Christopher Mitchell of the Institute for Local Self-Reliance recently wrote a 3-part article talking about why Gigabit Squared (“G2”) failed in Seattle. His articles talk about the challenges that any competitor has when going head-to-head with a large competitor like Comcast. I would take that discussion one step further and talk about why G2 specifically failed in Seattle. I think there are valuable lessons to be learned from their experience for anybody entering a new market.
The biggest problem faced by G2 is that they had a hard time raising development capital. This is an issue faced by almost every new infrastructure project in the country, both private and public. The US investment community no longer has much taste for the high-risk involved in funding the first step of a project. I call this development capital, but when this capital comes from private sources it is often called angel investing.
Up until a decade or so ago new start-ups were able to find angel investors who would take a chance on a new venture that had promise. For taking that early risk the angel investors got really large returns and a piece of equity in the business. But today it seems nearly impossible to get enough money to get a project to the point of being ‘shovel-ready’. I think a lot of this reluctance comes from the last few decades that saw the implosion of a lot of tech start-ups. There were a lot of start-up telecom and web-based businesses that failed since the late 90’s and a lot of angel investors lost their entire investments.
Second, G2 planned to launch the business in phases, probably due to the hard time they were having in raising money. They planned to raise $20 million to first build around the University of Washington campus. Then they planned to raise a little more and build a little more and repeat until they built most of the City. In the investing world this is referred to as raising the money in tranches.
The problem with raising money in tranches is that it makes it even harder to raise the early money because the early investors can’t understand the big picture. They can’t know how any equity they get from the business will be diluted by future waves of investors. This approach also makes it nearly certain that the business will fail at some point, because every time the company needs to raise more capital they end up on a financial ledge. For example, even if they raise two rounds of money, they will probably fail when they can’t raise the third.
There is a general understanding among people that raise money that it is far easier to raise $100 million than $5 million or $20 million. I know that sounds non-intuitive, but G2 probably would have had an easier time raising the money to build the whole City than they did in trying to do something smaller. Investors can understand the big picture a lot easier than they can understand a project done in phases.
The third issue that killed G2 is that they didn’t hoard their early money. They had raised some early money and they did some of the right things with that money like doing engineering and building relationships with the City and with other carriers. That is the sort of developmental steps you should do with early money, and I would characterize those steps as getting the business shovel-ready and ready to raise the construction money.
But before G2 was funded they put enormous pressure on the business by announcing a timeline for when they were going to launch retail service. They announced products and prices and even went so far as to launch a website where customers could get on a waiting list for service. They created a lot of public expectation. They opened shop and hired a few employees in the market. The company began eating into their very limited cash with operating expenses rather than sticking with pure development of the project.
It’s fairly easy to see why G2 did this. They were having problems raising money and I think they were trying to create a stir about the project by showing community support. They hoped that public support would make it easier to attract the needed angel investors. But all this did was to cut short the amount of time they had to raise money.
G2 is not the first start-up to fail in a market, and they failed for some of the same reasons that have sunk other ventures in the past. Anybody thinking of opening a new market or new venture should look at the lessons to be learned from this. First, never underestimate how hard it is to raise developmental capital. It is probably the hardest thing there is to do in the business world. Second, have a business plan that contemplates the full build. I think G2 might have had more luck if they were trying to raise money to build the whole City than in trying to build a neighborhood at a time. And third, never spend money on operations until you are fully funded. If you have some seed money use it only for raising the bigger money.
And who know, maybe Gigabit Squared is not quite done in Seattle and can take another shot at it.