Reap what you sow

Betabeat has been writing about the crunch for seed stage startups looking to raise series A since August of this year. The debate over this trend is now in full flower, with VCs divided over whether or not there is a reckoning in the works.

Regardless of what position you take on the series A situation, it's clear that 2010 saw a surge in seed stage investments. Pulling data from crunch base, Alexia Tsotsis found seed investments grew substantially while A rounds stayed flat.

As Josh Koppelman of First Round Capital writes on his blog today, this is reflected in the amount of time his firm spent evaluating new deals before deciding to invest. Over the last four years, the amount of time it took for a First Round deal to go from "inbox to investment" shrank by a staggering 50 percent.

Mr. Koppelman agrees with Chris Dixon that this is a bad thing, since it means they know less about the companies going in. And this more shotgun approach changes the outcome when it is time to raise a series A.

“Increasingly we are seeing startups who had their seed stage round done by one or more name brand VCs instead of only angels,” said David Pakman of Venrock, chatting with Betabeat by phone. “When they come to us looking to raise a series A the first question we always want to know is, why is that VC not leading this round? When they don’t, which happens for companies without overwhelming traction, that is an obvious red flag.”"

The growth of incubators like YC and TechStars, which now offer sizable investment upon entry to the program, means a lot more young companies find their way to seed funding. The same goes for services like Angel List, which aggregate and accelerate early stage funding. But so far there is no finishing school or supplementary service to help companies make the big jump to series A.

Funding makes Mr. Welde happy.

Smartling CEO Jack Welde just closed a $10 million Series B round from existing investors (U.S. Venture Partners, Venrock and First Round Capital) as well as a new face: IDG Ventures.Venrock's David Pakman is already on the company's board, now joined by Steve Krausz from USVP. Clients like Foursquare, IMVU, Scribd, and SurveyMonkey use Smartling's cloud-based platform to create and maintain multilingual versions of their websites and mobile apps. The platform allows for combing different translation methods such as crowdsourced, professional, or machine learning.

“The Web is, by definition, worldwide, so every site and app should be multilingual. With this funding, we’ll continue to optimize our elegant, easy-to-use solution for this historically complex and costly technology process," Mr. Welde said in a press release. But there's a more practical, monetizable motivation than just democratizing the web for the good of the global internet. According to the release:

"Every online business, regardless of size, wants to increase its “Y” variables over time: web traffic, users, donors, sales, profit. With more than 70 percent of Internet users – or 1.4 billion people – claiming a language other than English as their preferred and primary language, there is a massive opportunity to increase “Y” with these new audiences."

Or as Smartling's website says: "Translate your website. Double your market." Now, to a more pressing translation issue: Who can help us translate this article from The Marker from Hebrew to English? Based on the photos of tall buildings and Michael Bloomberg, we think it's about the New York's tech scene. But we can't say for sure.

Q: You always remember the ones that got away. Tell us about the startup you regret passing on the most.

A: That's easy. Twitter. It's not really fair to say that we passed, but we did not fight hard enough to get in to their Series C round.

Q: The last thing you want to hear from a founder is...

A: "It's a massive market and we only need to get 1% of it to succeed!"

Q: What “me too” trend should we avoid or invest in?

A: Transaction advertising and local commerce are real markets and are trendy right now, deservedly so. True, I wouldn't do a series A in a Groupon clone these days, that ship has sailed. But there are definitely ways to invest in me-to markets and still do well. I think the fascination with new ways to share photos is awfully over-heated and likely over-stated as a market opportunity.

Q: What’s the strangest pitch you've heard?

A: Those are usually the best ones. The ones that stretch your imagination and border on the unbelievable. When Cloudflare pitched us several years back, they were a bunch of security guys, saying that customers would be willing to send all their data to an external service in order to have it secured. At the time, it sounded nutty, but that is kind of what defines a great entrepreneur, they see things differently.

Q: What’s the best way to ride out a bubble?

A: As you know, Venrock is a VC firm that has been investing in startups for more than 40 years. Needless to say, this firm has seen many cycles come and go. Our approach is to keep our bar really high and invest in approximately the same number of companies each year, regardless of economic conditions or where we are in a cycle.

Q: Explain, without jargon, what the word pivot means to you?

A: First version didn't get traction, trying another approach.

In music, the carrier format shifted many times, from vinyl to cassette to 8-Track to CD to MP3. In all but the last shift, the content owners controlled the format changes. Along the way, largely driven by the allure of bundling economics, record labels started packaging songs together in albums rather than selling them individually as singles. This allowed the unit price to go up 3x - 6x. If singles cost $2 - $3, records cost $12 - $18. Consumer went along with it.

But as digital emerged, the labels were faced with a harsh reality: over the decades, consumers began to prefer singles. There was no economical way to get them, so we bought full albums to get the 1-2 songs we really wanted. We wanted the album unbundled, but we had no choice. With the emergence of alternative distribution (like Napster and then iTunes many years later), the latent demand for singles was unearthed and havoc ensued.

It was havoc because the labels had not prepared a business model or cost-structure for the unbundling of the record. They had grown accustomed to higher-margin and higher unit-priced albums. We started to witness the unbundling of media. And it took the record industry more than 5 years to offer digital singles for sale legally. Now, music industry total revenues are down more than 50% since their peak in 1999, and continue to fall every year. The biggest culprit is not piracy, it is the fact that consumers, when they buy music, are buying 10% of what they used to, because they only need to buy the single, not the album.

In print, newspapers and magazines have taken a bundled approach for decades. It is impractical to pay for editorial content by the article. Bundling articles into convenient formats like newspapers and magazines solved a distribution challenge and made the economics of selling editorial possible. Once editorial went digital and we could consume information by the article simply by following a link, the unbundling began. Today it is still impractical to charge consumers by the article, so newspapers are trying to convince us to subscribe to digital bundles.

But as it was with music, it is getting harder and harder to imagine this model holding for the vast majority of editorial we consume, since we are discovering more often what to read by following a link passed to us through social media. It might be from The New York Times, but it also might be from Reason Magazine or The Nation or Huffington Post. In looking back at the totality of the editorial media we consume online these days, I imagine it is from a far more diverse group of sources than in the past, making it harder and harder to justify these monthly subscriptions to bundled media, despite the model of metered access being touted the latest great hope for print pubs.

I believe the same unbundling is now happening to traditional and cable TV networks. For decades we watched networks. They made judgement calls about what shows we would like, and we had little choice, so we watched them. The economics of cable TV networks are fantastic (with their dual advertising and subscription revenue streams), so more and more of them popped up. But thanks to DVRs, and now internet video, we stopped watching networks and now only watch shows. We don't even care on which networks they appear, nor do we tend to know. This is the unbundling of television. And if consumers could only pay for the shows they watch and not the 500 channels times 22 hours per day of other programming I pay for but never see, we'd spend a LOT less on TV than we do know, and the total subscription revenues of cable networks would crumble. Until we have real choice among digital distributors, this is not likely to happen. And the powerful forces of TV networks are working very hard to make sure we must be paying them even if we are watching shows online somewhere else (read more about TV Anywhere here.)

My observation is that unbundled media results in smaller markets than bundled media by artificially inflating total revenues. Some will say, "if you only bought (TV shows, newspaper articles) individually, you'd have to pay (10x, 100x) what you are paying now." That is only true if you assume the cost structures must stay the same. And when media is unbundled, the cost structures do NOT stay the same. They are forced to radically alter themselves and become more in line with what the market is willing to pay to consume those atomized bits of content. We won't pay $120 per TV episode. We're willing to pay something closer to $2 per episode, and so production costs are going to have to fall dramatically. Mobile devices and the social web are accelerating the unbundling of media. This is the great disruptor.

David Pakman is a Partner at venture capital firm Venrock in NYC. He blogs at "Disruption: David Pakman's Blog", http://www.pakman.com.