A Startup Is Born

About Inception, Frustration and Arbitrage

A startup is a newly established business.

According to Neil Blumenthal, Co-founder and CEO of Warby Parker, a designer eyewear company:

“A startup is a company working to solve a problem where the solution is not obvious and success is not guaranteed,”

First, not all startups are technology oriented and the buck does not always stop at Sand Hill Road or Silicon Valley. Although, it is hard to overcome word association and visualizations of 20 something’s in shorts sipping cola with headphones around their neck and coding on laptops. A garage for an office soon to be substituted by a fancy downtown redesigned industrial setting with unique coffee machines, a cafeteria and interiors that reflect the founders view of the world. Conference rooms named after rivers or countries etc. All to create a culture that reflects a deliberate culture of breakneck growth disguised as hippiedom. For all those who watched TechCrunch (TC) Cribs, the description above sounds all too familiar.

Second, Silicon Valley veteran Steve Blank, writing for XConomy, classified startups into six types:

  1. The Lifestyle startups
  2. Small Business usually family owned
  3. Silicon Valley type startups
  4. Startups created to be sold off
  5. Large Company startups
  6. Social startups

This is just a basic framework that highlights the varied nature of startups. Startups can be classified by the industry for which they are solving a problem (e.g. Healthcare , Finance etc.) or by age (2 yrs, 5 yrs etc.), funding stage or type of funding. Products and creative pursuits are usually launched through crowdfunding (platforms such as Kickstarter, Indiegogo). The Jumpstart Our Business Startups (JOBS) Act, 2012 opened the gates for crowdfunding obtained from ordinary investors.

The bottom line is that the engine of growth in many economies today is a melange of disparate problem solvers sometimes chasing growth higher than the GDP of the host country. This above average growth, when combined across sectors, scales up to propel the economy faster. Or so is hoped.

According to Asian Entrepreneur, there are approximately 400 million entrepreneurs worldwide:

The Babson College in USA in association with London Business School has created a Global Entrepreneurship Monitor (GEM) that monitors entrepreneurial activity worldwide. GEM uses the following conceptual framework to explain entrepreneurship

Having laid a foundation, let’s look at the journey of a startup.

Inception

At a very basic level, certain stars align (resources are available) to create a solution for a problem faced by the entrepreneur. It could be a 15 in 1 cooler or an algorithm to solve financial problems. Lets say for example, a Phd in math could be applied to a problem. But, basically an entrepreneur feels that there are people (addressable market) who would pay a price to alleviate a common problem. Typically, the entrepreneur uses a domestic market to validate his/her concept. This is because of the relative familiarity of the local market.

Of course, inception also involves assembling a team that has very broad segregation. For instance, Steve Wozniak was the creator of machines while Steve Jobs was the face of the company. Similarly, a CEO can be tasked with raising funds from angel investors, handling accounts, marketing and sales while the CTO can be in charge of the actual technology/software platform.

Angel investors are friends, family, business contacts, affluent people with a high risk appetite and angel VC’s. Personal savings of the entrepreneur and/0r spouse are usually the first source of funds.

Decisions with respect to the type of legal entity are taken along with the best location in terms of taxes, availability of labor.

Many startups do start with a home office and a laptop.

The initial website is truly the first important impersonal form of communication with the external world. Use of multimedia especially videos to explain the concept are immensely helpful to new investors and clients alike.

Frustration

When dreams meet reality, a certain frustration sets in. Seasoned Venture Capitalists will invest only when a clients are on board and a revenue stream is established. Clients with existing IT systems are hesitant to incorporate an untested technology.

In the case of FinTech, many financial services firms have established accelerators similar in principle to YCombinator. Traditional financial institutions use the accelerator to keep in touch with emerging technologies to identify disruptors early.

An accelerator provides mentorship, connections, an audience. Once the ideas are presented, the accelerator may work with the startup and provide the startup an opportunity to give a Proof of Concept (POC) to the business. The business may also decide to invest in the startup to gain access to its technology. However, investment is typically unlikely for a very fresh startup and therein lies the seeds of frustration.

Without clients, there is no funding and without funding, the startup burns cash faster than it can keep track.

The startup then employs an open canvas and starts searching for potential buyers/licensees of its technology. In other words, the management attends a lot of meetings every day with potential clients. Very frequently, it has the door slammed on its face.

The key is to not lose hope. Easier said than done. The struggle for a breakthrough is not for the faint hearted. It involves, amongst other struggles, countless sleepless nights and gallons of caffeine to get over them. Falling out with the family is also a possibility. Abandonment of the startup is the ultimate price.

On the other hand, if the venture succeeds in getting seed financing, it has to survive the ‘Valley of Death’ to continue.

Arbitrage

Arbitrage, in traditional stock market terms, is buying a stock low in one market and selling the same stock high in another market where it is trading at a premium. In simple terms, it involves taking advantage of price differentials in two different markets.

A startup also faces a dilemma. Very few countries can match the ecosystem that Silicon Valley provides. The sheer amount of capital invested is also a big draw.

Thus begins the ‘valuation’ game. Entrepreneurs chase a source of funding for which the value (price) of a stake in the startup is higher than that in the local market.

Entrepreneurs have to provide value without sacrificing control. Therein lies one of the most interesting negotiation journeys one can encounter. Pre and post money valuation are the terms over which every entrepreneur loses sleep.

The Bottom Line

Societal perceptions of the glamour and status associated with startups need to be weighed against reality to truly understand the ramifications of being an entrepreneur.

Having said that, giving birth to a listed company is a legacy of a lifetime.

Risk is life. If you don’t gamble with the odds, you haven’t learnt much. For every entrepreneur, the journey is its own reward. However, if the venture leads to an IPO, the reward is a shared vision and the faith of the general investors.

Take risks but calculate the odds and have a backup plan. For without plan B, plan A might be untenable.

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