The Health of LA's Tech Ecosystem Relies On a Few Large Companies

By Michael Carney , written on June 19, 2012

From The News Desk

LA, I’m concerned.

There’s no denying the momentum that’s been building in the ecosystem, but I’m hearing too many whispers of trouble at key companies to rest easy.

There’s been a stigma for a long time that LA companies start fast but don’t finish strong. MySpace boomed then went bust. Overture was a great company that got its ass kicked by Google (via former cross-town rival Applied Semantics). Too many LA companies that are considered successes reached the pinnacle via acquisition by an out-of-town giant, drawing the rewards away from the LA ecosystem.

What LA is desperately looking for is a company that’s going to stay around, reach a billion dollar vaulation, continue to grow, and make all those nine-figure acquisitions itself.

Like it or not then, the success (or lack thereof) of the newest crop of brand name companies emerging out of LA will go a long way in determining how the rest of the world perceives LA startups.

And this is where things get a little dicey.

We reported previously that once-hot employee benefit network Betterworks shockingly laid off half of its staff in May and shortly thereafter sent service cancellation emails to its customers. Unexpected as this was, it’s the nature of startups, and one failure does not a crash make.

Around the same time, celebrity-favorite video sharing network Viddy raised its latest round at a reported $370 million valuation. The round was a hot one at the time -- just weeks after Instagram sold for $1 billion -- and was seemingly great news for both the company and the ecosystem. Hindsight isn’t quite as kind, however, and the half-dozen or so VCs I’ve spoken to since have described the valuation as “greedy,” “frothy,” and “problematic for future financings or exits,” among other similar sentiments.

Remember, we’re talking about building long term, sustainable businesses, not just generating flashy headlines. With the sky-high valuation on its latest round, an exceptionally lofty bar has been set for Viddy to be considered a success. An underwhelming end to this story is not what LA needs.

Now bringing this all to a head, we've been hearing troubling signals out of the subscription ecommerce set. Since the beginning of 2011, $160 million has been invested in the sector’s top four VC-funded companies -- ShoeDazzle, Beachmint, JustFab, and Honest, all of which are in LA -- not to mention the dozens of smaller “stuff in a box” companies.

We reported yesterday that ecommerce maven Brian Lee's ShoeDazzle has seen a significant management shakeup and a business model pivot in recent months. Lee and others within the company suggest that it took these steps to enable otherwise unattainable growth, but it does give reason for pause. Also, a source at an ad network working directly with the etailer says that the company's CPA figures were so high, as recently as two months ago, to virtually guarantee that it can't be profitable. That's not a huge surprise, since its recent move away from subscriptions almost ensured a near term revenue hit from no longer automatically charging thousands of women every month for shoes which they may or may not want.

Similar concerns apply to ShoeDazzle competitor BeachMint, another widely celebrated LA startup which has been a tough one to gauge. The whispers of trouble are there. It's hard to tell what's going on because CEO Diego Berdakin won't talk to us. He's emphasized repeatedly that he doesn't care about being in the tech or business press, aiming for fashion magazines instead.

That could be because that's where his audience is. It could also be because he doesn't like reporters who ask hard questions about his business. After an earlier PandoDaily story took a hard look at subscription business models, I got a terse note from Berdakin saying simply, "Really happy I didn't do this interview." We reached out to Berdakin for comment on this story but -- not surprisingly -- did not hear back.

Most of the conversations regarding BeachMint have centered around its decision to enter so many different verticals in parallel (it operates subsidiaries in jewelry, fashion, cosmetics, footwear, lingerie, and home goods). The general sentiment is that the company is chasing “low hanging fruit” in each category as the cost of customer acquisition increases within its more mature business lines. If this is in fact the case, it calls into question the long-term sustainability of this lauded company. The strategy didn't work so well for Gilt, which has since been trying to figure out which verticals to exit.

I'm not suggesting that these companies are going to fail. ShoeDazzle, for one, has opted for a long term goal over short term cash, and that's commendable. But what can't be ignored is the signal they send over the health and viability of the LA ecosystem -- whether that's fair or not.

One reassuring datapoint while reporting this story was a conversation with an executive recruiter who’s deeply plugged in to the LA tech market. (This was one of several sources in breaking the BetterWorks layoff story.) My source tells me that there have been relatively few early employees looking to exit either ShoeDazzle or BeachMint, and that morale within each company seems strong. He cited vesting schedules and increasing valuations as key motivators.

Like I said earlier, times have been good lately in LA. There’s palpable pride and optimism mounting as the startup community has grown more united than ever before. (Even if not everyone loves the banner of “Silicon Beach”). Between a dozen incubators and increasing capital flows from both local and outside investors, all the necessary factors are finally coming together to create a healthy and viable long-term tech ecosystem. What that the city badly needs is to actually deliver on all its promise.

Should one of the above iconic companies go bust, the effects would be felt across the LA startup ecosystem. Should more than one of them fail, it could conceivably cause outside investors to ask broader questions about the ability of LA to build companies that scale.

I don’t say any of this lightly. I’ve lived in LA for seven years and now consider it home. My career is closely tied to the health of the ecosystem, and I know many of the participants personally and want to see them succeed. When you work at a startup, you know the pain of building something from nothing, and you can't help but root for the people pushing through that pain, refusing to take the easy acquisition way out.

For all these reasons, I badly want for everything I’m writing not to be true for it to be my overactive, pessimistic imagination. But I’m not convinced it is.