Before we get stuck into this topic, I recommend you read two earlier posts which give important background on what I want to discuss here:
- From Idea to Impact, about the full chain needed to generate a measurable impact from an idea.
- Flailing, about the difference between activity and progress.
I should note that this post is full of my own prejudices. I assume that by reading this blog you’re interested in hearing about those. I don’t claim to offer fair and balanced reporting. I apologise in advance to those with ugly babies – it’s not personal.
I recently read the following summary of a new venture in the newspaper. I’ve removed the specific details as they don’t matter.
“The company has received [government funding] after winning [business plan competition], and has now joined [incubator program]”
Three strikes and you’re out, I thought.
What a hopeless cynic I’ve become! Why?
At the moment there seem to be a lot of people focused on creating start-up infrastructure: incubators, accelerators, shared working spaces and innovation hubs around the country; networks of angel investors pooling their resources and investing in a portfolio of ventures; countless competitions designed to flush out promising new business ideas; various initiatives to commercialise research done at universities; and, last but not least, millions of dollars of government funding – direct grants to companies, subsidised professional services and co-investment. This is all to try and create more high-growth companies.
So, is it working?
As far as I can tell, there is very little impact. Intentions are good, but the results don’t seem to be there. Why not? Let me give you a possible reason…
When the start-ups we work with think about their product, we quote Steve Jobs and tell them to start with the consumer and work backwards to the technology. In my opinion, those who want to help start-ups need to do the same. That is, begin with the founders of these ventures and work backwards from there to the constraints that early-stage companies actually have.
Unfortunately just about all of this “infrastructure” I listed above has been designed from the top-down, often to solve problems that those putting it in place have – e.g. we’re a bunch of rich dudes and we want an easy way to invest in some sexy start-ups, or we’re a big corporate and we want to look like we’re helping small businesses, or we’re from the government and the minister would like a ribbon to cut.
What’s missing in all of that? Motorways are not much use in the absence of cars!
Sadly, no matter how much you might want it, you can’t will an innovative eco-system that generates new companies into existence, you have to let one grow. As Dave ten Have said recently, entrepreneurial activity doesn’t come from central planning. So, while it seems like a lot is being done, in my opinion at least, it is mostly splashing and thrashing and not much forward momentum for the people that all of this is supposed to be helping.
The questions we should be asking in each case are:
- Is it needed?
- Does it work?
- Will it get to those who need it?
- Will they use it correctly when they get it?
Let’s consider each of these initiatives in the context of this idea-product-impact chain…
In a hospital an incubator is a safe place to put a sick baby – somewhere they can recover without worrying about the stresses of the outside world. Our youngest son was born with jaundice and spent the first week of his life in an incubator. It was horrible, and we were so pleased when he got out.
In a similar way, business incubators try to create a protected and supportive environment for young companies – typically offering a working space shared with other early-stage companies with access to advisors and mentors. Perhaps because of the negative connotations I described above, most incubators now prefer to describe themselves as innovation hubs. However, as far as I can tell the service they provide haven’t changed, so for our purposes, we’ll treat them as the same thing.
There are three problems for incubators/hubs:
Firstly, and most importantly, the problems they solve are not usually big constraints for smart founders, so the benefits are limited. It is good to be surrounded by supportive and like-minded people, and to be able to bounce ideas off them when you need some advice. But if this is what you need it is very easy to achieve, especially in a place like NZ where the business community is small and well connected and people are generally happy to help if you ask them to.
Secondly, they cost money to run, meaning there is a price attached to the help they offer. There are four possible business models that an incubator/hub can use to cover these costs, none of which are founder-centric:
- Renting desks. This effectively makes the incubator a real-estate venture, and normally means start-ups end up paying a lot more rent than they should (paying 3x market rates for a desk and access to a fancy coffee machine isn’t a good deal!);
- Taking a shareholding. This doesn’t seem to work for either side: founders need to give up a percentage of their company in return for no cash in and the limited benefits I described above – in the short term equity costs nothing to give away, but in the long run a “free” place in an incubator can end up being hugely expensive if things go well; on the other side of the equation the incubator/hub taking an equity position quickly ends up with a too-large portfolio of companies in which they own too small a stake for it to be material to them, and in which they are usually reluctant to play an on-going role by continuing to invest time and money as the venture develops. Because of this, few incubators/hubs contribute more value as shareholders than they extract.
- Corporate sponsorship. If it seems too good to be true then it probably is! Large companies are normally pretty keen to be associated with helping young companies, especially those that aspire to be suppliers to start-ups. It always helps to be aware of the strings, if any, that come attached to this sort of help.
- Government subsidies. I’ll cover these specifically below, so will save fire till then. Given that all of the local incubators use all three of the methods described above, it’s slightly depressing that government funding is required at all. On the other hand, if the incubators themselves had to raise capital to fund their business, how many of them would get it? If you took the amount “invested” so far in creating incubators and applied it directly as seed capital it could have funded a large number of start-ups.
Last, but not least, the advice that start-ups get from incubators/hubs is often terrible. We recently met with a promising start-up who had a good enough product and a handful of paying customers. Our advice was that they needed to get in their car and sell what they had. There was a possibility they could get to a break-even position with their current product and ~100 paying customers. Instead, having joined an incubator program, they were wasting their time working on writing an investment statement and market positioning document (whatever that is). We could only shake our heads and wish them luck.
There is no start-up methodology, sadly, so it’s not always obvious if the advice you’re getting is smart, or something that might make sense for a larger company but is misguided for a start-up.
You don’t need a special desk in a special room and a qualified grown-up in a nice suit to hold your hand in order to start your company.
Accelerators are the exact opposite of incubators. They are all about speed!
The idea is to take a promising idea, throw together a team and attempt to fast-track the venture to a funding event – ideally in just a few weeks or months.
There are many accelerator programs starting up all over the world, all with slight variations on the theme. But, by far the highest profile accelerator is Y Combinator, based in Silicon Valley. It runs two intakes per year – one in the summer, one in the winter. It gets over 1000 applications and from that picks about 30-40 start-ups to join the program. This runs for 10 weeks, during which time the chosen ones get access to an amazing array of mentors and alumni founders as well as regular office hours with the insiders, such as Paul Graham, Paul Bucheit, Jessica Livingstone, etc. Y Combinator typically invests ~$20k in each company (anecdotally, enough to pay the living costs of three founders for the time they are in the program) and in return expect 6% or 7% of each of the companies. The end goal is “demo day”, which is a chance for the start-ups to pitch themselves to the Who’s Who of Silicon Valley investors.
If you want to understand more about the approach and philosophy behind accelerators like Y Combinator, I recommend this interview with founder Paul Graham. Note, of the start-ups that have come out of Y Combinator so far, one of the most successful to date is Y Combinator itself.
Here is the problem with accelerators, in a New Zealand context: it is a volume game.
Accelerator programs attempt to mass assemble start-ups in the same way as manufacturing companies in China mass assemble electronics. To make it work you need a lot of capable people interested in start-ups (see: http://www.paulgraham.com/hubs.html) to put into the top of the funnel and a lot of investors willing to pick them up and fund them once they graduate. In New Zealand our competitive advantage is not in mass assembly – we just don’t have the population to support it.
Of course, there is also nothing to stop kiwi start-ups from applying to join these higher profile overseas accelerators. Some smart founders already are and I definitely encourage more to do so. As Elizabeth Iorns, a Y Combinator alumnus originally from here, told me, “There is already a Y Combinator for New Zealanders … it’s Y Combinator!” (Science Exchange, Elizabeth’s start-up, recently announced they have received US$1.5m of investment).
In early 2012 I’m going to be in Singapore as a mentor at JFDI Bootcamp (part of the TechStars Network). It would be great to see a few kiwi companies take the opportunity to apply and get over there and be part of this. If you have a business that would benefit from launching in Asia then I recommend you consider it seriously (applications close 16th December: apply now).
Unfortunately for local programs, as more smart founders realise they can do this it just accentuates the problem by further lowering the volume and quality that they have to select from. It’s not clear yet if accelerators are viable anywhere, even at scale. But, the model definitely doesn’t add up with only a small number of people – you are relying on a much higher success rate, which is a crap shoot. If we’re going to be successful at this sort of thing here we need to play to our strengths, rather than just copying the models that are working in Silicon Valley. Perhaps we should consider the philosophy of “Designed in California. Assembled in China.” that is printed on the back of every Apple iPhone?
As a potential investor, the rush to make early-stage companies investment-ready also feels a bit icky to me. To create something good takes time and/or money. I’m not convinced that it helps founders to try and compress the development of a start-up into an arbitrary period for the sake of investors. Many of the start-ups I’ve seen coming out of local programs chasing investment remind me of the young kids who are pushed into competing in under-age beauty pageants.
There is a famous mantra in technology: “Good, Fast, Cheap – Choose Two”.
Business Plan Competitions
There are now so many competitions for people with a business idea that we almost need a business plan competition of the year competition to help founders identify the good competitions.
Again, the intentions are all good, and they are possibly really useful to those people who need extrinsic motivation and artificial deadlines in order to get started. (see, for example, my triathlon posts)
But, the goal is the business, not the plan. As Steve Blank, one of the pioneers of the Lean Startup movement, says: “customers don’t ask to see your business plan.” Ideas are worthless in the absence of execution. The problem with competitions is that they reduce the start-up process to entertainment, just like Pop Idol or Master Chef. This ends up giving would-be founders quite a distorted picture of what it takes to create a successful business venture.
The latest fad in this area are start-up weekends, which combine a business plan competition and an accelerator into one 54-hour period (indeed startup weekends are often run by those looking to recruit people to be part of their accelerator). I haven’t been part of one of these weekends myself yet, but as far as I can tell they are heaps of fun and a good chance to meet some like-minded people. If they help connect two people who want to work on an actual start-up together … great. But the competitions themselves have as much in common with working on a real start-up as being a contestant in Survivor has with living unassisted in the Amazon for three weeks.
What’s worse, the value to founders, even if you win, is normally tiny. The prizes are typically a non-material amount of cash, and some free services from the sponsors (normally incubators, lawyers, accountants, marketing agencies or web development companies). You may get to have your picture in the paper or in a magazine. Or, you may get to meet someone famous and tell them about your idea!
So, you have to ask: whose problem are these business plan competitions solving? They are good for investors, who can use it for deal flow, and good for the sponsors, who get publicity for being involved. But do they help founders?
If you do want to win a business plan competition this is my advice: approach it as you would a popularity contest. Really get to know the judges and understand what appeals to them. Forget about what would attract customers or even be realistically able to be built. The people who pick the winner are the only ones you need to impress. You just need to make sure your idea gets the loudest cheer and the most votes.
An angel network is an easy way for a bunch of high-net worth people to invest in a selection of start-ups. There are a number of problems with these from a founder’s perspective, in my opinion, but here are just three:
Firstly, group think is unfortunately common. In these groups everybody tends to assume somebody else is doing the work to validate the opportunities, meaning often nobody is. Typically there are just one or two key individuals in the group, whom everybody else looks to and follows. It sucks to be them.
Secondly, because New Zealand is small and the credible investors are all well known and easily accessed, the better founders just approach them directly. So, an investment group ends up self-selecting for the worst opportunities from those that remain otherwise unfunded. It is incorrect, in my experience, for a new investor to assume that there are a lot of impressive but unfunded start-ups out there, who just don’t know how to connect with potential angels. You have to work hard to be an investor of choice for smart founders.
Lastly, but perhaps most importantly for founders, there are very few people who seem interested in investing a material amount in any one venture. The model that just about all of these groups adopt is a portfolio approach – i.e. they aspire to invest in a number of start-ups in the assumption that most of them will fail, and a couple of others will break even, but that there will be a small number of big winners that return the overall investment. This might work if you’re prepared to invest a seriously large amount (of money and time), but when the amount you’re starting with is already small, spreading this even more thinly across a lot of ventures means you end up with a minuscule amount invested in each one – far too little to make it material to you either way, or to justify spending too much time on it – so you end up watching from the sidelines and learning very little from the process.
I’m also not sure the odds stack-up in their favour the way that many angels assume when they start. Perhaps this portfolio approach works if your portfolio is big enough (e.g. hundreds or thousands of companies) but if you’re spreading across just 5 or 10 local companies then there is every chance that all of them will bomb. You can’t just randomly date strangers and expect to find your soul mate!
Unfortunately the standard angel experience is to make a few small investments that struggle, find out that it’s much harder than it looks, become reluctant to continue to invest the time and money required to support the ventures on-going and then bail on the whole thing having made very little positive difference to any founders at all.
In terms of access to government funding, it’s a great time to be a start-up founder!
I have no issue with pouring fuel on existing fires. Unfortunately, most of the time, it’s the exact opposite.
In addition to funding all three of the things I’ve described above, there are also a growing list of national and local government organisations who provide direct funding grants to new ventures. In fact, so many that it’s become a confusing and complicated maze for founders to navigate. There are even consultants who will help guide early-stage start-ups through the application progress (for a fee, of course) … that points to a problem!
As a result of this, in our experience, the best founders often don’t bother to apply because the benefit doesn’t justify the time spent. Funding programs create distortions on both sides of the fence. We’ve seen lots of examples of founders adapting their plans ridiculously in order to fit into the funding criteria – a classic example of confusing the engine and the tender. And, in order to justify their existence those administering the funding need to make sure that they are picking winners – and, of course, the easiest way to do that is to pick those that are already winners, rather than directing money to where it could make the biggest impact. Also, just like any investor, administrators are often loathed to write off obvious losers so continue to throw good money after bad. The majority of this money is provided as indirect funding of infrastructure or as grants with no material strings attached.
In my opinion, if the government funds your start-up then it should be a shareholder or, in the least, a creditor. Not to do this is to privatise profits and capital gains but socialise the up-front risk. Funding isn’t an entitlement. As Selwyn Pellett points out, this would also force founders to think a lot more carefully about how they spend grants as it would put a cost on the capital provided. Note, some funding is provided as co-investment – where the government tops-up an investment round by matching the amount put in by investors, on the same terms. This is a pretty spectacular deal for investors, who get to reduce the amount they have at risk, or spread their bets across more companies, while still having the option of most of the upside if things go well. I’m not personally an accredited investor, but some of the companies I’m involved with have received co-investment via other investors. I’m sure the high net-worth people who are part of this program appreciate the government’s help.
To summarise, the most promising ventures don’t really need it, it doesn’t often get to those who could use it, and those who get it instead end up applying it inefficiently. Welfare for early-stage ventures struggles to meet any of the criteria we started with above!
It is widely believed that there is a lack of capital for growth companies in New Zealand, which is part of the justification for government funding in the first place. I struggle with this, because just about all of the ventures that I see which really deserve to be funded manage to access the money they need, as do lots of outrageously stupid ventures that should never have been touched by investors.
The people who complain most loudly about the lack of capital are typically those whose ventures are unattractive to investors, either because their valuation is too high, or their likelihood of decent return is too low or non-existent. In my opinion, neither of those gaps should be filled by the taxpayer.
Is it working?
To know if an intervention is working you need to measure for impact. This means measuring outputs, not inputs. And, it means comparing the group who have received support with a control group who have not, to properly understand if the input your considering contributed to the output you’re interested in.
Is there any evidence that any of these things done to support start-up companies have an impact, when compared to other companies that just got on with the job? I accept that this is very difficult to measure because “success” is hard to define, but just because it’s hard doesn’t absolve those who promote the things I’ve described above from trying. Indeed, it forces you to think more about what you’re actually trying to achieve.
It’s tempting to quote the number of companies created, or the number of jobs created. However, these are still inputs.
A better idea would be to measure the impact on the economy. In that case, a good measure would be something like total export revenue earned or total tax paid. (e.g. In their recent press release NZTE “celebrated” that over the last 10 years they have funded 250 companies via incubators, of which 177 are still operating, and who have collectively paid $45m in PAYE and GST over that time. They didn’t say how much funding has been provided to achieve that result).
Or perhaps we are happy just raising awareness?
I’d love to see some full analysis of all of these different initiatives, and better understand what the desired outputs are and how well they are achieved. Perhaps my opinion is wrong. I’m certainly open to that possibility.
Show me the feedback loops! Or are we too scared to look at the results in case that forces us to admit that it’s not really making much difference?
Is there another way?
This is not school! You don’t qualify your start-up by winning a competition or getting a sucker to invest or being accepted into an incubator program. You qualify by building something customers want and win by selling it repeatedly to them at a price that is greater than your costs. There is already a well established way to keep score in business: profit and loss. If you think you need $100k to pursue your idea, rather than hoping for a prize or chasing investment, why not build something you can sell to 1000 people for $100?
If you are somebody who wants to support start-ups: be founder-centric and understand that most start-up infrastructure doesn’t help founders much at all. Rather than trying to solve meta-problems, like how to create an eco-system, why not get your hands dirty and help directly? This is exactly what we’re trying to do at Southgate Labs.
If you are a founder, or aspire to be, I have some good news: all of the things I’ve described are opt-in. The choice is yours.
But don’t just take my word for it…
Over the next few weeks I’m going to hand over this blog to a series of guest posts by founders who are doing just that. Some of them are higher profile than others. Some you have probably never heard of. All of them are heads down working on building a successful business, with a product, paying customers and a team in place. I’ve tried to pick those who have not over indulged in the various distractions I’ve described above, but there are amongst their number those who have dabbled, and hopefully their first hand experience is useful in understanding how that has helped, or not. I’m interested in the different business models, the different approach they are taking to getting in front of customers and making sales, how they put their team together, how they got started and how they funded their growth. I want to thank them in advance for taking the time to tell their stories. I hope you find this interesting as you think about how to approach your own ventures.
- Dr Sam Hazledine, MedRecruit, 5th December
- Dave ten Have, Ponoko, 6th December
- Marie-Claire Andrews, SmartShow, 7th December
- Nik Wakelin, MinuteDock, 8th December
- Vaughan Rowsell, Vend, 9th December
- Andrew Mayfield, Optimal Workshop, 10th December
- Richard Humphries, Trade Tested, 11th December
- John-Daniel Trask, Mindscape, 12th December
- Layton Duncan, Polar Bear Farm, 13th December
- Dan Lee, Beetil, 15th December
- Jos Ruffell, Garage Project, 16th December
- Scott Ryburn, Sharesight, 18th December
- Michael Dowse, Go Vocab, 19th December
- Jon Thompson, Productspec, 20th December
- Tarik Mallett, Third Screen Interactive, 21st December
- Rich Chetwynd, Litmos, 23rd December
PS thanks to all of the people who were kind enough to read a draft of this post and help me to make it better – I won’t name you in case you get tarred with my cynical reputation, but your contributions are much appreciated!