So, you’re a talented individual looking for a recession-proof startup or trailblazing tech scale-up that’s worth a billion or two. The only way is up, right? Well, not exactly. Spoiler alert: most unicorns aren’t real and they certainly aren’t recession-proof.
You’ve heard of the phrase ‘don’t judge a book by its cover’, right? Well, the startup or entrepreneurial version is don’t judge a unicorn by its fundraising track record. Want an example? Look no further than the recent and quite spectacular fall from grace of WeWork.
If ever we needed proof that the gap between private valuations and public trading levels is a coastal shelf-like chasm rather than a crack, the demise of WeWork (and other under-performing unicorns as Uber and Lyft) is it. It’s also evidence that cultural prominence, or being a “startup darling” of the tech and Venture Capital industries, means absolutely nothing.
When everything is built on foundations made out of sand, it’s not surprising when it all comes tumbling down.
Why are we telling you this? Well, if you’re looking for a job at a startup, a move up the career ladder, or a company that seems recession-proof – something priceless in our age of boom-and-bust economic cycles – then looking towards the [false] promised land of a unicorn is not the way to go.
A unicorn is (by and large) not a recession-proof startup
Unless you’ve been living under a rock, the recent controversy surrounding the spectacular fall from grace of WeWork, which saw its valuation plunge from $47 billion in January to less than $8 last month after a failed IPO, is a perfect example of a certain kind of culture and attitude among startups, founders and investors. The story goes something like this:
Somewhere in Silicon Valley…
Wannabe unicorn founder: “All we have to do, is take these lies and make them true.”
VC Investor: “Are you quoting George Michael lyrics?”
Wannabe unicorn founder: “No I’m not (although said founder begins to hum the tune of ‘Freedom’). I’m simply trying to tell you that we just need to agree and announce that we’re worth $1 billion. Then we can get a load of cool media coverage, attract the best talent, get a boatload of bro-grats tweets, and a slot speaking at Web Summit. Then the sky’s the limit!”
VC Investor: “Hey, that’s a good idea. What’s the worst that could happen? First though, let me make sure I cover my back with liquidation preferences and let’s go with it.*
*Hint. This won’t end well.
Another kind of dotcom bubble
While we may or may not have made up the above dialogue, believe it or not, this mentality is crippling so-called unicorn startups and scale-ups, that are biting off far too much than they can chew in the sake of fame, and being sent to their doom. A dangerous policy in the onset of an expected coming downturn that could rival the dotcom bubble in the early 2000’s.
And who suffers the most? Of course it isn’t the founders or the VC’s. Usually startup CEO’s and founders get out in time unscathed as they will have sold tens or hundreds of secondary shares, while the VC’s have cashed in already on their downside protection (liquidation preferences) as mentioned earlier.
Nope, it’s the common shareholders, i.e. the employees who get hit when things go south, or just not on the promised upward trajectory. This is why it’s really important to do your due diligence check on potential employers to understand if the company is actually that valuable, or it’s all a load of marketing fluff.
Many clued up media observers and industry insiders are calling the above scenario a new kind of dotcom bubble. The unicorn bubble, if you like.
That’s why, as we keep saying, the focus should be on a different approach. Because there is another way. And it’s foundation is capital efficiency, minimum viable investment framework (MVIF), and early profitability.
Yes, this is an actual possibility. Early-stage startups don’t always need piles of VC cash to be successful. The alternative is actually how you create a recession-proof startup.
Identifying a recession-proof startup from a fake unicorn
So how do you identify a recession-proof startup from a potentially fake unicorn? Or indeed a fake unicorn in the making? It’s all a question of one thing. One metric which is rarely spoken about in startup and VC land. EBITDA. That’s right, the fundamental ability of any company. Which is the ability to generate profits in order to serve their customers, employees, suppliers and, we’ll even go as far as to say society at large.
A lot of unicorns, unicorns-in-the-making, and talked-about scale-ups can look impressive in their vision, or work experience. The marketing can be so good around them that a few of them may even be seen as works of art.
But, if it can’t create economic value, then it’s a lost-cause. Because the first thing that happens in cases like WeWork and other big companies that fail to live up to their hype is layoffs. You can bet your house, or rented penthouse, on that.
So, when you’re thinking over staying with an existing employer, or moving to a more fancy-looking one, be sure to ask the question. Something like this: “What’s your EBITDA margin and can you explain to me how you expect to sustain it when the forthcoming downturn/correction hits?”
If you don’t receive a clear and simple (and confident) answer, then the alarm bells should start ringing in your head.
Another way: scale up responsibly
Of course the answer to the EBITDA question is not the only guiding indicator. We’ve talked extensively on this blog about about thriving startups and scale-ups, and we’re actually engaged in a related initiative here in Greece called #ScaleUpGreece. It’s basically our response on a local level to aim for a more sustainable entrepreneurial model.
But the truth is that we have no illusions about scale-ups. We don’t chase shooting stars, or radically disruptive startup ideas. Nor do we go after fake unicorns. We see ourselves as thoughtful work-horses, and want to champion a new type of contemporary entrepreneur, as well as showcase great, sustainable scale-up stories. Also, far from being passive early stage investors, we are actively involved in our portfolio companies daily work, through our Venture Building program. The aim is to give them a noise-free environment and the right guidance to making a success of their businesses.
Unfortunately, this is still the antithesis of what is still happening in Silicon Valley and beyond
The main reason is the wrong mentality. The attitude that the end justifies the means. But still, in 2019 you have to ask the question, how do things like the WeWork debacle still happen? The answer to this is mainly a matter of funding. Or how it is perceived.
But how can funding be of real value for a company? And what differentiates a healthy funding round from an ill-based one? A recent newsletter from CB Insights, quotes a tweet from a partner at Lightspeed Venture Partners named Jeremy Liew with the interesting statistic that 31% of unicorns are valued at exactly $1bn.
The crux of the matter is that this magic $1bn number is by no means a coincidence. It’s done on purpose. Why? For all the reasons we have mentioned above about becoming a “media and industry darling”. Astonishing, right?
Different perspectives, same deception
This is why if you’re seeking a job at a perceived recession-proof startup which is a unicorn, you need to double and triple check what’s happening behind the scenes. I mean on the surface it could all look incredibly attractive. You core checklist of success is satisfied. There’s positive media coverage, lots of funds invested and it seems that nothing can go wrong.
But, usually, things are not quite as they seem. What is the company’s real value? Even if we don’t have a PhD in Economics, it’s not that difficult to evaluate a company’s true worth. From more moderate investors we’ve hosted in workshops, the key messages are usually “numbers before ideas”. The thing is, which numbers and which metrics should you focus on? The answer: EBITDA of course.
Who’s to blame for the fake unicorn syndrome? Well, in our humble opinion it’s a joint-operation between startup CEOs and investors. The established industry and media culture is a product of the scheming that goes on between those two.
Is it greediness? Is it need? Or is it just naivety? Well more often than not, it’s a deadly combination of all of these reasons. Most founders an CEO’s try to get funded (to the maximum level) in any way they can. They try so hard to fulfill all investment criteria in order to get huge amounts of funds, without necessity needing that financing. And as we’ve discussed before on this blog, this failed practice is like doping in athletics.
Ordinary employees and team members lose
The effect of this kind of financial doping is a massive bill at the end of the day. And who pays it? As mentioned, it’s not the VC investors, nor the CEO/Founders. They may lose face and their reputation will take a beating, but they usually come out of it above water and with a few million in the bank.
The long-term consequences fall directly on employees, customers, partners and society at large. Because things like this encourage a much more economic conservatism approach that affects everyone. How? With fewer opportunities in terms for new ventures/startups, etc, there’s fewer job opportunities and ideas with real world value are held back.
There are those out there who believe that all the talk of a coming bust or recession is just another shelter for pessimists. It remains to be seen. In the end maybe we should be optimistic, as every cloud, whether you like it or not, usually does come with a silver lining. And that silver lining is the lessons that are learned.
Perhaps the WeWork phenomenon and others like it have as much of a positive influence to provide than negative. Maybe CEO/founders will not act as reckless. Maybe investors will too. And maybe a new mindfulness will prevail. Only then will we have a chance of moving away from catastrophic effects of over-investments.
If in doubt, go lean
We were always told as adolescents by our wise parents to stay ‘on the straight and narrow’. In other words, the safe, honest and moral route. Not to stray too far from the path. While we must often do the opposite in life in order to try new things and experiences in life, it doesn’t actually work the same way for investments.
In looking for a recession-proof startup, or for startups and new businesses in general, for ‘straight and narrow’, read ‘lean and capital efficient’. Don’t be fooled by fake unicorns or indeed fake unicorns in the making. Believe me the latter are increasing in number – even here in Greece too.
In general the fundraising mania (WeWork being the heavyweight champion of the world), pushes companies to look awesome, but most of the times they are far from it. Startup founders must themselves always question seriously the need to go for venture capital financing. You should only go there if any further, organic growth just isn’t possible any longer. And, you’ve exhausted all resources from those 3Fs, as well as angel investors.
In essence, keep thinking the lean way first, and capital efficiency. Because your startup’s financial health comes before anything else.