Starting up a new company for offering products or services, or both; to the market is nothing new. In these new times, concepts have changed with the rapid rise of technology and easy communications, but the basics of business remain the same as they have throughout centuries; a unique product or service, identification of customers, working partners to ensure seamless delivery and constant influx of capital.
Start-up founders in general are people with stars in their eyes and they rarely make an effort to understand reality. An idea or a concept that they “feel” will change the way of life is rarely a “product” that can withstand the acid test of the marketplace. Majority of start-up founders are unaware that the markets that they wish to sell their goods or services in; is dependent on a variety of factors; cultural values being the most prominent, followed by acceptance of the value proposition (what will the customer get in return for his spending the money), competition in the market from similar or identical products and services, and most importantly, the financial resilience of the start-up founders.
Most start-ups in India are technology based. And, start-up founders feel that the market will naturally absorb any and all tech based products without hesitation. That is where they make the first mistake. Technology offerings into the market require third-party validation, regardless whether it is software, hardware or system integration. Beyond the third-party validation, technologies require peer reviews, market reviews and finally customer reviews. Most Indian start-up founders refuse to get their products validated or reviewed since they believe that there will be Intellectual Property [IP] theft. This is a valid concern, but it’s a concern that can be controlled by having mechanisms in place to protect the product or service from concept to market.
Second issue within start-ups is the lack the vision to define the market share. Before the idea can gain traction, even at test levels; the founders start the evaluation game. Evaluation game is basically a fraud, perpetuated by the financers (aka Venture capitalists) under the concept of the “greater fool”. We will come to this concept later down in the article. The potential ‘market share’ dominance of any product or service in the market will not exceed 17% of the total market on an average and 25% of the market in exceptional circumstances. And; achieving this market share requires a well-defined strategy, a great team of dedicated individuals across the required verticals (tech, admin, HR, PR, marketing, and sales). As an aside, most entrepreneurs confuse PR and marketing with sales. They are separate entities that need separate efforts and unique strategies, which interact with each other to gain the market share and thus adequate profits. Hence, it is vital for the start-up entrepreneurs to define their market share in number of customers or financial volume to be achieved within a specified time-line.
About the ‘greater fool’ theory. This theory suggests that initial investors into a product, service or financial instruments can achieve profits through the sales of over-valued assets with a purchase price drastically exceeding their intrinsic value, and the idea that those assets can later be resold later at an even higher price. In this context, one "fool" might pay for an overpriced asset, hoping that he/she can sell it to an even "greater fool" and make a profit. This only works as long as there are enough new "greater fools" willing to pay higher and higher prices for the asset. Eventually, investors can no longer deny that the price is out of touch with reality, at which point a sell-off can cause the price to drop significantly until it is closer to its fair value, which in some cases could be zero.
The greater fool theory leads to the formation of Unicorns. In today’s financial terminology, a “Unicorn” company is a private company with a valuation of at least US$1 billion. The key word here is ‘valuation’ and not turnover or value of real assets acquired. It is assumed by the founders and initial investors into the unicorn company that with a valuation of US$ 1 billion or more, their company is too big to fail. That is not always the case. Unicorn companies do fail; and the reasons can vary. The fundamental reasons for unicorns failing are; overvaluation, extremely thin profit margins, an ever increasing cost of acquisition to keep the company functioning, differences in the mindset of individual investors and institutional investors, stagnation in employee numbers, declining customer attention, and secured excessive funding without plans to utilize that funding for growth. Well-known unicorns that have failed are; Evernote (the note recording app startup), Zynga (owners of the Farmville game on Facebook), Powa Technologies that made smart-phone apps, Quibi (micro-streaming platform), and the infamous Theranos (valued at US$ 10 billion in 2015 and valued at zero in 2016). Theranos is a clear example of both; the greater fool theory and the Unicorn valuation theory. Start-up founders should study these failures in detail and understand that a unicorn status and a billion dollar evaluation does not guarantee survival in the market place. In India, there is a marketing company pretending to be a edtech start-up that is spending seven hundred rupees to earn a rupee, and has become infamous for everything from complaints of fraud, financial impropriety and a non-functional customer service.
So, how do start-ups navigate these pitfalls?
- First and foremost, it’s necessary for the initial idea or concept to be validated by third party entities; which should include the potential financiers, technology experts and potential end customers.
- The second step is to invest into the formation of the management team, thereby separating ownership from control.
- Thirdly, isolate investors from the decision making process of the management team.
- Fourth, create clearly defined share-holding to enable old investors to exit and new investors to replace them.
- Fifth (and most important) create physical assets as the company grows.
- Sixth, ensure that legal entities are separate from any one individual owner, enabling the start-up to grow into a company with a potentially unlimited lifespan.
Start-up founders must make it a policy to ensure that their company value is based on actual assets and not on vague ideas of evaluation. The success of the venture lies in its ability to create profits from the 2nd year in existence and not on a fictional evaluation with major financial losses that are to be borne by the investors. Risk-taking is integral towards success. However, there is a difference in being a prudent risk-taker and a reckless one. Founders must have an exit route with a clear strategy in place, along-with a resilient business growth. Start-up founders must ensure that they have a mentor who will guide them in their initial steps and through complex issues as they grow. Without an experienced mentor, the start-up is already headed towards failure.
“We all have dreams. But in order to make dreams come into reality, it takes a huge amount of determination, dedication, self-discipline, and effort”.
