New Tech Incubators Put Finances First
wsj.com
wsj.com
I still think Clayton Christensen's "Be patient for growth, not for profit" quote is the sanest way to build a business.
I understand the idea of giving startups money to explore business models but I also think it can lead companies astray and into some very problematic business models like Ubers where subsidizing is disguised as a business model.
It's not that it doesn't work (it works remarkably well) it's just that it's creating a lot of companies taking in a lot of talent who aren't creating anything and I personally do not think the few that do end up being successful makes up for it.
If you are forced to look at your finances you are foced to look at where you can create value that people want to pay for.
People want "finances first" investment, but then complain that all we get is a bunch of sharing economy clones. If you want something other than doordash, uber, airbnb, instacart, caviar, lyft, etc. you have to be prepared to invest into ideas that have no financial story in the short term.
Edit: I can see from the responses that there is some confusion. I am of course not talking about companies who do some sort of research based incubation. I am talking about the host of companies who do no research or innovation and simply use VC money to get a team of the ground.
If you took the finances first approach, you would have missed Google.
Another good one is AirBnB. Staying in other people's homes was a pretty ridiculous idea at the time. Who would want to stay in a stranger's home? How does a company like that make any money? It's more obvious today but that capital had to be invested in order to open up the market for AirBnB to come in underneath the hotels and cement itself.
If you took the finances first approach, you would have missed AirBnB.
Yes, my examples are cherry-picked (I know someone is going to bring this up). But you asked for examples and here they are :)
I got the idea because some stranger on ICQ from Japan asked me if he and his girlfriend could live with me in Copenhagen for a couple of weeks in exchange for me being able to live with them if I ever came to Japan.
The service was called IKIKI (apparently meaning visiting each other and also at the same time a palindrome)
However, we ran into a lot of problems with generally getting people to trust each other.
I later ended up doing design for a couple of other airbnb ish companies amongst others vacationvalley.com owned by a very young swedish entrepreneur called Martin Schaedel who unfortunately died very early in a plane accident. http://www.businessinsider.com/2009/1/the-internet-says-good...
So I have had my experience with the Airbnb business model and never missed that. It was a timing question not a funding question.
It is not a good example as that had more to do with market adaption of social networks and mobile phones plus payment services than product innovation.
Not parent, but this seems to be key. Many say tech will be forever as innovative as it has been in past 10-15 years, but now it seems that all of that has simply been the effect of widespread adoption of the internet & smartphones, rebuilding parts of the economy on top it, and things are reaching saturation. Until there is another major breakthrough like that at the hardware level, we will see far less growth and unicorns.
It's not that there shouldn't be innovation done but you can't build a market only on that.
If you're talking about 2-4 million seed rounds, sure, back a great team. But when you're talking about nine-figure equity raises, you probably need a tenable financial model.
Another thing: software is high-margin. A lot of dumb VC is getting thrown into low-margin reinvention of relatively old business models (food delivery, hotels, livery), evaluated through software-like metrics. Maybe finances matter in low-margin scale businesses. It's just not as important in businesses based on pure software/design/IP-driven innovation.
Google Inc is a very interesting situation. I wasn't there as a fly on the wall during the first investment rounds but based on reading multiple sources of Google's history, it seems like there's been a little bit of mythology built up around Google's ascent -- some of which is perpetuated by very persuasive personalities like Ron Conway.
For example in the interview[1], Paul Graham asks Ron Conway if Google knew how they would make money and Ron says "no". So just based on that, it seems like investors such as VC firms Sequoia and KPCB made a blind leap of faith based on the sheer force of Larry and Sergei's brilliance.
However, other sources say there's actually more to that story. You have to split apart the "monetization" into 2 different strategies: (1) licensing the search engine to others like Yahoo and (2) AdWords.
When people say "Google didn't know how it was going to make money", they're likely talking about AdWords. However, Larry did have the idea of "licensing income" from the very beginning. The potential to sell a search engine license to Yahoo was why he was enlisting Ron Conway's help to connect him to the VC firms in the first place. With benefit of hindsight, we now know that Google pivoted from licenses to AdWords and it became the massive cash cow nobody predicted when the company was initially founded.
So VCs like Sequoia and KPCB did have "finances first" because they invested with the idea that licenses was a realistic revenue model. Contradicting Ron Conway, the VCs didn't necessarily need a 10th slide that showed the business model -- because they already bought into the licensing idea. Because of the strange way that mythology works backwards from the present, if you ask Sequoia today if they invested in Google without a business model, they will emphatically answer "yes" which reinforces the idealization that they "believe in their founders". It's an interesting feedback loop.
If there were Google investors that prioritized the idea over finances, it might have been the very first angel investors such as David Cheriton and Andy Bechtolsheim. Possibly Jeff Bezos as well.
If anyone close to the early Google days can correct the story, that would be helpful.
[1] deep linked at 16m20s and "Google didn't have idea about monetization" is at 17m04s: https://www.youtube.com/watch?v=1z87RGFGuxQ&feature=youtu.be...
An example company that might fit askafriend's argument better would be Craigslist. That started as a shared email list which grew organically into something bigger. Craig also turned down VC money.
The majority of the tech innovation for Google's original search engine happened entirely without VC funding. Google as a search engine was already up, running, indexing millions of pages, and providing demonstrably better results than competitors by the time KPCB and Sequoia funded it in mid-'99. I distinctly remember the librarian at my school instructing us to use Google instead of other search engines in '98 due to its higher quality results. "Finances first" may still have held because running the original engine wasn't all that expensive and they didn't have a bunch of engineers to pay, so getting to profitability was not exactly a long shot.
In the case of Airbnb, you seem to have ignored that there was already a strong short-term home rental market in place before Airbnb came onto the scene. Homeaway and VRBO both predate Airbnb by several years and had proven the financial viability of the market. What Airbnb did was completely ignore laws and lease contracts forbidding hotel-style short-term stays, and combined it with an easier to use and search interface for both sides. Also, Airbnb had already proven the model before they took funding - they dogfooded it with their own apartment, then used the original 20K investment from Paul Graham to prove the business model before any large venture money was raised. This is absolutely a case where "Finances first" worked.
Even though Google's tech was built without VC, their consumer product and fundamental business were far from built and people had written off the entire web search space by that time anyway. It's kind of like if someone came to you today and pitched you something like food delivery with a better algorithm when nearly all major food delivery services today aren't doing so well and people have already developed strong biases against the space.
AirBnB isn't only a short-term home rental market though - it's a bit more cavalier of a product than that. Short term home rental does definitely exist on AirBnB and is huge but AirBnB also encompasses the spectrum between staying on someone's couch and straight up short-term home rental. The other difference is that it also covered massive areas that were traditionally ignored by hotels and other short-term home rental services. So in that sense, the VC money was needed to market the product appropriately, build trust with users through insurance guarantees, build liquidity in areas where it was a competitive advantage and do the legal/lobbying legwork. That's the real magic and that couldn't have been accomplished through a traditional finances first approach and certainly couldn't have grown so large so fast. Let me put it this way: whether AirBnB ended up as a cute hipster alternative to VRBO (which was playing in a tiny market) or whether AirBnB ended up as a straight-up hotel-alternative depended on VC money to believe.
Furthermore Airbnb is actually finances first as they had a business model from day #1 they weren't actually using VC money to find it first.
And google had their secret sauce before they got the funding.
The discussion I was trying to start though wasn't that you should never get funding but rather that way too many companies in my view uses funding when they don't really need it and instead could just start to charge.
By charging you are also more likely to solve an actual problem need people have rather than just giving the first fix for free.
Uber is perhaps a quantum leap in that many people can now work on demand and make money off one of their existing assets (also like Airbnb).
Moreover, tons of money being poured into financially bad shops kills real market and skews incentives. Companies that could be able to make profit die. Meanwhile, startups are motivated to target quick growth instead of actual profit - until bubble breaks and everyone is effed for no fault of their own.
Drucker points out that the output of a small startup is radically different from a large, mature organization. From a large organization, investors might want growth of 15% and final profits of 20%. But he also points out, this is both too little and too much for a small startup. From an early stage organization, it is important to see triple digit growth, and no profits at all. The sign of a successful startup is that it finds a business model that allows it to grow rapidly. Drucker also describes the failure mode where the small startup gets enough growth to survive, but not enough to become a mature, independent organization. It then limps along in a crippled state.
For my money, Drucker has a better density of insight-per-page than any other business writer. I strongly recommend him.
Getting 15% on a 100k real estate flip is one thing. Realizing 15% on 70 billion dollars is quite another.
Doing sales before you have a product is uncomfortable and frustrating at times, but it is the best way to know what to build and for whom you are building.
Are finances not entirely dependent on the business plan and or idea?
Applying a one size fits all approach is extremely dangerous.
In my opinion, it is all dependent on which space you are in. Margins speak volumes.(They tell the story of most businesses) For software, the issue of money is not as important as it would be for a hardware business because it's much easier to scale.
The fact that "now" incubators are focusing on ideas that make financial sense may be one of the silliest things that I have ever heard. What that shows is that these venture capitalists/investors are starting to realize that "free money"( super low interest rate environment) will end eventually and it will be more crucial for these companies to be catious on how they spend their money.
Frankly, hearing this is scary, because they are somewhat admitting that the funded people lavishly and asked questions later.
It always makes me wonder how they benchmark vc's who invest in startups. Considering their returns are not public, it is hard to say.
What is even harder to realize and gauge is how they measure "successful investing."
So much of this is luck, especially in a crowded space/market.
Usually the best ideas(the paradigm shift) will always have access to infinite capital, but the ideas that may not be articulated fully, will be severely constrained until proven. That is not a bad thing, but may add some reality to what creating a company is actually about. Who knows whether is good or not, but in a few years we shall find out.
Finance is important but product, engineering, and marketing are far more essential to making something people want, and that is why YC and the best incubators spend most of their time on that.
I think of the failed Kickstarter campaigns that had massive customer interest, but weren't able to deliver a good because it ended up being more expensive than predicted, or they delivered it at considerable financial loss.
Many founders are out to solve a problem which they think requires solving at a large level. The issue being not knowing - where to get the numbers. What is your market size? What is the income strategy? etc.
Sure, there are some companies which succeed massively despite this but majority go down under because they don't understand it completely.