The Broken Startup System

Startups. It’s become hard to ignore the word. The media are full of it, everyone is calling themselves a startup founder, they are the new rock stars. If you haven’t raised funding, you don’t belong, because that is what startup life is all about, right? Attracting an investment? This startup system is completely broken.

Everything revolves around investments, right?

When you ask a startup how they are doing, the answer is often that they are busy bringing in an investment. Because it is very important to lock down financing quickly, otherwise they will never ever be able to attract their first customers. It’s with good reason that it does not surprise Timan Rebel (see the RTLZ article) that there are startups that spend 80 to 90% of their time bringing in financing. How on earth do you get the time to actually work on your product or service? The whole startup landscape has developed into a startup system that revolves around bringing in financing.

We are so completely focused on bringing in a VC investment or making an exit or public offering, that we almost forget what entrepreneurship is really about. Tatjana de Kerros underlines this in her article:

“That’s right, we’ve been so focused on VC investment, exits and IPOs as the only end-result of entrepreneurship, that we’ve started to trivialize the process and environment in which entrepreneurship takes place. We’ve gone so far in promoting ‘the cult of the startup founder‘, that lately, we’ve stopped examining what makes a startup grow, what makes it disruptive, and how it succeeds. We’ve actually even stopped caring about entrepreneurs unless they’ve had their startup featured at least once in VentureBeat or Business Insider (the only sure sign in today’s startup ecosystem that you’re on your way to the top).”

Startups that have brought in an investment receive loads of media coverage with the astronomical amounts of raised money. Startups that have grown autonomously are snowed under because of these reports, probably because they are not ‘sexy’ enough.

Startup Idea

Entrepreneurial Lifestyle

The image that the media paints on startup entrepreneurs is too rose-coloured. Entrepreneurs supposedly have flexible working hours, freedom, hyper modern workplaces, are young, hip and always cause radical changes. They pitch their idea everywhere, because they are ‘cool’ and go to every networking event. This Entrepreneurial Lifestyle is misleading the future entrepreneurs. They think that money is made when you often speak at events. These pitch events rarely or never lead to concrete investments, and almost never to contracts with launching customers. Of course there is always that one startup that’s the exception to the rule and does get successfully financed after a pitch or lecture.

Developing a startup takes an enormous amount of time. Time is the biggest enemy of the entrepreneur, running a startup is almost a double full-time job; you experience setback after setback and sacrifice a lot. You always have to work at the top of your game in order to bring in the first customers, retain them and continuously develop your enterprise. In the end you generate profit and clients by talking to the group that you wish to solve a problem for.

Why is this startup system so wrong?

The startup system is broken, people think they need to remain a startup. They bring in financing in order to be able to survive themselves. Founders make pitch decks that say nothing about the structure of cost and revenue model. Instead, it is explained what the dream is and the envisioned solution. Reference is made to a share percentage relative to a certain amount. This results in valuations of 1 to 2 million, without justifying this with a concrete revenue model or any assets. The only foundation for their valuation is: “we need it for the development of our app/platform or other prototypes”. The entrepreneurs don’t realise what will produce value and how investors look at these kinds of propositions.

What should be strived for instead?

Bootstrapped

Founders should first focus on a relevant problem that is common and large enough that people are in search for an alternative solution. The entrepreneur should invest himself or reach an investment through “Friends, Family and Fools”. Pre-seed arrangements are also an option for this, often in the form of personal loans. In some cases, financing can be completed with subsidies (for instance, in the Netherlands with the MIT arrangement). It is important that the entrepreneur understands what is happening in the market and how people experience the problem. If one is employed, a lot of this research can also be done while still being in another job. After all, the largest part of this phase consists of interviews and proposition pitches. There is still little commercial activity (revenue) and no product development.

Business model validation

When a relevant problem that people would like to have solved has been found, a solution strategy can be developed in prototypes. You may also transfer value “manually” to customers, for example by providing services themselves. You must focus here on validation of unknown elements in the business model. In terms of financing, Proof of Concept financing or Technical Feasibility studies can be considered. Investors will often not get on board yet, unless they come from the branch that you have figured out a solution for. They are able to estimate the value in an earlier stage than other financiers, that are not affiliated to the branch. There is no point in looking for bank financing or a VC firm in this phase. Alternative financing could be found through crowd funding, but be careful not to confuse any successes with real validation of your concept. The fact that many people get in on the crowd funding level does not say anything about the commercial feasibility of your concept. It says something about the degree to which people want to be part of the next-big-thing.

Crowd funding is good and a helpful addition to the existing financing landscape, but this phenomenon too is heading towards a bubble. One where investors (consumers) of the first hour are now seeming to lose their money, something they did not expect at all.

Value creation

In the end, everything revolves around the creation of value. When it has been established that there is a relevant problem, and people are willing to make an effort at solving this, it is important to keep further developing. When you develop a product with innovative elements, make sure that Intellectual Property (IP) is recorded in an early stage. There are special funds for this as well, such as a Pre-Seed arrangements. If you particularly benefit from speed, because there is no IP to record for your startup, make sure you start with minimal products. Don’t identify yourself as a ‘stealth’ startup. Come into contact with your customers immediately and stick to your vision. Accelerate and communicate openly to the market. Claim your position. Approach customers with a clear proposition and don’t get distracted by free demos. If you have something which proves to be necessary, people are willing to pay. Free demos cost time and you don’t have any.

When creating value, investors are opportunistic. They know what the profit is. Also, ask an investor what their horizon of profit is. Ask about available assets and risk appetite. What should the returns be? Be realistic in returns and prognoses. Clearly explain where the money goes to, based on data acquired from previous phases. Don’t go building castles in the air.

Only look for an investor if it’s absolutely necessary. Normalise the landscape, so investors will remain interested in (Dutch) startups. We can offer help in this early phase, have a look at our PreXLR program.

 

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