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Meet Your New Role Model: The Workhorse

I never liked the term Unicorn. It never made sense to me to aspire to something mythical and therefore of theoretical value.

I’ve written before about the risks associated with trying to make unicorns and the fact that entrepreneurs are the ones who bare the burden of the risks associated with a go big or stay home company building philosophy. Unfortunately, over the past several years, tech-entrepreneurship seemed to become synonymous with making unicorns. If you weren’t working toward a billion dollar valuation in short order, you were wasting your time and the time of all of the investors to whom you were pitching your business plan.

For entrepreneurs who – for the past five years – have been enamored to achieve unicorn status, it may be time to leave the horn envy behind. The Great Reset is on and tech CEO’s need to adapt their value creation philosophy to the constraints of the current financing markets.

Perhaps it is time for us to re-imagine our role model. Several of the doom and gloom articles I’ve read have proposed the cockroach as the new role model for tech-entrepreneurs. Having reflected on this a bit, going from unicorns to cockroaches feels like a bit of an over-steer to me. I understand there is a survivalist instinct triggered by the kind of valuation correction the markets are experiencing. But cockroaches are disgusting and while they are certainly master survivalists having been around for 340 million years, they aren’t a particularly appealing role-model with which to affiliate.

I also don’t think that the Great Reset is an “end of times” scale event. The Great Reset is more a calling back to fundamentals than a mass extinction.

WorkhorseA less extreme change in role model is called for.

Out with the Unicorns.

In with the Workhorses.

I like the workhorse as a role-model that is appropriate for the current state of the private financing markets. Workhorses are smart, tough, sturdy, dependable, docile and patient. They are strong, even in the presence of a storm. Workhorses are durable and adaptable. Oh, and workhorses aren’t mythical.

Think of the workhorse as an evolved unicorn. The unicorn is of mythical value. The horn was useless and the magic isn’t real. Workhorses are are evolved in that they are producers of fundamental value. They do real work and solve real problems.

Don’t mistake me for suggesting that the companies that have been anointed with unicorn status aren’t of value. Quite the contrary, I think that most of the “unicorns” are actually workhorses in disguise and most are phenomenally valuable. It is the mythology surrounding the unicorn craze and the resulting disconnect between valuation and fundamental value that has been the problem, not the unicorns themselves.

Unicorn mythology has warped investor sentiment and entrepreneur behavior and expectations in unproductive ways causing all to take the collective eye off the real task at hand – building fiscally disciplined businesses with sound unit economics that are of fundamental value.

Shed the horn-envy; turn your unicorn wannabe into a workhorse.

The post Meet Your New Role Model: The Workhorse appeared first on Non-Linear.

Unicorpse and The Moral Hazard of Making Unicorns

UnicorpseI’m sure that many more thoughtful than me has written about the moral hazard of venture capital. In economics, moral hazard occurs when one person takes an unreasonable risk because someone else will bear the burden of the negative consequences. In the age of unicorns, the moral hazard in venture capital has never been greater. Moral hazard and exuberance to make unicorns leads to unicorpses. I was reminded of this today during a conversation with an emerging growth business run by capable, but  young entrepreneurs.

The Situation

The 20 something entrepreneurs with whom I was talking have built a solid, already profitable business generating $4.3 million ARR. The company has taken a total of $200k of outside financing. With a modest amount of incremental capital, the business has the potential to be a $30 to $50 million revenue business in 5 years and to be meaningfully profitable. Such a business could easily fetch $100 to $150 million in exit value, producing a significant amount of wealth for the entrepreneurs. In addition to producing personal wealth, after such an exit the entrepreneurs will have built a successful company, made money for their investors, established a reputation for themselves and find themselves with the personal wealth necessary to finance the start of their next business. They would be imminently “back-able” and set up nicely for a long and productive career.

Objectively, a $100 to $150 million exit in three to five years is possible for this company. Objectively, a unicorn type multi-billion exit isn’t possible. But sticking to the straight and narrow of building a solid profitable business is hard. Bad influences abound. Entrepreneurs, like the ones running this company, are flooded with tech-centric news about the birthing of a unicorns and are shielded from the harsh reality of entrepreneurial failure. The infrequent unicorn gets lots of press where the 40% failure rates that plague venture capital fade to black. It is no wonder then that many entrepreneurs (particularly young entrepreneurs) fall victim to the instinct to try to make their company into a unicorn. Lets go raise $[fill in the blank] and pursue [fill in big hair audacious goal] becomes the mantra, whether or not the opportunity has unicorn characteristics or the use of proceeds is well aligned with what the business is. Raising all of that capital leads to spending, and higher burn. After all “we’re not giving you the money to have you save it” and “you can’t save your way to success” are common refrains. In most situations, higher burn rate equals higher risk of failure. High risk, but not necessarily higher reward.

Who mourns the unicorpse?

With high-loss rates and returns concentrated in a small number of investments that go full unicorn, venture capital is more fraught with moral hazard than ever. Venture capitalists have portfolios and their performance is generally evaluated at a portfolio level. This portfolio level evaluation applies whether the evaluation is of a firm or an individual investing partner. Venture capitalist cares less about the success or failure of any single investment than the success of his/her overall portfolio. Knowing that loss-rates are high and returns are concentrated in a few large deals, venture capitalists have an inherent incentive to swing for the fences on every investment, increasing the risk and potential reward of each investment.

Who bears the cost? The entrepreneur.

Pragmatically speaking, an entrepreneur can manage only one entrepreneurial endeavor at a time. In fact, we investors often tacitly, if not explicitly, require this. We want the entrepreneur single-threaded, we need the entrepreneur single-threaded. I’ve got a portfolio, but you put all of your eggs in one basket…

To make ourselves feel better, we have lots of platitudes for entrepreneurs who experience failure.

It is better to have tried and failed that never to have tried at all.

You learn more from failure than you learn from success

There is no shame in failure.

All true; but when push comes to shove, venture capitalists are master pattern matchers and a tried and true heuristic is that past entrepreneurial success is a predictor of future entrepreneurial success.  Many investors would prefer to back an entrepreneur with a successful track record and a mediocre idea over an entrepreneur coming off a failure with with a good idea. A 20/30 something entrepreneur coming off of a failure is going to have a very difficulty time getting his/her next business financed. Conversely, a 20/30 something entrepreneur coming off of a successful exit is with a successful exit under their belt is much more likely to get financed.

No Villains Here

To be clear, I’m not vilifying venture capital or venture capitalists. There is nothing untoward about the economic motivations of investors.

I’m also not suggesting that intentionally increasing the risk of an investment is risk-free for the investor. Higher operating  risk implies a greater chance of capital loss. There isn’t a moral hazard in every venture capital investment situation. For example, some businesses operate in winner takes all markets. In such situations the motivations of the investor and the entrepreneur are nicely aligned because the go big or go home philosophy of company building is the right approach due to market structure.

I am, however, suggesting that the entrepreneur bares a greater proportion of the risk associated with venture capital investments; or at least that the consequences of failure are greater for the entrepreneur than the investor.

An Alternative Approach

When you swing for the fences, you strike out a lot. No manner of platitudes for the entrepreneur who tried and failed can remove the moral hazard.

Entrepreneurs in growth stage businesses face different calculus. In a situation like the one I described, the entrepreneurs have already created value for themselves. Taking a bigger than necessary financing round and swinging for the fences puts that built in value at risk and buries it under a larger preference stack than is necessary.

Making unicorns is risky business. There is another way.

Consider taking less capital. Consider staying laser focused on your core market and building a defensible position that is resilient to attack. Win narrowly and then exit. This may mean taking a more risk averse path to unlocking the value of the business. Raise less capital. Moderate burn. Get profitable as soon as possible and exit sooner. If that means not raising capital or raising less capital (and taking less dilution) all the better.

Young entrepreneurs operating an already successful business would be wise to remember that some unicorns end up unicorpses. It is better to be modestly valuable and alive than to have had the potential to be wildly valuable and dead.

Call me old fashioned. Call me risk averse. I’m guilty as charged.

The post Unicorpse and The Moral Hazard of Making Unicorns appeared first on Non-Linear.