The glorified unicorn hunt… It’s the latest trend on the street to be an entrepreneur. With the increasing supply (number of startups) the number of VCs, Corporate VCs, Crowdfunding platforms et al (demand) is also increasing. Good ol’ economics 101. After all, the second biggest trend and buzzword (second to being an entrepreneur, obviously) is innovation. Everyone wants to be digital. Rightly so. Everyone also wants to get their share of the new Facebook pie. I mean if the guy who dropped out from University can do it…
I bet this guy’s Lemonade Stand valuation is in 9 digits, because, you know it’s on demand, organic, hand made, all American lemonade which is delivered to you by a drone managed by AI, right?
Well, maybe not, but anyway it’s a ‘cool’ concept. As the number of startups (trying to disrupt lemonade stands) increases so does the noise. As a result, the overall quality of startups has arguably gone down. It requires less capital and risk to start a business. Plus it’s looks sexy on your CV.
A further fuel to the fire (in a very positive way) is the shift in mindset of the large corporates towards startups. They are much more willing to engage in a working relationship with an unknown company, or an early stage startup, often becoming that crucial first or second client. While the fee of anything under £10,000 is usually less than the cost of a coffee breakout session at their quarterly town hall, large corporations are still careful. You don’t want to bet on the wrong horse and let the winner runaway with your competitors.
Lack of information on startups is an issues stopping the corporate partnerships from forming.
The Startup Stack Is Changing
Lucky, the startup stack is changing to address that. Here’s how I imagine it.
The first layer is the actual startups delivering (better) solutions to existing problems targeting retail customers or large corporations. Roughly 5 years back, we started seeing a new layer forming, the support platform for the startups, i.e. startups who are trying to solve problems that other startups create or face. Think of services like airbnb letting agency or products focusing on startups, such as Xero the, accounting platform.
With the choice so vast we are seeing the third layer forming to help navigate the treacherous sea of upstarts. It’s the discovery and validation layer:
The discovery layer – one of the more prominent here are ProductHunt, an aggregation site with popularity contest element of reddit (upvotes and karma).
The validation layer – the companies that can provide a badge of honour or a golden star to help companies stand out from the crowd.
The example for the latter would be Early Metrics, the first rating agency for startups and innovative SMEs. I was very intrigued by their business model so I have met with the co-founder, Antoine Baschiera, recently to discuss how it works and where he thinks Early Metrics come in (you can read the full interview here).
The company is a rating agency for startups that helps to ‘score’ their business potential and innovation. I found their business model intriguing. They avoid the usual conflict of interest (at least in my eyes) of the party being scored also paying the fees to the agency (as is the case with Moody’s, Fitch etc). Startups don’t pay to get rated. Early Metrics charges the decision maker who are looking to engage or invest in these startups. They then get a monthly report with the rating of a selection of startups in their selected fields and/or the analysis of startups they are particularly interested in. I think should help solve the information asymmetry that exists right now.
The Decision Process – Is It Going To Be Yes or Next?
The process of how large organisation would approach working with an early stage company is very linear. A simplified version would look and like this:
That’s the happy path, either company can pull out at any stage before the commitment happens. The hardest hurdle to pass is the stage two – will the large corporate allocate any resources to investigate this opportunity. What information would they use?
Frequently, the counterparty could be tempted to judge the quality of the startup by their VC investors and the stage and size of their latest funding rounding but this can be misleading. Bad VC investment does not equal bad company, neither does good VC investment guarantees a good company.
The reason is simple, VC has a goal to return x5 their initial money invested over 10 year period. As it is difficult to deploy VC funds quickly, and accounting for potential delays on exit, a typical VC firm is looking for an exit within 5 years. Often, if the company has great potential but the exit may be 10 or 15 years away, VCs will shy away from such investment. Hence the public outcry from VCs about Uber’s decision to stay private for so long.
This is why I think valuing the upstart for its business merit is so critical. Independent rating agencies can improve the quality of the startup ecosystem, analysing companies for their business merit not the potential to produce x50 return to its investors.
After all, if you’re a large bank looking to implement a middleware solution to stitch your current two systems together, you care about how sound the business is, not how rich their investors/founders are going to be in 5 years time.
This is a welcome change at the times of a constant chase of the unicorns and ludicrous obsession with higher and higher valuations. At the end of the day, the startups used to be about solving real problems not cramming as many buzzwords in your product description and trying to grow a horn on your forehead, and if that’s the only goal then I can save you the pain – you can buy one for $50 here. Why wasting 5-10 years of your life? 🙂
Thanks for reading! 🙂
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Also published on Medium.