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May 09, 2005

A Better Bubble?

Vonage has just raised an awesome $200 million in additional venture capital.  Skype has built a huge networks of users, most of whom contribute nothing to the company’s coffers; but Skype is rumored to have turned down nine digit buyout offers.  New companies are forming around new paradigms like the blogosphere, tagging, folksonomy, podcasting and search term optimization.  That means seed as well as venture money is available.  After a an IPO home run Google stock continues to soar.

Irrational exuberance is back!  To me that’s good news.  Nothing great is achieved without irrational exuberance.

George Bernard Shaw wrote:  “The reasonable man adapts himself to the world; the unreasonable man persists in trying to adapt the world to himself. Therefore all progress depends on the unreasonable man.”

Reasonable rational people don’t make breakthroughs; they do me-too products.  Reasonable rational people don’t fund breakthroughs; they fund proven technologies and yesterday’s winners.  I have nothing against reasonable rational people.  They are absolutely needed to take over at the point where entrepreneurs lose interest and run past the limits of their competence.  If the world were left just to entrepreneurs and intrepid early stage investors, all their breakthroughs would be wasted for want of competent management to bring their innovations to scale and commercial viability.

No new two bubbles are the same.  A very important difference between the bubble we can see inflating today and Internet Bubble One is the lack of early-stage IPOs.  The great IPO success story is Google which had significant revenues and profits before going public.  Whether Vonage becomes the phone company of the future or not, the next stage of its growth is being fueled by private and not public money.  The rhyme of Skype and hype may or may not be significant but it doesn’t look that will be a question for public investors any time soon.

In Internet Bubble One, companies routinely went public without being profitable.  Some went public without revenues.  ITXC, the company Mary and I founded, had revenues when it went public but not profits.  The individual companies had little choice once the public market developed a taste for early-stage IPOs.  You can’t turn down huge gobs of cheap capital if your competitors are taking it.  And they can’t turn it down because you might take it.  You can’t even compete for key employees if your competitors are offering options on soaring stock and you’re not.

Some companies like ITXC survived; many didn’t.  But I think we could have built better companies if we had gone public later.  The things you have to do to run a public company – including the time required by the basic regulatory requirements – are at odds with what you have to do to build a new business based on a new paradigm.  Public investors want predictability.  It is hard for established companies with huge momentum, known customers, known processes, and known markets to predict their performance.  It is simply impossible for start-ups.  Until you’ve earned a profit, you are never really sure how that is going to happen.

Public companies have an obligation to inform their investors.  That obligation has been strengthened by Regulation FD which I blogged about previously.  Reg FD says public companies can’t whisper something to large or otherwise favored investors without giving all investors and potential investors access to the same information.  That’s as it should be.  The trouble is that anything you tell to “the market” you also tell to your competitors.  Even worse, the plans, strategies, or alliances which you faithfully disclose under Reg FD may never amount to a hill of beans.  And, even worse than that, your decisions and actions may be twisted by the very human desire to make your predictions come true at the expense of doing what is best for the long-term growth of the company.  If ego doesn’t warp your judgment, then there are always class action lawsuits to contemplate if you turn out to have been less than a perfect seer.

Public companies have to pay what amounts to ransom to accounting firms to jump through all the hoops required to meet disclosure requirements.  Again, the tightened disclosure requirements are not a bad thing – it is hard to argue against them in the wake of Enron, Worldcom, and assorted other scandals.  The investing public does need to be protected (it’s not clear that the accounting firms are competent to deliver this protection but that’s another issue).  The expense of all of this is immaterial to a large company; it is a huge diversion of time and money for a start-up.  Some start-ups which aren’t yet grown-ups are now going private to avoid some of these burdens.

So my hope is that, since Internet Bubble Two is so soon after Internet Bubble One, we will postpone IPO fever.  Vonage and Skype which I have been blogging about and all of the other interesting startups will be able to do a better job of company building if they do it on private capital than if they go public before profitability.  They will gain by being able to discuss their plans privately with their private investors and still being free to change those plans on a dime when changes are required.  They can set goals and change them as often as necessary.  They can focus on their customers and competitors and not on “the Street”.  They can limit accounting expense to what their own sophisticated investors require rather than to the most cautious interpretation of what the SEC has asked for.   They can learn from their mistakes rather than defending them.

My first blog ever was on why bubbles are a good thing.  It is available as an audio file or podcast download here courtesy of VON Radio.  And, if for some reason you’d like to hear this post as well as read it, it’s available here.

I also blogged at greater length on Regulation FD here and here.

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