Ecosystem Myths

Let’s deconstruct six of the most common myths about our startup ecosystem…

This is part three of a trilogy. The first two parts are available here:

  1. Callaghan, Revisited
  2. Defining Our Ecosystem
  3. Ecosystem Myths

Sir Paul Callaghan shared some big ideas when he spoke. But, for me, the biggest lesson was his style of presentation, which I assume reflected his style of thinking.

He would describe a common belief, expose the flaws and then (importantly) in each case proposes a different, better way of thinking about it. He didn’t only tell us the correct answer (from his perspective, at least); he explained why our previous assumption was wrong!

So, with that in mind, let’s deconstruct six of the most common myths about our startup ecosystem.

1. We need more startups

We love to count the number of companies started. Or, as they progress, to count how many dollars of capital they raise.

But, we are quite poor at reporting on how many of these young companies survive beyond the early-stage and go on to actually contribute anything back, either to their individual investors or to the economy as a whole.

We forget that a startup is a phase, not a destination.

The problem is: all startups are not created equal.

Only a small percentage of startups ever create escape velocity and survive to become high-growth companies.

As a result, it’s tempting to treat early-stage companies, in aggregate, as a lottery, and believe that to increase the chances of a win we just need to buy as many tickets as we can afford.

But that’s not how it works. It’s not a game of chance. There is a pattern. Increasing the number of random bets we make doesn’t increase our likelihood of success. It just increases the amount we’ve spent.

It’s true, we need more startups.

But, when we think about what we can do to support startups in New Zealand we seldom start with founders and their teams. We’re much more likely to talk about what I’ve called “derivatives”: innovation hubs and clusters; shared working spaces all around the country; accelerator programs of different flavours; networks of angel investors pooling their resources and investing in a portfolio of ventures; countless competitions or networking events designed to flush out promising new business ideas; numerous business awards celebrating entrepreneurship, growth or innovation; various initiatives to commercialise research done at universities; and, last but not least, millions of dollars of government funding including direct grants to companies, subsidised professional services and advice, tax credits and co-investment.

A lot of people have put significant time, effort and money into creating these things. A large and growing industry has sprouted, all trying to increase the number of startups. Startups, and especially early-stage startups, are suffocated with support. And still we continue to invest in more.

We have too many preachers and not enough prophets. Too many people raising awareness, too few working miracles.

Too much of this is “startup theatre”: reality television inspired programs that try to make the idea of working on a startup seem fun and entertaining, but which only end up amplifying the wrong patterns and taking up all of the oxygen in the room. Successfully growing a company is much less about the joy of discovering the magic spark and much more about the repeatable grind.

We need to understand the reasons why some startups are successful and others are not. When we consider all of the ventures that have actually been successful and achieved escape velocity so far, none of them have their origins in this sort of activity.

We need to start with the constraints and problems that people working on startups actually have, and work backwards to the interventions we can apply to try and help them. Far too often, the benefactors of all of these schemes are those running them or funding them.

When we think about how the government can help, we need to prioritise companies at the high-growth stage rather than at the early-stage. This is when startups stop having an innovation challenge (needing to get one new thing right) and worrying about their survival, and start having an execution challenge (needing to get thousands of details right at the same time) and worrying about how to scale. This is when system-level support can actually help. There are repeated patterns and it’s crazy to let founders each make the same mistakes as they go through this phase.

When we do create these incentives for fast growing companies they need to be as transparent and as low friction as possible. They should reward the things we want directly (e.g. export revenue and productivity, measured by high revenue per FTE) rather than factors we hope will contribute to these outcomes (e.g. R&D spending). Life is hard enough as a founder without having to deal with nonsense grant applications and slow processes overseen by people who have no direct experience themselves. The aim should be: first, do no harm.

(A side-benefit of a much simplified system of startup welfare: it would free up many hundreds of people who currently work in the administration of that system to move into roles working directly on startups - I wonder how many of them would?!)

We have thrown a lot of spaghetti at the wall, but how much has stuck?

We need to be more honest about how our activity translates into progress. We need to stop funding programs that generate lots of new companies without ever converting them into high-growth companies. We need to remember that the ecosystem grows one company at a time, when individuals working together come up with a new idea and grow that into a great business.

We don’t just need more startups. We need a higher conversion from early-stage to high-growth.

2. We just need to be patient

This one is complicated, because it’s true. An ecosystem takes a long time to grow, so we need to be very patient.

Facing that reality, it’s tempting to try to accelerate. But creating large, successful companies takes a long time, and nearly always longer than the founders and investors optimistically predict at the beginning.

We’ve got to stop pretending that we can make this happen faster just by being impatient. We need to be much more suspicious of anybody who has a fast-track or short-cut to sell.

We need to stop pushing early-stage companies to raise capital too soon. Watching founders get rushed onto the stage at a “demo day”, mostly for the benefit of advisors and investors, when they’ve only been working on their startup for a few weeks or months, reminds me of the young kids who are pushed into competing in under-age beauty pageants. Really great pitches start with the words “we realised”, and that always needs time.

We need to stop mythologising being “global from day one”.1 Our most successful companies have often expanded from market-to-market rather than all at once. There is a big difference between having a smattering of customers in many countries (as is common for early-stage SaaS companies, for example) and having solid sales and distribution teams in multiple markets around the world. Those teams need to be built carefully and methodically.

There is a method to scale.

First we crawl. Then we walk. Then we run.

First we create one high-growth company. Then we do it again. Then we do it multiple times at once.

As tempting as it might be to skip the intermediate steps and jump straight to the end, because that is where the most fun and biggest value is, doing that is almost certain to fail.

As impatient as we might be, we need to take the time to really absorb the lessons from each stage, because those experiences are what enable us to be successful at the subsequent stages.

Related: How to Scale

The more slowly trees grow at first, the sounder they are at the core, and I think that the same is true of human beings. We do not wish to see children precocious, making great strides in their early years like sprouts, producing a soft and perishable timber, but better if they expand slowly at first, as if contending with difficulties, and so are solidified and perfected.
– Henry David Thoreau

Nearly everybody who talks about wanting a larger, more vibrant and more successful ecosystem misses this. They jump straight to trying to solve the problems of scale and repeatability, without first proving they really understand what it takes to do it once, then twice. So it should be no surprise that the things they create tend to be brittle, prone to failure and seldom achieve their potential.

We need to get more comfortable with the idea of letting things grow at the pace that is best for them.

But, …

Patience is also a convenient excuse to just continue with current initiatives, and hope that it’s just a matter of time before they start to work.

There is a dangerous idea that has taken root recently: because it will take a long time for the ecosystem to grow (generations, probably) there is no easy way to measure in the interim how we are tracking.

I reject that. Many of the things we’ve tried have not worked. That by itself shouldn’t surprise us. We’re dealing in uncertainty, and that requires experimentation. We won’t know if something might work or not until we try it.2 The problem is we often seem to be reluctant to admit when things have not worked, and to stop and try something different.

Real failure is not learning and improving on the next iteration. So at the moment, we’re mostly failing.

The good news is the ecosystem is growing. So it must all be working, right?

No, we need to do better than that. Real impact is the difference between what happened with you and what would have happened without you. We need to prove that the specific things we’ve done have made the difference. We need to link the inputs with the outputs, and attribute success. We need to measure our “velocity made good”. Otherwise we will continue to confuse activity for progress.

We need to stop accepting the excuses of those in the ecosystem who claim that their own impact is hard to measure. Or that it’s too soon to tell.

Sooner is over. It’s later already.

We need everybody working on a startup derivative to answer these four important questions:

  1. Who does this help?
  2. What constraint do they have?
  3. How do you hope to reduce or remove that constraint for them?
  4. How will you show it’s working?

If they can’t say in advance how they will demonstrate that they’ve helped, they’re very unlikely to be able to later.

If there is no way to show it’s working, then it’s not an experiment. It’s just wishful thinking.

Of course we need to be patient. But we also need to create much shorter feedback loops, honestly measure our progress against regular milestones, and stop repeating things which haven’t worked hoping that next time will be different.

3. We need to grow our tech sector

This is an easy one, because it’s nonsense:

Every sector is a tech sector.

There isn’t a separate tech sector.

If we can find any business that isn’t using technology at the core of its operations then it’s a huge investment opportunity. Buying that business and applying technology to it will likely have a big impact.

Equally if we think the most interesting aspect of our own business is the fact that we hire engineers and designers then we need to think harder about what sector our customers are in and how we fit into that sector, rather than defining ourselves as tech companies and thinking that is enough.

We don’t call our local cafe an electricity company, just because that’s how they power their coffee machines.

We need to stop reaching for participation trophies based on how high or deep we think our technology is. We need to start applying technology everywhere, to make every sector of our economy better.

4. We need more capital

To light a fire we need three things: fuel, oxygen and heat.

To create a vibrant venture capital sector we need spare capital, great companies to invest it in and people with the judgement required to predict which companies could be great before this is obvious (keeping in mind that most startups are not great).

Unfortunately Meatloaf can’t help us in this case: all three elements are necessary.

I started working on startups in 2000, shortly after the government at the time setup the New Zealand Venture Investment Fund (NZVIF) to try and bootstrap local venture capital funds, based on the assumption that there was a shortage of capital available to startups.

Ever since then it has been dogma that there is a shortage of local venture capital, and that this makes it hard for startups to raise the money they need to grow. It has become the most widely believed, the most enduring and the most incorrect ecosystem myth of all.

Maybe it was true, once upon a time. But now there is an abundance of capital available (some might even say a glut!), and this amount will likely continue to grow on the back of further success. The shortage, as it always has been, is in the finite number of great companies to invest in, and in the people with the judgement to tell them apart.

In other words, we now have so much fuel that it’s getting silly. But I think we forgot that for a blaze we need oxygen and heat too!

We need to put this myth behind us, so we can start to focus on the real constraints and barriers we have now. If you think that raising capital is hard wait until you try and spend it efficiently!

It’s true that raising capital to fund a startup is hard. But there is a reason for that …

The returns from any investment in a startup are extremely uncertain. So, finding investors willing to provide cash up-front is inherently difficult.

This is the capital raising advice I give the founders I’ve worked with:

If we can’t raise money for our particular venture there are only two possible reasons:

  1. We’re not as great as we think we are; or
  2. Investors don’t know how great we are yet.

Both are problems we can solve.3 In other words: don’t wish it were easier, wish we were better!

We need to stop blaming a non-existent shortage of capital. We need to explain what startups need to do in order to attract capital, and based on that understand why some companies are able to raise the capital they need relatively easily, while others struggle. If we want funding we need to create startups that are fundable.

The ensuing focus on venture capital has caused us to think of capital as the solution to all our problems. If only we had more money, everything would be easier, right? Unfortunately, no, that’s just not correct.

We need to stop subsidising and underwriting investors in startups. At least until we can better articulate the public benefits and collective return on that investment. The private benefits are more obvious and now well proven, but by themselves definitely don’t justify the cost of incentives (unless we believe in the trickle-down effect).

Imagine a system where we incentivise startup investors purely by waiving all tax on capital gains. Unlike subsidies paid in advance, this would mean that taxpayers don’t take on any of the up-front risk. Plus the benefits flow mostly to those investors who generate the outcomes we want by successfully turning startups into high-growth companies.

Note: This would be easy to implement. The capital gains tax on startup investments in New Zealand is already 0%.4 We just need to turn off the subsidies!

We need to push back on investors who need even more incentive than that to get involved.

Speaking of tax on capital gains … We’ve got to stop pretending that the residential property market is to blame for the level of investment in startups. Property investment has no tax advantage over venture investment. There are no capital gains taxes on either. The reason investors generally prefer real estate is because it is lower risk. It would require significant incentives for venture investors or disincentives for property investors to shift this. In any case, if we are waiting for the substantial problems with the housing market to be solved first, we’re unlikely to ever get started.

We need to stop trying to just copy what has worked overseas. Unless we can recreate their specific context we’re unlikely to replicate their results. Our attempt to implement the Israeli Yozma scheme has failed completely, but we continue to re-invest in NZVIF (now rebranded Growth Capital Partners or NZGCP) hoping that the next round will finally be different. Instead, we need to think about our own context, and play to our strengths.

Related: Import

We need to understand that a vibrant venture capital sector is, in part, a consequence of a successful startup ecosystem, not a cause.

Investing in startups is mostly about judgement. Those managing venture capital funds qualify to compete in the next round by investing in the rare companies that go on to become the big successes.

There have been funds like this in New Zealand the whole time I’ve been working on startups - but until recently there have been very few that produced remarkable returns for their investors. Those funds that were around in the early 2000s completely missed Trade Me and Xero and as a result had poor outcomes.

More recently, some local funds have had successful exits, and as that capital is recycled those funds will grow and flourish. This is how it’s supposed to work!

Mostly, we’ve got to stop treating raising capital as the pinnacle of success for a startup. It’s like applauding the pilot for refuelling the plane. They haven’t even gotten off the ground yet! The goal isn’t to burn aviation gas. The goal is to fly somewhere. And land! Then go again and again. We should measure and celebrate that when it happens.

We need to stop behaving as if capital is our constraint. We need to stop complaining about how hard it is to raise venture capital. We need to start being honest about why it’s hard.

5. We need to retain ownership

Ownership is complicated.

When Minister David Parker re-booted NZVIF as NZGCP in 2019 his stated aim was to “help keep more startups in New Zealand for longer“ as they expanded beyond their startup phase.

However, the venture capital market is global, and most, if not all, of the startups we celebrate as our biggest ecosystem success stories were funded in part by international investors.5 That capital from overseas usually comes bundled with expertise and networks that are invaluable. This is a measure of the maturity of our ecosystem and should be celebrated rather than discouraged.

This question really comes to a head whenever a startup is acquired by an overseas buyer.

We need to be clear about who actually owns these startups that we think are “ours”. Often it’s a mixture of local and international investors and local and international staff. A sale is usually a good outcome for all of those people. In many cases the product of the startup is the company itself. The goal was to eventually sell the startup for more than it cost to make.

So the “another one lost” headlines that are common are not helpful. When a startup is sold overseas the local owners who exit are importing capital.

A large amount of the capital that is invested in startups, especially in the critical early-stages, is itself the exhaust of previous startups.

Every single founder I know who has grown a great business and sold it has gone on to reinvest a significant portion of the proceeds of that exit into new early-stage ventures. And in many cases large amounts of their time and experience to go with that. This is how we will grow our ecosystem. This is how we have grown our ecosystem. It’s happening.

NZVIF was tasked with seeding local venture funds. But we didn’t think very deeply about this. We failed to look through these funds and think about who their investors were. Ironically, the most successful funds under this scheme were entirely funded by international investors. We learned that billionaires are happy to take our underwrite and subsidies, but those haven’t really translated into enduring benefits for New Zealand.

We need to level-up. Our long-term ambition should be to become international investors ourselves. If we are successful in growing a thriving ecosystem, eventually we will be the ones investing in startups based elsewhere around the world; our companies will be acquiring startups based in other countries; our superannuation funds will be investing in venture funds elsewhere. Of course, all of those things are already happening, albeit at a small scale, but we just don’t tell those stories well.

For reasons I can’t explain, we prefer to see ourselves as victims of global capital markets and think that the solution to this is to try and barricade ourselves off. That’s a losing strategy.

We need to stop worrying about retaining ownership of startups. We need to stop getting angry when a startup is sold. We need to describe the outcomes we want from our startups and then find the optimal mix of ownership that helps us achieve those.

6. We just need a small number of crazy founders

The myth of the lone genius has towered over us, its shadow obscuring the way creative work really gets done.
The Power of Two, The Atlantic

We’re not a small country. We’re just a very lightly populated country. And so we don’t have a lot of people with the skills we require to be competitive. For our ecosystem that is a real problem.

Given this constraint, it’s tempting to look for solutions that don’t require so many people.

Towards the end of his talk in 2010 Paul noted that the income gap between New Zealand and Australia was $45 billion (that gap has subsequently increased) and also that the top ten companies in the 2010 TIN Report had combined annual revenues of $3.9 billion.

So, combining those two facts, he suggested that in order to close the gap we just needed 100 new companies as big as those top ten 6 (between 2010 and 2020 we created eight).

He said:

I believe that just 100 inspired entrepreneurs could turn this country around. It only takes one genius entrepreneur to make a company like this. So, 100 individuals could earn us $40 billion a year in exports.

But I think he was wrong about that, and if he were still with us I reckon he would have evolved his thinking, based on the results we’ve seen since.

We know now it takes much more than one crazy individual to create a high-growth company.

It’s true that there is often just a single name attached to each of the businesses that becomes big enough to get our attention (e.g. Xero is Rod Drury, Rocket Lab is Peter Beck etc etc). But, when we scratch the surface of any of these companies we find that their path to success was actually forged by a large team of people, with a wide range of skills and specialities, all working together.

Further down the curve there are many people that we’ve all never heard of who have created significant smaller businesses. Often the first we hear of these are when the business is sold.

Meanwhile the same small group of people get the bulk of the headlines.

We need to stop putting inventors on a pedestal. Invention isn’t the multiplier. It’s the ticket to the game. Our goal should be to find markets for products, package them in a way that attracts customers, convince people to buy them and then support them post-sale. I acknowledge, that doesn’t sound nearly as fun as being an inventor. But that’s what shifts the needle. R&D is great, but D > R.

We need to stop believing in hero founders. If we want to build 100 great companies we will need to find 10,000 great people. Maybe more.

People are to startups what location is to real estate. We need to continue to convince many more people to work on startups. The nature of this problem means there isn’t one big initiative that will unlock this. It will require hundreds of initiatives each contributing in a small way: education programs; graduate programs and internships, diversity and inclusion work to open opportunities for those currently ignored, overlooked or excluded; immigration schemes to attract and integrate skilled people from overseas (not just for a holiday or to hide in their bolthole, but to live and work); attracting back more of the skilled kiwis who currently live overseas; campaigns to convince those currently working in corporate or public sector roles to take the risk on a role in a startup; productivity investments (so that each person can contribute more); a more global mindset + remote work options (so we become more comfortable with working in teams not entirely based in New Zealand); and many many other things.

A lot of these experiments won’t work. So this will only be successful if we are clear up-front about what we want and then brutally honest in measuring each thing we try against those criteria.

This is, in my opinion, our biggest constraint to creating a thriving ecosystem.

We need to stop assuming that a small group of people make the difference. We need to dig below the headline names and share the stories of all of the people who are doing the heavy lifting and building these high-growth companies. And, in the process, hopefully inspire many others to consider doing the same.

The Paradox

Paul finished his talk by considering leadership.

He quoted Lao Tzu:

As for leaders,
The worst, the people hate,
The next best, the people fear,
The next best, the people honour and praise,
But for the best leaders, the people do not notice their existence,
When the best leaders work is done the people say:
“We did it ourselves”.

While others were debating how to create an ecosystem, some of us just got on and did it.

This is the paradox7

We realised that the best way to contribute to building an ecosystem is to create one great company.

Others setup derivatives and waited for somebody else to do the hard bits. They are mostly still waiting.

It’s ironic now to see who is most vocal in celebrating and taking credit for the ecosystem that has been created.

The most frustrating part about this is just how long it’s been obvious, but ignored.

I appreciate this is an uncomfortable truth for those who have been leaders, advocating for the ecosystem. They sometimes like to pretend that the ecosystem is a single shared objective that we all need to work towards together.

But, the outcomes from the ecosystem are multiple, complex and very unevenly distributed. Many of the benefits that have been realised are individual benefits, rather than shared or collective benefits. We need to do a much better job of differentiating these, especially when we put our hands out for support.

I’ve been critical of those leaders and the approach they promoted, and in return I’ve received lots of criticism from them over the years. I learned that people really don’t like it when you call their baby ugly! They called me a hater. They called me selfish. Meanwhile, my days were filled working directly with founders and teams. Together we built some truly great businesses that I’m very proud of. I’m happy with the choices I made. What a privilege that has been!

We all need to stop thinking that somebody else is selfish because they don’t contribute to our personal vision for the ecosystem, or seem motivated by the outcome that we think is most important. Actually the opposite - everybody focussing on making the specific things they are working on great is what will contribute the most to an overall healthy ecosystem.

Maybe the things you want from the ecosystem are different to me. Different people are going to want different things. Some of those things might even be contradictory. That’s okay! It’s not a zero-sum game we’re playing. Everybody can make their own contribution to the overall health of our ecosystem.

We each need to articulate clearly what we want, have a theory for how that outcome could be achieved and then measure our progress towards that outcome.

I hope you’re sitting comfortably. After all of this I’m finally going to give you the secret that will unlock the success of our technology ecosystem in New Zealand…

The one thing we need to do is stop believing in silver bullets.

Then find one startup to work with. Ideally one building something we want to exist in the world. Use the skills we have. Try and make it great.

If enough of us do this, we’ll have an amazing ecosystem to enjoy together.

  1. I’ve found that most early-stage companies who talk about being global from day one are often dead on day two. ↩︎

  2. This is really not that hard:

    1. Have a hypothesis,
    2. Test that hypothesis,
    3. Update the hypothesis based on the results.
    4. Repeat, until you get the outcome you want.

    There are only three ways to be wrong↩︎

  3. This isn’t necessarily true for founders from under-represented groups, who often struggle to find any investors, despite the evidence showing that in many cases these are the best founders to back. Eventually the market will catch up on this, but that is no consolation to those founders struggling to get support in the meantime. ↩︎

  4. Perhaps the quid pro quo of no capital gains taxes should be a requirement that results are public, so that everybody can have a more accurate picture of what successful exits look like. In the absence of that at the moment, many of the exits that get publicity are not as great as founders and investors in those companies represent, and at the same time many of the biggest wins go mostly under the radar. ↩︎

  5. For example, Vend had some investors from New Zealand along with investors from Germany, Australia, USA, and Singapore. ↩︎

  6. The top three companies from 2010 (F&P Appliances, Datacom and F&P Healthcare) accounted for nearly 60% of that $3.9 billion. And, Paul’s maths wasn’t great (he was a physicist!) … actually what was needed was 115 additional companies, for a total of 125. ↩︎

  7. A paradox is “a seemingly absurd or contradictory statement or proposition which when investigated further proves to be well founded or true”. ↩︎