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Web 3.0 Smartups: the New Web Business Space

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<Smartups Series Part 4 of 5>

This is the fourth article in my five-part series about Powering Startups to Become Smartups. In part 1, we discussed why Web-2.0 startups were stuck in the box and how in-the-box thinking leads to missed opportunities. In part 2, we discussed the most salient aspect of Web 3.0, the Web of Data and the emergence of the Social Web.

Part 3 was a rather in-depth discussion of the challenges and pitfalls of relying solely on a 40-year old database model, the RDBMS, to power a Web-3.0 smartup. We looked at the NOSQL class of database models and discussed how they might provide a better fit to a smartup’s increasingly-complex dataset in the realm of the Social Web.Don’t confuse idealism with realism. Most startups do not have a vision that can scale to a Twitter or Facebook-sized company.

In this next article, we’re going to look at how the first three facets of Web 3.0 create business opportunities and challenges. In particular, we’ll discuss the new startup funding paradigms that smartups can leverage to evolve, grow, and succeed in business.

Hanging Up a Shingle is Easier Than Ever

In Web 2.0, the barriers to entry for a Web startup began to decrease. The quality and number of Open Source tools with which to code, design, market, and serve up a website ballooned. Many of the tools were free (as in cost) or cheap to use. However, even with these great tools, there were still a number of barriers that prevented a potential startup from quickly and easily hanging out its shingle.

The cost of hardware, hard-drive space, bandwidth, and hosting were a few key hurdles. The other two big hurdles were finding skilled programmers (who expected to receive high compensation for their work) and the availability of easy-to-use Web programming frameworks with which to prototype quickly a new site.

These barriers meant that a startup often had to raise a few million dollars to adequately capitalize itself, to give it a fighting chance at building up enough traction to get noticed by users, additional investors, and potential acquirers. But the Web-2.0 business space continued to evolve, innovating new, more efficient ways of doing business.

The wisdom of agile development via frequent iteration and the rise of the lean startup movement–with its minimally viable product mantra, customer development practices, and smart pivoting–transformed the way most Web startups conducted their affairs.

Now, as we enter the final stages of Web 2.0, the barriers to entry are quickly crumbling. In most cases, smartups can startup with a lot less money and the tools, funding options, and potential talent pool are better (and cheaper) than ever.

For instance, it is easy to obtain high-quality, cheap computers, and quickly compile from source (or install from binaries) powerful Open-Source Web development frameworks. There is also an army of young, talented software engineers each chomping at the bit to play the startup game and do so for little up-front. It is relatively easy to secure funding, especially as the amount required to get going is a fraction of what it used to be. The biggest challenge that startups face now might be hiring—how to identify and attract sufficient talent from the hot-shot coder pool, talent that has the proper skills, fit, and alignment for your company.

Whereas securing great talent might be one of the most difficult tasks facing startups today, I believe that the most revolutionary change in the Web business environment is how Web-3.0 smartups will be initially funded.

Smartups Know Their Niche

If you are starting a business then there must be a reason. All businesses are founded with the same fundamental goals: to generate revenue so that they can grow, make profits, and financially benefit their owners. As we are not talking about not-for-profits (which still require revenue generation to fuel growth), it is assumed that this basic truth is known by your startup.

Vision, goals, and strategies are all key parts of a startup’s foundation. But the most crucial aspect of any startup should be its ultimate goal—its exit strategy. This is the financial payout or payback for the risk taken and hard work invested into the startup.

Your vision might be for your smartup to change the world in a bold and positive way. Your goals and strategies are focused toward achieving that vision. But the ultimate business goal as an owner is to profit from your risk and hard work. Profiting not only enables you and your family to survive, but also can fuel your future visions to positively impact the Earth.

At the earliest stages of your startup, you should come to an understanding, an agreement on your exit strategy. To do that, you must decide if your startup realistically has the potential of growing to a Twitter or even Facebook-sized company, or if you think it is more of a small or medium-niche player, an acquisition candidate. This one issue can radically dictate your operational strategies and it can determine your probable funding path.

In determining your niche, don’t confuse idealism with realism. Most startups do not have a vision that can scale to a Twitter or Facebook-sized company. Although many startups think that they have the next killer Web service, the one that will give Google, or Twitter, or Facebook a run for its money, the reality is that many of these startups lack a game-changing vision. Instead, they are small to medium-sized niche players who will either be perceived by the Web’s behemoths as bugs to squash or, if they play their cards right, considered as potential acquisition candidates.Web 1.0 was the reign of the VC; Web 2.0 saw the rise of the Angels; Web 3.0 will be the domain of MicroAngels

Smartups are honest and clear about their niche and potential market size. If they truly have a game-changing vision backed by extraordinary technology, then they proceed down that path. If they have a great idea that adds value to the Web but does not have the potential to become the next Google, then they proceed down a different path.

There is nothing wrong with being a small to medium-niche smartup. Recognizing that fact upfront can give you a competitive advantage over your colleagues at other startups who are clueless about their market potential (and are therefore not smartups).

But being realistic, instead of idealistic, does not mean that you undervalue your vision. You need to remain flexible and periodically reassess your exit strategy. Small niches sometimes grow into larger niches over time—when Google and Facebook started up, the current market niche for them at the time was rather small as well.

Whether you’re a first-time entrepreneur or a serial entrepreneur with a record of success, you need to have passion for and belief in your smartup’s vision. If the results of your honest assessment about your smartup’s current market potential do not turn out the way you had hoped, don’t reactively hedge your risk because of disappointment or fear. You need to remain tenacious, positive, and take measured risks.

Web 2.0 = lean startups; Web 3.0 = keen smartups

Although Web 3.0 is fermenting evolutionary changes in the Web business model, economic reality is hard to overcome. Those Web-1.0 and Web-2.0 businesses with the biggest coffers still wield a mighty sword of influence. If you don’t realistically believe that your Web-3.0 smartup is destined to become its own behemoth, then you must learn how to play with the Web-1.0 and Web-2.0 relicts.

Keep Your Eye on The Exit

Why should smartups make figuring out their exit strategy a top, early priority? Since most smartups are not in contention to become the next Facebook or Google, the most realistic exit option they have is to be acquired.

Yes, scaling up for an IPO was all the rage during the disastrous-dotCom bubble, but today that is a difficult task. Instead of shooting for targets that are too far away, it is best to focus energies on targets that are much closer.

It is not atypical for a VC-backed startup to require 5 or so years before it either is acquired, has an IPO, or closes shop. The greatest majority of them do the latter. Big companies are actively swooping up startups to fuel their innovation and augment their talent pool. Many of the acquired startups are pre-revenue, being purchased for less than a $20 million valuation. It is significantly easier to shoot for this type of early exit rather than shooting at an IPO target that usually requires five or more years to pull off, if at all.

If a smartup plays its cards right, it can startup, build traction, and attract the interest of a potential acquirer in a two to three year timeframe. A successful, early exit will allow each happy entrepreneur to launch their next venture and try for even greater rewards.

Keen Compliments Lean

The lean startup movement incubated and spread its wings in Web 2.0. But in Web 3.0, it will be the keen smartup that succeeds. A keen smartup is a lean startup that wisely embraces the Social Web and the Web 3.0 paradigm. Being keen requires you to be well versed in all aspects of your business. It requires you to remain agile not only with platform development, but also with funding.

Smartups need to apply the same agile, lean thinking across their entire business operations —not just their platform development approach. This can be a real problem as many startups are formed by a team of software engineers, the majority of whom have little if any prior business operations experience.

The initial funding amount that most startups now require is often way below the level at which a traditional VC considers investing. But VCs do not like to be left behind. Paraphrasing Aristotle, VC’s abhor a vacuum. As VCs saw that the trend of decreasing investment requirements was becoming a general reality, some innovated their financial models creating a funding category called super angel, seed-stage VC, or MicroVC.

Remember, smartups not only know their niche but also have determined their ultimate goal for forming, their exit strategy—what they consider to be a desirable, achievable, and adequately-profitable sale of their business.

But investors often look at and treat startup teams as if they were a flock of lost sheep: sheep who love grass and are experts at eating it, but have no idea how to get home. That is the challenge that every business faces. How do you get home? How do you win the game? How do you succeed at bringing your ultimate goal to fruition?

This can be an issue as a smartup’s exit strategy may not be in alignment with an outside investor’s exit strategy. What one considers a fantastic acquisition offer, the other might scoff at as unacceptable.

Funding Revolution: VCs to Angels to MicroAngels

During these late stages of Web 2.0, we’re beginning to see important shifts in the way startups are funded. Startups can bootstrap in innovative ways by the joint leveraging of tools like Kickstarter and social networks to quickly generate operating funds. The meteoric funding success of the Diaspora Project is a great example.

Is Disapora’s funding success a fad? I believe not. I think it presages a fundamental revolution in startup funding—what I call the rise of the MicroAngels.

MicroAngels are investors (professional or part time) who provide small amounts of capital usually less than $10,000.

Although it appears to me that Diaspora is not a startup, but an Open-Source project, their novel funding approach is a harbinger of the changing funding climate in Web 3.0. These changes will accelerate, bringing more opportunities and challenges for both entrepreneurs and investors alike.

Before accepting angel funding, make sure that your team has a pre-agreed upon exit strategy and that any potential angel investor agrees to the exit strategy as well (in writing).MicroAngels will start to play an increasingly important and prominent place in the earliest stages of a smartup. However, this does not mean that typical, larger angel funding will not be necessary at a future stage in a smartup’s lifecycle. It takes a lot of runway to fuel a startup, to help it gain sufficient traction so that it becomes a tasty and attractive morsel to potential acquirers. As we discussed above, a smartup knows its niche and has a well-defined exit strategy.

Most Web-3.0 smartups require a lot less money to get going. They need fewer funding dollars than they would have three or more years ago. Whereas a few million (two to five) might have been the norm in the past, now a smartup might be able to open shop with $50k to $250k (or even less). This is a relatively easy amount to acquire.

A Thousand Angels in a Land of Giants

It is my opinion that for the majority of today’s Web-3.0 smartups, VC (Venture Capital or Venture Capitalist) funding will be a last, not first, resort. In fact, a startup that accepts VC funding as its first resort, instantly boxes itself in, greatly reducing its flexibility.

In general, the offered financing terms of VC funding are often too restrictive. Smartups that accept VC funding could very well turn their once-agile smartup into an inflexible small business. Why is this the case?

In Smartups Know Their Niche, we discussed the essential requirement that smartups need to honestly assess their market potential and size. Whereas VC funding is likely a poor fit for the vast majority of Web-3.0 smartups (at least in their initial stages), it might be absolutely necessary for those few smartups that truly have a solid, game-changing vision. Whether you initially seek VC funding or even consider VC funding at all greatly depends on your smartups vision and true potential.

It is not atypical for VCs to expect a minimum 10 to 20 fold return on their investment. A VC literally has the power to decide whether an acquisition offer is accepted, whether you as a founder and entrepreneur get to cash out and be rewarded for your vision and hard work—often referred to as letting the founders earn.

This can mean that acquisition offers that might seem attractive to founders, angel investors, and share-holding employees are not sweet enough for the VCs. The VCs will literally disallow any sale until either an offer is received that meets their minimum ROI or the startup folds.

This effectively obviates any early exit strategy that founders may have and more times than not results in the startup fizzling out after five or so years if there is not a successful M&A bid or IPO. Whereas insufficient operating capital (runway) will lead to failure, in the above scenario, failure is the result of ridged VC expectations and not due to insufficient runway.

A Caveat
The reality for smartups is that attracting first round funding from angels (or via other means) does not guarantee that you’re heading toward a healthy early exit. It is very likely that after your first round of capital, you’ll require a second round. This might be from a mid-level angel or it could be from a MicroVC. You should be aware that it’s realistic for your anchor investors to seek subsequent rounds of financing, not solely for the additional funds (i.e., for increasing runway) but often so they can turn over the daily investment oversight as the smartup begins to scale. For that single reason, it is always wise to stay friendly and connected to VCs, even if you think you’ll never need them.

If funding decisions are not made wisely and at the proper stage in a smartup’s lifecycle, the result could be to powerdown your smartup returning it to the lowly startup classification, throwing it back into the Web-1.0 and Web-2.0 funding shackles.

Is the current spate of early exits just a Web acquisition bubble? How long will the current early-exit renaissance last? That is difficult to predict. Since it is more than likely that at some future point the current wave of early-exit opportunities will hit a roadblock, it is wise to keep your options open and your connections with the greater funding community (MicroAngels, Angels, MicroVCs, and VCs) healthy.

Conclusion

The Web is at a tipping point, not a proverbial tipping point, but an actual point in time where accelerating changes brought on by increasing social connectivity, data complexity, and user frustrations are literally transforming the startup and business landscape. There are big challenges and opportunities to those startups that embrace the Web-3.0 paradigm.

The biggest challenge and opportunity may be the emergence of the Social Web. The Social Web is about users. It’s about innovating new ways to provide increasing connectivity to the masses on one end while on the other providing individual users with open access to and control over their data, wherever those data are stored.

Users are getting fed up with the difficulties of navigating between social networking islands. A typical Web user today has a multitude of accounts, each with its own username and password, each associated with a specific Web service, and each as a separate, independent repository of a subset of their overall content, of their overall IdentitySpace.

Whereas their are few single-sign on solutions, most do not address the larger issue of data portability, data redundancy, and user control. As we’ve discussed throughout this series, one paradigm-busting change that Web 3.0 may bring is the liberation of users’ data from the data prisons and the yielding of its control back into the hands of individual users.

Web 3.0 will break down Web 2.0’s proverbial walled garden of disparate user data. The omnipresent closed data silos will be relegated to a distant memory.

Web 3.0 is about small changes and tiny connections making big differences. But it’s also about big, disruptive ideas in user data freedom and revolutionary funding models altering the Web’s business environment.

It’s no longer sufficient to simply startup. Web-2.0 startups are trapped in a box, oblivious to much of the changing Webscape. In order to survive and thrive in Web 3.0, you must breakout of the box, step outside the box factory.

Smartups will prosper in the coming revolution by embracing the Web of Data and the Social Web, by carefully modeling their dataspace so as it can scale more quickly and efficiently, and by being keen about their funding options and ever aware of their exit strategy.

Web 3.0 is the realm of the Smartup!

Angels and VCs to Follow on Twitter

Here are a few Angels and VCs that I follow who actively tweet. There are others, but I feel that I get a sufficient overview of startup-investment news and ideas from these guys. Also, and this is very key to me, most of these guys provide useful information and usually do not pollute my Stream with stuff that does not apply to the topic at hand, does not stray too far off the reasons for which I follow.

Steve Blank

John Greathouse

Eric Ries

Mark Suster

Venture Hacks

Fred Wilson

AngelList, from the Venture Hack guys

Here are a few others to consider (I do not currently follow but will occasionally check their public Stream):

Jeff Clavier

Sean Ellis

Dave McClure

Keith Rabois

Y Combinator

Additional Resources

Paul Graham has an interesting take on The Future of Startup Funding

An interesting article on crowdfunding via Kickstarter.

Mark Suster has an interesting, five-part series on angel investing

An interesting book on the topic of exit strategies, Early Exits: Exit Strategies for Entrepreneurs and Angel Investors

Basil Peters, the author of Early Exits, has a very informative, four-part video presentation: How Not to Sell a Business – Don’t Blow The Biggest Deal of Your Life

Basil also has additional, useful information on his AngelBlog website

Tech ‘seed’ investors kick valuations into long grass

Is Convertible Debt Preferable to Equity?

Rise of the Angels by Naval Ravikant (co-founder of Venture Hacks)

A disturbing article claiming that some of the top MicroVCs (SuperAngels) may be in collusion. There is much debate to the validity of the claims made within this article. My point in including a link to this potentially-specious article is that Smartups need to be very careful in the way they approach funding. The professional startup-funding world is a game in which most players are trying to get the best deal for themselves at the expense of all others. Smartups are best served by partnering with funders that are truly trying to help them succeed and not just viewing them as another chip on the table. Here’s a follow up article on what is now being called AngelGate as well as Mark Suster’s perspective— a VC I recommended above to follow on Twitter.

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</Smartups Series Part 4 of 5>

Continue on to Part 5 — Building the Social Web: the Layers of the Smartup Stack

Other Smartup Series Installments

Part 1 — Web 3.0: Powering Startups to Become Smartups

Part 2 — Web 3.0 Smartups: the Social Web and the Web of Data

Part 3 — Web 3.0 Smartups: Moving Beyond the Relational Database

Part 5 — Building the Social Web: the Layers of the Smartup Stack

Article Comments

  1. @johndeo says:

    Jeff,

    Thanks for this four part series. Interesting and well done. I chuckled at the end when you recommended some people to follow who don’t “pollute” your stream with off-topic content. That’s precisely something that the semantic aspect of Web 3.0 should help us resolve. You should be able to follow people who talk about what your interested in only 10 percent of the time, and content-addressable publishing, semantic filtering and context-sensing mechanisms should get the right messages to you.

    I wish more people would get fed up with the current tools, rather than getting really good at workarounds. It would help bring about the next phase.

    Thanks again.

    • Jeff Sayre says:

      Thanks for the comment, John.

      Providing Stream filtering, or as I call it Channeling your Stream (A Flock of Twitters article), is one big user benefit the Semantic Web will bring. Channeling will help to significantly increase the signal to noise ratio, making the journey more useful and enjoyable.

  2. Thanks a lot for sharing this awesome post. I helps me to rethink my strategy for the development of the Leukippos Institute. You ideas about the semantic web are also quite interesting in the context of developing concepts for a data driven science.

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