What Sank Veoh and Joost? Too Much Cash Too Soon

The Same Scourge Will Claim Dozens of Other Media and Advertising Startups

Posted by Warren Lee on 07.15.09 @ 12:08 PM

Warren Lee

There are many reasons why things went wrong: technical missteps, lack of premium content, tough terms from content owners such as CBS and Viacom, etc. But that's not the whole story. Joost and Veoh had an even bigger problem, one that will likely claim dozens of other media and advertising startups that have been founded over the past three years: too much venture money, too soon.

In the last few years, the top 25 most heavily-funded video startups (excluding Hulu, which has raised over $130 million) have collectively raised over $1.2 billion in venture capital, or an average of $48 million each (see chart). The top 10 companies in the group, names like Spot Runner, Move Networks, Visible World and DailyMotion, have raised $720 million, with an average of $73 million. More significantly, nearly three-quarters of this money was raised within the first two years of the initial funding. That's an impressive pile of dough, even for VCs.

Raising lots of money is not a problem, per se. Raising too much money too early and before hitting key milestones (e.g. getting paying customers, showing attractive margins) can be. This is particularly important for online video startups, which, due to their costs, need to be run with tighter margins from the start.

This year and next, these companies' venture backers and boards will have to make wrenching choices: continue to fund these companies with the hope that the economy will turn around or a generous buyer shows up, shut the companies down, or sell on the cheap. This will turn into a buyer's market for the next several quarters.

Dangerous path
The simplest lesson to take away here is don't raise too much money too quickly. Unfortunately, that's easier said than done. Too much money, often, though not always, leads to poor habits like over-hiring, overspending and a lack of discipline, which itself leads to mistakes such as sticking with bad ideas too long and throwing money at a problem rather than solving it the right way.

I should disclose here that, as a partner in VC firm Canaan Partners, I am invested in and serve on the boards of several media and advertising startups, including Associated Content, Motionbox, Peer39, Tremor Media and Vivox, and I have previously invested in two successful video companies (Arroyo Video Solution and Broadbus Technologies).

In any new technological era, too much money inevitably rushes in to fund too many me-too companies. In the late 1990s, it was optical networking companies and dotcoms; more recently, ad-supported media, social networking and so-called Web 2.0 companies have been targets of the influx. Most VCs, myself included, have been guilty of making these mistakes.

Not all of the companies in this group will fail. True, many will run out of money and either shut down or get acquired for much less than what was invested. Others will turn into good but not great businesses. However, a select few will turn into great companies with highly profitable business models and significant revenues.

I continue to be bullish about the online video space. Roy Amara, a noted futurist, once said, "We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run." It's hard to believe that it's only been three years since YouTube exploded onto the scene.

It's difficult to predict the pace and course of how the online video space will change, but there are reasons to be optimistic, as the costs -- production, streaming, and storage -- continue to decline and as users and businesses invent new ways to best leverage this new medium.

Source: Venture Source

25 Comments

  By patricia2 | los angeles, CA July 15, 2009 01:24:23 pm:

I would disagree. The market is just too early for web TV.

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  By mwitzling | St. Louis, MO July 15, 2009 01:49:49 pm:

Clearly too much investment cash can create poor habits. Too little cash can also create poor habits as firms hold back pursuit of key opportunities. The leadership challenge is to balance the investment cash flow with prudent initiatives to achieve growth objectives.

Second, the consuming market is clearly ready for online tv, video and audio. It's not all new either. SBTV.com has been delivering online video business news daily since 2004. Across the spectrum of video sites, it is the business models that have not kept pace. Some are clearly better than others. They will all evolve.

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  By RealTVCritics.com | Los Angeles, CA July 15, 2009 01:58:37 pm:

When will VC's learn? They keep dumping their money into environments that are either stale or there are too many players in the game. More important, there has to be a revenue model at the end of the day that will make these investments safe. It's teh same old story. Put up a screen, whether it be online or in a mall, and investors think they are automatically qualified to make millions. EEEEEEET as they say in the gameshow world. If at the end of the day an idea looks and sounds like a good idea, then back out. Because no one these days have any thought about the dollars that need to come in to that idea to make it a solid revenue based by business model. Finally it's all about hype. It's all about marketing. Out of the list of 25 content deliverers listed I can only pick 8 that I can say I have ever heard the name. No marketing, no hype, no users, no money, out of business. Period.

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  By Gene w. | Atlanta, GA July 15, 2009 01:58:59 pm:

Warren --
Your faith in online video chat is well founded. Here is a story today from All Things D about a leading video chat, Paltalk that just boughtout their VC investment for a preimium. Video done well and right is a business for today and tomorrow. http://mediamemo.allthingsd.com/?p=9251&ak_action=printable

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  By TimFielding | Brooklyn, NY July 15, 2009 02:03:36 pm:

Nice piece Warren. It wasn't just the weight of ROI expectation that troubled Joost (who if anyone had the independent means to keep indulging the vision) as the malaise that spreads through an organization once the penny drops that the founders made a huge conceptual blunder. Fresh from the success of Skype, they assumed that what works in telecom works in entertainment, and that consumers would opt for second rate content if served up via cool technology. And to assume, as they say...
all the best, www.riverphonic.com

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  By Warren | Westport, CT July 15, 2009 02:16:29 pm:

Thanks, Tim. Interesting point that you make about telecom vs entertainment. Having invested in both telecom and media/advertising, I'm always struck by the differences in the two industries. Voice is an essential utility that everyone needs. Entertainment/media is (usually) a discretionary purchase. Lessons that work in one often don't work in another.

Warren

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  By burtbernard | denver, CO July 15, 2009 02:25:03 pm:

I think the VC backers of these companies are as culpable as the founders/management teams. My experience is that in boom times, typical VCs push founders to take and spend as much money as fast as possible with the goal of capturing a large segment of a hot emerging market and raising the chances of a high value exit.
I like the article and agree with the conclusions, but my question is "who is to blame for this problem of too much cash too soon?" and I think the blame largely lies with the guys writing the checks.

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  By patricia2 | los angeles, CA July 15, 2009 02:38:16 pm:

@Gene, so what do you think of the online video chat that has failed for the past ten years?

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  By bikingbill | Carlsbad, CA July 15, 2009 02:42:56 pm:

VC's overfund to create a sufficient capitalization for the purpose of establishing value for the IPO or acquisition.

I am the CEO of a iPhone publisher with 13 app in iTunes and 4 apps in Google's Android market (27 pending for Palm Pre). Bootstrapped.

My close competitor has about 9 titles in iTunes, no other platform, and SIXTEEN MILLION DOLLARS IN FUNDING!

Draw your own conclusion.

William Volk
CEO, PlayScreen

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  By Warren | Westport, CT July 15, 2009 02:55:06 pm:

Hello Burt,

I agree with your comment. I would say that there is plenty of blame to go around: VCs didn't have to write such large checks and founders/management didn't have to accept so much money. Remember that it takes two to tango.

Warren

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  By tdunning | San Diego, CA July 15, 2009 02:58:02 pm:

I can say from personal experience that Veoh had high costs, but was not extravagant. In particular, our effective bandwidth costs/MB were well below our competitors.

Veoh also had significant revenues, although clearly not enough to maintain full operations.

The real problem was competing with a company that could afford to throw as much money down the drain as Veoh ever got from investors.

I still agree with the advice, if only because it radically decreases the likelihood that the founders and employees will ever see a dime. If you take a lot of money early on, the minimum exit value for any return to the original risk takers becomes enormous. Preferred stock makes a lot of business sense because it allows you to attract investors, but enormous preferences make no sense for the founders.

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  By Warren | Westport, CT July 15, 2009 03:24:52 pm:

Hello Tim D.,

I remember meeting you several years ago when I visited Veoh. We were impressed with the technology/P2P and bandwidth management tools that your company had developed.

Yes, competing with a company that has "unlimited" funds is really tough. Both YouTube and Hulu are very formidable.

Your last point is an important one to reiterate. A win-win is when both founders/employees and investors make money. Raising too much money early on makes that that much more difficult to achieve.

Warren

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  By stuballatt | Mountainside, NJ July 15, 2009 03:26:30 pm:

Broadly speaking, it seems in recent years "the technology" has been too-much the driver behind decisions to start a company and to fund a company.

As an entertainment media executive (not a technologist or a VC/PE expert) I am surprised by the number of companies that have walked into my office to pitch a capability that has no relevance or is already widely available from other sources. These companies seem funded on the basis of their technology and patent applications having corporate value, rather than on the basis of a defined customer need and with a clear value proposition.

Of course, many great products started that way, TV and cell phones among them. But as relates to funding decisions, would you agree that there's been too much focus on "what it can do" instead of on "what potential customers need done"?

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  By Randall | los angeles, CA July 15, 2009 03:31:51 pm:

thanks Warren for bringing this up. So much ink lately on the struggles of video publishers, where the emphasis should be on the inability to produce the expected ROI based on their wild projections, big early bank accounts and spending habits that match early budgets.

The bottom line is that publishers need to have a long term strategy that makes them sustainable. This is done by using "bolt on technology" and creative revenue sharing deals with rights holders. It's unfortunate that most VC's don't even want to talk to you if the deal is not $3 mil+ . That formula in my mind is troublesome. Not many firms reward an entrepreneur for looking for less money because they have been clever in build/ spend.

I've built a sustainable, VOD portal and know how far your money can go if you are really forced to bootstrap - especially in the video/ entertainment space.

The other unfortunate aspect is the studios financial licensing model with minimum guarantees (unless you are owners - Hulu, zillion) and huge encoding fees (vendors they have used for years). They certainly don't help their future distribution partners be sustainable and choose the short term profit route instead.

Randall Green
COO
www.butaca.tv
www.verandaentertainment.com

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  By jetatomic | Portland, OR July 15, 2009 03:53:32 pm:

Wait... You're going with the "Mo' Money, Mo' Problems" defense? The scourge of having resources?

"The simplest lesson to take away here is don't raise too much money too quickly."

There are two problems here. The first is predicting precisely how much money is the correct amount of money. Do entrepreneurs approach VCs and ask, "I know exactly how much money I need, but will you please give me too much?" Do VCs say, "Hey, let's figure out how much money is the right amount of money, then give them too much?" Entrepreneurs think they need X, VCs think they need Y, and at some point a degree of voodoo estimation slips in.

The other problem, the one I'd say is the simplest lesson that VCs and CEOs should have learned somewhere along their journeys leading them to their position is that having money doesn't necessitate squandering money. Granted, having learned that lesson is not easy to test for, but allocating funds is an executive responsibility nonetheless. Not allocating it properly isn't the money's fault.

At the future time when the condition of "too much money" exists, the extra money doesn't cause bad habits, it reveals them. I'm sure there's a quote along those lines floating around already.

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  By visualplant | new york, NY July 15, 2009 07:58:37 pm:

For the majority of founders, CEOs and VCs, I agree "too much money... leads to poor habits... and a lack of discipline, which itself leads to mistakes such as sticking with bad ideas too long..."

But the problem isn't too much money, it's the bad habits.

An experienced, responsible and deft founder will have the ability to temper spending amidst VC pressure and be nimble in an ever-changing market, i.e., change course to pursue opportunities in a nascent industry.

On the other hand, a smart founder will also be able to bootstrap a successful product without VC funding.

Success comes down to brains, stamina and resilience. Too little or too much money is just an excuse for lack of those qualities.

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  By JudyGShapiro | new york, NY July 15, 2009 10:46:56 pm:

Hi Warren,
This is Judy Shapiro of Paltalk.As a successful and profitable video based community, we are the happy exception in this space. So it seems as worthwhile to examine successful outliers like us rather than dissect the cadavers of probable failed startups.

First, it is useful to say I am writing this post on the heels of a very important press announcement we did today for Paltalk. We announced that we bought back our VCs shares at a premium. Yep – during one of worse downturns, we were able to buyout our VC, Softbank with cash on hand. 2008 was our most profitable year ever BTW.

So I'll offer some insights into what can go right.

Lesson 1: Technology bench strength is the backbone of any successful technology business
Paltalk has been doing what we do for ten years (we are the largest video based community with 4000+ chat rooms). We have 9 patents and another 5 pending. We recently asserted our patent rights in a suit against Microsoft and our rights were confirmed. Now that is a huge advantage. We were first in the group video chat business and therefore had first mover advantage. So as the market grew, we were well positioned to benefit from market growth that followed.

Sadly, newer technologies companies tend to focus way too much on cool graphics rather than focus on the performance and quality of the application.

Lesson 2: Real business plans are not a luxury but a necessity
Paltalk was the first community platform to recognize the volatility of an advertising revenue model early on. So we built a subscription revenue model that today drives 85% of all revenue. With a proper business plan you can create the secret sauce of elements that move your users from free to paid, (sorry, folks but Paltalk's secret sauce is just that – secret). It really makes a big difference if a company knows how they intend to make money going in rather than make it up as they trot along.

Lesson 3: Depth in management counts
Real business plans emerge when you have real business leaders in charge. In the case of Paltalk, the key senior leadership technology and business teams have driven this company for a decade. That depth is an investment made in early days which is easy to overlook, especially in the meteoric rise of new "web 2.0" technologies.

In the end, people need to be reminded that in the pre-Internet days there was one reliable way to make money. You had a vision for a product or service, you scraped together some money and you started selling as soon as possible. As you grew, you reinvested in the tecnology to enhance your vision. That basic, market driven model became "unpopular" in the Internet boom days where people bought visions of businesses that could be. One would have thought we had learned our lesson back in 2002. But it seems some lessons are not easily learned.

Judy Shapiro,
Sr VP, Paltalk

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  By Warren | Westport, CT July 16, 2009 12:36:54 am:

Jetatomic,

I agree with your comment that it's hard to predict exactly how much money a company needs to raise. One reasonable approach is to raise enough capital to give a startup enough time (15 mos? 18 mos?) to achieve some critical milestones, plus some extra cushion since things never go exactly the way one plans. Then go raise money at a higher valuation after these milestones are achieved. In most situations, there's no reason why a startup needs to raise all the capital it ever needs at once (there are certain types of companies in specific industries -- semiconductors, cleantech, and biotech to name a few -- that have good reasons for raising large amounts of money all at once).

Judy,

Congrats to Paltalk for building a profitable business, especially during a tough economy. That's quite an achievement. I advise at least two-third of the startups that I meet with that they shouldn't raise venture capital and instead should look for alternative forms of funding (i.e., credit cards, bootstrap, friends and family). Venture capital is expensive.

Warren

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  By pinakis | Chicago, IL July 16, 2009 11:28:14 am:

Hi Warren,

Good perspective on over-funding! In fact, we entered the market in a completely bootstrap mode with some angel contribution to get our platform up in place. However, when you mentioned that too much has flown into the sector too fast, a thought/observation crossed my mind:

If these deal flows are so intense in cash amounts, why didn't the VCs do a due-diligence on quarter by quarter P/L, costs, sales, paid contracts and +ive cash flows? Seems like everyone was drinking their kool aid!

One problem with too much money in the bucket upfront is that the failures completely dry up the future funding landscape with panic settling in. This chokes vision and scouring for future opportunities even if the pitches are solid.

I wish the VCs are less driven by flow and more by growth potential in a company by company (management I meant) basis. Ideas are dime a dozen but not the execution of them!

Pinaki
Me!Box Media Inc.
http://twitter.com/pinakis

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  By glasbcy | Atlanta, GA July 16, 2009 01:02:01 pm:

Regardelss of cash flow, I think everyone (VCs and start ups) gets so excited about the technology, they forget about the consumer. Certainly there are early adopters, but most people just don't want to be bothered to change unless they have to or there is a better value to them (dial up to broadband for example). It will take a long time for video to become what these companies envision.

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  By novazoom.com | PISCATAWAY, NJ July 16, 2009 01:29:05 pm:

Unfortunately, VCs are often too consumed by the thought of the next big thing that they overlook basic details including an overly saturated market. That said, I'm not convinced over funding was the problem for these companies. For one, their marketing strategy could not withstand the beat-down Hulu gave them. Flaws in the operating model are one thing but an inferior marketing strategy is just as bad.

Hey, BTW, if anyone has extra VC money to invest in a small but efficient marketing agency – email us: info@novazoom.com. We're always looking out for angels :)

Nadine, President -- NovaZoom
www.novazoom.com
twitter.com/novazoom

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  By rgibralter | NEW YORK, NY July 16, 2009 04:25:42 pm:

Great article.
Please do not give us any money.
http://urtak.com
But do feel free to start your own urtak surveys for business and fun.

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  By nashway | Englewood Cliffs, NJ July 16, 2009 05:20:36 pm:

Warren -
reading your post was equal parts informative and depressing. While I applaud the point that many startups waste a lot of the cash influx they receive, I cringe at the idea that there's "too much" VC money in the market.

I've been working with a web startup that has viable model, proprietary content and a juicy demographic that has been surveyed with promising results. We can't seem to buy a meeting with a VC firm. "Raising lots of money is not a problem?" PLEASE help.

Can you write a post on your blog about how to get a meeting with you? Better yet, can you twitter me with your email address? I'd love some real-world advice from a real-word VC.

Thanks,
Nader Ashway
Twitter: @nashway

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  By voyager360 | SANTA FE, NM July 17, 2009 07:25:19 pm:

It's nice to see that there are plenty of VC Bozos stupid and blind enough to think they can toss a few million dollars at another, Me-Too idea ina feeble attempt to take away market share from Google's YouTube. How do you combat first in the mind, funny TV Commercials like Hulu featuring Alec Baldwin as an alien?

I love the line where he says he's about to slurp out our brains when it turns to goo from watching too much TV "As aliens,.. that's how we roll."

Funny stuff. And it can't be replaced. It's like trying to replace the AFLAC Duck commercial created by Kaplan Thayer Group.

Bart Wilson
CMO
Voyager International

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  By qh22 | A, CA July 20, 2009 03:53:01 pm:

One of the problems with many of the companies on the list abive is that they didn't or don't really have a valid business model.

Many VCs seem to have believed that one just needs to invest a lot to allow the portfolio company to become the first global leader in this space, not realizing that in fact the content and consumer markets are fragmented.

It is much better to build a business market by market, learning how to adapt to each in the right way than to build a one-size-fits-all.

It is interesting to note that the list does not list one company that actually has a valid business model: Zattoo.

It has by and large avoided many of the mistakes the other companies on the list have made.

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