Beware of the Mega Money Startup

The Internet world might summarize former CEO as "the guy who didn't sell his company when it was hot."  Jay Adelson would be quick to point out for all the Monday morning quarterbacking, no company actually offered Digg a real deal.

But his experience, watching Digg go from the cover of BusinessWeek to a eulogy (weirdly, both written by the same author) probably gives him a wisdom few in the valuation-happy valley seem to have.

"We've seen [bubble-like conditions] before," says Adelson.  But of Facebook and Twitter he says "these private companies do have revenue potentials, when you look at the fundamentals, do take you up into the billions of dollars in valuations."

Where Adelson sees trouble is in what he calls the "roll off effect."  The high price of Twitter pulling up the valuation of a group texting company.  Or social network Facebook lifting a brand new social startup to new highs.

"Particularly in the early stage of investment, when there's a spike of valuation for series-A venture capital, that's scary," Adelson said.

Though he did not name app developer Color Labs by name, he might as well have.  The company has developed an iOS and Android app that allows you to share pictures with people nearby.

Venture capitalists have poured a staggering $41 million dollars into first round funding.  Why? 

Probably because of Color's pedigree.  Its founder sold his last company, LaLa to Apple.  And it makes apps.  Apps are for the iPhone. And the iPhone is really popular.   That's our first clue: just as Adelson says, a startup's link to Apple can lift valuations higher.

But can an association with Apple really get you $41 million dollars in funding?  Probably not alone.  Add in its social function -- Color lets you share pictures with people.  That's social!  Facebook is social!  And you suddenly you have $41 million.

This for a company whose app currently scores 2 stars on 237 ratings on the App Store.  "This is nothing more than Chatroulette" points out one reviewer.  "Only a matter of time before porn shows up."

Reviewer Chris Wronsky says Color is "Social to be social, location to be location."

Color Labs isn't alone in its unusual funding of course.  A Chicago startup called "DealsGoRound," which allows people to sell coupons they bought on Groupon just got angel funding.   It's associated in some way with Groupon!  Groupon is worth billions!   Gilt by association again.

As for Jay Adelson's advice to the CEO of the real Groupon?  Adelson says based on the revenue data he's seen,  his business sense says Groupon was right to turn down Google's multi-billion dollar offer.

But common sense demands, he says, "if someone offers you a billion dollars for your business you should say 'yes.'"

Adleson will appear on this week's episode of Press:Here, Sunday at 9 a.m. on NBC Bay Area.

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