The Web 2.0 Debate: Bubble 2.0?

It is about time I posted something on this. I was waiting to cover it in my podcast (rescheduled to the end of this week) but I thought that a wrap up of all the viewpoints and issues was in order. A Web 2.0 debate primer, if you will, which can accompany the podcast. Now, a lot has been said about Web 2.0. Both good things and bad things. The first major problem was the lack of a solid definition for Web 2.0. Tim O'Reilly has discussed this quite a bit and even created a meme map for Web 2.0 which clears up the space a bit. Wikipedia also has a pretty broad and succinct definition that I like. I guess the real problem is no one can agree on what companies fit into the Web 2.0 bucket and what the business models are. This is where the debate heats up.

Many very smart and capable people including David Hornik and Jeff Clavier have been chiming in over the past couple of weeks with their thoughts on the Three Big Questions. Drum roll please...

1. How will these companies make money?
2. Are Web 2.0 companies being built to stand on their own or just to be flipped?
3. Are we in Bubble 2.0 as well?

David recently wrote a piece called Built To Be Bought (Bubble 2.0) in which he talks about his reasons for feeling like we may in Bubble 2.0. The main reason David has is that there are a lot of "companies" being created with the express purpose of being acquired. David says that he has met with companies who clearly state that they want to be acquired by Google or Yahoo in their pitch. He even had one company pitch him at the Web 2.0 Conference stating that they plan to be acquired by Odeo. For all of those who don't know, Odeo is a company that helps people find, produce and distribute podcasts founded by Evan Williams formerly of Blogger. Odeo is also a very new and pre-revenue start-up. I don't think I need to say anything else on that.

David also gives a good reason why building companies with the sole purpose of being acquired is not very good for venture investors.

Acquisitions in and of themselves are certainly not a problem. The vast majority of money-making venture investments reach liquidity through acquisition. But, by in large, the most successful venture investments end in Initial Public Offerings (IPOs). It certainly isn't surprising that independent, stand-alone companies would in most cases be worth more than companies that can only survive through being consumed by larger entities. Therefore, from a venture capital perspective, startups that have the capacity to be stand-alone entities are by their very nature more appealing than companies that will ultimately require acquisition.

However, build-to-flip can be pretty lucrative for the entrepreneurs involved especially in the current iteration of the web. Bootstrapping a start-up in Web 2.0 is becoming very common due to the low cost of developing new features and applications. In fact, Kevin Burton has developed a very interesting way to bootstrap his new company, TailRank. Jeff Clavier explains a typical flip scenario, and subsequently why it is lucrative for the entrepreneur (and even the early stage VC), in his first ZDNet article.

The early stage flip takes place after one or two years of running the company and a bit of financing has been raising ($1M to $2M). A $25M to $30M exit provides a 3X to 5X return to early stage investors and a nice chunk of change to founders who will then spend a couple of years working for the acquirer, contributing elements of their DNA to a number of projects (e.g., Flickr/tags/MyWeb), take a year off (recommended), and start again. Nothing wrong with that in my book, and by the way, nothing saying that $25 to $30M is the expected exit range for these companies.

While these comments put Web 2.0 in a bad light, David Hornik does mention that,

while Webvan and Pets.com and Excite@Home were born and died in Bubble 1.0, Yahoo and eBay and Amazon were born and thrived.

This is a very good point as there are some great companies emerging now that could have a long lasting impact and are not "features companies" being built to flip. While I can't knock anyone for being cautious after what happened back in 2000 and 2001, the thought has crossed my mind that we may be getting ahead of ourselves with the Bubble 2.0 talk.

Dick Costolo (CEO of FeedBurner) seems to agree as can be seen in a comment written in response to David's "Built To Be Bought" post.

If people are worried about there being a bubble before there is even the slightest public market interest, I'm wondering of Bubble 3.0 will be declared the first time somebody says "Web 3.0"... by Web 4.0 you'll only have 19 minutes to found and sell your company before the markets go cold. Bubble 5.0 will happen before Web 5.0, which will see companies founded with cash that doesn't yet exist. These organizations will be said to have "futurestrapped" the enterprise. Ray Kurzweil will write FutureStrapped! and claim that he owns a chicken that can pass the Turing test. It's all good.

Dick's comment has a lot of merit. The public markets haven't even caught on to the Web 2.0 wave yet. The blogs we all read and the audience that reads those blogs and our own is a small sub set of people who are are on the cutting edge and keep up with the start-up/tech market. Many people I know, including those in top tier mutual funds and investment firms, don't even know about any of the companies that are already household names to us.

Dave McClure follows up Dick's comment with a nice piece speaking to the low cost of most emerging Web 2.0 start-ups which is a far cry from the Bubble 1.0 companies. Dave also makes a good point about the types of people looking to buy Web 2.0 companies and how they are much different than the Web 1.0 buyers and sellers.

furthermore, the difference in today's Web 2.0 world is not simply a shift to recognize that M&A is a more likely exit than IPO (as you note, that's always been the case) -- rather, the difference is that there are so *many* public Internet 1.0 companies (YHOO, GOOG, AOL/TWX, MSN/MSFT, ASK/IACI, EBAY, AMNZ, etc) with large cash hoards going shopping, not to mention large userbases with which to monetize the acquisitions.

this is quite different than the "car dealer i-banker/analyst" & "clueless retail investor" driven IPO market of the late 90's which blew up in everyone's faces. the liquidity exits are now being fueled -- rightly or wrongly -- by large platform company M&A that assess acquisition value based on the incremental ROI to their revenue / userbase / market caps from grabbing a new feature/startup & rolling it out to their x00 million users.

With all of that said, I am with Jeff Clavier and Chris Pirillo on this one. Let's all stop arguing over what Web 2.0 is or isn't and just go out and build some world class companies. If we all do what were are truly passionate about great ideas and companies will undoubtedly emerge. (Can you tell I just finished "The Monk and the Riddle" by Randy Komisar? Great book if you haven't read it already. I highly recommend it.)

Looking forward to the podcast! It should be a lot of fun. Click here for the revised guest list.