Iterations: Public Market Sentiment Rattles Consumer Startups’ Cages

Editor’s Note:  Semil Shah is currently an EIR with Javelin Venture Partners and has been a columnist at TechCrunch since January 2011. He hosts a weekly TCTV show In the Studio and pens a weekly column, Iterations. Follow him on Twitter @semil.

The consumer technology startup world is largely insulated from most happenings in public financial markets. That seemed to change this week. Facebook’s stock has taken a real beating on the NASDAQ after its $100b IPO just a few months ago. At the same time, the second-most popular network, Twitter, continues on a path to lock-in users with new features as it primes itself to increase revenue. Typically, these kind of events wouldn’t really impact the very early-stages in consumer-facing startups…that is, until now. There is unquestionably a trickle down effect this time around, one that is imparting some sobering lessons. However, upon closer examination, the fear that has spread from public markets to startups is probably more of an overreaction and more likely a response to volatility and overall market uncertainty. And it is up to the ecosystem to respond.

In this column, I’m going to confine my comments to the two big “platform” plays, Facebook and Twitter. The market has responded to other companies recently, such as LinkedIn, Zynga, and Groupon, with mixed feelings. These matters are the subjects of an entirely different post and argument, but for now, I want to stick to the platforms and channels which consumer startups use to gain audiences and growth.

Let’s start at the top, with Facebook. In roughly three months since the company’s public offering, which included one earnings call, public investors have now changed their minds about valuing the social media company at 25 times their annual revenues. The stock has been pushed down hard, but so much of the chatter about why that is focuses on the company itself (“their ads don’t work” and “they can’t do mobile”) and not enough analysis that considers (1) what Facebook could execute on and (2) how the macroeconomic environment has also impact stocks in general (Euro Zone crises looming with Spain and Greece, and housing market illiquidity, among other things, in America). Yes, Facebook has a lot of work ahead of itself to not just become an app in a world of mobile devices and to start powering transactions, among other high-value opportunties. It’s worth keeping in mind that the company has only been public for a few weeks, and I personally believe they’ll figure out how to execute on their grander vision, one that is more interesting than simply driving clicks.

While I may believe the long-term future for Facebook is bright, fear today is a legitimate concern. Twitter, too, has played a role. In addition to serving as the echo chamber for minute-by-minute doomsday stock analysis about Facebook’s share price, the second most popular social media property is now operating in an environment where many are wondering if and when the company will be ready for its own public offering. In order to get there, Twitter will have make some moves that inevitably will spread fear and frustration within its own vast developer community. The product’s network effects are now strong enough to continue on a path to “lock-in” more and to make content-creation and consumption activities occur “in-line,” within properties and interfaces the company itself controls. While this has been happening for years, every now and then, the ecosystem gets a harsh reminder about the risks associated with platform dependency. Twitter, like Facebook once did, has a very large private valuation, one that it will need to grow into as well. And just like with Facebook, I’m personally bullish on the long-term potential for Twitter to do that, especially in the context of mobile devices.

In the world of consumer-facing technology startups, these effects are trickling downstream. Experienced, savvy investors are now comfortable discussing that the bar for early growth in consumer startups has been raised. They want more users, more retention, and more engagement. And, those could command lower prices because, right or wrong, the enthusiasm delta between how public markets and private investors value these opportunities couldn’t be wider. If Facebook isn’t exciting the public markets with its roughly 500m daily active users, and if Twitter’s revenue isn’t at the quality public markets expect, startups building new products and services that depend on the average consumer’s finite reservoir of attention may also simply be competing for that user’s time.

While I personally believe it’s unreasonable to judge Facebook harshly on one earnings call in a three-month period or Twitter for acting to protect its core interests, it’s clear that every consumer-facing startup, the big ones and all the little ones just starting out, now both have a tremendous amount of work to do to prove public investors wrong. The future may be bright, yes, but until that day comes, we should expect that uncertainty, combined with shaky international conditions, to drive down prices and raise the bar for what consumer-facing startups would label as success. Early-stage investment won’t stop, of course. New site and apps will be launched every day. A few handful may breakout.

What will be most fascinating is to observe how the ecosystem responds moving forward. Will employees at top companies leave for the next big thing once their shares have vested? Will insiders dump stock after lockup periods or on secondary markets? Will the current crop of early-stage investors continue to be willing to take bold bets without high-growth metrics? Will startups seriously take into consideration the realities of how many fragmented goods and services consumers really want? Will attention shift to pure B2B revenue models and enterprise technology, which already seems to be happening in certain pockets? The long-term arc favors companies with characteristics like Facebook and Twitter over incumbent architectures, but for now, the public isn’t ready to hand over the keys to the kingdom just yet. It will need to be earned. This shouldn’t come as a major surprise to entrepreneurs — these factors are all known knowns. The conditions shouldn’t provoke outcries and stoke fears; instead, these conditions should pose the next great challenge to overcome.

Photo Credit: AZRainman / Creative Commons Flickr