A great time for building great companies

Nobody told me there'd be days like these
Strange days indeed--most peculiar, mama
--"Nobody Told Me," John Lennon

How quickly things change.

It seems like just yesterday that every major business periodical was dedicating more and more real estate to the Internet, start-ups, and the wonderful world of venture capital. Dot-com was cool, and the Internet was going to change everything.

The press is now focused on dot-com carnage, and what was a giddy glass-half-full world has turned into a race to uncover the most recent bloodshed. The race to write about the "next big thing" has become a search to exploit the "next failed thing."

Ironically, this "new new" environment is the best thing that could have happened to ensure the long-term vibrancy of the venture capital business and the start-up community. That's right: For VCs with a long-term perspective, now is better than then. In other words, things are taking a turn for the better.

Many readers will find this hard to fathom--that the venture capital outlook could be improving. Of course, it is really a matter of timing. Young entrepreneurs complain that "they can't believe how crazy this (now) market is." But today's markets only seem crazy when compared to yesterday's markets. And when the dust settles, it is the market of the last three years that will be deemed "crazy." The year 2000 will be remembered as the year that everyone caught a disease known as sanity.

Herein lies the issue. The race we just ended was, in the end, unsustainable. Most investors that had seen a few cycles before likely knew this in the back of their minds, but had no incentive to mention anything. The conservative ones that cried wolf in 1994 and 1995 were run over and left behind. Conservative thoughts were abandoned as well, and "growth at all costs" was embraced as standard operating procedure.

None are innocent in this game--not the entrepreneurs, nor the VCs, nor the public market investors, nor the press. Everyone was part of the game. Early in my previous career as a stock analyst, I suggested to a very senior executive that we were in a "tech bubble" and that he should stay away from PC stocks. He eloquently informed me that it wasn't a true bubble until I believed that it wasn't a bubble like everyone else. It seems that bubbles don't burst until we all believe in the "new" rules. We certainly reached that point.

With rationality now in ample supply, the environment is again ripe for building great, lasting businesses and great, lasting venture firms. While this may seem absurd in light of the current state of pessimism, consider the below phenomena that are happening at the margin to improve the outlook for start-ups.

Excess rationality
In July 1999, Drkoop.com signed a deal with America Online whereby Drkoop would provide AOL with its proprietary content--and in lieu of this kind gesture, pay AOL $89 million for the privilege. Imagine the schizophrenia that occurred in dot-com boardrooms, when Wall Street boosted Drkoop's shares on this announcement. It's hard to preach good judgment when bad judgment is so damn rewarding. Today, start-ups are more focused and more understanding of the need to eventually deliver profits to the bottom line. This is quite healthy.

It's not about the money
The "get rich quick" reality of the Internet invited many opportunists to the market that really didn't have the desire or patience to build companies one step at a time. Truly great companies aren't built by the greedy, but by the passionate. These quick-hit artists are long on hype and short on substance, and many of these "promoters" played a temporarily important role in a market that was temporarily tuned for them. Today's market is a great filter for finding passion-driven entrepreneurs. It's really not about the money.

Lower prices, more resources, better deals
Over the past several years, Silicon Valley corporate real estate prices have multiplied; great recruiters, attorneys and PR firms have been incredibly unavailable; and companies have paid enormous prices for uneconomic partnerships. Slowly but surely, these things are "correcting." "Real estate available" emails are quite common in the Valley today. Service firms are again prospecting for business instead of turning away clients. Lastly, companies that use the Internet to acquire customers are finding that customer acquisition costs are falling through the floor.

Last man standing
In many markets, excess capital and excess optimism have led to an excess number of competitors. However, as the markets correct, to the victor go the spoils. Savvy companies that adapt quickly and conserve capital may find themselves in a position with few to no competitors--an enviable position.

This is certainly the case with OpenTable (in which Benchmark is an investor), the leader in restaurant reservation systems. Over the past four months, we have seen three competitors go out of business, and the one that is remaining has been frequently publicized in the press as struggling. OpenTable controlled costs, raised sufficient capital, and implemented a "safety net" program whereby competitors' customers were ensured a safe landing with a quality built-to-last company. The response in the market has been tremendous, and growth is accelerating as a result.

Everyone wants to be a VC
The abundant returns of the past several years have invited new entrants into the venture capital business at an unprecedented rate. It's flattering to be in a business that everyone wants to enter, but it's not as interesting to have everyone enter your business. On the whole, this just leads to more companies funded of increasingly lower quality.

Two things will rationalize the number of players in the venture market. First, while the future is more stable, there is still much work to be done. Sleeve rolling and heavy lifting will encourage attrition. In addition, economics will drive many back to other professions. Capital is a requirement for investing, and those without success will have trouble raising capital.

The end of the trend
The past few years have witnessed a rise and fall of many "hot sector" cycles in B2C, B2B, infrastructure and optical. In the November/December 1993 issue of the Financial Analysts Journal, Howard S. Marks noted that there are really four types of predictions based upon two criteria: accurate and inaccurate, consensus and non-consensus. The problem is that only accurate non-consensus predictions are valuable.

Market forces ensure that the returns from consensus accurate predictions are marginalized. Bird hunters know that it is important to "shoot ahead of the duck" to hit it. Aim at it, and you're late. Venture investments made based on today's latest trend will be late. Ending this lemming behavior will be good for the overall markets.

It would be improper to suggest that all the pain is gone, and that no more companies will go out of business. Likewise, there is still much hard work to be done, and companies that wish to survive and then thrive will need to make quick, hard decisions regarding focus and frugality.

However, when it comes to building great companies on sound fundamentals, tomorrow does look much more reasonable than yesterday. And for those companies that can shift quickly, the long-term future may be brighter than ever.

J. William Gurley 2000. All rights reserved. Above the Crowd is a monthly publication focusing on the evolution and economics of high-technology business and strategy. This column can also be found on CNET online and in Fortune magazine. The information contained herein has been obtained from sources believed to be reliable but is not necessarily complete, and its accuracy cannot be guaranteed. Any opinions expressed herein are subject to change without notice. The author is a general partner of Benchmark Capital, a venture capital firm in Menlo Park, Calif. Benchmark Capital and its affiliated companies and/or individuals may, from time to time, have positions in the securities discussed herein. In particular, Benchmark Capital is an investor in OpenTable. ABOVE THE CROWD is a service mark of J. William Gurley.

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