How to save startups?

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November 17, 2012 by davebu3

By David Buccelli, MSc in Management Consulting 3 student

Since the end of World War II, venture capital firms began to emerge, seeing an opportunity to cash in on the potential success of others by helping them start along their path.  Over the past 15 years an average of $22 billion/year has been invested, after a peak of over $80 billion in 1999 (dot com boom).

Anyone and everyone has become part of the game with Google, contributing $300 million/year to its venture capital firm Google Ventures and Intel contributing $500 million/year to its Intel Capital, while the big firms like Andreessen Horowitz (Facebook, Twitter, Groupon, Zynga, Skype, Instagram) and Sequoia Capital (Airbnb, Apple, Google, YouTube, PayPal, Cisco, Oracle, Electronic Arts, Yahoo!, Kayak, Admob, LinkedIn, etc.) lead the Silicon Valley venture capital industry.

There is no shortage of funding in startups ($12 billion in California alone in 2011), but 90% of these startups still fail.  Pay By Touch failed after six years and after $340 million in investments.  Boo.com did the same after $130 million, Reatrix after $75 million, SearchMe, Joost, Spiral Frog, Friendster and Color after $40 million each in investments.  All are considered failures, if not already out of business.

Just funding these companies in their early stages isn’t enough.  This is where Y Combinator came in.  They hold three-month incubation program for a small number of carefully selected startups, about 3% of applicants.  In exchange Y Combinator receives between a 2-10% share of the company and guarantees a $150,000 investment.  They must be doing something right, as their top 21 alumni companies are worth a combined $4.7 billion (though the other 189 are valued much less).

Why this is important is that there has been an expansion from the traditional venture capital style into Y Combinator’s incubator style program.  They have become so good at selecting participants for their program, Y Combinator alumni have lines of angel investors waiting to throw money at them afterwards, every tech blog covers them, and they are instantly seen as elites.  They are often called “The Harvard of Silicon Valley”.

Is it enough?  That $4.7 billion comes from 10% of those companies they assist.  Are they doing anything special if 90% of their companies still fail, or hover around mediocrity?  There is still a large gap that could potentially be turned into $47 billion instead of $4.7 billion.  Closing this gap is something that should be addressed more aggressively, as the growth potential is limitless.

Y Combinator has soothed the concerns of angel investors, but has not closed this gap.  A more thorough program is necessary, and who better to close this gap than specialized management consultants?  Though there are a handful of small consultancies attempting to take advantage of this market, there is no dominant player.  Startups are all about innovative ideas, and these consultancies are pitching ancient ideas, not innovative ones.  The only way to break into this industry is to be as innovative as the startups are.  Will this manifest with new boutique consultancies or consultancies within venture capitalist firms?

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A blog by Grenoble Graduate School of Business students.

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