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Freemium Is Dead

I discovered Jason Tryfon the last night, the CEO of @vital_insights. He had a number of really cool and intersting posts on his website, but one in particular post from June 2010 stood out in my mind.

Jason explores the link between the venture capital market and new emerging companies with a freemium model gathering users. Is it sustainable, is it investable and is it the right way to build a company? Read on…

The venture capital market in the past two years has been interesting, to say the least. On a whole, transactions are way down, and what intrigues me the most – from a preliminary perspective – is that the valuations for intellectual property are reaching its tipping point, or an emerging bubble.  My fear is that when this bubble bursts – and it will – there will be lots of collateral damage.

I see the problem in these stratospheric valuations, being served up as venture capitalists clamber and climb over each other to lead deals, typically revolving around a social media-esque company. Has anyone learned anything over the last 24 months?

Few, if any of these companies have monetized, let alone exit. Most of the start-ups recently launched are yielding mega-million dollar valuations with no revenue.

Here’s what I don’t understand: millions of dollars for NO revenue, NO earnings, NO EBITDA, NO cash flow and most importantly, NO assets? Software code, which seems to be the foundation of these valuations, holds no monetary value, at least in the financial sector. A concept or idea being sold certainly warrants some blue sky, and a patent or two definitely helps. However, the actual investment into the company is being made on something without a tangible net worth and worst of all, it isn’t making any money.

Business 101 clearly stipulates that in order to make money, you need to spend less than you made.

The rules have changed, at least in the Silicon Valley, where the less one makes, the more it maintains its SUBSTANTIAL value. It becomes an interesting market where anactual business with income, revenue, and a strong EBITDA are constantly passed over by venture capitalists, private equity and angels.

They continue to wait for the next big social media winner.  Case in point: Foursquare and we can’t ever forget Facebook and Twitter.

Foursquare has recently turned down a $100 million acquisition offer. Personally, I’m still struggling to find any value in this company, even with its shiny new “geo-location” technology. The whole concept of Foresquare is annoying and I have yet to meet a person that cares if their friends “checked- in” to a Walmart, Dairy Queen, or McDonalds. And it’s not just me. Critics abound, with TIME magazine touting the social media company one of the WORSTinventions ever.

Yet, after all the indifference and lack of widespread acceptance, where did this valuation come from? What exactly was worth $100M? The data? Geo-location data? To be honest, that data isn’t worth much. Advertising agencies aren’t paying the premiums like they were 2 to 4 years ago for this kind of data. It’s strictly a commodity. Even bigger questions surround both the Facebook and Twitter valuations at $15B and $1B, respectively. These two have had years to monetize and develop a profitable business plan and neither has accomplished a thing. Sure, there have been hints and even an executive hire for a “VP of Monetization”, but nothing has come to fruition.  Want to know why? Freemium is dead.

Long gone is the business model of inducing users with a free membership to one day (hopefully) converting them to paying subscribers – that is so 2008 and so done.  For example, Facebook launches an insignificant user interface change and thousands of Facebook pages emerge containing a ton of users protesting the Poke removal feature. Good luck charging these folks to post pictures.

I can easily point to hundreds of overinflated deals in the Silicon Valley that will continue to bring false hopes for their investors, their funds and themselves, but I won’t.  The bubble is about to break open and big names are going to fall and like the subprime mortgage crisis, there will be damage.  Will this problem ever get fixed? I’m not sure. One suggestion for the capital community: release your addiction to social media.  While the concept and business models are important, it’s the value of nothing that needs to be considered and changed.

Follow Jason on Twitter at @jasontryfon and you can find his post on his own website here.