1Mby1M Virtual Accelerator Investor Forum: With Dave Hornik of August Capital (Part 5)

Sramana Mitra: One thing that I find very annoying of what venture capital allows entrepreneurs to do is ignore fundamentals. I think there is a very bad habit in venture-funded companies of ignoring fundamentals and delivering services at rates that are not sustainable. What are your thoughts on that?

Dave Hornik: It’s bad investing. All of these companies that have gotten funded have presented a business plan where people have said, “At scale, these things work.” There is always a theory that it will work. Maybe the theory in an upmarket like today is, “We’ll get a bunch of users. We’ll get value for those users.” Ignore monetization and all of those things. Just grow a user base and we’ll be fine.

It turns out that that is true in a very narrow set of circumstances. We’re investors in a company called Wattpad. It’s a storytelling platform where people are writing stories and posting them to Wattpad and reading them on Wattpad. These are serialized stories about Harry Styles or whatever. You can say, “We’re not going to worry about it. Eventually, we’ll get to sufficient scale that we can monetize people.”

If you were to pitch that business that way today, I think people will be like, “How are you going to get to sufficient scale?” On the other hand, there are tens of millions of people reading on Wattpad for billions of minutes a month. I can tell you Wattpad is of a scale where they have no problem monetizing. For the first many years, people could be sitting there saying, “You guys are going to go out of business. You are making no money. You have a small number of users and you’re busy focusing on the consumer experience.”

I agree with you. I think that it’s important to have a view of a business where, at scale, you can get to a business. That means it has to be self-sustaining. You have to see somewhere in the future where you make more money than you spend. If people are funding companies where they can’t envision a time where that company makes more money than it spends, they’re dumb. They should not be funding those things. If you have to spend from year one to seven, the only question is, “Do you think you can raise enough money to get from year one to seven?”

Sramana Mitra: It’s a huge question.

Dave Hornik: Yes, I have companies that go out of business as a result of that. It turns out that in year four, there isn’t money to get them to year seven. It’s the high wire act of entrepreneurship. It’s hard.

Sramana Mitra: The other concluding pointer I’m going to make for everybody on this topic is a piece that I just published and it was in our newsletter this week, “Will capital kill capitalism?” The question that I raise there is, by putting so much capital into businesses, we are allowing entrepreneurs to spoil consumer habit. Consumers only expect things for free.

Like you said, you’re never going to pay for Candy Crush. Me neither. Consumers expect value for free. That destroys the basic tenet of capitalism, which is producers produce value and consumers pay for it. If we destroy that basic relationship between producers and consumers at scale, then we are left with a welfare society.

Dave Hornik: I think it misses a point though. I’ve spent a lot of time thinking about business models. When you dig into it, there’s only one real business model. That is you have consumers, and they pay for things. The reality is, there are proxies for paying for things. We know one of this proxies.

One is that advertisers pay for the attention of someone. You get it for free but you have to deal with advertisers. It’s explicit these days because if you want to listen to Spotify without advertisers, you pay for it. Otherwise, advertisers get your attention.

Sramana Mitra: Advertisers’ business model works fine except you have to have scale to be able to monetize.

Dave Hornik: Yes.

Sramana Mitra: The danger that is being created is more on the freemium side. Freemium became a fad. It’s neither here nor there and freemium conversion rates are terrible.

Dave Hornik: I agree with you 100%. In the vast majority of cases, freemium is a bad business. It’s a bad model that results in millions of dollars being spent on a theory. This theory is that if you make it free, it’ll be easier to acquire customers and then you’ll be able to convert them. It turns out that free doesn’t make it that much easier to acquire customers. You’re not even getting the value of the free. It’s not that easy to upsell to paid.

There are very few instances where freemium has worked. In those instances, it’s because serving your free customers costs next to nothing. Skype worked because computer to computer communication was free. They used other people’s resources. When you need to get actual value, then you had to pay. But for Dropbox or a bunch of these companies where it cost real money to serve the customers when they’re free, it’s a challenge to get this model to work.

Sramana Mitra: Thank you. I’m so glad that you reinforced that point. This is a point that comes up all the time. It was a real pleasure to have you.

This segment is part 5 in the series : 1Mby1M Virtual Accelerator Investor Forum: With Dave Hornik of August Capital
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