It’s fun to imagine the vast potential of a new product that is attempting to create a brand new market. Space exploration, nanotechnology, virtual reality, breakthrough cures for diseases, etc. This type of innovation has enormous potential to change people’s lives and with that, huge potential investment returns. Many early-stage investors focus on companies developing cutting-edge products or technology.
It’s easy to be seduced by these sexy new ideas. These investors easily envision a world (or at least a target market) positively impacted by these innovations and they project outsized returns by investing in the first-movers. While this investment approach is helpful in terms of serving as a catalyst for important, technological advancements, the risks involved are ill-advised for many early-stage investors.
In many cases, trailblazers in these nascent markets not only have to figure out the technology innovations driving their vision, but they must also educate potential customers about the product and its benefits. There’s no greater money-suck than when companies engage in missionary work.
So the risks are much greater when investing in new technologies, but I would also argue that even when these companies are successful, they have fewer liquidity options than startups in more established fields.
You have to look at the end game for most early-stage companies in order to determine which investment thesis is appropriate for you. There are very few IPOs happening these days. As a result, the most practical exit route for most startups, if they are lucky, is an acquisition.
It is far easier to sell a company that is serving a market that is already established than it is to sell one blazing new paths, creating new markets with new technology. One can easily identify potential buyers for a successful startup in an already-existing space. The pool of potential acquirers for companies in nascent industries is much more limited. A good example of this is the recent $1 billion acquisition of Dollar Shave Club. Talk about addressing an established market — it doesn’t get more established than razor blades!
Most acquisitions are done for strategic reasons and these happen in hundreds of prosaic industries all the time. There are fewer opportunities to sell a company in a brand new market that lacks incumbents, competitors and strategic buyers. These aren’t the deals that make the headlines, but they happen much more frequently than the headline-grabbing IPOs of the companies with the newest, hottest technology.
Although potential payoffs for companies in completely new markets can be huge, the odds of an exit are much worse. In a sense, “cool” can be a cop out, a short cut. “Boring” often takes more nose-to-the-grindstone work. Researching and understanding the benefits offered by a product in an already established market and the way that it is differentiated from, and superior to, the existing solutions is time-consuming work. Figuring out the universe of potential strategic buyers is challenging. Understanding the nuances that make the product defensible and desirable and different enough to result in an acquisition takes time and research. It takes knowing the dynamics of an existing market as opposed to imagining the potential of a new one.
Dollar Shave Club succeeded by innovating in a well-established, large market suffering from antiquated sales channels and marketing approaches. The innovations DSC brought to the space enabled them to grow quickly, capture a sizable share of the market and position themselves as an attractive acquisition candidate for a huge multinational company.
Peter Thiel is notorious for his belief that we are only making incremental scientific and technological improvements as a civilization because we are shying away from the moonshot ideas that jumpstart exponential societal advancement. At an event in 2014, he said that these incremental improvements — he uses Twitter as an example, insisting he’s not picking on the company because of any particular gripe he has with it — aren’t “enough to bring our civilization to the next level.”
As a member of the global community, I am appreciative of Peter’s focused effort and substantial investments. And I think that such moonshots are appropriately the province of those who can afford to focus on what is in the best ultra-long-term interests of civilization as a whole — for example, billionaires. For the rest of us, let’s focus on the stuff that’s sometimes boring, the building blocks of our world, the companies that are focused on established markets and that yield outsized investment returns day in and day out.
Also shared on Medium.
Phil Nadel is the Founder and Managing Director at Forefront Venture Partners (formerly Barbara Corcoran Venture Partners). You can follow him on Twitter: @NadelPhil or on Medium.
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