What’s behind the social startup decline?

Fewer and fewer entrepreneurs are starting social startups. Why? Fizzling IPOs and disappointing return on investments mean that social is no longer the investor darling it once was. The facade has fallen.

While some have warned against a coming social media bubble, it took volatile social startups like Groupon, Zynga and Facebook to make up-and-coming entrepreneurs think twice about starting a social-centric venture.

Social has traditionally been about user numbers first, business model second. It’s for this reason that analysts estimate Facebook stock to be at least 76% overvalued. As deal seekers turned on the online coupon business during the course of 2012, Groupon lost 80% of its value which saw the eventual exit of its CEO, Andrew Mason.

It’s not that these businesses aren’t special in some way — Groupon became the fastest growing company in history, raking in US$1-billion in 17 months — it’s that when users are the product, revenue turns as quickly as user sentiment. You have to feel for Groupon. The original social-buying company had it doubly hard at the hand of investor greed and a co-founder, Eric Lefkofsky, who was never in it for the long haul.

Social gaming startup, Zynga had a similar trajectory. It grew rapidly through virally permeating Facebook news feeds. Then, the company had a high-profile IPO, peaked at about US$14.69 two months later, and blam, free fall — a share is worth about US$3.41 today. The problem again, users.

The amount of revenue per user Zynga was making was declining. Why? The most likely explanation was a combination of Facebook news feed changes and gamer fatigue. Facebook tweaked its news feed algorithm to make it harder for Zynga to promote its older games virally. That, and Zynga started running up an accelerating down escalator as it tried to crank out new hits that fell short of the initial infatuation gamers had with Farmville.

Social and IPO doesn’t seem to go together. Perhaps, but how do we explain LinkedIn? While it definitely falls in the social category — it’s Facebook with a suit and tie — LinkedIn has a better business model, it’s called LinkedIn Premium. For a monthly fee you get a bunch of additional useful features. LinkedIn also monetises its ads well.

While it helped that LinkedIn’s IPO was more modestly priced, the key here appears to be the business model. Could it be the reason why Twitter still hasn’t had an IPO? Could it be the reason why Instagram took Facebook’s offer?

Y Combinator, the mega Silicon Valley accelerator responsible for companies like Dropbox, Airbnb and Heroku, recently played host to 500 investors looking to invest in new ventures. Of the 47 companies that pitched on the day, little to none were social startups. Instead entrepreneurs are solving “boring” problems while keeping sound business models top of mind.

“The valuation hike for early-stage companies occurred amid the boom in social networking and other consumer-facing apps and Web services. The disappointing IPOs of Groupon, Zynga and Facebook last year reversed the trend,” says The Wall Street Journal (WSJ).

On pitch day, startups presented revenue-growth charts, whereas before, the founders were focused more on the number of people using their service, Don Dodge, developer and startup advocate at Google told the WSJ.

So monetisation. Important. Yes, we get it. But could there be another reason? In social, there’s a finite pool of products (people), and it’s almost always one company that becomes king of the hill while all others perish. The market seems to support at most one, perhaps two social services with similar DNA. People flock to where their friends are and rarely do they like to repeat themselves to the same friends, on multiple networks.

If you’ve ever wondered whether or not there was a tech bubble after the one in the late 90s, yes, but it was a special kind of one, a social bubble, and some say it’s finally popping. The hype is over, new ventures are going back to basics, making money and perhaps even distancing themselves from the word “social.”

Where to from here? Many, many jobs have been created as a result of social startups. These jobs are held by talented people who work for great companies. There is definite value in these social communities, but the key here is to show investors that it’s possible to convert these audiences into consistent revenue streams.

Amazon recently bought social reading startup Goodreads, for it’s 16 million-strong engaged community. It’s a good move for both companies. Perhaps there are more of these partnership opportunities out there.

For now, it seems that there is little room for new social startups, and yet, human ingenuity knows no bounds. At this point however, a new social venture requires a spark of unprecedented brilliance. If you do have a social startup and intend to accelerate at some point, be ready to wow investors, if we’ve learned anything, they’ll want you to show them the money first, user numbers second.

Image source: Yahoo Finance