The Return of the Large Pre-Launch Consumer Web Financing

I’ve been clipping stories about companies who have raised fairly large (as in greater than $10 million) amounts of venture capital for consumer web services prior to launch. I am not sure that three data points constitutes a trend, but I noticed that Avvo in Seattle (link here), Powerset here in the Valley (link here), and Metaweb (link here), have all raised north of $10 million for projects that are still, for all intents and purposes in stealth.

This is an interesting departure from the “old” web 2.0 model, which has been to build a basic version of the service, raise a small amount of venture capital (less than $5 million) , build the user base, and then raise a larger round once you have traction in the marketplace. I am personally a fan of this model as it ties fundraising to market traction. The other benefit is that you can only go so far (in terms of development) before you have to validate yourself with the market.
Larger rounds prior to launch are really interesting. A company can build a lot more technology before bringing the product to market. The advantage is that this private time can be a great way to make progress on technology without the glare of user feedback. It can be a great opportunity to deliver a more fleshed-out product that ends up being more defensible. The downside, however, is that companies who build products in “stealth mode” for long periods of time, you can end up developing features, interfaces, and functionality that ends up missing the mark. Worse, not only have you absorbed the opportunity cost associated with building features your users don’t want, there is work that needs to be undone in a very public way.

1. The money is available, so entrepreneurs are taking it. There is certainly venture capital money in the market today looking to fund ambitious projects. That money is likely looking for a home, so the venture community (or particular venture capitalists) might be looking to fund entrepreneurs who are looking to take larger rounds. For shorthand purposes, we’ll call this the “push” model.

2. These are ambitious engineering projects that will take a lot of hard work and expenditure before they’re ready to be shared with consumers. The other alternative is that these projects are really hard engineering projects that require substantial amounts of venture capital investment and product development before you can show a decent alpha/beta product to users on the open Internet. This is certainly possible. For shorthand purposes, I’ll call this the “pull” model.

I really don’t know which of these two is actually at work here. It could be a combination of both. Regardless of which model is at work, I will be interested to see how these extended betas turn out. I am generally not a fan of keeping things secret for secrecy sake — the benefit of getting feedback early and often before you’ve baked too much code into the service can often outweigh the benefits of keeping things secret.

Feel free to share your thoughts in the comments.
Update – I wanted to point to a post that Jeremy Liew at Lightspeed did on the pros and cons of being in stealth mode. Click here if you want to read more — it’s good stuff and worth a read.

  • I think what you’re talking about is essentially how long a company stays in stealth mode, and if this is pre or post funding. I tend to agree with you that there are very few occasions when it makes sense to be in stealth for a long time. I blogged about this on the Lightspeed Venture Partners blog a few months ago – if you’re interested click on my name in this comment

  • jeremy liew

    I think what you’re talking about is essentially how long a company stays in stealth mode, and if this is pre or post funding. I tend to agree with you that there are very few occasions when it makes sense to be in stealth for a long time. I blogged about this on the Lightspeed Venture Partners blog a few months ago – if you’re interested click on my name in this comment

  • Shaun

    Another interesting topic would be how these pre-launch “stealth” companies are able to establish a high enough pre-investment valuation (for round A) that they don’t end up giving up 75%+ of their company to the VCs.

  • charles

    Shaun,

    Thanks for the comment. My sense is that these deals have to get done at high valuations — otherwise, the teams wouldn’t have the economic motivation to launch and grow the company.

  • charles

    Shaun, Thanks for the comment. My sense is that these deals have to get done at high valuations — otherwise, the teams wouldn’t have the economic motivation to launch and grow the company.

  • Shaun

    While I do agree that giving a VC too much ownership greatly reduces the economic motivation for teams to launch and grow the company, I also can’t see how a VC can justify the risk of seed stage investment in, what is essentially, an “idea” for 20-40% ownership. Especially when business plan (“idea”) was likely shopped around – making the “secret sauce” not so secret.

  • charles

    Shaun,
    My sense is that these deals have to get done at valuations where the VCs walk away with 40-60% of the company after the round. Anything more or less than that probably doesn’t make sense given the numbers.

  • charles

    Shaun, My sense is that these deals have to get done at valuations where the VCs walk away with 40-60% of the company after the round. Anything more or less than that probably doesn’t make sense given the numbers.