There is a lot of good money chasing bad ideas these days and most of it going towards building vapor (social) ware, if you will!
This week, US based Y-Combinator, the poster boy of micro-venture investing, has seen one more of its startups graduate. Imoveyou.com is that start up and it lets friends commit to a fitness initiative provided the other person commits to one such act. What could be a weekend project for a high school kid hogs international geek headlines. I am not sure how it will ever make money.
Back in India, there are startups that promise to hook you up with friends in your part of the city and they say that the local advertisers will come in droves to pay for advertisements. Then there is a company that’s advertising about the first ever social media course for Rs.1 lakh and they teach all about using twitter, FaceBook, Buzz and a couple of other me-too apps. I’d learn them all by just hanging out in these networks or just by reading their help pages. These are tell-tale signs of a “Get rich or famous, quick!” momentum building around social media.
While worthless startups and plainly fly-by-night consultants entering the market has always happened in the past, this time too, it need not undermine the credibility of a remarkable industry. However there is another serious pointer towards a bubble. It’s the math behind the investments that go into these new social media startups.
Social media startups are rarely funded by traditional VCs till they see substantial revenue. So globally and in India we have them funded through incubators and angels. Let’s say there are 10 incubators in a country like India and 10 angel investors who are active. The latter part is a gross over-simplification. Let it be this way for our analysis.
An incubator funds and releases about 10 companies a year and angels invest in 3-4 startups a year. So that takes us to 60-80 startups coming out in India per year through these measurable channels. But there are about 400 startups that don’t get funded (bootstrapped) for every 60 that get funded. Of the 400, majority die between ideation and beta stages and so we are left with some 100 startups a year, clamoring for attention in a fairly early stage internet economy like India. If you know the typical thumb rules that govern startup successes, one or two in this hundred will succeed to provide superior returns.
An incubator or the angels, by definition, invest small amounts of money and hence they need a volume play to deliver substantial absolute returns to the investors. So we would see a lot of bad ideas getting funded under the halo of “social media” and when the market does not have the means to support so many such startups, we would see diminishing returns for the incubators, leading to poor fund performances. Compare that with what Sensex would deliver in the next 3 years, on the back of a resilient national economy. Money would go where there is more returns to be made, leaving the fledgling startup ecosystem to fend for itself from self-destruction.
While the case for not investing in startups is very explicit in India, due to the opportunity cost of not participating in the market rally, its not as apparent in a mature startup ecosystem like the US, where the economy is on its way to a double-dip recession. However, there too, the funds are chasing far more startups than the market (which is not consuming much) can support.
So if you are an entrepreneur, prepare for lower valuations and longer funding cycles once again while investors spare less money and deliberate more.