Startups Adjust to Web's Down Cycle

VC based business find it hard to survive and need be have a modified strategy that is not focused on an exit. Aivars Lode avantce

Startups Adjust to Web's Down Cycle 

By PUI-WING TAM, GREG BENSINGER and IAN SHERR

Prominent venture capitalist John Doerr coined the phrase "SoLoMo" in 2010 to describe how three technology trends—social, local and mobile—were fueling a new Internet boom.

But now that Facebook Inc., FB +2.55% Zynga Inc. ZNGA 0.00% and Groupon Inc. GRPN -3.94% have fizzled in their first year on the stock market—even though they were considered on the cutting edge of some of those tech trends—the hype over "SoLoMo" has subsided.

For many of the still-private Web startups that rode the wave up, that now means grappling with the downside of the cycle.

Some companies that were preparing for a public offering after Facebook's May IPO have shelved those plans. Others are distancing their businesses from those of Zynga and Groupon, amid concerns their companies will be tarred by the same brush. And some have watched their user growth trail off and are working to recapture the viral magic they once experienced.

Several Web startups have closed shop entirely. Color Labs Inc. raised $41 million in venture capital last year before even launching its social photo app for mobile devices, but it has since imploded and the app won't be available after Dec. 31.

"There's less heat in and around the SoLoMo market," said Brian O'Malley, a venture capitalist at Battery Ventures in Menlo Park, Calif. "For a while, there was a suspended disbelief about how hard it is to build a company. Now that's coming back to bite people."

Here is how three closely held SoLoMo sector startups all raised hefty financing at sizable valuations during the froth and how they are dealing now with the other side of the hype cycle.

MOBILE

The roller coaster for Viddy Inc. Chief Executive Brett O'Brien began in March. His Venice, Calif., startup, which launched last year, was steadily growing its user base for a free app that lets people enhance, edit and share videos on their iPhones. Viddy, with about 10 employees at the time, was "pretty much heads down," Mr. O'Brien said.

Then Viddy connected its app to Facebook's Open Graph platform in March, enabling people to automatically share their Viddy activity in their friends' Facebook news feeds. That raised Viddy's profile.

The number of monthly active users connecting to the app through Facebook quickly soared—to 890,000 by late March, up from 60,000 in January, according to AppData. By late May, the number skyrocketed to 31.1 million.

At the same time, Facebook in April said it was acquiring mobile photo-sharing app Instagram for $1 billion, spurring investors to hunt for the next mobile hit. Though it was producing no revenue, Viddy was inundated with investment offers. In May, Viddy announced it had raised $30 million. The company's valuation was pegged at $370 million, said people familiar with the matter.

All of that "brought a spotlight to this category that I don't think anyone expected," said Mr. O'Brien, 46 years old. "That brought issues and challenges, as well as opportunities."

Among the problems: The user influx strained Viddy's technology so some people were unable to get onto the app on their first try, or they found the app operated slowly. Some consumers vented their frustrations about the app in emails and online posts.

"We were getting distracted just trying to deal with all that," said Mr. O'Brien.

Viddy's user growth through Facebook started cooling off. By July, the number of active monthly users connecting to Viddy through Facebook had fallen to 10.9 million; by November, that amount was down to 650,000, said AppData.

"The hype helped Viddy, and it hurt them," said Battery Ventures' Mr. O'Malley, who is a Viddy board member. The startup now has enough capital for several years, has built out its back-end technology, and today counts 40 million registered users, up 10 times from the start of the year. But "the hype also changed the bar and [Viddy] lost focus on some things," he said.

For Mr. O'Brien, it's now back to the basics of improving the app. Viddy is hiring and currently has about 30 employees. This month, it released an app for devices powered by Google Inc.'s GOOG -0.86% Android. The company also plans to launch a new version of its app early next year.

Mr. O'Brien said he isn't "hung up" on all the ups and downs, and Viddy has "learned a lot."

The hype "was a moment in time," he added. "We're fortunate we got to spend the last six months without the noise."

LOCAL

For LivingSocial Inc., 2012 has been a year of contraction.

Enlarge Image

Agence France-Presse/Getty Images

LivingSocial has now tabled an IPO, and its valuation is declining. Here, a view of the reception desk in Washington earlier this year.

The Washington, D.C., daily-deals firm rode the boom last year along with rival Groupon as consumers paid up for the online discount coupons the sites offered from local merchants.

LivingSocial raised about $580 million in funding last year; its latest $176 million round in December 2011 valued the company at $5 billion to $6 billion. LivingSocial used the money to expand and build its brand, including blanketing TV channels with ads.

LivingSocial also began talking to bankers in the summer of 2011 for an IPO that would raise about $1 billion, people familiar with the matter said at the time. One person said the company, which was founded in 2007 and is led by CEO Tim O'Shaughnessy, said LivingSocial was "all teed up" to go public. That position changed soon after Groupon's November 2011 IPO, when its stock began to drop partly amid questions over the sustainability of the daily-deals business.

LivingSocial has now tabled an IPO, and its valuation is declining. Amazon.com Inc., AMZN +0.66% a 29% stakeholder in LivingSocial, said in filings that LivingSocial's book value plunged to $324 million in September from nearly $1 billion in June. Groupon's stock, meanwhile, has fallen nearly 80% since its IPO.

"When the only comp for us is Groupon, and Groupon's value has come down a long way, that has a bearing on LivingSocial," said Jeremy Liew, a venture capitalist with Lightspeed Venture Partners, a LivingSocial investor.

LivingSocial is no longer airing any TV ads. In October, the company reported a $565 million third-quarter operating loss, compared with a roughly $400 million operating loss in all of 2011. Recent losses were mostly due to write-downs from the declining value of some acquisitions, the company has said.

Last month, LivingSocial said it was cutting 400 jobs, or about 9% of its 4,500-person workforce. It added it was moving the bulk of its customer-service operations to Tucson, Ariz., from its headquarters and is scaling back some office space.

The recent changes "put us in control of our own financial destiny as we move into 2013," said LivingSocial spokesman Andrew Weinstein. He said Mr. O'Shaughnessy wasn't available to comment. An Amazon spokesman declined to comment.

LivingSocial is now trying to separate itself from Groupon with offbeat offerings such as food-ordering services and cooking courses with rapper Biz Markie. The company has said it favors such special events because they can be priced as it sees fit and aren't dependent on discounts off of menus.

LivingSocial investors said they remain pleased with the company's trajectory. In an October note to employees, Mr. O'Shaughnessy said September was the company's first cash-flow positive month.

"One of two things will happen: Either the public markets will recognize more value in Groupon, or we'll continue to take share away from Groupon," said Mr. Liew. "Both of those will take a couple of years. But that's OK."

SOCIAL

Kevin Chou wants the world to know his social-gaming startup Kabam Inc. isn't like Zynga.

"We can show the market we're an incredibly different company than Zynga," said the 32-year-old CEO.

Mr. Chou's San Francisco company, founded in 2006, benefited when Zynga's rise helped spur investor interest in the social-games category. Amid that buoyant climate, Kabam raised $125 million and was valued at $525 million as of its last financing in May 2011.

Now Zynga is wrestling with losses, and investors are shying from social-games companies. Tim Chang, a venture capitalist at Mayfield Fund, said he has pretty much stopped investing in game developers because the growth waves from new platforms such as Facebook and the iPhone have passed, among other factors.

"Investors are skeptical now," Mr. Chang said. "It creates extra friction to explain on your IPO roadshow how you're different from Zynga."

Mr. Chou, who is eyeing an IPO in the next two years, said his 580-person company is distinct from Zynga because Kabam makes more intricate titles such as the strategy and empire-building game "Kingdoms of Camelot," compared with more casual games like Zynga's "CityVille."

And unlike Zynga, which has been weaker in mobile games and remains best known for its games on Facebook, Kabam now makes only 30% of its revenue from Facebook's website, with the rest split between partner websites and mobile devices like the iPhone, said Mr. Chou. Kabam's revenue comes from sales of in-game virtual goods like digital weaponry and other game enhancements.

Kabam is also still growing fast, he adds, with projected revenue of more than $160 million this year, up more than 60% from 2011. Zynga posted an 11% decline in revenue bookings, or the actual value of virtual goods sold, for its most recently reported quarter.

Still, Kabam's coffers aren't rising as the company spends to buy other gaming studios. Of the $125 million that Kabam has raised, the company has about $45 million left.

Mr. Chou said that's all part of Kabam's growth plans. "We've had a lot more interest among bankers in the last six months," he said. He adds that the startup is developing 15 new games for 2013, as well as a new line of business that he declined to disclose.