Despite the tremendous success of the ‘blockbuster’ venture capital model, a new venture model is emerging in the tail of the venture industry. A growing number of start-ups choose a different path to develop a product or solution and to realise their dream. They build upon a new breed of venture innovations such as the lean start-up model, cloud services, collaboration platforms, accelerators, crowd funding and micro venture capital. I expect corporations and institutions to join this path in the near future. In this blog, I will outline the main challenges of the venture economy of today and describe five trends, which I expect to have a huge impact on the future of business incubation and venture funding.
The blockbuster VC model
Disruptive platform technologies and new business models enable unprecedented start-up activity. Yet, only a few start-ups realize ultra successful exits or IPOs. Think of the acquisition of yammer by Mircosoft, facebook buying instagram and the IPOs of workday, linkedin, facebook and recently twitter.
In the blockbuster investment model, a venture capitalist needs no more than one or two home-run exits to compensate for portfolio losses and to generate top-quartile returns to the limitted partners. The winners curve and the ‘high risk, high return’ venture capital model go hand in hand for a small group of highly specialised multi/late-stage venture capital firms and the high growth start-ups they back. The investment rounds become larger in size and most investment rounds are syndicated amongst a small group of trusted venture firms. As a result, the league of the succesful late-stage venture capital funds has been highly concentrated with a long tail of poor performing funds.
Innovations in venturing – do they pay-off?
Whereas late-stage funding of ultra successful start-ups has become a league on its own, a new breed of initiatives and developments are taking place in venturing and seed investing. Incubators, accelerators, start-up events, angel investment platforms, micro venture capital funds and crowd funding platforms all provide a variety of early stage venturing services and seed capital. Y-combinator has had over 500 start-ups in its program so far and Angellist has over 75 thousand start-ups and investors on its platform looking for funding. In an average month, AngelList claims to match start-ups with at least $10 million in funding. Entrepreneurship and venturing are more popular than ever.
Despite these successes some critics say that the majority of these start-ups will fail, not being able to attract follow-on funding. CB Insights research shows that “companies that receive seed funding from large, multi-stage venture capital firms attract follow-on funding at a higher rate than companies that are just funded by seed or micro-VCs”. The underlying assumption is that seed funded start-ups require follow-on financing to become successful, whereby success is defined in the context of the ‘blockbuster’ venture model.
The venture economy: ‘build to change’, not to ‘exit’ …
A growing number of (social) entre- and intrapreneurs are taking a different ‘intrinsic’ perspective on success and value social impact, sustainability and innovation as much as economic value creation. These entrepreneurs ‘build to last’ or ‘build to change’ with no pre-determined ‘exit’ in mind. Although one does not exclude the other, an alternative venturing model is emerging based on innovations in venturing such as the lean start-up methodology, cloud services, collaboration platforms, accelerators, crowd funding and micro venture capital platforms. These developments are the building blocks of an emerging venture economy in which start-ups, institutions as well as corporates participate. This is what I call Open Incubation. Open Incubation constitutes of a collection of venture innovations that facilitates the development of the venture economy. Yet, before we enter into the venture economy, we first have to deal with the limitations of the venturing practices of today.
The challenges of the venture economy
I see five key challenges to make the venture economy happen. These challenges are: the exclusivity of VC blockbuster model; poor performance of seed capital funds, rigid focus on the execution of the business plan; the corporate performance trap and the corporate – start-up dna gap.
1. The exclusivity of the blockbuster VC model
The blockbuster VC model is only applicable for a very small number of potentially ultra successfull start-ups. For the entrepreneur this is a high-risk, though potentially high rewarding trajectory. What are the funding models for the very large group of remaining start-ups that do not fit into the blockbuster VC model?
2. Poor performance of seed capital funds
On average seed capital funds generate poor returns. Only a small group of top quartile performing seed capital and multi-stage VCs is attracting the most sought after start-ups. Moreover, most seed capital providers provide additional services such as business development, access to networks and talent recruitment, making the balance between effort, investment and return even worse …
3. Rigid focus on the execution of the business plan
In the traditional start-up model, entrepreneurs build a team to develop proprietery IP based on a business plan. Funding will be attracted based on the realisation of the milestones outlined in the business plan. The reality is that every entrepreneur knows that initial business ideas never come to life according to plan. Most entrepreneurs need to pivot their plans several times before the business gets traction. Yet, pivoting your business into new directions is difficult to explain to investors and building a business without a team is even a greater challenge.
4. The corporate performance trap
Imagine, that any good idea would find an entrepreneurial team with the right mix of capabilities, experience and stamina. It would certainly cause an explosion of breakthrough innovations improving our life and wellfare. Unfortunately, most people are stuck in day filling jobs experiencing ongoing performance pressure. No room is left for experimentation, not to mention venturing activities.
5. The dna gap: corporate vs start-up
Entrepreneurship is pivotal for the economy. As product life cycles (PLCs) are rapidly shrinking and businesses become mature sooner than ever, innovation and entrepreneurship should be in the soul of any corporation. A sharp contrast to the corporate dna focussed on planning & control and developing proprietery IP, not to mention the ‘not invented here syndrome’. Start-ups can fill in the gap and help corporates and institutions to innovate. They even might need corporates to leverage on their scale as the window of opportunity for start-ups is shrinking as well (that same shrinking PLCs …)
The future of business incubation and venture funding
Needless to say that it is hard to predict the future of business incubation and venture funding. Nonetheless, I see a number of trends of breakthrough methodologies and innovations that are changing the venturing landscape dramatically. Interestingly, these innovations are taking place in the tail of the investment curve – the area of incubation and seed funding. Like, the challenges, I have summarised the main emerging innovations in venturing into five categories: democratised entrepreneurship, a broader definition of contribution & reward, explore the opportunity, building upon a vision, transparency and empowerment, and the corporation revised (platforms enabling venture ecosystems). These trends address to a large degree ‘the challenges of the venture economy’ described in the previous paragraph.
1. Democratised entrepreneurship
Whilst the VC blockbuster model is only suitable for a small number of potentially ultra successful start-ups, a number of venturing developments enable entrepreneurship for a much wider audience. I am very hopeful about the potential impact of dozens of succesful micro-finance initiatives, micro-venture capital funds and crowdfunding platforms. Moreover, most cloud services and (mobile) collaboration platforms are making entrepreneurship much more accessible and scalable than ever before. Cloud services reduce the up-front investments for start-ups and through API’s, ventures can integrate those cloud services into their own offering.
Customer/stakeholder engagement platforms
Rather than an alternative for bank financing, I see crowd funding portals emerging as ‘customer/stakeholder engagement platforms’. Crowd funding platforms help individuals, groups and start-ups to develop products and to realize dreams with the (financial) support of backers. These backers can be individuals, potential customers, employees, supporters, jobbers, companies, partners or stakeholders. In addition to backing these projects financially this group is happy to help, collaborate and to provide valuable feedback on early product releases. Moreover, this group is likely to promote your proposition into their network. Crowd funding is therefore more than a funding alternative. It is a platform to raise ‘smart money’, organize the ecosystem and to catalyze ‘word of mouth’ … all very important building blocks for start-ups to launch successfully.
Mobile payment services in Africa
In Africa where telecom operators provide mobile payment services to millions of people who previously had no banking account but did have a mobile phone. The widespread acceptance of mobile payments in Africa is spurring entrepreneurship, exponential innovation and business opportunities. Safaricom, the Kenyan mobile-phone operator who successfully introduced the mobile payments service M-PESA, now widens its mobile payments services to savings and loans. This way, micro-business financing becomes available to anyone with a mobile phone. M-PESA is already being used by almost 15 million people out of a population of 19 million adults.
2. A broader definition of contribution & reward
A broader definition of the contribution and reward of the participants of a venture is entering the ‘cap tables’. This definition should go further than ‘exit driven’ return on investment (for the investors) or salary and options of the venture employees. In an open incubation model where participants collaborate to develop a product or solution, a transparant governance framework is needed to agree on the contribution and reward structure for all participants. Clearly, the contribution may vary not only in nature but also in time. Similarly, the reward structure may vary as well and could comprise of shares, cash compensation, salary, free products or access to IP (i.e. open source)
3. Explore the opportunity, building upon a vision
Eric Ries describes in his bestseller book ‘The Lean Start-up’ a radical different venture methodology. Instead of developing a detailed business plan, Eric Ries advocates short development sprints of the MVP (Minimum Viable Product) followed by the execution of a thorough testing plan focussed on obtaining customer feedback early in the development process.
4. Transparency and empowerment
Ventures that work remotely together in a network of partners and open-source development teams experienced that the traditional command & control management model does not work. Instead, new organisational models are emerging based in full transparency and empowerment of the venture teams.
5. The corporation revised: platforms: platforms enabling venture ecosystems
Over the last decades corporations and institutions have reinvented themselves several times. Vertically integrated industries transformed into supply chain driven networks driving efficiency whilst benefitting from flexible scalability. The next challenge for large corporations is to find an answer to shrinking PLC’s of their offerings, making products and solutions obsolete sooner than ever. Current thinking is that corporations and institutions need to adapt an agile organisational structure with an increased focus on innovation, partnerships and corporate venturing. I expect that corporations and institutions will transform into ecosystems of (cloud based) platform providers and innovative, customer focussed micro businesses operating through API’s on those platforms. Whilst this may sound futuristic, most large corporates have already established corporate venturing teams to invest in new business opportunities and partnerships.
The return of corporate venturing
Whereas corporates and ventures need each other more than ever, M&A is no longer the exclusive recepe for succes. A smart approach is needed to preserve the venture culture on the one hand and to optimally benefit from the corporate infrastructure and platforms. This is why we see the return of corporate venturing. In the late ninties, corporate venturing came into existence as corporations realised that technology choices became too risky. Through corporate venturing, business leaders created an instrument to hedge their technology choices. The inherent consequence of investing pockets of venture capital in early stage start-ups was that corporate venturing became detached from the core business …
A new corporate venturing approach is emerging however. Rather than hedging technology, corporate venturing facilitates innovation and business development in the core business and adjacent markets. Establishing a business partnership is the highest priority. The equity investment is an instrument to substantiate the partnership and to capture the value creation as a result of that.
Contrary to vertically integrated, non-collaborative media companies, platform publishing is an ecosystem whereby platform based service providers enable the emergence of new innovative micro-publishing models. Platform publishers offer media initiatives, start-ups, bloggers, app developers and content owners access to all services required to develop, manage and exploit a media proposition.
A successful platform publishing provider is WordPress. WordPress, founded in 2003, enables bloggers to easily develop a blog or website. Yet, WordPress would not have been the most successful platform publisher if it had stuck to the provisioning of a blogging platform only. Today, WordPress has developed into the largest ecosystem of bloggers, service providers and ventures that offer thousands of services helping us to develop a blog into a – all strings attached – media or ecommerce company. The third party services are provided through the WordPress (app-)store and range from hosting, advertising optimisation tools, design, site analytics to (micro) payment services.
I believe that the below overview of these five venturing trends will give us direction on how future incubation and funding models might develop in the near future. Together, they might provide a foundation for the development of the venture economy consisting of ecosystems of innovative microbusiness and platform driven corporations and institutions.
|The challenges of the venture economy||The future of business incubation and venture funding|
|1. The exclusivity of VC blockbuster model||1. Democratised entrepreneurship|
|2. The poor performance of seed capital funds||2. A broader definition of contribution & reward|
|3. A rigid focus on the execution of the business plan||3. Explore the opportunity, building upon a vision|
|4. The corporate performance trap||4. Transparency and empowerment|
|5. The corporate – start-up dna gap||5. The corporation revised: platforms enabling venture ecosystems|
It’s through this blockbuster VC model that the venture capital industry became renowned for fueling innovation and entrepreneurship. In the next decade this model will no longer be the exclusive venture approach. Venturing will become accessible to any one with an idea and deep desire to establish change.