Tuesday, January 22, 2013

Investors contribute to an unhealthy feedback loop for unsustainable startup valuations

This post was originally created as a comment on the Glen Hellman blog, Driven Forward.

I think there are (at least) two different parts to the problem of investors contributing to "bad startups".

First, as the industry cycle starts heating up and a bubble is close to forming, we have the issue of a lot of existing startups (as well as the launch of new ones) becoming "valuation driven" instead of "business/revenue/profit driven". 

Before there is a bubble, there is a direct link between these two different forces and they are one and the same. When the market starts heating up, a disconnect appears and decisions on what kind of startup to launch or how to run a startup gets made based on KPIs that drive outsized valuations of competitors or other online companies, instead of doing what is right for your own company. 

During the .com bubble this was clearly visible (at least on the back end) when startups received outsized valuations because of user growth but no revenue. I think we are seeing patterns in the market right now where similar problems are starting to become visible.

Second, while I think the changed investor landscape over the past ten-fifteen years has been incredibly helpful in general for startups (more angels, VCs moving upstream etc), I do think that it has skewed the industry towards both inexperience and risk reduction. 

While a good angel community really is critical to nourish a solid startup community, I think the rapid growth of the angel community has by default brought in a lot of people with limited experience from both startups AND investing. This has led to a lot of startups getting funded that maybe shouldn't have.

You could argue that, "what's the problem with that?", the more startups the merrier. There is definitely some truth to that argument. More startups leads to more entrepreneurs and founders who get to learn what it means to run a startup and even if they fail, they may be in a much better position the second time around. Great.

BUT. There is always a but. Part of the problem is that there is a feedback loop in the system (just like in point #1). Ie the growth in the portion of funding going to "turds" (startups less likely to return funds with any multiplier), will inspire others to take the same road. At least if the market is slightly out of whack because it is over heating. If this goes on long enough, it can actually move the needle on what passes as a startup. 

Is a startup today an app, a web app, some super local thing or something that could potentially be a sustainable business in the future with a lot of luck and hard work?

You tell me...

1 comment:

  1. What is a startup - could be an app that disrupts and changes the way things are done (locally summize created twitter search and trending topics and is now part of Twitter) or a company that is a small company today and will be a huge company in the not too distant future.