Last month’s delay of the WeWork IPO and the subsequent turmoil around the company got me thinking about the startup scene again. There seems to be a never-ending supply of capital available to promising startups. We’re seeing public market exits for companies Uber, Lyft, Slack, Peloton, Pinterest, and Zoom in the billions of dollars. On the surface, it would appear that we are in a golden age for startups.
Are we really in a golden age for VC-funded startups? Or is it possible that we could be in the gilded age of VC funded startups?
What is the ‘Gilded Age’?
A quick lookup at dictionary.com gives two definitions for gilded: 1) covered or highlighted with gold or something of a golden color; and 2) having a pleasing or showy appearance that conceals something of little worth.
The term Gilded Age was first coined by Mark Twain in his novel, The Gilded Age: A Tale of Today, to describe the second half of the 19th century in the United States. Rapid economic expansion brought on by the industrial era and the growth of railroads masked the growing disparity between the wealthy elite and those in the lower and middle classes. Unregulated businesses, cutthroat competition, and corruption were some of the unseemly elements that laid beneath a surface of prosperity across the country.
The Internet as Today’s Modern Day Railroad
During the Gilded Age, railroads enabled producers to spread their distribution footprint across much larger geographic boundaries. Thousands of small producers who serviced and sold to local markets were put out of business by these larger firms that sold nationwide and beyond. While it was a time of prosperity and expansion, it came at a cost. Market share was amassed by the powerful, leading to reduced competition, monopolistic practices, exploitation of natural resources, ruthless labor policies, and poor working conditions. The result of these practices led to government intervention through the Sherman Antitrust Act. It also led to the rise of unions to protect and promote worker’s rights.
There is a lot that the emergence of the internet has in common with railroads. It has dramatically reduced the costs of creating and providing services to consumers. It has allowed companies to market and advertise on a global scale. The internet has made it easy for companies to dominate markets in both the online and offline space. Just look at the tremendous impacts Google has had on advertising (killed the local newspaper advertising model), Amazon on retail, Facebook on human interactions, Apple on the music industry, Netflix on the movie industry. Even the smallest policy changes by these companies can have tremendous impacts on the industries they control. The result is an ever increasing centralization of power and accumulation of wealth by the companies and their shareholders. It’s easy to draw comparisons to Vanderbilt’s control of the railroad industry, Rockefeller’s control of the oil industry, Carnegie’s control of the steel industry, Ford’s control of the auto industry, and J.P. Morgan’s control of the finance industry back in the day.
Disturbing Trends in VC Funded Startups
My rant is not meant to be an indictment of the venture capital industry by any means. Venture capital has been and will continue to be an important source of financial capital for emerging startups. I’m also not accusing all founders and venture capital firms or their partners of poor behavior. There are many out there who are doing the right thing and working towards building lasting companies of values and technologies that contribute to the greater good of society.
However, there are some emerging trends in VC funded startups that have me concerned about the direction of the industry.
- Engaging in questionable ethics
Pushing the boundaries of what’s acceptable is becoming the norm in the quest to dominate markets. What’s worse is that it’s being accepted and actively promoted among those in the community. I’m on board with Steve Blank when he says that founder’s need to have a moral compass. I’ve also previously written that success in business should not require sacrificing your morals.
- Cult-status founders
There is a tendency these days to look for the next Steve Jobs, Jeff Bezos, Bill Gates, Elon Musk, or similar. These are founders who have cult-like personalities and inspire cult-like followings among the media, investors, employees, and the public. The problem is that tolerance for bad decision-making, questionable ethics, and bad behaviors become tolerated at the expense of devaluing the company. Examples at Uber, Theranos, and WeWork are just the ones we hear about. There are many other instance that go unreported because the companies aren’t impressive enough to garner the media spotlight. In any case, we need to recognize that founders can lead without having to achieve cult status. In many cases, it’s the quiet ones who work hard and persevere behind the scenes that create the companies making the biggest impact.
- The ‘winner-take-all’ scarcity mentality
These days, once you find success in a market, the mantra is to pour money in as fast as possible to dominate it. The goal is to own the market. This is a classic scarcity mentality. When one thinks in terms of scarcity, rather than abundance, they rationalize questionable behaviors under the guise of ‘doing what it takes to win.’ Particularly when opening up new markets, startups need to operate from a position of abundance. The more companies that can contribute to a space, the better off everyone is. It legitamizes the technology. It promotes open and fair competition. If provides consumers with choice. It’s possible for markets to support multiple winners, and those market that do end up being much healthier that those that don’t. And the companies that emerge from those markets tend to be much stronger and better run as well.
- Ignoring the path to profitability
Because of the ‘winner-take-all’ mentality, founders and investors can fail to take into account creating value and making a profit. They are willing to spend absurd amounts of money on marketing to acquire customers, even if it means losing money on each sale. Losing money with every sale is not a sustainable business practice. It’s what led to the implosion of WeWork, and it’s still undecided if the ridesharing companies Uber and Lyft will ever find a way to profitability given their customer acquisition costs. VentureBeat had a great article recently on the WeWork IPO failure and the perils of ignoring the unit cost economics and the path to profitability.
- Misaligned incentives between founders, investors and employees
Going public should be a heralded event for private companies. It’s coined an exit event because it allows founders and investors to recoup the time, energy, and return of capital that they have put into the company. A key piece of this exit is to also reward employees by providing value to the stock options they’ve been granted. The trend today, however, especially among ‘unicorn’ companies with multi-billion dollar valuations, is to wait as long as possible to exit. It allows the larger stakeholders, primarily the founders and VCs, to extract as much future value as possible out of the company instead of allowing it to be harvested by the public markets. Not only does this concentrate wealth further among a select group of people, it also misaligns incentives. To keep things brief, I’m going to refer you to another article by Steve Blank where he details how this tactic by venture investors impairs the relationship between startups and the employees they depend on to create the company’s value.
- Confusing service companies and technology companies
Many startups today that are considered technology companies are really service companies in disguise. In other words, they may use technology to provide a service, but they are not creating any new technologies or delivering innovations into the market. WeWork is a prime example. Yes, they use technology to allow people to book rooms. They use technology to run their business. However, they are not creating any new technology that existing market players like Regus couldn’t use or copy. In other words, WeWork does not have a competitive advantage or defensible market position. Companies like WeWork paper over a traditional market and business model under the guise of technology when it’s really just the use of existing technology to provide a service.
- Business models based on value extraction from the public domain
I don’t want to belabor the point as I’ve written about this before (see here). The point I want to make is that companies that are focused on exploiting loopholes or weaknesses in regulation aren’t creating value. What many of these companies are doing is transferring value from the public domain to their shareholders, which creates greater concentration of wealth. As a case in point, when Uber exploits the independent contractor rules so they don’t have to pay benefits, FICA taxes or disability, who takes care of these workers when they are injured on the job or require health benefits? The common taxpayers foots the bill for these workers who, in many cases, are making less than minimum wage because the rideshare companies continue to squeeze margins in order to show they can become profitable under their current prices. It’s unfortunate that the media glamorizes these practices to exploit loopholes, and in some cases, exploit the contractors.
So where do we go from here?
My thesis is that we need to be more aware and mindful of the impact that the internet is having on today’s startup environment, and more broadly, our society. We need to be wary of promoting, supporting, and rewarding bad behaviors by companies, founders, and investors whose sole motive is to maximize the size of their returns, even when it comes at the expense of greater public good. We should be rewarding those that are doing the right things. Those who are putting in the time and effort to create companies that make an impact. Businesses that provide benefits that improve the life for all in society and not just a select few.
When we reward the right behaviors, it will result in the creation of companies that last. Companies that create value for their shareholders, and more importantly, value for their employees, their customers, and the communities they serve.
So while I may argue and contend that we may be in The Gilded Age for VC funded startups, it’s not my call to make. Quite honestly, it’s to soon for me or anyone to tell whether this is a ‘Gilded’ or ‘Golden’ age. It will be up to history and the passage of time to determine on what side of the line that this era falls.
At the end of the day, I’m a firm believer in the human spirit. While it may take a few more WeWork like failures to get us the right place, the optimist in me says that it will happen.