A re-think on startup investment

There are many reasons why the “startup movement” is thriving throughout the world. Whilst many aspects of its ecosystem are under various transformations, the investment/funding aspects remain static.

From bootstrapping, grants, FFFs, angels, equity crowd funding, venture capital, to private equity or IPO.

Especially for the early stage startups, these concepts seem to be so fixated that we just have to take them for granted, or worse, as golden rules that can only be correct.

But if we take a look at the current investment models for early stage startups (mostly angels and VCs), there are some basic assumptions that are worthy of closer examinations.

  1. Focus on (mega) growth
  2. Ability to identify these startups
  3. Nurture these startups to realise their growth potential

Focus on (mega) growth

These days, startup is generally defined by its (mega) growth characteristics/potential – therefore the huge return on the initial investments – therefore the excitement in the investment world.

The question we must ask is – is there only one growth model that we should expect for our next generation of new ventures (i.e. mega growth potential for ‘startups’)? Can we not expect a less aggressive growth but with a stronger sustainability model (it can still be very profitable)? Can we not expect investors in the future are equally concern about financial returns and social/environmental returns?

The problem with this closed mind-set is troublesome. First, by basic intuition, companies with mega growth are few and far between, both in the old, modern and future economies. And if these are the ones that we are all chasing, the investment model inevitably has to be one that spreads a lot of small bets so it won’t miss the ‘unicorn’ (i.e. a calculated lottery system) – the only way to compensate for the big portfolio of other failing investments. This means they need to make the ecosystem to tirelessly generate the ‘next great idea’. So we can see these new initiatives, programs and sometimes deliberately generated hypes, are all there to get the ‘population’ of startups up. With a bigger population, one would hope there is naturally more unicorns from a statistical standpoint (though the probability does not change).

But is this correct?

Obviously we understand “high risk high return” but is this the only way to go about investment? If we take away the modern definition of startups, ventures in the past generations experience different growth models. For example, starting a farm, a convenient store in a small town, a great burger place in the neighbourhood. What’s wrong with these? Aren’t these businesses (which can also gradually grow much bigger) that got us to our prosperity today?

The other concern is the narrow definition of success. First, big growth potential generally means you need bigger initial capital/investment upfront.  And with everyone chasing the unicorn with the mega growth, there will be more ‘wasted’ investments because by definition, a lot of startups with ‘fail’ according to this narrow definition.

Perhaps we are generating a vicious cycle that we are not even aware of.

There has to be a new way to do this.

There has to be a new way of looking at startup growth model, which in turn change the way we want to generate and build startups for our next generation of economy.

Ability to identify these startups

With the assumption from above, great investors therefore are defined by their ability to identify these unicorns. However, statistics have proven that most of them don’t do so well. If professional investors are not superior at identifying these unicorns, how can the average investors do so? Therefore, we are educated that average investors should rely on the professional investors to do so (regardless of their actual success).

Overall, The world is having a bipolar approach to this. Either individual investors should trust their monies to professional investors (as above) who then invest into a portfolio of investments (mega many/institutional-to-many model), or people are proposing crowd funding model that many small investors invest into one project/company (many to one model).

There has to be a new way to do this.

Let’s have another re-think. First, if we accept that we don’t need mega growth startups to be our only definition of success, and that there are good chances for new businesses to experience a more moderate growth cycle, doesn’t the selection of these startups fall back to something more fundamental, i.e. whether investors like what the startups actually do and do well in long term?

Also, with the information, knowledge and wealth available in the modern society, shouldn’t there be a market where a small group of educated investors (forming a small syndicate) making a moderate size investments into a small portfolio (2-3) of startups (mini many-to-many)?  Perhaps this is the ‘private banking’ model of the next generation of micro-VCs? The biggest of the biggest investors will always be well served by the existing market, but the up and coming middle tier market for direct investments is still very much underserved.

Nurture these startups to realise their growth potential

In the current model, the nurturing of startups rely on accelerator programs, mentors and professional investors. And there are problems in each of them.

Accelerators are too short. At best, they can filter our really bad startups.  It’s not designed to help the startups longer term.

Mentors are generally volunteers. Therefore, the quality can be mixed. More importantly, because they are generally not (well) compensated, they don’t have a ‘skin in the game’. It’s hard to take advices seriously when the person has little stake in it (other than personal affection to the startup).

Angels are generally busy (and perhaps some being lazy). Nonetheless, if startups can somehow find a great angel, the value is tremendous. But there just aren’t enough good angels around, particularly in Asia.

Good VCs have people with great experiences in the industry. But fundamentally these people are in the investment field rather than the actual business, not to mention the very different nature from startups. With their experiences, they are very well suited to bring good startups to the next level but less equipped to deal with the earlier stage ones. This is perhaps the real reason for the widening of funding gap.

There has to be a new way to do this.

Perhaps for the next generation of ‘professional investors’ for startups, currently played by the VCs and angels, their focus should not be on fancy financial engineering or complicated risk profiling, but rather on actually growing the startups?  Specifically, they would “influence” startups not through majority ownership or contractual terms but with common non-financial interest?  Particularly for the middle tier model highlighted above (small syndicates investing in a small group of startups), they can make use of this new breed of professional investors, or more correctly professional business managers, who would be playing a crucial role in our future economy of startups?


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