Archives for posts with tag: startup

A question that came up during my session with Andree last weekend at BarCamp Munich, was how effective accelerators like SeedCamp or Y Combinator are in helping startups receive funding.

Before digging into the numbers, I would first like to point out that receiving funding is not necessarily a good indicator for a startup’s success. And while the above mentioned programs are very different (in both nature and geographical focus) a blunt comparison might not give each the credit they deserve.

I am still convinced that both are doing a terrific job creating great startups and I highly recommend applying there to get real mentorship, exposure to great, passionate people, and accelerate your startup.

For the following analysisI used publicly available data from TechCrunch’s CrunchBase.

It should be noted that there is a minor presence of error as some companies of Y Combinator weren’t showing up on CrunchBase and others did go through funding rounds but did not disclose the amounts raised.

SeedCamp
Having been established in London about 3 years ago, SeedCamp is primarily focused on the UK and Europe. Its primary event, SeedWeek, is happening once a year in London. Due to its roots and its geographical focus, it is also not surprising that the companies coming out of this program are primarily from the UK. But the program’s outreach into other areas has created a pretty diverse roster with startups from 11 different countries.

Y Combinator
Y Combinator has been around for 5 years. Unlike SeedCamp, Y-Combinator doesn’t have fixed deadlines for application. However, Y Combinator hosts its 3-month-mentoring event twice a year. The first data points available for my analysis are from the June 2005 intake. Y Combinator is known for being an American program and hence the startups applying here are primarily from the US (with some minor exceptions like the UK).

Due to the afore mentioned differences, it should be of no surprise that the programs created a very different output in terms of startups going through their programs.

Hence, the fact that the total amount raised by Seedcamp companies was at around € 9.6M whereas this number is at about $ 135.4M for Y Combinator. To determine the spread of these rounds, I looked into the averages and the standard deviations:

What might matter more is the question about how these two programs differ in their performance. While Y Combinator is around for a longer time, the hypothesis can be made that these large amounts are due to sheer numbers. So let’s have a look at averages by plotting how many of each class were funded grouped by the classes they were in.

As is pretty evident by this chart, Seedcamp started out way more successful along this metric. But even Y Combinator shows some swings. The most recent classes should not be considered in both cases as they are both pretty young (Seedcamp’s class usually starts in September and Y Combinator’s in June).

As we will soon see, these numbers are also quite inconclusive as the spread is too big to jump to any conclusions. Going through the individual rounds and plotting these in a bubble chart provides a more visual approach, providing more helpful insights in answering the question above.

The X-axis is the program these startups went through whereas the Y-axis denotes the days between the start of the program and the first funding. I did not consider the amount these startups were receiving from the respective programs to go through the mentoring months. However, should there have been a rather large amount provided by e.g. Y Combinator, I considered this a first funding round.

Conclusion
Again, as these graphs show, both programs are doing a great job bringing out some fine companies. And Y Combinator’s quick flips (e.g. Reddit, Zenter, GraffitiGeo, Omnisio all got acquired within 6 months after going through Y Combinator) show that Y Combinator is doing a great job, accelerating companies for an acquisition.

A lot of the negativity VCs are feeling from entrepreneurs roots in the misunderstanding of why VCs keep telling entrepreneurs to grow really big and hence seem to be pushing for more and more, making them appear like slave drivers.

VCs also serve someone else
Even though there are many VCs who might make you feel that it’s their personal money they put into your startup (which, in all honesty, is usually partly true), it’s usually coming from a fund. Funds are composed of smaller sums of money contributed by wealthy individuals and/or institutions. These people/organizations usually get to know in which companies their money went but they care only about the return their money in the fund makes. In order to make the investor happy, a VC needs to generate quite an excessive amount of money over the lifetime of the fund (usually something between 5 to 7 years). And since the failure rate of each individual startup is very high, a VC pushes for everyone to make the most and compensate for the failure of the others.

It’s unsustainable to remain small
Many people think that it’s ok to have a business that is generating enough money to provide a living for oneself and maybe a family. While this model might still work in some areas, it is usually not true in today’s hyper-competitive internet market. With radical shifts happening every couple of years, a business can easily be leapfrogged and killed by competition every second. Hence, it is hard to make a point that you can provide a sustainable living for yourself for long with a small business in a niche.

The solution: grow!
So, the answer to this problem is growth. There’s always four ways to grow according to Ansoff:

As you may understand immediately, defending  a competitive edge is something very hard to achieve for a small startup with a small customer base in the long run. Diversification can increase complexity and might create other problems (organizational, economies of scale, burn rate) at smaller companies as well. So, there is basically only one of two ways: straight up or straight right, penetrating more markets with your product or expanding in your current market with new products. And this is exactly what large enterprises are seeing: small competitors that are in a niche they have not conquered before and which are cheaper to acquire than to running the risk of failing themselves pursuing the same users.

No matter which path you choose, it will always feel like an uphill battle no matter the size or age of your company. The chances of losing connection to your target market are increasing the larger you grow because of the complexity you add with more products or more people to manage. But this is exactly why startups will always have a chance in today’s market. And this is exactly why there is still a huge supply of capital from venture capitalists to this industry.

While most of us do business every day, we barely write a plan for that. But when it comes to starting a business all of a sudden people start asking for a business plan. While this might seem odd at first, there is good reason behind all this.

A plan is not just for some unknown investor–it is for you and your team! I am a great fan of focus and commitment. In order to survive the ups and downs in startups you have to fit a certain profile. However, knowing where your partners are saying they are and handing in a written document stating this are two separate things. Manifesting this commitment in written form has usually a deep impact on people and I am sure that if you haven’t done so already, you will see what conversations you will spur doing so.

A plan is about a vision you should have and be able to communicate. In seed and early stages, a business plan is barely ever going to predict what’s going to happen in the long run. Even short to medium term is hard when your product doesn’t exist yet or is still a prototype. But aside from getting everyone on the same page (literally), a business plan is also a good indicator of how well your idea is crafted, if you can see beyond the initial product, having a vision that is greater than just developing something and hoping for people to come.

A business plan is the acid test of a relationship. Some businesses don’t qualify as an investment because they are service based instead of product based (I will dedicate another post to this later). Seeing through your idea and understanding what you have in mind is exactly one thing you should be able to reveal concisely and focused. When you pull an investor on board, you need to be effective in your communication in order to work on what’s most important: the product. And trust me: I don’t enjoy sitting in a shareholders meeting for 4 hours (and yes, I did have that as well).

Planning involves some basic knowledge about business and shows how good you are aside from product-based development. In order to write a complete business plan, you should have some knowledge about the market (past, present, and future trends), competition, and financial planning. If you miss out on any one of this completely, it might indicate a lack you might not have identified. I don’t expect engineers to run sophisticated LBO-models but instead justify their financial needs as well as proving some sanity in the numbers. After all, business is about numbers.

About the validity of the plan in comparison to real life remains something for future to prove. We have barely seen a plan that was hit by the buck (most under- or overperformed tremendously). And I know some investors use business plans to make sure that they have something in writing that does not conflict with their investment limitations (e.g. geography, industry). However, I have also seen some companies go down because investors were tying their future tranches to certain milestones.

So, regard the document as a form to come to a mutual understanding for all parties. And make sure your investor knows where you are in your plan. Once we start being interested, we will monitor your business closely, checking it with your business plan. We have seen startups hitting milestone after milestone according to plan and hence gaining a lot of momentum and outrageous valuations.

When it comes to pitching, a lot of people seem to know best how to lure your audience: talk, use slides, talk even more, use more slides. In general: slides should always support you, never become the center of the presentation  (unless they are handed out without someone presenting them). Unfortunately, none of this works when you want to present an experience product. The name already suggests that an experience product is all about the emotions, feelings, and perceptions.

But what exactly is an experience product? Well, from my perspective the following factors must be true to give you a clue:

  • Senses (one or more) are involved to a great degree.
  • It stirs emotions (good and/or bad).
  • The product might do more than just entertain (i.e. serve another meaning).

From my list you can tell that a product does not necessarily need to serve a greater good. However, most do. A game could be such an experience product even if it just exists to kill time. A radical example is skydiving (hard to explain the feeling but a memory you will never forget). A more common example is cars. But cars also serve a purpose aside from entertaining you: they transport you from A to B.

But how do you pitch such a product? By exposing it to your audience. That’s one of the reasons car dealers do not shy away from letting you sit in and drive your desired car for a short while: touching the handle, opening the door, pushing the pedal, feeling the thrust–it’s all part of a greater experience called driving.

And how does all of this make sense in an all-digital world? Well, handing out free versions and letting people play with it. It’s what lured many people to play FarmVille and getting hooked up on it. Sure, there is more to it than the experience, but I found this a nice example of what can happen when you get people to try your product rather than just trading it for cash.

I attended Telekom’s Innovation Day a couple of weeks ago and joined a discussion on European Entrepreneurship. The other people joining this discussion were from different backgrounds: Finance, product management, startups, entrepreneurs. After a short while the discussion centered around two questions: what is the reason Europe seems to be creating less successful startups and how do you successfully start a company internationally?

How do you start a startup to become big internationally?
I think a great comment came from Sebastian Wallroth who pointed out the difference between the business and the developer perspective. Developing something to be internationalized and building something for international use might be seen differently by these two parties. I personally believe that it is important to start your company close to your initial users/customers. It is crucial to get as much feedback as possible–especially in the beginning. Facebook’s Net Jacobsson also repeated this theme at the very same event, stating that he attributes much of Facebook’s growth in applications to Facebook’s developer garage events which were held locally to strengthen the community and gain insights into what developers wanted.

Having been a software developer for several years, I know how tempting it can be to build the best, most robust and extensible application right from the start. And while I certainly agree that web applications should be built with internationalization in mind, I can also see the threats of over-engineering and getting tied up in details. Starting a company in a European country (aside from the UK most probably) almost demands rolling it out in the local language first. However, if your application has global applicability, it might be worth considering a first beta version in English.

As Julie Meyer from Ariadne Capital put it in a panel discussion earlier at that event: there are many startups which think small but then need to grow big quickly.

What about Europe?
As there are more than enough examples of highly successful European entrepreneurs in the US, the logical inference was that it might be Europe which is limiting the growth in new companies. While many agreed that the lack of sufficient seed and early stage capital might be a factor, I doubt that the underlying problems can be solved by just providing more cash for young entrepreneurs. On the other hand, I do not neglect that Germany should provide a better soil for more VCs. However, an entrepreneur who wants to work at a startup just for the salary is probably not all aware of the difficulties ahead.

I certainly believe that the attitude towards taking risks is different in Europe. Having spent two years in the heart of Silicon Valley, I am pretty sure that rewarding risk is almost unique to the most vibrant startup scene on this planet. Risk-taking is a vital part in startup life. Europe lacks this sort of entrepreneurial thinking. This thinking also includes the idea that people who have been out of the large corporate setting for some time are still able to adapt and thus capable of switching to a different working environment. Unfortunately, this is just not (yet) part of our thinking.

Selling too early?

Another, very interesting point came up shortly before the discussion ended: what about the statement that a lot of companies in Europe are not able to develop fully before being sold? The hypothesis was that a lot of investors in Europe are also still not willing to take larger risks and hence hinder greater exits. Thus, the lightning rods like the ones in Silicon Valley with high valuations are lacking and in turn not creating enough interest for people to pursue an entrepreneurial career. I found this to be a really compelling statement. Too bad it is most probably going to remain a hypothesis for the lack of actual data.

I figured that there is a great deal of confusion about valuations out there. Hence, I decided to shed some light on this from the other side of the table. I am going to concentrate on early stage businesses here. There is a great deal of books for mature companies (I personally recommend McKinsey’s book on Valuations on this topic).

Misconception #1: it’s all about other valuations
Nothing can be further from the truth. Although this might sound counter-intuitive at first, other valuations are just one piece of the puzzle. Only because a competitor might receive a high valuation does not imply the same for your business. There is a great deal of factors that make up a valuation, even more so in the early stages of a business. The reason why so many VCs state that the team is a great factor, comes from the fact that it is common knowledge that you might switch your business model around three times before you hit the right market.

Misconception #2: the higher the valuation the better
This is something that you might not realize when you’re just thinking about your first round. However, it might get back to you in the following rounds. Down-rounds, i.e. rounds in which the current stock price is considered lower than in previous rounds, may have many implications. For one, your previous investors might receive more shares due to anti-dilution clauses. But even worse: it signals that you might not have hit the target set out by your previous investors, maybe decreasing your chances of raising another round.

Misconception #3: there is a fixed formula
If there were, we would not have those nice negotiations, right? There are many tools that you can use to calculate the pre-/post-money value, the share founders get if the option pool is considered, etc. But the real valuation, determined by the amount of the investment for the share of the company, is always a plug-in number. Therefore, a tool like the Valuation Calculator should not be taken too seriously. There are some indicators (stock market prices, general market development) but they may have different value for different people.

Misconception #4: first revenue means higher valuations
The more data you have on the actual money value of your business, the more likely it is that the valuations from different people might be closer. More data points usually help assessing a business better, hence the valuation can be done more accurately. But it doesn’t necessarily mean that your valuation will rise. If you are greatly underselling your product, this might also indicate that the customer does not value the product as high as you might have expected or your ability to sell is just weak. And having missed certain milestones or not being able to expand the business is at least equally bad for a valuation.

Misconception #5: valuations are a primary business concern
It is reasonable to think that you should only pursue the fields driving most revenue and thus creating most company value. And higher revenues usually drive valuations up. Nevertheless, constant business does not increase valuation. There were a couple of companies which were once valued less than the money they had in the bank. Don’t forget: valuation alone does not help you grow your business–business does.

Demand: a: to have a strong desire for b: to wish or demand the presence of

Need: a: a lack of something requisite, desirable, or useful b: a physiological or psychological requirement for the well-being of an organism

It is vital to understand the value proposition of your startup’s product or service. In so many cases ideas will not generate businesses as so many are not solving an issue a customer feels pain at. Needs-based businesses are far more likely to succeed as their clients/customers are more likely to pay for the product or service. Hence, it is crucial to know your customer and u derstand his business needs.

In order to make my point clear, let us have a look at a promiennt example: virtual goods. Virtual goods are basically electronic items that can only be used in special applications or platforms. Facebook’s “buy your friend an icon for her birthday” is a feature that qualifies for this category.
As Piper Jaffray recently published, the virtual goods market is going to grow tremendously–future will tell if it’s by the predicted 10x to more than $6bn over the next 4 years.

So, what customer pain are virtual goods solving for it’s acquirers. All of our personal networks get more and more geographically dispersed. We get to know people on vacation or at work and add them to our network. When we just want to send a short notice for someone’s birthday, we look for the easiest way to achieve this.
And virtual goods are offering exactly that: $1 and you have your friend more likely pay more attention to your birthday wishes than all the other wall posts. Why is this important? Because you need to stick out if you want to be different.

As you rightly perceived, I used the word “want” as well. But let’s not confuse the demand for an easy present and the side-effect of the personal wall.

An example for the ill-fated want-business would be WebVan. WebVan was a company at the height of the bubble, offering grocery deliveries via web orders. It collected quite a lot of venture capital from very prominent sources and in the end got acquired by Amazon, which eventually shut it down. As much as each one of us probably likes to dream about home grocery deliveries, it clearly failed because of a lack in consumer demand. To put it more bluntly: orders didn’t materialize at all.

But why didn’t consumers pick up on that although it was clearly offering to save time and effort? There might be many reasons for a businesses failure. In this case WebVan was facing a well established infrastructure of grocery stores and restaurants. People might want to order food and groceries online, but they clearly don’t need to. It just doesn’t seem to be a pain point.