Tuesday, July 28, 2015

The Need for Substance Behind Disruption.


Much has being written about the merits of disruptive business models. They are redefining numerous business sectors and creating new companies with massive valuations in the process. But many startups, using disruptive business models, fail for the lack of a sound strategy and basic business acumen.

Many young entrepreneurs, founders and investors dive into business sectors they don’t know much about. And for all the creativity, drive and vision of gifted programmers and founders - writing code is a completely different skill-set than many years of industry expertise, or the basic lessons learned in graduate business schools.

Here are four cornerstones of “substance” that emerging growth companies should consider:

Sound Business Acumen:

Groupon offers deals and coupons for restaurants, retailers and service providers. It made a big splash back in 2011 when its IPO it went public raising $805 million. Investment banks including Goldman Sachs made millions in fees.

Only a few months later, regulators flagged some questionable accounting practices. The company admitted to “material weakness” in its internal controls, restated its 4 Q 2011 financials and the stock tanked by 44%, and $350 million in equity valuation vaporized. Groupon’s accounting practice gaffe reflected the extreme downside risk of not having sound business acumen, especially in accounting matters.

Industry Expertise:

Some startups simply don’t understand the business sectors they’re entering.

The American Bankers Association recently posted a video on the need for financial technology startups to hire both seasoned executives that understand the industry (including regulations) and younger developers who bring creativity, innovative and disruptive ideas.

A great example of this combined skillset in practice is Polly Portfolio.

Barron’s recently featured a cover story on the rise of “Robo Advisors.” Firms like Wealthfront and Betterment offer web portal access for investors seeking a simpler and less expensive way to manage their investments. This approach is perfect for Millennials who don’t see the value in an expensive investment advisor sitting a fancy office.

But do the developers and founders behind these online asset allocation algorithms have the investment management experience, regulatory insight and proven track record to match Wall Street? The jury is still out.

Polly Portfolio has the pedigree of some leading Wall Street hedge fund managers and their quant investment models. The company offers a sophisticated portfolio asset allocation customization feature with great graphics, and the benefit of active portfolio management and rebalancing.

If you don’t quite understand all this, it simply translates to turbo-charged industry expertise in investment management, delivered conveniently to your laptop, at a fraction of the cost compared to traditional investment advisors.

Clear and Tangible End Benefits:

A basic tenant of good marketing is that people are much more motivated to buy benefits from a product or service rather than features. K Mart sells lots of Craftsman drills with nifty features, but in the end people buy a hole in the wall.

Uber stands at the pinnacle of the startup unicorns, companies valued at a billion dollars or more. They closed $1.6 billion in financing earlier this year. Their concept of affordable and safe, on-demand transportation delivered by a smartphone app has translated into 58 countries and 300 cities worldwide. They use a clear and simple “value proposition.” Uber makes makes local travel in all these cities easier, more accessible, and often more affordable than options, in most cases local taxis. 

They are presently estimated to be worth $50B on annual revenues of $10B. Not a bad growth track for a company that started with $200,000 in seed funding back in 2009.

Sustainability:

Smart entrepreneurs design business models that are sustainable. Sometimes this requires them to “pivot” or evolve their business models over time to find something that works. 

Zygna is the company behind online games such as FarmVille, a farming simulation social network game they launched back in 2009. Despite the initial success of the game, it garnered some negative reactions. TIME magazine called the game "one of the 50 worst inventions" in recent decades, due to to its being "the most addictive of Facebook games" and a "series of mindless chores on a digital farm.

Zygna launched its IPO in late 2011 and raised $1.2B with a $20B valuation. 

In the end Zygna became a "one hit wonder" of sorts with FarmVille, and the stock quickly went from $15 per share to $2 per share and it has bounced around that value for the past three years. While the company still have a market cap of $2.4B, many investors took big losses on a company that did not have a sustainable offering. 

The company is now facing a lawsuit that contends that they defrauded shareholders about its financial prospects before the December 2011 IPO. Shareholders also claim that Zygna hid its true earnings potential to enable insiders to sell $592 million in stock before a post-IPO lockup was to expire, thus avoiding the 75% drop in share price. 

It's clear from these huge success stories, promising up-and-coming startups, and roadkill just examined that a combination of sound business acumen, clear end benefits, relevant industry expertise and a sustainable business model will go a long way towards driving long-term startup success.