As we head into 2011, the business picture for startups is continuing to improve steadily. Around San Francisco and Silicon Valley, the startup “buzz” is reaching levels not seen in a long time. Funding continues to grow, cautiously. The cost of launching a startup is falling. The end game remains a bit cloudy: The vast majority of startups plan to exit by selling themselves to a larger company. Here are my thoughts for 2011, with a particular emphasis on software startups. (See also Silicon Valley Startup Investing Trends blog posting.)
Start With Non-traditional Funding. Angel funding in particular are gaining strength and with the lower financial barriers to getting a startup going, in many cases the Angel round can be enough for many startups to achieve escape velocity. Also consider the investment arms of larger companies. This is particularly true in CleanTech and BioTech but there are large companies that will invest in software startups as well. VC funding is out there, but you need to have a running application with a vibrant and active community before seeking funding.
Build & Deploy in the Cloud. Startups can build and deploy services in the cloud for much less up-front money. Using platforms such as Amazon EC2, Salesforce.com, Heroku (acquired), Google, IBM, and even Facebook. The financial benefits of the cloud will mean a much lower barrier to entry for new companies. It has gotten to the point where nobody in their right mind would fund a startup that built their own datacenter. Even if your plan is to have your own data center for competitive differentiation reasons, it still makes sense to start on the cloud first, test the viability of your idea, and then invest further.
Have a Plan to be #1 or #2 or Forget It. Geoffrey Moore spelled this out in his book, “The Gorilla Game” and it has never been more true. With the speed of Internet innovation and the lowered barriers to entry, markets mature and consolidate faster than ever before. The only companies who typically make money are the top two players. Special exception: Sometimes it is possible to carve out a profitable niche market and defend it. Think hard about the barriers to entry are in this market and prepare to defend them if this is the path you chose. Niche Example: Security products and services in the U.S. Medical market requires specific expertise in HIPAA privacy rules.
Solve a Specific Problem for a Specific Customer. A lot of people are in love with the idea of “ship it, listen to your customers, and iterate.” That approach only works if you are the market innovator or a market leader. In a crowded market or when you are coming from behind, that approach does not work. You must have a clear business value proposition and clear market differentiation to separate you from the rest of the pack. Actually, that is good advice for every startup. Example: Zynga found specific and unmet customer needs around social gaming.
Plan Your “End Game” Carefully. IPOs remain unlikely in the current economic conditions for all but the very most successful startups (Groupon, for example).
- Be clear about what your end game is. If it is to sell to a larger company, make sure that this is built into your business plan, that your core team knows it, and this goal is prioritized correctly.
- Be clear about who your target buyers are and how you plan to position your startup to them.
- Never only have one target buyer. You always need a backup plan, even if it is just for bargaining leverage. When you say you are willing to walk away from the table, you had better be willing to do just that – which means you have to have a Plan B.
Have a Community Plan. Most startups with a social element to the offer will have some aspect of community to them. The question is, where will you get your community?
- Build Your Own: This is very hard to do if you are trying to build a large generalized community. Even Google is struggling with this.
- Specialize: Some topics are not for everybody to hear. There may be ways to build community for specialized topics like neurosurgery, cloud computing, or startups. The challenge will be to offer a significant enough incentive to make it worth people’s time to create another online identity and profile.
- Borrow One: You can build your service on the Facebook platform, for example. This gives you an instant community of 600 million users, but comes with significant constraints and risks.
People Count. A lot of startups I talk to spend all their time thinking about innovative and cool ideas. That’s a good start but, when it comes to getting Series A or Series B funding, the quality of your core team count for as much or more than your business idea. Why is that? See the next item below.
Listen & Iterate. Lots of startups launch, listen to their customers, and find out that they need to change their business direction. Sometimes radically. Thanks to Agile Development techniques (example: SCRUM) and cloud platforms, many startups are able to make the changes required if they are listening to their customers. The good news is that customers will happily tell you what they want and where you are screwing up, if you listen. Social media makes that customer interaction even faster and more powerful. Your customers generally will want you to succeed and will try to help you to do so. Another key lesson here is not to go too far down the path on v2.0 until you have listened to and completely internalized the customer feedback from v1.0. Everybody in your organization has to be listening after the release of v1.0 — and that includes the development team.
Low Barriers to Entry for You Means the Same For Your Competition. The good news is that you can get your startup operating and competing for a lot less capital investment. The bad news is that your competitors can too. So, the question is: How are you going to stay out in front of them?
- Out-grow: Grow faster than your competitors and leave no breathing room in your target market. For example: Facebook is in a dominant position just because of the sheer size of their community. Users are fatigued with creating and managing multiple online profiles. A startup that asks users to create a new one is facing a serious uphill battle in 2011. That does even for a competitor as powerful as Google.
- Out-innovate. Listen to customers better, and provide more value that way.
- Specialize: Carve out a niche and defend it by catering to the specific needs of the market.
Partner. There are a lot of good reasons to partner. The important thing is that if you are serious about the partnership then you have to staff them. Partnerships managed by busy people in their “spare time” almost never work out. Partnership goals include:
- Whole Products: Partners can help you to fill in the gaps in your product and deliver a “whole product” or solution to your target customer, not just technology.
- Apparent size: Small fish swim in schools to look like a bigger entity to larger predators. Partnering can make you look more viable.
- Ideas: Partnering with other startups can help just through shared experience and ideas.
- Market Access: Larger partners can help you get into markets. Just don’t look at them as sales channels for your products. You have to bring value to the table and that usually means qualified customer leads and/or a way to make their products more competitive in the marketplace.
- Your End Game: Build a relationship that may grow into something deeper. Like acquisition. In many cases, it makes sense to partner first to test out the relationship before buying the company.
Right now, most of the software startup action is in social media and mobile applications. That doesn’t mean there isn’t opportunity elsewhere, it is just that the path of least funding resistance is here. With all the “action” concentrated in this space, it makes it all the more important to have clear market differentiation.
A couple of years ago, the advice to software startups would have been to develop offshore (to reduce costs) and to open source your software (to position it as open). These two things are no longer flat requirements for funding but can be useful tactics if they make sense for your business.
Best Wishes for 2011!
