Ask HN: End of IT Venture Capital?

Here I make an observation somewhat familiar on HN, draw a conclusion, and seek reactions.

Currently for a first equity investment in a project in Internet Web site information technology (IT), it is nearly universal for the investors to assume that (1) the software is easy and can be done in a few weeks and (2) the investment decision is to be based on a working prototype.

Another more explicit criterion for a Series A is a Web site with at least 100,000 unique visitors a month.

Mostly such projects plan to get revenue from ads on the Web site.

So, suppose that the software is done and goes live. Suppose the 'business idea' is good and is 'promoted' well and the number of pages served start to grow.

Now the founders can seek equity funding. The usual stories are months of contacting some dozens of investors, giving demonstrations, studying term sheet details, forming a C corporation, etc.

But, as is reasonable for a good project, suppose during those months the number of users of the Web site continues to grow. Suppose there is just one ad on each Web page sent, and suppose, from whatever ad targeting is available from the ad networks, etc., the result is $2 of ad revenue for each 1000 ads displayed. So, that would be $2 CPM (charge per thousand).

Suppose the project has a server that can serve 10 pages a second 24 x 7. Then the monthly revenue would be

2 * 10 * 3600 * 24 * 30 / 1000 = 51,840

dollars. For the computing, that might be just a 4 core server with 16 GB of main memory and some RAID disks with an Internet connection with, maybe, 30 Mbps of upload bandwidth. So we're talking a tower case on the floor next to the knee of one of the founder programmers. Ten months of that, with no further growth, would be $518,400 in revenue, more than a usual seed round.

So that revenue would be plenty to buy more servers and bandwidth, move to the cloud, a hosting site, a colocation site, or just build a server farm in a few hundred square feet of commercial space and get a 1 GbE Internet connection.

For 1 GbE half filled 24 x 7 with Web pages with, say, 2 Mb per page, that would be

(0.5 * 109) * (1 / (2 * 106)) = 250

pages per second or

250 * 3600 * 24 * 365 / 1000 = 7,884,000

dollars a year. So, a 1 GbE connection can support a nice stream of revenue.

If the project is good, then in a few months usage should increase by a factor of 10 to

2 * 100 * 3600 * 24 * 365 / 1000 = 6,307,200

dollars a year in revenue, and that is more than most Series A rounds. And, yes, that would fit in a 1 GbE Internet connection.

So, the "observation" is that a few servers in tower cases and a good Internet connection have the capacity to generate some significant revenue. Indeed the revenue should arrive so fast that, in the months it would take to get equity funding, the revenue would exceed the usual amounts for a seed or Series A round.

So, the conclusion is, a good project should just remain 100% owned by its founders and f'get about equity funding.

Yes, it is true that so far all the famous Web startups did get equity funding, but maybe this situation is about to change. If so, then we will see some successful projects that remain 100% owned by the founders, or maybe just one founder?

Are we about to see the death of equity funding for such projects?

Reactions?

keefe 15y ago ↗

where does the $2 CPM come from?

NY_USA_Hacker 15y ago ↗

Not from a good source, just from various claims that $1 to $5 CPM are common, some rough calculations starting with some summary data for Google, etc. I'd very much like a good source.

But if the $2 CPM is within a factor of several of reality, then the broad conclusion still holds: By the time a project is live and has users and, thus, qualifies for equity investment, if it is a good project with usage growing rapidly, then it should throw off enough cash to make equity investment unattractive due to how long it takes to get a check and the chances that after a year the revenue and pre-tax earnings will be larger than the check.

But, if cut the CPM by a factor of 10 to $0.20 and assume 5 ads per page sent, then the revenue per page sent is only cut in half and so are the monthly and annual revenue figures. Then the broad conclusion still holds: By the time the project is ready for equity funding, if it is a good project, that is, with usage growing quickly, then it should soon no longer need and maybe not want equity funding. And with some irony, here "soon" means in time about the same as that required to raise equity funding. So, the founders can sit there and ask,

"For the next six months, what do we do? Do we use the time to jerk the chains of a few hundred investors, pitch to a few dozen, and get a check or just keep working on our project, help the usage keep growing, and at the end of the six months have more in cash in pre-tax earnings than we would get from an equity investment check and still own 100% of our business and not worry about a Board. Also, now we just own the business outright, but the day after an equity investment we will own none of the business and, instead, have to work for about four years on a 'vesting schedule' to get back our fraction of the business, and we will never get it all back. So, what do we do for the next six months?"

So, broadly we have to ask, will there soon be some really successful Web sites that never took equity funding? So, for this part of investing, is venture capital dead?

keefe 15y ago ↗

my research seems to indicate you start off low, plateau at around a quarter and then once you have a niche you can see these high values. I've heard that $1-$5 are common in the sense that you see them, not in the sense that they are within a small number * standard deviations from the mean.

overall the principle holds but the investment is an accelerator, once you have users you have competition.

NY_USA_Hacker 15y ago ↗

Okay, to 'out do' the competition.

But that is a relatively new reason or emphasis if only because in the past 'venture capital' could invest in something on the back of a napkin and was needed for a lot in buying hardware and software, office furniture, recruiting, salaries, doing the development, building a marketing organization, starting the selling cycle, etc. before any revenue.

Now a motherboard for a 4 core processor with a 3 GHz clock is about $100; a server farm style 1 TB disk drive is about the same; Unix style software is not very expensive, and the Microsoft BizSpark program will let a startup use Microsoft software for free for a while, etc. The venture people want the development done, the site live, users, and, thus, likely revenue, and users and revenue growing rapidly. So, the situation now is much different than before.

So, before there were a lot of strong reasons to take equity funding, and now the reasons are much weaker.