In late July, I met up with Chris DeWolfe, co-founder of MySpace and the current CEO of SGN, a social gaming company.
DeWolfe was in town to promote SGN, the online and social games company he founded a few years back, after leaving MySpace. SGN has several successful games under its belt (Legends: Rise of a Hero, Bingo Blingo, and Panda Jam) and is reportedly on track to make $50 million in 2013, though DeWolfe would not confirm the number. He would, however, confirm that the company is profitable, and looking to make several more acquisitions in the near-future.
DeWolfe has always been pretty honest about his feelings on the gaming industry. In the past, he's criticized Zynga's model of game development, and argued that the company has grown too quickly at the expense of its financial well-being. But Zynga is just the tip of the iceberg--a metaphor for what's wrong with Silicon Valley, in his opinion. In the past few months, DeWolfe has watched as start-ups with little-to-no revenue raise huge sums of money at outrageous valuations. And he's beginning to wonder--what's wrong with Silicon Valley?
Snapchat's Absurd Valuation
SGN is based in Los Angeles, not too far from another Silicon Beach upstart, Snapchat. Founded in May 2011 by two USC graduates, Snapchat and its founders have raised a staggering $73 million from investors to push its free photo-deleting text messaging service. Forget the fact that Snapchat has yet to earn a cent of revenue--Snapchat has already been valued at half a billion dollars.
I asked DeWolfe about his impressions on the company. He was uncompromising in his assesment:
"I'm at a loss on that one," he told me. "I thought Snapchat would be one those apps that would be three months and out."
I've also been at a loss about Snapchat, too. Besides the absurd valuation (and the existential angst the valuation has apparently unleashed for some) I just never understood something more basic: What's the incentive or value of taking on that much VC at such an early stage?
First, the founders simply don't need that much cash to scale. Second, you're seriously diluting your shares at such an early stage. Third, and most importantly, taking on that much VC severely limits your options as a founder when it comes to an exit.
DeWolfe said his experience with MySpace proves these lessons.
"You don't need that much money," DeWolfe told me. "I know this because we scaled MySpace to profitability with a couple million bucks. If you know how to make money, and you know how to get users, you can do both. I really don't understand taking on way more money than you need."
In some respects, Snapchat is just the latest high-profile example of a start-up that has embraced a familiar strategy. Its founders have bought into the notion that revenue and profit are secondary to "users" and "usage." And by taking on so much initial capital, they're basically trying to strong-arm companies like Facebook or Twitter buy them at an inflated price.
That would be the best-case scenario. Worst-case scenario, Snapchat's users fade and the company raises more and more money but is still without a real revenue scheme.
The Facebook Effect
Which brings us back to the initial catalyst that started it all: raising a ton of money. Why do it?
"It's all the kids that watched The Social Network," DeWolfe says. "Or they've seen the Facebook sales guy worth $15 million because he joined Facebook in 2007. Facebook has created this culture of 'We've gotta have this billion-dollar exit or it's a complete failure' mentality."
DeWolfe happens to believe that's a bad thing for the Valley, and I agree with him.
"I think the days of raising $500,000 [at] a $3 million valuation and selling for $20 million will come back," he says. "There's nothing wrong with making $15 million. That, in any business, would be a huge home run."