9. May 2013–
Big financing rounds, rapid growth and a headline-grabbing exit as a finale – these are the things often demanded of startups. But for many, this strategy is entirely the wrong route. Alex Hofmann explains why there's more to business than this...
Rapid growth is a tempting trap
Everyone seems to be after it – VCs, media and the startup scene itself all demand one thing: Rapid growth. Germany desperately needs bigger exits, as one startup personality recently put it, otherwise the country's founders will be a laughing stock in Silicon Valley. Young businesses can only call themselves "startups" if they are after explosive growth and show global ambitions, postulated another. For many young companies, however, following this business plan would be a potentially fatal stupidity.
Startups are not a synonym for forced growth. While the endless reach of the internet does encourage scalable products and means that many businesses are oriented for huge growth from the get-go, a one-size-fits-all model does not work for startups – from its launch, Facebook needed a different focus to a kid's learning site like Germany's Sofatutor, Zalando a different focus to a traditional auction offering like Auctionata.
And consider smart B2B solutions like Berlin's Aupeo, which sold for an undisclosed amount to Panasonic earlier this year – explosive growth was never on the agenda for the 20-person team.
Do digital businesses always need an exit?
In order for a business to grow, it needs to have a product that many customers want. It also needs to reach all those potential consumers. It’s become a common train of thought that the only successful startups are those that achieve both, and on an international scale. But is a business less successful if it establishes itself well in a smaller market? How is a company failing if it is adding customer value, making money, creating jobs and learning all at once?
Digital businesses don’t always need to have multi-billion dollar exits in their sights. Wooga and SoundCloud have both stated that they want to grow as organically as possible and are not solely working towards an exit (though this is still naturally dependant on the price they're offered).
Thinking of cloning? Think again...
Not every market is cut-throat competitive and requires rapid growth in order to succeed and, regardless of this, founders should carefully decide beforehand whether they have the nerves to deal with the constant pressure of beating rivals. There's no doubt that speed is usually of the utmost importance – as investor Peter Read most recently emphasised – not only when developing the product, but also when considering the market penetration.
Growth just for growth's sake, however, can never be the appropriate strategy. Plus, the business model of “clone and be taken over” doesn't work anymore. Even the Samwer brothers, infamous for their aggressive cloning ventures, are experiencing this as they struggle to sell both Airbnb clone Wimdu and Birchbox copy Glossybox. In both cases, the envisioned buyers were not convinced by the copycat companies – now Wimdu and Glossybox are being forced to shrink back to a “healthy” size.
Lastly, this kind of “Blitzkrieg” expansion demands large funding rounds and often require questionable business methods. The business plan must be aggressively executed, almost always at the expense of the staff. Typically, capital is burned too quickly, business models are pivoted too quickly and the focus is too quickly centered on markets with network effects. What do you get for all this? Too-high valuations, huge amounts of growth financing and a few big headlines.
Building long-term growth
The last months have proven that building long-term worth becomes more difficult when previous growth was too high. Facebook, Groupon and even Apple, though definitely no longer startups, are all suffering from inflated – and often self-promoted – expectations. There are smaller scale examples of too-ambitious growth closer to home, German design-your-own-perfume company MyParfum was just forced into insolvency, while games outfit Bigpoint let go of 120 staff member in Autumn.
So what can we learn from this? Being the right size in each business phase is important, as is keeping your desired numbers in sight at all times – which also means adjusting your business concept to fit these. Founders must first understand their business in detail and maintain a clear and realistic awareness of their company's profitability. Sometimes the market just isn't ready yet – Instagram wouldn’t have had much growth pre-iPhones.
Even if this seems like common knowledge, translating these concepts into the everyday workings of a startup isn’t always so easy. Sales are quickly inflated when new distribution channels are found. Or the marketing budget is rapidly expanded to ensure the brand quickly becomes well-known. All this means that, in quieter periods, the company will have large overheads and be stuck in a cost trap, which often results an undesirable hire-and-fire mentality.
At the bottom line, the risks of rapidly growing often exceed the benefits. High running costs mean financing is essential to keep the company afloat, which can lead to accepting funding rounds with unattractive conditions, or, worse still, being forced to stop operations all together.
Even if organic growth from the company's own cash flow doesn’t seem sexy, for many businesses it represents a secure and sustainable route. It is worth noting that, while self-sustained growth can be beneficial, it's still important to keep an eye on the competition to ensure you're not being left behind. Scaling too late means the competition can quickly draw ahead and a huge loss of opportunities.
Keeping up the momentum
VCs love to encourage strong growth. They rely on making up for the losses from the many faulty investments they make through one “hit” – a VC can consider itself blessed if one in ten investments is a success. But not every startup can be the next Facebook (as much as the founders would like to imagine) and there's a good reason why established US investor Kleiner Perkins had to change its financing strategy – its last three funds are deep in deficit.
What's more important than growth? Startups need to have constant momentum. In stark contrast to traditional corporations, young companies are expected to have the ability to react flexibly to opportunities in the market and be smarter than the "dinosaurs" of the offline world. What's problematic is that many of the current founders have not yet experienced a real market drop – since 2009, the digital economy has only been on the up. They need to be prepared for less favourable conditions, in which companies that purely focus on growth are more likely to sink than swim.
Essentially, blind growth upends everything that the startup scene stands for. This is, however, something which many startups – as well as VCs - still need to fully grasp. And soon.
Translated by Michelle Kuepper
Flickr user: JMR_Photography
Kai Niemeyer at pixelio.de
For related posts, check out
Berlin: what’s missing from our startup scene and 8 ways we can step it up
Caught in a startup Catch-22? How entrepreneurs can overcome common dilemmas
Fast forwarding from failure – Userfox’s Peter Clark on his next career chapter