Here’s Why You Should Be Tougher On Startups In 2017

Here’s Why You Should Be Tougher On Startups In 2017

“I think we should really call people out on things,” said Kara Swisher, a mega-star Silicon Valley reporter and Re/Code co-founder, when asked about tech journalism in 2017. “We have to stop being quite as cooperative. We sort of suspend disbelief when these companies get money — this isn’t just in tech, but it’s everything,” she said, referring to credulous articles about tech companies raising huge funding rounds.

“We always tend to try to ‘get along’ when we should be asking questions, at the very least,” Swisher added. “We don’t ask enough questions. We allow them to lie, we allow them to say things that are false, we don’t question things as much as we should — for lots of reasons.”

Swisher has done some soul-searching as a leading journalist. However, if we want to change the modus operandi of the tech industry, we all need to get behind this idea. To put it another way – journalists, entrepreneurs, investors, accountants, researchers, and actually, everyone around tech should be tougher this year.

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As mentioned by Erin Griffith at Fortune, 2016 marked the year of tech scandals. The growing capital searching for hot tech investment and science fiction-ish ideas looking for money – matched with hype and uncertainty – can lead entrepreneurs to exaggerate in the best case and lead them to deceive in the worst. “No industry is immune to fraud, and the hotter the business, the more hucksters flock to it. But Silicon Valley has always seen itself as the virtuous outlier, a place where altruistic nerds tolerate capitalism in order to make the world a better place. Suddenly the Valley looks as crooked and greedy as the rest of the business world,” writes Griffith.

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Just to name a few scandals: Theranos, the blood testing company reached a $9 billion valuation before it became apparent that its technology seldom actually work; Snapchat was sued by a former employee who says the company was inflating growth metrics ahead of a planned initial public offering; Zenefits, the HR software startup lost over half its value after acknowledging that its software enabled employees to dodge state licensing requirements; Hampton Creek, the eggless mayonnaise company, ordered contractors and employees to buy back its own product from retailers, effectively inflating sales figuresMagic Leap has used extravagant marketing and demonstrations of technology still in the research phase to raise expectations for its mixed reality headset. But with no release date set and Microsoft already in the market, Magic Leap is already behindFaraday Future, the secretive electric car startup backed by Chinese billionaire Jia Yueting, is plagued by lawsuits and unpaid bills. 

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Investors, it seems, are not impressed with this, and they keep pouring funds into startups. According to Pitchbook, VCs had invested $73 billion in U.S.-based startups, compared with $45 billion at the peak of the Dotcom boom. This is caused partly due to a growing lack of transparency, as more and more startups stay private longer.

But today more money is sloshing around, with $73 billion in venture capital having been invested in U.S. startups in 2016, compared with $45 billion at the peak of the Dotcom boom, according to PitchBook. There’s also less transparency as companies stay private longer – there are 174 private companies are each worth $1 billion or more. Lastly, tech startups continue to branch into more and more areas, and now are occupying space in our lives in areas such as automotive, home infrastructure, and health.

When everyone, not only journalists, but also investors, partners, and service providers start asking the tough questions, CEOs and entrepreneurs will have harder times hiding the risk points. Here are some of the points that need to be verified with entrepreneurs, before jumping to conclusions:

  • Competitors: Entrepreneurs don’t like to talk about them. Founders tend to exaggerate the uniqueness of their company, saying that “they are the only one that is making this innovative solution,” and that their competition is with employees filling equivalent functions in various business. When pushed against a wall, entrepreneurs will describe giants such as Facebook and Amazon as their indirect competitors and disregard the startups in their space, that have sometimes raised twice as much funding or even more.

 

  • Growth: While talking about growth can actually mean very different things, in the startup economy every growth is a blessing. But since entrepreneurs don’t like to talk about numbers, as important as they may be, one has to be cautious about the nature of growth. Is an increase in the number of customers because of a free trial or pilot? How much of those customers are recurring customers? And if the growth doesn’t bring in revenue yet, when will that happen? Growth from $0 to 10,000 is much steeper than the growth from $10,000 to $1 million. Remember that when a startup doesn’t mention absolute numbers.

 

  • The chasm between idea and a working product: As in the recent cases of Theranos and Magic Leap, and older cases such as Clinkle, the chasm between a prototype and a product can be tricky. Also, it’s important to ask during a demo if some special effects were used to enhance the experience.

 

  • Work Environment: Every entrepreneur describes his office as a warm and friendly place where a healthy culture of innovation and mutual feedback is preserved and a balance between work and life is practiced zealously. Fortunately, the internet allows us to double down on these cliches. For instance, Glassdoor can give insight into the popularity of a CEO and shed some light on the general sentiment among employees (and former employees).

 

  • Total Employee Count: Entrepreneurs will rarely tell you about layoffs or a complete halt in new hires. Many services allow you to see those stats for yourself.LinkedIn Premium, for example, enables you to check a two-years employee count graph and search for new management hires.

 

  • Founders: Nobody told you that the three founders sitting in front of you are not, in fact, equal partners. The co-founder and CEO holds ten times the shares in the company than co-founder #2 holds, and twenty times more than co-founder #3. This asymmetry between the founders might hint at future disputes, as each of them is committed to the company in a different way.  That’s not a real team. A one person show might be a better description of the management in this case. There are other companies in which executives join the group and receive the title of co-founder, even though they weren’t part of the company’s original founding team and joined later. In some instances, original co-founders leave and those that join instead get their titles. In other cases, disputes with a dominant CEO cause executives to come and go like a revolving door. Therefore, it is important to check the stability of a managing team.

 

  • Previous Experience: A group of founders might present themselves as seasoned entrepreneurs who sold two companies to global corporations. But, a brief background check can tell that the first company they founded went bankrupt and sold its IP, and that the second company was sold for a only few million, causing massive losses to the investors. Naturally, not all “exits” are good. Most of them aren’t.

 

  • Fund Raising: Lately, growth companies (companies in stages C/D/E) have raised large amounts of money at the expense of their valuation, which could be a sign of the cooling investment atmosphere in Silicon Valley. Founders who were used to having their companies infused with large amounts of money and seeing their valuation increase with each new round, are now sometimes agreeing to a down round (decreasing valuation between financial rounds) in order to continue to raise funds and not lose momentum. Therefore, it is not enough to know that you raised $20 million or $30 million, but rather to know if a startup just experienced a down round.

 

  • Downloads: Entrepreneurs are happy to disclose that they’ve counted 5 million downloads so far, but they are less willing to tell you how many daily active users (DAU) or monthly active users (MAU) they have. This is an important question to ask, as it tells you how many people are regularly engaging with a product.

 

  • Selling The Company: When you hear the usual “we’re here to build a large company,” remember that on average, most founders will agree to reasonable acquisition offers. In many cases there are so many preferred stocks that are connected to many different investors that founders are not actually in control of their company.

 

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Kara Swisher / Image: C Magazine

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