Not everyone can be Jeff Bezos
Funding for French startups has never been so readily available. Low interest rates, lower returns from other asset classes and an appetite for tech combined with a lack of representation of those subjects in liquid markets have caused investors to turn to unlisted companies in great numbers. In 2017, a record 16.5 billion euros was raised by French players, driven on the one hand by a sharp rise in the number and amount of investment vehicles and on the other by the dynamics of corporate funding.
The abundance of liquid assets has led to, among other things, a high inflation of valuations, which bears little relation to the ability of companies to generate profits or even revenues. In digital markets, the first performance criterion is ‘traction’. The premium placed on ‘traction’ is based on the idea that the more customers or users a company has, the more it will attract new ones. This phenomenon of positive feedback, called network effect, favours the formation of natural monopolies. The idea is that the company will eventually oust most of its competitors and dominate the market: ‘winner takes all’.
Funds raised are invested to accelerate this growth, often to the detriment of companies’ financial viability, even in the medium term. Once the dominant position is reached, it becomes possible to increase prices or create a range of monetizable services for a large base of captive users (example of Google Maps, which, after ousting the competition with its free service, switched to a paying model and which, on June 11th, will multiply its prices by a hundredfold for its largest customers). For the investor, the benefit is obvious: betting on the right horse results in huge returns, superior to those of any other asset class. From an investor’s point of view, the risk is reduced by the number of companies in the portfolio. For entrepreneurs, the risk is much greater: the investor’s ß is therefore considerably less than the entrepreneur’s. And let’s be realistic: not everyone can be Jeff Bezos.
On the one hand, for every Amazon, hundreds of businesses vanish. Recent history abounds with examples of aborted ‘success stories’ that failed to find a profitable economic model: Jawbone, Quirky, Take Eat Easy — models with impressive traction but that were unable to ‘negotiate the bend’ to reach maturity. On the other hand, not all tech and digital markets and economic models necessarily fit this pattern. Finally, if the ‘winner takes all’, then statistically only a few will be selected by sector.
This is why the focus on growth indicators (traffic, customers, users, downloads, etc.) should not overshadow the fundamentals of business management, namely the relevance of the cost model in relation to revenues and the objective of profitability and the ability of the management team to deliver. Unless the company is working excellently and has a solid revenue — and profit — generation model, it will remain fragile. The ability to generate traction does not, in itself, guarantee success. The example of the French company Save, a potential gold mine placed in receivership for not being able to manage its growth, underlines the importance of exemplary operations management.
It is certainly vital for entrepreneurs to focus on growth with the aim of gaining market share when they start their business, but it is also essential that this growth be accompanied by the rigorous monitoring of the use of liquid assets, investment profitability and customer acquisition cost. Being able to justify the cost-effectiveness of capital invested and a positive development of these indicators over time is key. We must not forget that beyond the early stage, the valuation of a company, including digital ones, in most cases relies on EBITDA. Having a strong business model is more important for its longevity than the ability to raise a lot of money. In addition, it’s advantageous for entrepreneurs to focus on profitability: limiting their losses allows them to raise less money and thus be less diluted; it’s a guarantee for remaining independent and maintaining leadership.
In addition, the situation where there’s an abundant supply of private equity cash available will not continue indefinitely. Once it has reached its limit, companies that have managed to be viable only with a permanent inflow of external capital will have to transform very quickly, or die. We will then see a hierarchy of entrepreneurial values very different from the current one, which seems to be based on an ability to achieve record fundraising.
