A look at what will happen next in the world economies
Tuesday, November 18, 2014
Free Spending by Startups Stir Memories of Dot-Com Era Excesses
Sounds a little dot com-ish to me. Remember for those that didn't see the title of my first book, This time its different NOT, and then if not convinced the title of my second book So Did We Not Learn Anything From the First Book HUH. Aivars Lode
San Francisco real-estate agent Jeffrey Moeller wants tech entrepreneurs to spend less.
“A four-person startup will tell me, ‘We need a 10,000-square-foot office for future growth,’” he explains. “I’ll say, ‘No, you need 1,000 square feet.’”
“Generally, they just get angry at me,” says Mr. Moeller, who during the dot-com-bust had clients that were burned by leases they couldn’t afford.
Mr. Moeller is resisting pressure in startup land to spend, spend, spend. The trend is especially pronounced in San Francisco, where venture capital is pouring in, competition among startups is fierce and rents are rising to dot-com-boom levels.
Venture capitalists have spoken out in recent weeks. Benchmark partner Bill Gurley says Silicon Valley startups are burning capital faster than they have since 1999. Andreessen Horowitz co-founder Marc Andreessen has warned entrepreneurs about overspending, punctuating a string of tweets with the word, “Worry.”Startups feel the need to outspend on recruiting, marketing and designing their offices, echoing poor choices made 15 years ago when unprofitable companies overextended themselves, then crumbled when the market turned.
Big-spending venture capitalists are part of the problem, though. Low interest rates combined with once-in-a-decade investment returns on deals such as WhatsApp’s $19 billion sale to Facebook Inc. have enticed pension funds and university endowments to funnel money into venture capital. Meanwhile, crowdfunding sites such as AngelList have made it easier for entrepreneurs to attract early investment, and mutual funds and hedge funds have rushed in at later stages.
This year 84 U.S. venture-backed technology companies have raised at least $50 million in individual rounds of financing, a figure that was inconceivable a few years ago, according to Dow Jones VentureSource. U.S. companies raising financing in the third rounds or later collected $15.59 billion through the first half, on pace to break the full-year record set in 2000.
That rate is likely to accelerate; venture firms raised 53% more capital in the first half than a year earlier, according to VentureSource. But increased interest rates or a sudden stock-market chill could slam on the brakes.
“In an inflated market, everyone feels like a steroid-adjusted baseball player,” says Khosla Ventures partner Keith Rabois. “But once the steroids are gone, guess what, there are only about five to 10 people who can hit 30 home runs.”
Meanwhile, deep-pocketed startups are spending big on rents, salaries, marketing, public relations, interior design and seemingly limitless perks to impress potential recruits.
“I have one CEO who is building an octagonal, mixed-martial-arts cage-fighting ring because one of his employees asked for it,” says Valerie Frederickson, who owns a executive-recruiting firm bearing her name.
Costs add up quickly. The average salary for a software engineer is about $126,000, up 20% from 2012, according to tech-jobs site Dice. Top engineers’ salaries can be double that or more.
Justin Kan says startups are paying high salaries partly because they can. Mr. Kan, who started Exec, a personal-assistant service acquired earlier this year for less than $10 million, raised $3.4 million for his first round of financing. Justin.TV, which he started in 2006, raised just $300,000 in its initial round.
“When you raise a lot of money easily, it’s easy to try to solve your problems by spending money,” he says. Exec was quick to pay high salaries, he says. “I regret doing that.”
Then there are the perks. Free catered lunches cost about $12 a person each day. A $2,000 custom-designed standing desk may seem unnecessary. But some investors and founders say that such intangibles can help startups nab the best talent, who may be considering several job offers.
“No one wants to lose a candidate over the last emotional mile,” says Dustin Dolginow, a partner with Atlas Venture.
Bay Area interior designer Lauren Geremia, who has consulted for app makers Instagram and Path Inc., charges about $50 a square foot to outfit an office with custom furniture or art.
Commercial rent in San Francisco’s trendy South of Market neighborhood hit about $56 a square foot in the third quarter, its highest level since 2000, according to Cassidy Turley, the real-estate firm where Mr. Moeller is an agent.
And not just any office will do. Entrepreneurs are on the hunt for cool space: exposed-brick walls, polished concrete floors and high ceilings with exposed pipes. Renovations to get that look cost nearly $15 a square foot, roughly a quarter of the cost to rent the space, Mr. Moeller says.
Matt Galligan, co-founder and chief executive of Circa 1605 Inc., which runs a mobile application for news, says rent on his 3,000-square-foot office in SoMa has roughly doubled since the company moved in two years ago. But the rent and renovations to expose the brick walls weren’t “unnecessary burn,” he says. His 12 employees “are spending nearly a third of their life there,” he says. “It helps for it to be a positive experience.”
More worrisome, Mr. Moeller says, are startups with small teams looking for massive spaces and locking themselves in to long leases. Startups are signing five- to seven-year leases on spaces that used to require two, and more landlords are pushing for 10-year leases on new construction. Those could become a burden if financing tightens.
Web-storage company Dropbox Inc. raised $850 million in financing this year and signed three leases in San Francisco in excess of 10 years each. Car-hailing service Uber Technologies Inc., which secured $1.2 billion in funding this summer, recently announced plans for new headquarters in the Mission Bay neighborhood that will consume a half-million square feet in a 15-year-lease.
Sam Altman, the president of Y Combinator, an incubator based in Mountain View, Calif., says he is more concerned about the cultural risk created by “fat startups.”
“I used to live on ramen and Starbucks coffee ice cream,” says Mr. Altman, a former entrepreneur. “It sucked, but it made me very focused on doing what I needed to do to make the startup successful.”
Mr. Altman says he met a few months ago with an entrepreneur who drove up in a new Porsche sport-utility vehicle. The man’s startup had completed a $10 million early round of financing the previous week. Mr. Altman says he looked at him sternly, asking him, “What message do you think you’re sending to the rest of the company?”