A recent Wall Street Journal article pointed out the lopsided investment patterns now seen in Silicon Valley. According to the WSJ, a lot of money has been poured into consumer companies, lured by the high valuations of high traffic sites like Facebook (king of them all) and Groupon, and hopeful consumer plays like Color and FlipBoard. Less and less is being invested in “old fashioned” B2B businesses with a few notable exceptions. The article points out, correctly, that typical B2B products cost more to build, take longer to gain market traction, are a lot harder to sell and have smaller chances of becoming viral hits. Personally, I think consumer companies actually cost investors more than business-facing software startups and the lopsided investment pattern is an indicator of that fact.

Getting a smashing hit with consumers simply takes a lot more luck, and, therefore, requires a bigger bankroll. It is a high stakes game. Angry Birds may not have taken a lot of cash to build, but probability-adjusted, the investment was expensive. Consumers are unpredictable. What’s hot, popular, and viral, is very difficult to determine until it becomes obvious ex post facto.

On the other hand, most businesses’ actions are formulaic. There are costs and there are revenues. Show a business a way to increase revenues or decrease costs and, if you are believed and have a few reference customers to back up your claim, you can sell your product to a department with the right budget. It is not hard to justify buying a Salesfoce.com seat if you can show that with very little upfront costs your sales process will be more manageable and effective. And even isn’t hard to get Bloomberg terminals on traders’ desks if the second advantage in speed and efficiency of information delivery will more than compensate for a hefty monthly fee.

With consumer-facing products, things are different. If someone came into my office and showed me an game that let me fling birds out of a slingshot at burbling green monsters sheltered by brick walls, I would have called it “fun” but would have not invested. Especially, I would think twice about investing in a company started by three Finnish students six years prior with a string of J2ME titles to their names (see Rovio). And I would have missed the boat. I would have told them to see how thing go, and after that little bird-flinging app got downloaded 42M times, the big boys at Accel et. al. would step in and fund the company to the tune of $42M.

I find that I have adopted the prevalent lingo of the consumer internet and have now, unfortunately, started to ask for “tangible traction” before considering a consumer-facing investment. Why? Well, my theory is that asking for traction is another way of saying “Who knows?” and recusing oneself from placing a bet on something as fickle as popular sentiment with which I, and most other VCs, are out of touch — different demographics: age, income, gender, etc. “Traction” means that whether I get it or not, the public get it first and provide proof of its acceptance on a silver platter. Now, investing becomes closer to shooting fish in a barrel instead of placing a risky bet on a bunch of birds crashing into walls.

Unfortunately, investing in ideas that have already won in the public arena is expensive. And not too many investors can afford to play at these high stakes. This is why the overall dollars invested in consumer companies is high: it takes a lot of small checks for the failures and a few giant checks for the successes.

So, what’s an investor like me to do?   Well, if you don’t mind placing lots of smaller bets on companies that have a chance of “going viral” — consumer is the glamorous space. There are more and more seed funds doing just that. The only problem here is that it still takes a cartload of cash to followup on those investments once the companies prove they have a hit on their hands and the most you can hope for is a tiny piece of a giant pie.  On the contrary, if I have to place bets, I’d rather place them on technologies that are likely to succeed on the merits of the value they are offering rather than a consumer’s whim.  Don’t get angry: I mean “whim” as in “whimsy” — a good thing, not as a condescending term.

I’ll take SpringSource or MuleSoft any day over Instagram or FlipBoard. Less “sexy” but so plainly useful and needed by businesses with budgets.

And I don’t think I am just being conservative. There are exciting new possibilities for unglamorous but incredibly valuable companies that, for example, aim to wrestle with processing big data (CloudEra), try to change the way information is stored (Mongo, Couchbase, fluidInfo, Redis), analyze how our social interactions propagate and influence the world (Klout, bit.ly). There are entire new programming paradigms (node.js and socket.io). There is much exciting technology out there looking to be funded. And these technologies will be the shovels and picks that thousands of B2C miners will be using.

I’ll still be playing Angry Birds and springing for a Mighty Eagle every now and then. But I think I’ll skip the GroupOn clones, social networks for plumbers (there are millions of plumbers in China, you know), and barter sites. Nothing wrong with them and they may all become profitable businesses. I wish all the entrepreneurs working on new ventures nothing but the best.  But one has only so many chips to play with.

Related articles

• B2B Startups: Tech PR for a Tougher Market (customerthink.com)
• Business Startups Don’t Get The Same Bubblicious Love As Consumer Startups (businessinsider.com)
• Facebook’s possible worth? $100B (thestar.com)

Today, we saw the long-awaited announcement of FourSquare’s $20M round.  Whispered about and long in coming (well, not too long considering the company’s relative youth) my hat is off to the founders and their VCs.  The “traction” (to overuse a term) FourSquare has been able to generate is remarkable.  However, I, along with others in the web/blogosphere keep asking the same question:  ”Now What?”

The pattern I have seen with people in New York, and especially with people who come from the NYU’s ITP program is their fascination with “social” aspects of the internet for the sake of these social aspects themselves.  Every presentation is about friends, trust, networks, graphs, recommendations, etc.  They seem to live in a world of recent college graduates who feel that the dorm culture they experienced in college (not sure if NYU has dorms or just cool SoHo pads) where the social ties that were strong during their undergrad days somehow persist into adulthood.  Sadly, that’s rarely the case.

I graduated from Stanford in 1989, where people DID live in dorms.  Most of my friends went to work for Oracle because that was the sweet, high-paying company that enabled one to work around Highway 92 and still have a manageable commute from San Francisco — “the city” (or, as I now call it, “the town”).  We used Oracle*Mail to communicate work-related and non work-related intentions because in those days every new Oracle employee got a VT220 and a 9600 baud modem for their home (how fast was that!) and even a leased line if you were a developer.  We used email to be social, and continued to use it to be social for the first couple of years after graduation.  However, we grew up.  The number of “friends” decreased, people got married, people moved away, people moved on to start companies or work at others.  We kept in touch electronically through occasional emails, FaceBook profiles, and LinkedIn.  But the interest in “where is everyone tonight” faded exponentially.

I use FourSquare every day.  I love the application, love the fact that the back end is in Scala (my favorite functional-ish language) and the fact that in the two places I have lived in the past year (San Francisco and New York) there are so many venues into which I can check in.  My wife uses it too.  She is a VC in Medical Devices - smart, tech-savvy, but no computer geek by any means.  I asked her recently why she uses FourSquare.  Her reply: “to kick your ass.”  She felt that it was a competitive game against me on who can have more checkins during a given day.  When we walk into a restaurant together, we whip out our iPhone’s and see who can check in first.  Sometimes I have to remind her because geekiness is always on my mind :).

So, what will happen when either one of us gets tired of this?  Why would we get tired?  Because FourSquare, at this early stage, offers no value other than “social connection” which has less and less relevance in my life once I know who is in my social circle, once my social circle shrinks as I figure out who my few friends that matter really are.  Social is NOT the ultimate reason one uses a product.  UTILITY (if you’re an Adam Smith capitalist) or HEDONS (if you’re into felicific calculus).  “Social” is a vague awareness of what others are telling you they are doing, feeling you’re a part of a group (watch South Park’s Facebook episode).  The need to have many “friends” fades with time — the few real friends (you know who they are and you know where they are) remain.

In order for “check-in” services to continue to keep the attention of adults like me (it’s a pretty good market, too), they have to provide something useful in return for my telling them where I am.  Whether it’s financial offers for something I WANT (come on guys, you can figure out my gender, age, income just by looking at my checkin history) or telling me about something I might like (sort of the way Hunch and Amazon’s recommendations do).  When I travel, and I arrive into a new city (I recently went to Raleigh where I have never been before), FourSquare told me nothing.  I had no friends who checked in anywhere, “likes” from people I didn’t know and whose profile I could not query.  I resorted to Yelp — something of real value on the web.

FourSquare is, arguably, a web phenomenon that others are actively chasing…  and the competitors are not amateurs (Google, Microsoft, Yahoo, Yelp).  There have been lasting and powerful web phenomena (FaceBook) and not so lasting (Second Life).

As I mentioned, I am really a FourSquare fan.  I just hope they start delivering value to their loyal “gamers” that goes beyond social.  They’re smart, I think they’ll figure it out.

I started three geeky software companies in Silicon Valley.  As co-founder of the first, I was working all day while getting an MBA at U.C. Berkeley at night.  My second and third were done post-MBA.  Based on my experience, having an MBA from a good university (as is true with almost any degree from a good university) definitely helps when it comes to raising capital, attracting talent, and growing the business, even from infancy to “young adulthood.”

First, a better formal education helps with credibility when fund-raising, especially if it’s the first time you are doing trying to raise money.  Take a look at the backgrounds of most of the partners and associates at the VC firms you are pitching.  There seem to be just two patterns:  an entrepreneur or executive that has done something significant OR (predominantly) someone with a good undergrad degree, some work at a technical company, and an MBA from a top 20 B-school.  Like it or not, having an educational or professional background that is similar to the backgrounds of the people giving you money breaks through the initial credibility barriers.

Secondly, having an education that is not strictly technical is a huge plus when it comes to actually taking an initial, often, technical idea and painting the first broad strokes that make that idea into a profit-making business.  Understanding how companies (vs. technologies) operate, being exposed to broadly applicable disciplines such as Organizational Behavior and Business Law make those first moments at the helm of your new venture feel a lot less daunting.  Having read a few cases (Harvard or otherwise) gives you a perspective that while the market and technologies you are chasing are completely new, the cycles and processes of making a business grow are decades, if not centuries, old.  Notice, I said nothing about “contacts” — never found that aspect of Business School to be all it’s trumped up to be… maybe I should have done Wharton and not Haas.

Is an MBA a requirement?  Absolutely not.  There are plenty of business savvy people that have arrived where they are without a formal education in business.  You don’t need it, but it’s a good thing to have. 

However, don’t be fooled.  While having a business degree is big plus, the thought that you can start, lead, and build a technical company without a technical degree of some sort (or at least a close partner who does) is ludicrous.  In New York City, where I now live, I meet start-up founders with a familiar educational pattern — Econ undergrad, Wall Street, MBA who are hoping to start a new, usually internet-based business.  Naive.  Your business acumen will be negated by your inability to innovate technically and attract the right technical talent (at least in the software business).  You won’t hire smart technical people because, chances are, you have never met one and don’t know how to tell the real from the bullshit.  You can not outsource Version 1.0.  And don’t listen to anyone who tells you that you can.

Worse is a VC with the same (Econ/Wall Street/MBA) background.  Remember, Venture Capital should be your last job, not your first.  It that’s what you have, do late-stage investments and stay out of seed + early…  you are not prepared to evaluate the technical risks.

So, my advice to the technical founders:  either get a business degree (after you’ve had your first professional successes in technology) or get a co-founder that has a business degree.  

Vice versa, for the non-technical founders… don’t even think about starting a business in technology without having a strong, presentable, technically savvy co-founder by your side.  Don’t even think about it.  YES, the market and the idea are what matters most, but you are doomed if you think that technical innovation and execution can be outsourced or “hired later.” 

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Why do VCs do this?  This morning I read about a $7M investment in Snapfinger, a company that lets you (get this) order food from (get this) chain restaurants via (get this) iPhone!  Just what we needed… now, there’s an App for THAT.

While pining for a native iPhone SeamlessWeb app (it’s just a mobile web site for now) and wanting to volunteer to help them write one for a mere $1.967M paid to me for the idea, I noticed a quote from Snapfinger’s new investors and saw the light:

“What they’ve done at Kudzu [Snapfinger’s parent] is combine three of the hottest areas right now for venture capital investing — e-commerce, mobile and local,” said Joshua Goldman, a Norwest general partner who will join Kudzu’s board.

“Combine, eh?”  Recalling the bits of set theory I took at Stanford, I seemed to remember than when things (s.a. markets) are represented on a Venn diagram, their intersection is usually a subset, not superset of the whole.  Wonder how their slides looked.  Probably a lot of hockey sticks.  

But, I guess, if you’re a VC sitting on a $1B+ fund, you need to put the money somewhere.  Too bad.  There are about 5 FourSquare’s (meaning agile companies) that could have been funded by this investment. 

And, speaking of spaces, compare this to something like Square (which is also e-commerce and mobile) but, unlike this one, interesting, new, and brilliant (in my opinion)  though also funded by a large investor (plus others)…  See a difference?

So, startups… you heard it:  e-commerce, mobile, and local.  Let’s write those business plans and make sure you mention the three terms.