We are in the midst of what research from Erasmus University refers to as the “entrepreneurial economy”, with governments, VCs, and others pumping record sums into the creation of new startups, and the entrepreneurial ecosystems that are supposed to support them.
A recent paper from the Global Entrepreneurship Monitor (GEM) taps into the zeitgeist by proclaiming that startups will be vital to successfully tackle global challenges, such as Covid-19 and Brexit. When we look beneath the surface of all of this activity, however, it’s not exactly a pretty picture.
Famous research from Stanford’s Nicholas Bloom illustrates the difficulties we face in keeping the wheels of innovation turning. Bloom illustrates that while we’re spending more on research and innovation than ever before, we’re getting diminishing returns for that investment. Accenture data reveals that this is replicated at the corporate level, with firms getting precious little return on the £2.5tn or so they’ve invested in innovation in the past few years.
Engines of creation
This gummed-up process of innovation is not confined to big-company transformation. Indeed, data reveal that rates of entrepreneurship have been in perpetual decline across the United States between 1978 and 2011. This has resulted in the share of overall employment in young firms falling from around half of the workforce in 1980 to just 39% by 2006. This is at the same time as the share taken up by big firms grew from 51% to 57%.
This is compounded by the changing nature of those startups that do exist, with data from Wharton revealing that the proportion of entrepreneurs with a high level of education fell from 12.2% in 1985 to 5.3% by 2014. This perhaps goes some way towards explaining the decline in the impact of the startups that are created, with the proportion of startups that are profitable when they go public at record low levels.
It’s perhaps no surprise, therefore, that data from Rice University shows that market power today is more concentrated in the hands of a relatively small number of incumbents than ever before. An environment of creative destruction most definitely is not present.
A different picture
One could certainly be forgiven for not recognizing such a picture, especially if you’re a regular reader of the technology press, which features a daily exposition of the vast sums being raised by startups around the world.
Indeed, globally venture capital investments are at a record high, with data suggesting that around $300 billion was invested in the first half of 2021, which is more than the entirety of 2020. This has made the once-fabled unicorn a much more frequent sight, with recent valuations hitting the frothy heights of 40-50 times revenue.
When the term unicorn was first coined in 2013 by venture capitalist Aileen Lee, there were just 39 private firms with valuations and revenue of over $1 billion. Just seven years later that figure had jumped to well over 600, with a collective valuation of over $2 trillion, with that figure now over 800, with those firms worth around $2.6 trillion at the time of writing.
It’s perhaps illustrative that in all of the hoopla surrounding such transformative ventures, actual revenue scarcely merits a mention. Indeed, while many startups are happy to boast about the funding they have raised, they are much shyer when it comes to disclosing their income.
A busted flush?
That shouldn’t necessarily mean that the unicorns aren’t sound businesses. For instance, according to standard investing metrics, to accrue a $1 billion valuation would require an expectation that the business would eventually secure pre-tax operating profits of around $200 million, which while certainly no walk in the park is equally not excessively ambitious.
Zoom, for instance, became an instant darling of the pandemic, which was reflected in an incredibly strong flotation that valued the business at around $166 billion at its peak, before falling to its current level (at the time of writing) of $56 billion. Even this is a hefty multiple considering its pandemic-boosted revenues amounted to just $2.7 billion, with its profits growing from $25 million pre-Covid to $672 million after the world went remote.
The problem is, Zoom is relatively rare among the unicorn herd, as of the 73 unicorns that have gone public, just six of them have managed to make any kind of profit, with many instead posting huge losses. This is not usually a case of a new startup finding its commercial feet either, as the overwhelming majority of unicorns were over 10 years old at the time of flotation. There seems to be a general hope that they will mimic Amazon, who famously took four years to turn a profit after its flotation, and some 20 years before it turned into the money-making behemoth we know today.
Looking in the wrong place
In many ways, Amazon is illustrative, however, as in one of his annual letters to shareholders, Jeff Bezos famously remarked that he likes entrepreneurs to be missionaries rather than mercenaries. In other words, entrepreneurs should be focused on building great businesses that leave a lasting and positive impression on the world rather than a quick buck at a time in which the world is awash with cheap credit after a decade in which the global printing presses have been running non-stop.
Recent research from Boston College’s Carroll School of Management demonstrated the nature of the problem, as it found that startups in traditional VC-focused accelerators tend to chase rapid growth that forces entrepreneurs to make choices they wouldn’t ordinarily make. This, in turn, makes more sustainable development much harder and turns entrepreneurs into just the kind of mercenaries Bezos so despised rather than founders who leave a positive impression on their local communities.
What’s more, the study found that such is the rush for scale that entrepreneurs were forced to always choose the path of least resistance and homogenize their products for the biggest market possible. This often meant leaving their hometown in search of more customers, more talent, more investment. The desire to make a difference in one’s community was superseded by the rush for a quick buck.
The wrong path
Various studies have shown that entrepreneurs start their own businesses not to get rich but to make a difference. They want to experience the freedom and excitement of entrepreneurship and use that autonomy to try and change the world in their own small way.
The VC bonanza seems to be destroying that, with the torrent of cheap cash scarcely helping businesses to thrive. Indeed, WeWork is an illustrative example of a company that was so propped up by VC funding that it was allowed to make mistake after mistake with few consequences.
For all of its numerous flaws, the company was at one point valued at nearly $50 billion. Rather than the unraveling of the WeWork story serving as a reset point for the community to reconsider how tech firms are valued, supported, and reported on, however, the money keeps on flowing, with some arguing that such is the inflation evident in the community that a new benchmark of $12 billion is required to describe those firms truly at the bleeding edge.
This runs the very real risk of crowding out those startups looking to take a slower and more sustainable path to growth in favor of those seeking the path to riches as quickly as possible. It runs the risk that startups targeting niche problems get crowded out in favor of those forced to chase mass market problems.
At the moment, the whole startup world seems to be playing the tune of the VCs, and it’s time for that to change.
