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Overpopulation of unicorns is bad for the startup environment

Overpopulation of unicorns is bad for the startup environment. Main image: pingvin_house, Shutterstock.com
Written by Alex Nechoroskovas

Alex Nechoroskovas on unicorns, and valuing startups based on business merit more than anything else.

The glorified unicorn hunt … it’s the latest trend on the street to be an entrepreneur. With an increasing supply (number of startups), number of VCs, corporate VCs, crowdfunding platforms et al (demand) is also increasing. Good old economics 101. After all, the second biggest trend and buzzword (second to being an entrepreneur, obviously) is innovation. Everyone wants to be digital, and rightly so. Everyone also wants to get their share of the new Facebook pie. I mean if the guy who dropped out from university can do it …

As the number of startups increases, so does the noise. As a result, the overall quality of startups has arguably gone down. It requires less capital and risk to start a business. Plus, it looks sexy on your CV.

Further fuel to the fire (in a positive way) is the shift in mindset of the large corporates towards startups. They’re much more willing to engage in a working relationship with an unknown company, or an early stage startup, often becoming that crucial first or second client. While the fee of anything under £10,000 is usually less than the cost of a coffee breakout session at its quarterly town hall, large corporations are still careful. You don’t want to bet on the wrong horse and let the winner run away with your competitors.

Lack of information on startups is an issue stopping the corporate partnerships from forming.

The startup stack is changing

Lucky, the startup stack is changing to address this. Here’s how I imagine it.

Startup ecosystem stack, by fintechsummary.com

The first layer is the actual startups delivering (better) solutions to existing problems targeting retail customers or large corporations. Roughly five years ago, we started seeing a new layer forming, the support platform for the startups (i.e., startups who are trying to solve problems that other startups create or face). Think of services such as Airbnb letting agency, or products focused on startups such as accounting platform Xero.

With the choice so vast, we’re seeing the third layer forming to help navigate the treacherous sea of upstarts. It’s the discovery and validation layer:

– The discovery layer – one of the more prominent here is ProductHunt, an aggregation site with the popularity contest element of Reddit (upvotes and karma).
– The validation layer – the companies that can provide a badge of honour or a gold star to help companies stand out from the crowd.

The example for the latter would be Early Metrics, the first rating agency for startups and innovative SMEs. I was intrigued by its business model, so I met with co-founder Antoine Baschiera recently to discuss how it works and where he thinks Early Metrics comes in (read the full interview here).

The company is a rating agency for startups that helps to ‘score’ their business potential and innovation. I found the business model intriguing. It avoids the usual conflict of interest (at least in my eyes) of the party being scored paying fees to the agency (as is the case with Moody’s, Fitch and so on). Startups don’t pay to get rated. Early Metrics charges the decision maker who’s looking to engage or invest in these startups. They then get a monthly report with the rating of a selection of startups in their selected fields, and/or the analysis of startups they’re particularly interested in. I think this should help solve the information asymmetry that exists right now.

The decision process – is it going to be yes or next?

The process of how a large organisation would approach working with an early stage company is linear. A simplified version would look like this:

Corporate partnership engagement process, by fintechsummary.com

That’s the happy path, either company can pull out at any stage before the commitment happens. The hardest hurdle to pass is stage two: will the large corporate allocate any resources to investigate this opportunity, and what information would they use?

Frequently, the counterparty could be tempted to judge the quality of the startup by their VC investors and the stage and size of their latest funding rounding, but this can be misleading. Bad VC investment doesn’t equal bad company, neither does good VC investment guarantee a good company.

The reason is simple, VC has a goal to return five times its initial money invested over a 10-year period. Because it’s difficult to deploy VC funds quickly, and accounting for potential delays on exit, a typical VC firm is looking for an exit within five years. Often, if the company has great potential, but the exit may be 10 or 15 years away, VCs will shy away from such an investment, hence the public outcry from VCs about Uber’s decision to stay private for so long.

So what?

This is why I think valuing the upstart for its business merit is so critical. Independent rating agencies can improve the quality of the startup ecosystem, analysing companies for their business merit, not the potential to produce x50 return to its investors.

After all, if you’re a large bank looking to implement a middleware solution to stitch your current two systems together, you care about how sound the business is, not how rich their investors/founders are going to be in five years’ time.

This is a welcome change in times of constant chasing of unicorns, and the ludicrous obsession with higher and higher valuations. At the end of the day, startups used to be about solving real problems, not cramming as many buzzwords into a product description and trying to grow a horn on your forehead. And if that’s the only goal, then let me save you the pain – you can buy one here for $50. Why waste 5-10 years of your life?

READ NEXT: Looking for a live unicorn

– This article is reproduced with kind permission. Some minor changes have been made to reflect BankNXT style considerations. Read more here. Main image: pingvin_house, Shutterstock.com

About the author

Alex Nechoroskovas

Alex Nechoroskovas is "an economist by education, growth hacker by trait, and entrepreneur by nature". He has worked in tech startups and global financial organisations, and blogs about all things innovation, fintech and startups at Fintech Summary. He is based in London and has been recognised as a global fintech influencer. In his spare time, Alex is a tech geek, footballer and travel enthusiast.

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