The reality of “unreliable” projects.
The world of investors is quite difficult to understand. When you hear the word “reliable”, you must think it is a positive meaning. But what the investors like is those called “unreliable” projects.
Why do venture capitals invest in some projects even normal people think they are unreliable?
However, it doesn’t mean unreliable when something looks unreliable.
Judgements by normal people have no values. Although even judgements by investors do not seems reliable, the most basic logic is to not believe everyone believes.
For example, there was a guy who opened his company. Unfortunately, shareholders divested because the co-founder jumped to another company with his team. This made the guy had no revenue for four years. He could only rely on his mother, rent a car and went to public bathroom when he went to events. After trying his best to sell his company, his despondency made him only go to drink and have fun. Luckily, persuaded by his good friend, he opened a new company in another area and got some revenue but banned by government soon. He then changed his company’s name and continued to do a same business. When he found he couldn’t afford the company domain, he used his 2% stocks to exchanged the domain.
Will you invest this guy if you met him?
This company is called Uber.
Actually, over 90% of the things which are looked unreliable may be unreliable finally, so many people want to avoid such a kind of mistake. That’s why they often makes mistakes. For the VC investors, it is very necessary being brave to make a judgement which is even different from most of people. Changing an angle, the projects which got big success are always not looking well at the beginning.
It is ordinary when your invest failed.
VC is same with other investments which look at portfolio but not a single time investment success. Therefore, the essence to get a positive return is to use risk/rate of return. When risk/rate of return gets higher, the return will be more and safer. For example, if you invest $250 and get $2500 profit, then your risk ratio is 10:1. Simply say, you took $1 risk to win $10. If you keep this risk ratio investing 5 times but only got one success in it, you got $6 and lost 4$ . Even you lost 4 times, you still got $6 as your profit.
However, in the ordinary situation, keeping a 10:1 risk ratio is very rare and hard. Normally, investors will expect a 3:1 risk ratio which means they hope to invest in $1 to get $3 profit. Everyone wants to take risks to get more because this is one of the nature in our bloods.
Angel investment and venture capital are just like brothers. The failure rate of angel investment is incredibly high. They are really angels, like personal loyalty. If a billionaire thinks your idea is good, you are the guy who can trust, then he will give you some money to take your risk. Then what are they expecting to you? What they think importantly is whether you can get money later from venture capitals. After a project gets money from angels, the chance of the project can get an investment will be lower, then Series B, Series C, the chance will be lower than 1%. Therefore, for most angel investors, most of projects are going to fail.
If the reality is so cruel, why are the angel investors increasing? It’s because the successful cases are happening one by one. Zynga was a good example. At that time, social games were very popular so that four young guys said they want to make social games even had no experience in making games at that time. Then they began to find investors everywhere.
Plum Ventures’s Mr. Wu just sold Kuxun and had some money at that time, so he invested 400 thousand Yuan to get 20% shares. Half a year later, the game didn’t get success and even the investment was gone. The founders began to borrow money from Wu. Would Mr. Wu care about that little money? Of course not. So he lent 500 thousand to them again. Then, the second game failed again, and same with the next three games. The team who couldn’t see the future turned to smartphone games and borrowed money twice again from Mr. Wu. Mr. Wu didn’t a sharp eye, he just didn’t care about that little money. At last, the smartphone game was developed and Mr. Wu got nearly 1000 times return at last.
Because of that, comparing to some “reliable” projects, investors prefer betting the “unreliable” projects to get huge profit or change the industry.
Investing in some arguable projects has no detriments but only benefits.
The judgement by venture capitals
As we all know, venture capital has very high expected return. So their portfolio companies should have enough exponential growth potential. To achieve this kind of exponential growth, the product or service must have this two basic quality: scalability and defensibility.
From the view of defensibility, everyone can find its defensibility no matter in traditional 2B or new internet 2C. It’s even better if B2B can enter 2C successfully because it can not be easily replaced by other competitors. This is the reason why people think strange that VCs prefer to invest in 2C (especially hardware) products on the contrary.
This is because even successful B2B company is inferior by mid-class B2C in the possibility or speed of scalability. The most essential reason is B2B needs salesmen to contract one by one, thus it is very hard to get an exponential growth of users and sales. Comparing to B2B, 2C products are totally relying on marketing sales by exciting and beautiful products with flexible sales and distribution strategy. This is why 2C products has a bigger chance to achieve an exponential growth.
Someone may argues that B2B also has sales. Yes, B2B can attend trade fairs, build booths, put commercials on TV, distribute leaflets… However, everyone who has experience in 2B business knows no matter how many business cards he/she exchanged in parties, he/she has to go to the customer’s office, do a brilliant sales talk and then can sign a contract at last. This is also why B2B companies has the best bonus system to get a growth even other employees are mainly inspired by stocks.
But the reasons mentioned above are not the reasons why VCs reject 2B startups. In most cases, founds do not even understand their position on the value chain. B2B is a simply functional value sales which focuses on helping enterprise users to increase sales or decrease costs. In other words, the price of B2B products are limited by how many profits the product can help one user increase and can be calculated by mathematics accurately. Therefore, if a B2B company does not understand its position on the value chain, it can not get its piece of cake as it thought even it contributed to the whole industry.
This can be simply analysed an imaginary 2B hardware. The value chain is thought as below:
40% — Distribution (retail and wholesale)
15% — Marketing sales costs
30% — Material costs
15% — Brand or the gross profits that company hopes
If a startup develop a product and increase one part, then:
- How much can the price of the final product be increased by the parameter provided by this new product?
- Do the consumers care about this parameter the most?
- Can the increased parameter be promoted well to the users to let them pay a higher price?
- Do the product brand or company really care and promote this increased parameter?
Many times 2B hardware founders do not analyse the value chain well and just do it at first and believe they will have “business chance” personally. If founders managed their companies by this kind of attitude, the business strategy will be indefensible and too late to change when they realised.
Different from the “functional value” 2B, 2c focuses on “sensible value”. Indeed, the profits will be lower and lower by homogeneous products in a perfectly competitive market. But the hardware which has sensible value can get back the ability of making price to evacuate the perfectly competitive market.
Of course, to create sensible value successfully is not easy. But comparing to those famous brands, startups has no baggages of old brand images or pressure to develop a new product to contribute a large sales. Startups can begin from building their users and test all kinds of promotion. If one of them gets success, they will be like GoPro or Fitbit, even they are facing on the competition of those electronical giants, they can still catch the users’ hearts and make them to pay the preferable price.
All in all, the things which look “unreliable” sometimes are really unreliable. Successful cases must have some “common” reasons but not have no rules to follow.
