One of Seattle start-ups, iLike, was acquired by MySpace for $20.5 million ($13.5 to buy the company, and $6 million to retain talents). While I am glad to see an exit for Hadi (we used to work together in Microsoft building Internet Explorer), this price tag bothers me a lot (I run Big Canvas Inc., which offers "Big Canvas PhotoShare" - a real-time photo sharing social networking service application to iPhone users).
According to "Why is iLike selling out to MySpace for $20 million?", iLike has 50 million registered users and 10 million active users. It means the value per registered user is only 40 cents.
I still remember that Microsoft has acquired Hotmail for $400 million when they have only 9 million registered users at the peak of the first Internet bubble - $44 per each user.
Yes, we are in the middle of financial crisis, but it makes it very difficult to invest money into social networking business, if this is a fair market value today. iLike has raised $16 million from external investors, and they get only $13.5 millon - a negative return.
When I presented our business at the business plan competition (where we won a "best consumer business" award) in April this year (2009), a lot of people, especially venture capitalists, suggested me to raise money -- millions of dollars just like iLike did -- and aggressively acquire users before competitors do.
The price tag of iLike is yet another proof that those venture capitalists are wrong. Building web services became very cheap these days because of crowd computing services like Amazon's ec2. A couple of thousands dollars is enough to bootstrap the service, and venture capitalists should put money into those companies who can actually generate revenue (even from a small number of users) and clearly present the way to lead to profitability. Putting millions of dollars into a company too early, does not necessary help the business.
The statement like "we don't need to worry about revenue today. We just need to acquire enough users, and sell this company to Google before we run out of money" by CEO is probably acceptable during the bubble, but is just plain wrong in this economy.
A good entrepreneur should be able to say "The gross margin per active user is A cents today. If we are able to keep our fixed/overhead cost at B, we will turn profitable once we get C users. We typically need to spend $D to acquire each user. Therefore, we need to raise $E million as a working capital to get to a profitability."
This is very much like the way people run restaurants and movie theaters, and I think the Internet business should be run just like that.