Success Factors of Tech Startups (Part 2): The Idea
In my previous article I’m describing why the right team is the most important success factor of a tech startup. But the team alone — sitting in a hip co-working space — cannot become a commercial success, it also needs a product to sell, an innovation, an idea. Hence, the second part of my articles on key success factors is evolving around the idea that underlies a successful startup.
Idea
Looking at the business idea of a team, investors clearly expect to see an element of innovation within the business model.
Innovation is a rather broad and philosophical discussed phenomenon. The Austrian/German/US-american economist Joseph Schumpeter (1883–1950), the Padrino of the entrepreneurship and innovation concept in science I’d say, perceived innovation as a creative destruction, meaning for each new thing, and old one has to disappear. Same goes for Nietzsche who let his Zarathustra say:
And he who hath to be a creator in good and evil — verily, he hath first to be a destroyer, and break values in pieces.
So when you hear the myriads of startups claiming to “revolutionize” and “disrupt” something, keep in mind that this creative-destructive ingredient of entrepreneurship is more than a century old :).
Anyway, I like to continue with a more modern definition of innovation (by Trott and Myers/Marquis):
“Innovation is not a single action but a total process of interrelated sub processes. It is not just the conception of a new idea, nor the invention of a new device, nor the development of a new market. The process is all these things acting in an integrated fashion.”
Thereby theoretical elements are combined in a absolutely novel way, or existing methods, processes, tools are smartly recombined to create a new product’s basis. Hence, innovation appears in different shapes, it can be incremental or disruptive, tangible or nonmaterial. The following table gives an overview of innovation characteristics and examples:
Startup ideas are based on those types of innovation (sometimes on several innovation types at the same time, for example mass customized online Müsli commerce). Innovativeness is a necessary condition. But it’s not sufficient. Think about those fintech startups providing a new banking app or offering p2p lending. They are innovative compared to the traditional way (i.e. bank loans), but how do they distinguish between each other? What’s their unique selling proposition (USP)? And if they have one, is the USP directly and clearly perceivable? Does it address an existing customer pain and represent a benefit? “Experts” say if the advantage of your innovation is not 10x better than the alternative, then you won’t succeed. 10x seems to be a huge factor, but the point here is, it can be difficult for your target group to recognize your USP if it’s not jumping right into their faces. Besides, switching from an established product or process to a new one, the latter is always connected to transition costs and risks (pharmaceutical companies would barely switch to an alternative production process to save 10% production costs because the original process is crucial to be running risk-free and production costs are also not the matter). So the new has to be really worth it.
Speaking about competitors, how strong is your protection against them? Do you have valuable intellectual property (IP)? Can you lever patents on your technology that prohibits a competitor’s market entry (at least for a few years)? Or are you at least the fastest shark in the tank? Ask yourself: How much money and time does it cost for your competitors to be there where you are now. However, build up fences between you and the competitors, weather by speed or by IP or an unrivaled 10x advantage.
Investors take a huge financial risk investing in your team and your idea. That’s why they expect to see a chance to make a neat return. For a payback the startup they invest in needs to be sold (“exited”) on a much higher price level compared to the entry valuation of the investor. Because of that, growth growth growth of the startup is crucial (this is mainly valid for venture capital backed startups, of course there are also different approaches like bootstrapping or automatized cash flow generating side-preneurship startups which are not focus in this article). If growth is an essential element of a startup’s idea, the business model has to be scalable. Simply spoken, scalability means you can increase the output by x times without increasing the input by x times. Example: If a hairdresser likes to double his/her revenues, he/she needs to work twice as much or employ the double amount of hairdressers or open a second barber shop. Cutting hair is therefore not a well scalable business. Contrariwise, if you sell software, let’s say through an app store or “as a service”, you can easily double, triple, quadruple… the output (selling more software) without employing more software engineers in the same amount. Thus, the software business as well as other business models based on digital products or services (selling eBooks, hosting websites, online advertising…), are pretty much scalable. Apart from the business model, the specific market size and the market development you address is also crucial for growth of your company, as well as the structure of competition (is it a huge but dominated market by a few players [oligopoly]? Is it a small “blue ocean” but without any competition?).
While growth is appreciated in the VC world, it mustn’t come at all costs. Financeability is the real world limitation that brings both founder and investor back to reality. Your idea has to be fundable. Acquirer venture capital better step by step (starting with a business angel or seed round, followed by a series A, B, C…) to reach you goal or valuable milestones after each round rather than trying to collect the whole amount in the first place.
Depending on what kind of investor you approach with your business idea (business angel, seed investor, venture capitalist…), different progresses/states are expected. While a business angel might be fine with investing in a team with just a concept of an idea (documented in power point slides), venture capitalists usually expect to see a proof-of-concept, a prototype, an MVP, first positive test results (medtech), traction (investors love that word) from real customers. A founder needs to find out what are the requirements of a certain investors regarding status and approach them accordingly. The more you have (ready-to-market product, paying customers…), the better for you, since the valuation of your startup increases (and the risk for the investor decreases). On the other side it’s more difficult for a founder to reach a further development of a startup’s idea without external funding. So find the right balance is key here.
So now you have an innovative idea with a strong USP, scalability potential, enough traction (but not too much capital need) to receive funding. Do you have a super startup idea? Not yet! The last important characteristic of a great startup idea is the exit potential, or the answers to the questions: who is going to buy your company for what reason at what stage to what price? This topic is essential for a VC since he/she can mostly generate returns only by selling shares in the event of an “exit” (no dividends during the fiscal year because of cash flow negativity). The exit expectation of the investor depends again on the stage: the earlier he invests, the higher is the risk of failure, the higher is the return assumption (business angel and strategic investors might have a different expectation than simpleminded financial investors).
We are going to deep dive into the financial resources in the next article, but for now, the team is set, the idea developed, you’re ready to pitch!
We are going to deep dive into the financial resources in the next article, but for now, the team is set, the idea developed, you’re ready to pitch!
This story is published in The Startup, Medium’s largest entrepreneurship publication followed by 273,103+ people.
Subscribe to receive our top stories here.
