Report: Most Storage Startups Flop

Despite the tech bubble bursting, venture capitalist firms have continued to pump billions into storage projects. But most of the VC-backed companies will never see financial success, according to a new report from Crescendo Ventures.

The Crescendo report, "Venture Investing in the Storage Sector: The Cold Hard Facts," shows that VC firms have pumped over $3 billion into more than 150 storage projects over the past three years. This supports Byte and Switch Insiders conclusion this month that, while the sector has also seen a drop in VC funding since the crash, it remains well funded compared with other sectors (see The Billion-Dollar Slump).

But the Crescendo report also predicts that the majority of venture-backed storage companies today won’t achieve the level of commercial performance required to make them financially successful. In fact, the report, which looked at 456 early-stage storage companies over the past 34 years, shows that seven out of 10 storage ventures fail.

And the bad news for VCs investing in storage doesn’t stop there. In order for a VC to achieve its target of at least tripling its investment in a company, the company has to be worth about 10 times the total funding it has received when it enters the public sphere. But of the three out of 10 companies that actually survive, the report shows that only 27 percent achieve a return of 10 times the investment, while 34 percent are worth less than three times the total investment in them.

So, how can VCs spot the winners in that sea of losers? John Borchers, a partner at Crescendo and co-author of the report, suggests that investors take a hard look at what storage segment a company is playing in.“There’s an unintentional mis-gearing in the way different storage companies are capitalized,” he says, pointing out that, while the amounts invested in different segments are about the same, the number of companies that actually survive in the different segments varies greatly.

Figure 1: Source: NVCA, Thompson Financial, VentureOne, Company Reports, Dow Jones Factiva Database

The report shows that mean total investments in storage companies in nearly every segment is clustered around the $25 million mark (except service companies, which received a mean investment of $61.7 million). But while 56 percent of all funded tape companies, and 35 percent of all disk and component companies make it to IPO, only 23 percent of NAS vendors and a mere 17 percent of service vendors persevere.

Figure 2:

Source: NVCA, Thompson Financial, VentureOne, Company Reports, Dow Jones Factiva Database

“People are investing the same amounts, but with dramatically different outcomes,” Borchers says. “There’s much lower success in services and NAS.”The fact that good old tape vendors have done so well, also goes to show that the investment community's tendency to chase the next best thing doesn’t always pay off, he says. “There’s a lot to be said for investing in stuff that may not be quite as sexy." [Ed. note: Not quite as sexy as network-attached storage? Hubba-hubba!]

On average, the report shows that it takes storage companies seven years to reach an IPO and that companies that receive much more funding than average have less chance of success.

Figure 3: Source: NVCA, Thompson Financial, VentureOne, Company Reports, Dow Jones Factiva Database

The report also shows that companies founded by techies have a better chance of making it to an IPO or of being acquired than do companies with marketing or administrative founders. “Often, investors like to see a full management team around the table from the get-go,” Borchers says. “But in many cases it may be better to not have anyone in business development and marketing in the company for the first couple of years.”

In addition, the report shows that investors should be wary of funding companies offering technologies based on evolving or not yet existent standards. “There’s a lot of naiveté surrounding how long it takes for standards to be adopted,” Borchers says. “Often, companies think the standard’s just two to three years away, but in almost every case over the past 30 years, it has taken six to seven years.”

Figure 4: Source: Fibre Channel Industry Association, SCSI Trade Organization, ATA/ATAPI.com, Company Reports, Dow Jones Factiva Database

And while the report shows that it takes seven years on average from the time a standard is first conceived to the time it is approved, it also indicates that it often takes several years after that for companies to actually make money off the standardized technology.

— Eugénie Larson, Senior Editor, Byte and Switch