Because they renew the regional industrial tissue and spawn new OEMs, startups that bravely develop new advanced technology should be cherished the most. However, their very nature makes them most susceptible to failure. Former startup entrepreneur Henk Zeegers offers advice on how to increase their chances.
In 2013, I, along with several partners, Eindhoven University of Technology (TUE) and health insurance provider CZ, started the company Rose. It was founded to provide remote care robot services to the elderly and people with physical limitations. In April 2015, we were only left with enough money to carry on for two more months. Shortly after, management and shareholders concluded that it was no use to go on and decided to discontinue the company. In early 2016, Rose was deregistered with the Chamber of Commerce: the end of a promising adventure.
Many startups end up in bankruptcy or are forced to terminate. Startups are very special companies: they have to survive a long time without any operational income. During this period, they depend on private investors and public funding. If this funding is interrupted for whatever reason, their backs are against the wall: they get stuck in the infamous valley of death. Breakthrough startups, which focus on developing a completely new advanced technology, are most vulnerable. The question is: can we help them overcome the valley of death?
Explorers and appliers
What exactly are startups? Financial institutions tend to emphasize company growth and business model scalability. The economic bureau of ING Bank defines a startup as “an organization looking for a globally scalable business model.” However, scalability and growth could apply to many new companies. What sets startups apart is that they either apply a new business model or base themselves on a new technology. Therefore, a better definition would be: “Startups are new companies that use new globally scalable business models or new technologies or both.”
That’s not all: to qualify as a startup, the new technologies that new companies concern themselves with must be cutting-edge. This advanced technology may be deployed both in an exploratory and applicational way. I like to call startups that explore and develop new advanced technologies “breakthrough startups”, and those that apply them “start-apps”.
Rose and another TUE spinoff like Xeltis – which develops a biodegradable heart valve prosthesis – are examples of breakthrough startups, as were Google and Tesla in their early years. Airbnb, Uber and Netflix are examples of start-apps, as are the many, many developers of software apps. Yet another type of startup applies existing technology to a new business model – examples are Ryan Air and Starbucks. All in all, there are five types of startups – the new companies that do not use new business models or new technologies are copycats.
The general public doesn’t see the difference between startups that explore a new technology and those that apply it. To them, they’re all “tech startups”. However, these ‘explorers’ and ‘appliers’ are very different from one another, and the differences determine the challenges they meet. These differences are significant when it comes to increasing their chances of success.
Eras of ferment and incremental change
What exactly is the valley of death? To fully comprehend this problematic period, we must go back to the technology cycle as proposed by Anderson and Tushman. They divide this cycle in the era of ferment and the era of incremental change.
In the era of ferment, new technologies are elaborated on and designs for new products emerge. In this era, there’s not yet competition on markets, there’s competition on the dominant design. The dominant design is the biggest in terms of the number of implementations; sometimes it’s called the standard. The coming about of the dominant design marks the end of the valley of death and ushers in the era of incremental change, in which sales and the competition on market share start.
The era of incremental change is, in turn, interrupted when another breakthrough ignites a new era of ferment. Whereas breakthrough startups start early in the era of ferment, start-apps only start at the beginning of the era of incremental change, when the first applications have been implemented. Also, there are tech startups in between these two extremes.
The moment of entry determines the technological complexity, uncertainty and distance to the market. For breakthrough startups, these are much larger than for the typical start-app and ordinary startup. Breakthrough startups, therefore, require much higher investments, which, moreover, are incredibly difficult to get due to the high risk and long payback time.
There are three options to bridge the long period of little or no operational income: raise enough funding to reach the market with the planned product ‘in one jump’, build up the value proposition to a certain value plateau – which mostly coincides with a technical readiness level – and sell the company, or generate early income with an intermediate product, which is based on the same technology as the planned ultimate product but offers simpler functionality. A thorough analysis of the situation at hand is necessary to find the best option to use. Sometimes a combination of options is the best strategy to follow.
However, even following the best possible scenario is no guarantee for success. From the perspective of society, failure is an issue when dropouts represent large economic or social potential – which is the case with quite many breakthrough startups. Also, breakthrough startups are exceedingly important for the continuous renewal of regional industrial tissue and the emergence of new OEMs.
Therefore, we as a society should do all that’s necessary to help bridge the valley of death. In the Netherlands, access to knowledge and funding are the most important issues. First, we should find better ways to valorize the knowledge built up by universities – today, it’s overly difficult for outsiders to get access to research groups and profit from their knowledge.
Secondly, governments should provide financial support consistently. During the debt crisis of 2008-2016, the expenditure on public research was cut back – which forced many startups out of business – despite it representing only a small portion of the government budget (approximately 0.75 percent of GNP). If, for instance, the government would have increased (instead of decreased) the public R&D budget during the crisis to the level of best in class (which was South Korea, with 1.05 percent), government debt by the end of 2017 would have been only 1.7 percent of GNP higher than it actually was.
Thirdly, governmental agencies should do more to guide startups to complex European subsidy schemes. A survey carried out in Brainport Eindhoven in 2013, showed that SMEs were unfamiliar with the schemes, and governmental support agencies operate single-mindedly, primarily focusing on their assigned EU scheme. The sheer number of available schemes and (semi)governmental organizations involved are like a jungle in which SME entrepreneurs can easily get lost. This situation could be improved by establishing one overarching intelligent back office, which matches startups with schemes. Moreover, this government agency should provide practical, hands-on, support regarding consortium-building and drafting applications.
Fourthly, the availability of private venture (and scale-up) capital is currently on an incredibly low level in the Netherlands. Public and private parties together should find ways to increase private funding for tech startups. One may think of governments (partially) guaranteeing equity investments in breakthrough startups. A capital return tax exemption would help as well to entice people to invest in startups. Another source, which so far hasn’t been tapped into, is the pension funds. Although the few hundreds of millions that are required per year in the Netherlands are peanuts, very little progress has been made here.
Taken together, the measures could turn the already promising Dutch startup scene into a startup powerhouse.