Hey startup! You will fail.

You can’t avoid maths and statistics in life. If you are a Startup you will likely fail.

The “Startup” is a business model in itself. Founders try to convince themselves they are in the business of X, Y or Z. When in fact, they are in the business of V for Venture Capital.

So I’d like to help Startups overcome their cognitive dissonance on this or maybe it’s just a a blind spot.

The most powerful investor group, the last holder of equity, before retail buys it on the stock market, are Venture Capitalists.

I see the “Startup” as a business model in itself designed by VC’s because this powerful investor group asks and expects founders to follow a market accepted paradigm. They ask this without regard to the appropriateness of that for your market, product, service, lifestyle, risk appetite, location, growth intentions and more.

Angels are also compliant with the VC styled Startup playbook. Angels need VC’s to invest causing the Angels to get some valuation uplift under their wings.

In the Startup model the founders are heavily focused on capital raising. It is almost as though that is the entire purpose of existence for some founders. It becomes religious.

There’s even multiple systems in place in the paradigm to ensure all startups keep with the program. Creating alignment and group think is best facilitated by some key tribal hubs. Collaboration and knowledge sharing will reinforce the paradigm more likely than encourage contrarianism or God forbid, disagreement. Else you might need to leave the friends group in the school yard. It’s not for you.

Incubators, Co-working, Startup Conferences and Startup Mentoring are just some of these tribal hubs.

Don’t get me wrong they can be a blessing (if you are completely new to entrepreneurialism) but can also be a curse. I’m not totally against any of these, we partake ourselves but from a position of seeing them for what they really are.

So what business are startups really in?

Well that depends on your perspective. From a VC’s perspective you are an investment with a payoff profile not unlike a cheap Call Option.

Now to avoid complication lets simplify this as a very small bet with a very large potential payoff that is limited by time (cash burn).

When VC’s make enough of these bets (as a portfolio) the VC’s tend to win over time (averaging effect of many bets placed at odds in their advantage). They need to place lots of bets because mostly startups fail. It’s like Sales, you need to earn lots of No’s to get the Yes. Picking the best bets is the VC’s craft.

From the founders perspective you have found a problem in the market and you have a great solution. That’s your business from your perspective. Next you are going to carve off a huge amount of time to get on your bike, peddle hard around town and collect investor money.

What is the VC Paradigm Startup?

More specifically startups are call options in a growth feedback loop.

The earlier the investor is in the cheaper the call option (but note there is also more future dilution). So the paradigm and the playbook employed tend to look like this (simplified)…

Startups begin with the founder often seeking a co-founder for skills coverage and to share the financial load. Noting that they invariably stuff up the equity splitting exercise. Next family and friends are sold on the idea and that’s often the first capital raising. The funds primarily being used for innovation and operational systems. These funds don’t last long so next Angel investors might be next in and their money starts to deviate into more customer acquiring activities. Sales/Marketing spend is at its core. Growth is God.

From here it’s a simple cyclical model:

  1. Raise capital
  2. Buy market share using said capital
  3. Pitch increased Customer Growth Rate (CGR) to ask investors for more capital.
  4. Go to step 1

The typical startup using this model will work the loop tirelessly until their probable death.

Death, because less than 1% of you will get to the end of this Darwinian exercise.

I prefer the authenticity of being blunt and the tools of science, maths and statistics.

The typical capital raising hierarchy is:

  1. Co-founder
  2. Cheap early employees (proxy form of funding – cheap labour)
  3. Early employees invest
  4. Early partners and/or customers
  5. Family, friends and fools
  6. Angel investors
  7. Venture Capitalists
  8. Big Venture Capitalists, ones that need $5mio+ revenue hurdle met.
  9. Local stock market listing in your country (non-USA)
  10. NASDAQ Listing
Some startups might hit up these investor segments multiple times. So how do you know you are an innocent victim of this lie? These businesses will likely have a business model canvas and a long form business plan written up (an overly optimistic document for selling the business to investors) but they will be in denial about what their actual business model is, Capital Raising. As an example I have asked new startups what business is Qantas in? They will say “the Airlines business”. Qantas is really a conglomerate of multiple business models that are quite distinct. They are:
  1. Commodities trader (oil prices)
  2. Labour hire and services (crew)
  3. Technology Sales/Marketing stack (digital sales/marketing)
  4. Lease management (interest rate trading and asset management)
  5. Partner and affiliate sales (channel sales)

You could re-cut these in a few different ways and I have left some bits out for simplicity.

Should Qantas be in the Commodities trading business? If it doesn’t hedge all forward oil exposure then they are whether they know it or not. They would be risk exposed to Oil prices and their P&L would reflect that over time.

Should Qantas be in the Lease Management business? Well if it leases planes instead of holding planes on balance sheet then it is. They need to manage interest rate risk. Billions of dollars of debt.

So if you are a startup and as the CEO/Founder you spend all your time raising capital inside the VC Paradigm then you are in the capital raising business plus that other thing you used to do all day when you first started.

At this point you might be saying but I do lots of product development and PR. I’m sure you do, but look honestly at the time you spend and the activities that indirectly all about capital raising. By default if you don’t spend time on Capital Raising activities then you are an organic growth business model. Customers and channels will be the ones grwoing your business. There are startups like this by they are dwarfed by the a-typical startup going after funds day after day, living the VC styled Startup playbook.

Bubbles, butterflies and bullets.

Some startups are so good a faking or fueling hype that their equity price gets way beyond reality into bubble status. We saw this recently in the farce that is WeWork.

In acquiring market share fast it usually requires great deals and offers rather than attracting customers due to brand loyalty. Fast growth can imply a customer base full of flighty clients known as butterflies that might not be fully invested in the service or the product. There is a tendency to seduce versus attract clients which results in weaker LTCV and this is part of the bubble problem.

At the end of the day, if it starts to fall apart and the company can’t keep raising capital, then they have to start using bullets to reduce staff, make cutbacks and find ways to get the business profitable

Buying market share with capital raised funds often results in a manufactured sales/marketing model. Ad Spend and PR hype are king. This is the one that everyone seems to go for in the market. The issue being that with a mass-market type approach where you’re going for retail or the small business segments, it’s very expensive to get to that broad flat market. You may spend millions just educating the market. A mistake I readily admit having made at to the benefit of my competitors.

The growth required in the startup model means it’s tougher to target a niche or small addressable market more aligned to your value proposition.

You need to raise a lot of money to manufacture sales.

You’re raising capital by increasing market share in a feedback loop. Your using capital to more directly impact your CGR (customer growth rate) via sales marketing rather than a longer term organic innovation approach. The idea is that you can then go back to markets and investors and ask for more capital because you’ve got proof that you’re growing the business.

Businesses that get really smart at this model rinse and repeat it. They grow their customers then use that money to create more acquisition, then they go back to the market get more capital and cycle it up until they get to a point where they can find an exit strategy. I think many enter the grey zone in this area.

Retail buyers in the stock market are the last investors in the cycle and to be upfront I think take huge risk at this point late in the cycle. The payoff diagram starts to look more like a coin toss. Just look at IPO success rates over the last year.

Are you woke?

It’s good for startups to be awake to their situation, aware of their paradigm. It’s never spelled out honestly and clearly in my opinion. It’s the main reason I don’t involve myself in the startup community. Most investors don’t like my views on this. It’s against their interests. I don’t want to facilitate the lie.

After the Dotcom 2.0 bust happens there will be a time of self reflection and the paradigm will be called out for what it is. Things may swing back towards some balance between funding versus building.

I think Startups are much better served by going much further down the road before engaging VC’s. Look at example like Campaign Monitor or Atlassian. They approached the VC industry late, long after they grew themselves organically into profitable businesses. This dramatically improved their probability of success and survival. Product/Service focused, not funding focused.

I hope it does because I believe innovation should be at the core of a startup. Being a maker, inventor, creative marketer and attracting customers to your brand through great product and services. Once upon a time there was a lean “customer solution” focused startup paradigm of running from the garage. It was fuelled by self belief. It feels long lost. Remember how Apple started? Now days precious startups blow their money on Ad campaigns and expensive WeWork offices. Their focus is on spending and raising instead of inventing and making.

Photo by Marius Ciocirlan

Categories: Startups

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