generation approach to the venture capital conundrum actually looks a whole lot more like old-school capitalization of business than today’s absurdly abstracted startup game.

“In the Internet industry, you’re basically a custodian of your own idea for maybe three to five years and then you’re supposed to sell. That’s insanity,”
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Kickstarter cofounder Perry Chen told Fast Company when he was trying to explain his platform’s approach to venture funding. He and Yancey Strickler started the now-famous crowdfunding site with $10 million in 2009 but made investors agree up front never to sell their shares. “We hope that we can return some of these funds to shareholders through some kind of profit sharing or dividend,” Chen explained, “and that’s it.” Six years later, in 2015, Strickler still enjoyed enough authority over the direction of the company to turn Kickstarter into a benefit corporation.
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None of his shareholders objected.

He’s offering his investors something that’s anathema to conventional thinking: a way of participating in living commerce, a sustainable mission, and a continual flow of dividends. It treats money less like ice than like water.

Besides, if the Kickstarter platform works as planned, there will be a whole lot less need for venture capital at all. Kickstarter, and other crowdfunding sites such as IndieGogo and Quirky, seek to democratize fund-raising. They give small businesses and independent creators a way to bypass investment by instead seeking funding in advance from their future customers. It’s how a musician like Amanda Palmer funds her tours and albums, Neil Young funded development of his high-fidelity digital music device Pono,
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and Lawrence Lessig funded his super PAC, Mayday.
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Individuals have raised a few hundred dollars to produce products from coloring books to news articles. Filmmakers have raised millions to produce movies, and a team of video-game producers raised over $70 million to develop a new platform.
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All that’s really happening here is that customers are paying in advance for the products they want to buy. In some cases, this earns them a discount on the final product. In others, early backers pay a premium in return for a souvenir, a token of thanks, or some other confirmation of their participation in the project. They get the satisfaction of driving production—of tastemaking and participation—instead of simply pulling from the consumption side of things. They have a share in the greater enterprise.

From a business perspective, the lender has been disintermediated. Instead of pitching their ideas to a banker, creators get to pitch directly to their audiences. (Yes, it helps to have an audience in the first place—but more than a few talents and products have been discovered through these platforms, which let users spread news of worthy campaigns easily on social media.) The point is not whether this is a better vetting process for new art and products. It’s that the payoff that venture funders once expected for risking their capital has been removed from the equation.
That’s a major reversal of the way industrialism once removed humans from value creation, and a significant shift in the way people—especially the young people who use these platforms—are learning to think about capital.

Investment capitalism is itself predicated on risk taking. The earlier and more speculative an investment, the greater percentage of the winnings that investor can demand. One could argue that risk may not have value in itself, but in an economy where cash is scarce, those who can take risks with money can demand compensation commensurate with the odds. In capitalism, a new thing doesn’t happen without someone risking that the product fails to find a market. By allowing entrepreneurs to take cash orders in advance, these platforms are effectively reversing the clock: we now know the results before the product is made. No cash is risked, because the backers don’t pay until the total amount sought has been raised. The only risk is that the project is never completed, but the open market seems pretty good at evaluating competence: 98 percent of projects that meet just 60 percent of their funding goals are fully completed. Startups funded by venture capital do about the reverse, with more than 90 percent of fully funded enterprises failing.
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The same crowdsourcing dynamics that Upwork or 99designs
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use to shift risk onto freelancers can also shift risk off the table altogether. The less risk, the less money is owed to the risk taker.

So, used appropriately, the net disintermediates the funder, eliminates the need to abandon ongoing productivity in favor of a quick exit, spares the marketplace from having to pay back investors, keeps cash in circulation instead of being extracted, and gives regular people the opportunity to put their money toward what they want to see happen.

Although crowdfunding platforms may solve many an entrepreneur’s dilemma, they don’t address the investor’s. From the funder’s perspective, Kickstarter and its peers count as “investment” only in the grander sense.
The platforms don’t let backers reap financial rewards, no matter how well the comics, movies, and products they have funded end up doing in the marketplace.

For example, when the Kickstarter community provided Oculus Rift with $2.4 million to develop an immersive virtual-reality headset for video games, the crowdfunders didn’t share in the payoff, or the jubilation, when the company was acquired a year later by Facebook for an astounding $2 billion. Sure, those who paid $250 or more got the VR kit they purchased, but the thousand or so people who gave less than $250 didn’t even get an unassembled prototype kit—just commemorative T-shirts and posters, the sorts of premiums they’d get if they were subscribing to a public radio station. As
Guardian
tech writer Steven Poole wrote on the acquisition, “About 10,000 people gave Oculus $2.5 [million] between them. I for one am struggling to think of a good reason why each of them shouldn’t get a proportional share of that $2 [billion] sale.”
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They shouldn’t for the same reason that those of us writing for Arianna Huffington didn’t get a piece of the Huffington Post’s acquisition by AOL: because we weren’t in on it. Our labor and funding was crowdsourced but in a one-way fashion. In both cases, an Internet platform allowed for an independent operator to leverage and extract value from the network in order to achieve quite traditional economic goals. This is just digital industrialism—the sort that benefits a very few at the head of the long tail.

A number of new platforms are attempting to go to the next level by giving crowdfunders an opportunity to participate fully as venture capitalists in the projects they support. AngelList, a Web site originally dedicated to helping startups connect with angel investors, offers a feature called “syndicates” through which people can back portfolios managed by notable investors, such as author and advisor Tim Ferriss or Launch founder Jason Calacanis. Subscribers pledge to back each of the leader’s investments by a certain amount. If the investment works, they then pay between 5 and 20 percent of profits to the leader and 5 percent to AngelList.
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While SEC regulations are under revision to lower the barriers to entry, currently
most of these platforms are limited to “qualified” investors—people who have at least a million dollars in savings. As of this writing, numerous platforms that give less wealthy people access to the startup investing market are under construction.
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While these may be democratic developments, they’re also as sure a sign of a bubble as any we’ve seen. Opening the floodgates to more angel investment doesn’t mean there will be a greater number of successful startups; it simply means more money will come in at the very top of the funnel. More startups get funded, but a smaller percentage of them survive and pay off. We’re back to net-exacerbated winner-takes-all extremes. Under the pretense of individual empowerment, unsophisticated investors enter a market where good information is even scarcer than it is on Wall Street. True, they have proxied their participation to more experienced investors, but those investors are now competing to find winners in an even more crowded marketplace. The more authority amateur investors gain over the placement of their funds, the more likely they are to be exploited as the lowest levels in new pyramids.

As far as the startups are concerned, the plentitude of all this angel-type funding makes it all the more probable for them to get stuck on the startup treadmill, committed to improbable home runs instead of a sustainable business. If anything, it exacerbates the problem, because now all those angels are in an anonymous, disconnected crowd. Like any other long-distance shareholders, they just want their returns.