As more Web 2.0 startups fail and the market for VC investment contracts, Om Malik has asked whether it's now an ideal time for somebody to create a vulture fund that acquires startups " with decent technologies that have otherwise failed to get themselves off the ground. "
Om notes that such vulture funds are not new. During the "telecom depression," vultures bought up distressed assets and later flipped them for "a nifty profit."
And he notes that the implosion of the US real estate market has led to the creation of real estate vulture funds.
There is no doubt that there will be many buying opportunities as Web 2.0 meets the one and only Reality 1.0.
Brad Greenspan's acquisition of Revver and Pageflakes at prices that are rumored to be heavily discounted from the valuations the VCs who invested in these startups gave them indicates that there are buyers looking for a deal.
But does that mean that the creation of a dedicated Web 2.0 vulture fund is a compelling opportunity for investors that specialize in distressed assets? I would argue not.
The primary reason is quite simple: Web 2.0 startups will not be undervalued so much as they were significantly overvalued.
It would be inaccurate to state that no interesting Web 2.0 startups exist. But I would argue that many, if not most, of those that are viable targets for a hypothetical vulture fund have one or more of the following characteristics:
- No defensible technology.
- No significant differentiation from their competition.
- No clear path to sustainable monetization and profitability.
Given this, it's hard to ascertain just what real "assets" the average failed Web 2.0 startup will have that are worth buying.
Telecom and real estate assets on the other hand, for instance, are "hard" assets that have some intrinsic value.
One commenter, David Sachs, provides some interesting insights into the rules of "distressed investing" and notes two important facts:
".Great distressed investments have come from highly out-of-favor assets with long useful lives where the cost to replicate the infrastructure in place is vastly greater than the cost to acquire it...
"...the fundamental problem that forced the business into distress cannot be that the company has no capability to generate cash over the long term, only that it found itself temporarily upside-down in terms of short-term assets and liabilities..."
Given that much of the "technology" behind Web 2.0 services is cheap and commoditized, Sachs is correct in pointing out that most Web 2.0 startups "have few tangible assets that can be acquired below replacement cost" and that the value of any intellectual property is "fleeting."
He also correctly observes that most "never demonstrated a cash-generating ability in the first place."
Other commenters note the fact that the two most desirable “assets” many Web 2.0 startups have are their userbases and their talented creators.
These are difficult “assets” to value:
- As we have seen, many Web 2.0 startups don't truly "own" their users. Buyers face the possibility of user revolts and also have to deal with the very real risk the startups they acquire could quickly fall out of favor as their users move on to “the next big thing.”
- When it comes to the talent that a startup has in the ranks of its founders and key employees, it's worth considering that, in many cases, this talent will not stick around for long to help a buyer, if this talent sticks around at all.
As such, it seems unlikely that Web 2.0 provides a lucrative vulture opportunity with and I doubt that we'll see a significant amount of pure vulture activity in the space.
Instead, it's much more likely that most distressed Web 2.0 startups will go straight to the deadpool.
The lucky ones that are saved from the grips of the grim reaper will most likely be picked up by companies that see a potential to integrate them with their existing businesses.
In some cases, those companies may be similar in nature to Brad Greenspan's LiveUniverse. In others, they may be larger corporations that want to add Web 2.0 “features” and who are attracted to cheap acquisitions that enable them to avoid having to invest time and resources on internal development.
One commenter, Mark Sigal, makes what may be the most important observation:
"Om, part of what your comments point to is a fundamental re-pricing of a lot of assets, as those assets go from being assessed as standalone businesses with some audience value, proxy of a business model to a technology/team buy of ‘piece parts’ for use in someone else’s larger strategy."
The truth is that many Web 2.0 startups never had the potential to become viable standalone businesses.
They offered nothing more than "features" that, while sometimes valuable, could never reasonably create the type of value that their investors had hoped for.
Some of these Web 2.0 startups will find themselves as smaller parts of bigger businesses, which is what they probably should have been in the first place.
But what makes sense for bigger businesses that can leverage some of the features that failed Web 2.0 startups offer likely doesn't make sense for pure vultures.
After all, successful vultures don't reap financial windfalls by buying everything that declines significantly in value.
They reap financial windfalls by buying those assets that decline significantly in value but that are likely to regain significant value after they have become oversold and/or correct their short-term woes.
Failed Web 2.0 startups likely don't fall into this latter category.