[This post has been coauthored by Abhishek Surendaran, Principal, Exfinity Venture Partners.]
There is a lot of buzz about startups over the past few years and justifiably so, given the disruption that these are causing by either decimating existing business models or creating new business models where none existed. A lot has also been written about their funding, unicorn status, acquisitions, and exit.
However, the media writes overwhelmingly about successful startups and while few articles are written about the failures, it is not in proportion to their mortality rate. If you ask any VC or look at statistics of success vs failures, you will find invariably that approx. 10-20% of the VC portfolio gives blockbuster returns – the rest either give par or mostly sub-par returns but the blockbusters really return your fund.
The phenomenon of power law in VC portfolios is well-documented and popularised by Peter Thiel in his VC bible “Zero to One”. The power law is a modification of the 80-20 rule which dictates that 80% of the returns of a VC portfolio is from 20% of the deals. The deals that provide blockbuster hits are called Unicorns – startups that are valued at > $1 Bn.
Union Square Ventures and Sequoia Capital US lead the unicorn tables with a hit rate of just 8% and 5% respectively. This is not surprising as only very few startups can get it right in terms of team, product market fit, capital, business model etc. Increasingly, most tech-led businesses are becoming winner take all businesses. As a startup progresses from Seed stage to Series A, B, C etc., the bar for business metrics keeps increasing and just 1-2 companies emerge as victors. As per a report by PwC, over 100 horizontal ecommerce companies were launched in India in 2010 but by end of 2015 only two – Flipkart and Snapdeal – survived and emerged as victors.
Why are the mortality rates so high? What makes start ups succeed? What makes them attractive to acquirers? What has been the key learnings thus far?
One of the prime reasons why few startups make the cut is because they have successfully metamorphosed their idea into a business. Many startups fail because they fail to decipher the problem statement correctly or assess the opportunity size or fail to understand the competitive scenario which results in an abject failure to design a robust and differentiated value proposition. I am not going to delve into this issue.
There are, however, startups that have seemingly got everything right – team, problem statement, technology, product, funding, customer and market insights but still fail to deliver returns commensurate to their potential.
A Sustainable Business Model Is Need Of The Hour
Housing.com falls into this category. The startup had a charismatic leader, a large market, an innovative product , huge funding ($150 Mn) , marquee investors etc. As per news reports, the company was valued at more than $250 Mn in its previous funding round but was in discussions with Snapdeal to acquire it for $50 Mn-$100 Mn .
But inspite of the public nature of the spat between the founder and the investors, the real reason for the downturn in Housing’s fortune was the lack of product market fit and its inability to build a business model that can justify its valuation. A similar story has panned out at Jabong which was snapped by Myntra for $70 Mn in 2016 while it was valued at $508 Mn in 2013 . The culprit is again the management’s inability to build a sustainable business model.
This is when the problem starts becoming interesting. Why would a startup having every possible thing going for it, meander? According to us, one of the prime reasons why such startups fail to realize their potential is that they remain as startups – they fail to transform their startup into a “ “business” – and only sustainable business can have increasing or sustainable valuations. Early-stage investors bet on a team, idea, product, market etc., but do not value companies as its impossible to value companies early on.
According to us, one of the prime reasons why such startups fail to realise their potential is that they remain as startups – they fail to transform their startup into a “business” – and only sustainable business can have increasing or sustainable valuations. Early-stage investors bet on a team, idea, product, market etc., but do not value companies as its impossible to value companies early on.
A company’s valuation is determined after Series B, C rounds. It is, of course, not necessary to show profitability or even revenues early on. But the product the company has built must show clear signs of high customer engagement and scalability, for eg. Google, Facebook, Whatsapp etc. At the bare minimum, a startup must create a universally-liked product that can add value to users.
A few startups might get acquired at stratospheric valuations for their technology, for eg. Deepmind was acquired by Google for over $600 Mn but had no commercially launched product or business model. These are the exceptions and not the norm. Also, an acquisition is not the benchmark to determine a startup success.
What does it take to transform a startup into a business?
Absolute Clarity On Product Market Fit Which Is Understood by Stakeholders
Product value proposition needs to be clearly articulated and it should have sustainable differentiation vis-à-vis competition. While competition does catch up and gaps are rapidly bridged to overcome differentiation, challenge is to continually listen to customers, build relationships, make the product proposition better and execute on the promise made to customers.
Clarity is needed on which customer segments and markets you are going after. You can’t be everything to everybody so pick your battles and be mindful of your resources and execute well. It is extremely important and many startups falter because they have no idea on “what we will not do” and end up doing everything, thereby having a muddled proposition or frittering away resources without any focus.
Uber has built a strong customer loyalty around the world by focussing just on the point to point transportation problem. On the other hand, fab.com went bust due to premature expansion to Europe and holding inventory. Fab was valued at $1 Bn before being sold at 15 Mn.
Respect the competition and always track their movements on several parameters. Most startups have a very myopic outlook towards competition and track metrics like funding received or customer acquisitions. However, there needs to be sustained tracking of various tangible and intangible metrics like quality of hires, patents, and quality of IPR, pricing, customer engagement processes, product features, and functionality, assessment of technology and engineering etc. Many startups have an exaggerated view of their own competitive position and by creating charts that show this to the investors, they also start believing in this which could prove disastrous.
Build an objective assessment of competition and build differentiators.
Sustainable And Robust Revenue Model With A Strong Focus On Cash Flow
Any company that needs to build a business must have a strong revenue model. The litmus test for a startup is whether customers are willing to pay for the value proposition they perceive.
While one can look at an appropriate pricing model at different stages of evolution (discounts, freemium etc. for initial customer sign ups or for marquee customers) it needs to be understood that getting customers that do not pay or do not wish to pay for your product is your first sign that they do not perceive value.
Successful entrepreneurs are those that read those signs and either pivot, re-work their proposition or retreat. Most failures occur when you continue to push your “value proposition” when the market signals are loud and clear.
Focus on cash flow is absolutely essential to build a business. This needs a complete understanding of your pricing model, your burn, overheads, collections, and payables. Strong businesses are built on robust cash flows and not on burning disproportionate cash to acquire customers or retain them. A judicious balance needs to be achieved between conserving cash and using it build a sustained and differentiated business.
Consistently Execute On The Strategy To Deliver On The Promise
Execution is what differentiates the men from the boys. There is no point in acquiring customers or penetrating markets or creating a media hype unless the start up can execute on its proposition. Execution needs strong attention to detail and it transcends several areas – product quality, product performance, product scale to processes that are customer or market facing to configuring an appropriate team with well-defined roles, competencies, and remuneration to other support processes.
While it is understandable that startups may not have systematic processes like a well-oiled business, there should be enough thought on paying attention to these details so that you create a “Wow” experience for your customers. Conversely, if you do not deliver on your promise and the exit barriers are not strong, the company can be in trouble no matter what funding, quality of manpower or your campaigns may proclaim. One of the key messages here is therefore, focus on “How” rather than “What”.
Capital efficiency is the hallmark of good execution. Many Indian startups fail to build capital efficient firms because capital was abundant and labour was cheap and abundant. In the new world order where capital is constrained startups are required to show more revenue per employee. This transition has not been easy.
Most startups though call themselves as tech startups have failed to invest and build technology to automate repeatable process.
Uber is a classic example of building scalable technology. Till recently, Uber had less than 10 employees per city in India while its competitors had greater than 150 employees per city. Even more astonishing was Uber’s customer satisfaction levels which was better than competition. Uber has publicly stated that it has broken even in US a unique and rare feat for a startup that has raised $8 Bn and has a presence in 300 cities worldwide.
Building The Right Organisation And Culture
Appropriate organisation design is imperative to achieve success as a business. While it is acceptable to have an amorphous organsation structure when you begin, it is also important to create and set the right expectations (even among founders) on how the organisation will evolve as the company makes progress.
For example, there may not be much emphasis on building sales or marketing bandwidth when you are starting up and working on the product (although it needs customer and market insights) but as you make progress these roles will come into play.
Founders who do heavy lifting have to realise and cede control over some of these functions to professionals else achieving scale will be impossible. Founders need to have the sagacity to realise that they do not get fixated with certain roles but find the right people to fit those roles, particularly at the leadership level.
Having designed the organisation, it is equally important to walk the talk and create a fertile environment for people to express themselves, collaborate and perform by aligning incentives. These softer aspects are often ignored and fixing organisation design and culture at a later date is extremely complex and cathartic.
Transforming a startup into a business is about achieving scale and it is not possible to achieve scale unless the organisation design is appropriate. Remember that the people who take you to the base camp may not be the same who will take you to the peak.
There is, therefore, no special mantra to transform your startup into a business. A lot of it has to do with developing an “outside in” perspective as well as to dispassionately introspect and evolve. The ability to make timely course corrections without being dogmatic is the key to success. An idea however brilliant it is, will never succeed unless strong thinking and an affirmative action that underpins the areas mentioned above back it.