Thursday, August 03, 2017

Startup dilemma: build to sell or build to scale !

The term unicorn has been bandied around a lot more in recent times than fairy tales of past; in some circles, unicorn spotting is a very profitable sport especially early on. The number of unicorns had grown rapidly a few years back but appears to be slowing down. Most of the earlier unicorns have scaled higher after they achieved the status ($1 billion valuation or market capitalization), the younger ones are happy to be acquired. Meeting young and not so young founders some interesting trends are emerging.

The startup ecosystem has been conducive for many budding entrepreneurs with path breaking as well me too ideas tweaked to local markets or different segment of the market; many of them reached a critical mass to sustain a set of customers and grow organically. The founders were focused on building real business offering products or services to their defined customers. They build sustainable costs and drove business with passion; as a result they also created new proposition and market where none existed.

Their growth was not exponential and neither was their market valuation; demonstrating patience they learnt from their mistakes, changed course when customers demanded a change, collected a team of passionate believers and sought money only when they wanted it for a specific purpose. Their perseverance paid off with founders, investors, employees and customers benefiting from the glory that was due to them. These unicorns get discussed in every conference on disrupting the market and innovation.

For every outlier that made it, there are thousands if not more who fell of the wayside, cast into oblivion, never to be heard of again; not that their ideas were not good or the founders not passionate enough, they somehow failed to execute and change course when required. In a few exceptional cases, the founders bounced back wiser from their learning of falling, nobody is tracking the rest. But that is not of significant interest except to historians, the focus at this time is on the ethics of startups seeking valuation to sell.

Recently in news one of the potential unicorns was accused of fudging data and questionable business practices and ethics. The whistleblowers were ex-employees whose conscience woke up when it did, probably when they discovered these or maybe because they did not get part of the spoils. Irrespective of the instigation for them to come out, the more interesting fact is the shock it created for the industry and the business; auditors descended with vengeance to scrutinize data, transactions and reports.

They had scaled well and zoomed past some of the earlier players with initial rigor that gave them a financial cushion courtesy of investors and venture capital. Their success was talked about with release of growing numbers that showed path to profitability and the fact that the scale made them larger than competitors. They were portrayed to become the first unicorn in their defined segment; within a year with increasing valuations they managed to hit the magic number and were formally classified as a unicorn.

Greed is a very big motivator; the founders and investors believed that they were onto something big and that it will surpass all expectations. Founding team tweaked numbers to show continuous exponential growth even when the market was not growing; investors believed the story. All the due diligence and rush to invest in the company was built on the first big round of funding and the credibility of the investor; future investors did look at the numbers and aberrations were explained by the founders to their satisfaction.

The reality hit the investors when allegations surfaced on everything not being as it appears to be fulfilling the idiom: if something is too good to be true, it probably isn’t. Auditors painstakingly poured over the records separating the truth and fiction; incriminating evidence pinned down some of the senior staff who worked at the behest of the founders. With operations curtailed and staff motivation down, the valuation went Deep South and customers came out with their own version of horror stories.

In hindsight it is evident that though the company was built on a real business opportunity, the love affair with valuations resulted in a change of strategy to build for valuation so that the business can be palmed off at the height of the hype. Greed again played a role in the exposure when some of the perpetrators discovered that they were not going to benefit to the extent they believed. And all fell down as the nursery rhyme goes, the investors turned their attention to check their other invested companies for similar ailments.

Those who got away thank their stars, the rest ? I wish them luck !

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