Happy New Year! When I see a chart like the above, it’s unfathomable to believe that it’s a good time to be in the airline business, let alone be a startup trying to enter the capital intensive sector. But that’s what David Neeleman (the founder of JetBlue) plans to do. History is littered with failures of upstart airlines due to a myriad of factors that make it an extremely difficult sector to compete in. Today’s 3 large legacy carriers (Delta, United and American) are the result of years of consolidation and currently control ~50% of the US market.
If you have a small but growing business selling on Amazon or even direct-to-consumer (D2C) you’re bound to hit a point where you require money to scale. For as much as the media talks about venture capital, the reality is that less than 1% of startups here in the US are able to raise money from VC’s. The challenge, however, is that consumer brands often have working capital needs associated with carrying inventory or affording increasingly expensive paid media. So where do these types of businesses get the cash to grow? Traditional lenders, such as banks, often have strict covenants in their terms and have not historically catered their products to this cohort, but a growing number of new, innovative solutions are disrupting the model. I should note that pre-revenue/pre-product startups are likely not going to be a candidate for institutional debt – but a convertible note, SAFE or crowdfunding remain a viable alternative at this early stage. As a side note on crowdfunding, the SEC recently increased the cap for fundraising via this channel to $5m (from $1m) which I suspect will open up more activity in this space.
There’s been an interesting dynamic occurring in SaaS businesses over the last 5 years – Fintech solutions have slowly been added to their core software product especially in niche vertical markets such as construction and fitness. An example of this is Shopify, which initially focused their product offering on small businesses. They soon realized that this cohort was in need of more than just tools to build an e-commerce website – they also needed payment processing solutions, financing for working capital and insurance. Ant Financial, which owns the widely successful Alipay in China, is another example of a company that fundamentally is a tech platform that facilitates relationships with legacy banking partners. Because companies don’t want a lot of disparate tech solutions, it was easy for the SaaS businesses to create new revenue streams by offering these additional services. According to VC firm Andreessen Horowitz, by adding fintech, SaaS businesses can increase revenue per customer by 2-5x and open up new SaaS markets that previously may not have been accessible due to a smaller software market or inefficient customer acquisition. In the same way consumer brands have moved horizontally into adjacent categories to (hopefully) increase AOV, SaaS businesses are following the same path.
When I was at Jarden, a large global CPG, we announced a merger with Newell Brands. Over the next 6 months, our headquarters in Atlanta and NY turned into a conference room full of management consultants who were tasked with finding efficiencies between the two large $8b organizations. What they were providing was a high margin, somewhat commoditized service. Large global companies are often inefficient and can afford to pay these rates, but the same can’t be said for startups. There’s definitely a time and place for management consultants, but like other industries, theirs is also being disrupted. This is good news for entrepreneurs who now have alternative tools.
I spent 10 years in corporate America before making the leap to the startup world. I wasn’t actively trying to make the switch but during my last few years in a big company, I was yearning to be involved with something more nascent where I could have a seemingly sizable impact on the outcome. I felt like I was just another number among thousands of employees at a F-500 and was at a point in my life where I felt I could take the risk. It’s worth clarifying as well, “startup” can mean very different things. A company that just raised a few million dollars will be very different from a late stage pre-IPO startup. Most individuals who do make the switch from corporate to startup typically join the company during later stages as its less of a culture shock. I’ve heard from numerous founders that they are leery of bringing in a hire from the corporate world in the early days of the business for fear that they won’t function well in a world that isn’t yet defined and lacks a matrix org structure. To be sure, it’s not for everyone but here are my thoughts on making the change.
We’ve all been there. You’re sitting in a meeting that already has gone over its allotted time and think to yourself, what exactly are the next steps here. It seems everyone is talking in circles, bouncing ideas around, but times up and there’s a lack of clarity on how to move forward. This scenario plays out in most every company large and small, especially matrixed organizations. Compare that with the professional services space, where you’re not as likely to encounter this dynamic as a result of a flat organization. This is one major downside of a matrix model. It’s hard for one individual to truly own an initiative when it touches so many cross functional teams. I recommend startups adopt the DRI approach so each party understands where they stand in the decision making process.
If you have a startup and you’re venture backed, then you ultimately need an exit. Historically, this has been through M&A or by going public. However, with the exception of some SaaS deals, there’s not been a lot of M&A activity recently in the consumer space. Strategic buyers often feel many startups are overvalued and aren’t interested in paying the premiums. The alternative is an IPO and there’s a lot of new innovation to look forward to here. Earlier this year, there was growing support for direct listings among some high profile VC’s, namely Bill Gurley, who felt many startups were leaving “money on the table” by going through a traditional IPO. Slack and Spotify are two examples of companies that have done direct listings. His argument is that in a traditional IPO the bankers engineer the deal to get a pop for their institutional clients and ultimately the company doesn’t get to keep any of the upside. Case in point is Snowflake (SNOW) that went public yesterday via a traditional listing. The stock jumped 111% on the first day and as a result left $3.8b on the table. The downside with doing a direct listing has been the inability to raise capital as has been the case in a traditional IPO. That said, the NYSE has been working with the SEC on a way to do a primary raise concurrently with a direct listing that was recently approved but has since been rescinded as other parties pushed back. More to come here.
A landmark case against Uber and Lyft is playing out in California courts that could fundamentally challenge their business model. Proposition AB5 would require companies like Lyft and Uber to reclassify their drivers from independent contractors, as they are today, to employees. As a result, both companies have threatened to pull out of California altogether as they simply cannot comply with the ruling. Their business model isn’t built for that structure. The economics of ride hailing don’t contemplate having W2 employees. If this was the case, fare’s would rise substantially across the board, and demand would likely fall. That said, they are already prepping to lose this fight and this will require a radically different approach to how their business functions moving forward. It’s been surmised that they will pivot to a franchise model whereby independent franchisees will license the ride hailing companies software as well as brand IP while making drivers now regular employees. If you think this is a step backwards, you’re right. Under this model, you’ll end up with potentially thousands of black car and taxi companies using the software. This is exactly how the model existed before the Uber’s of the world came around and, I’m afraid, won’t even address the larger issue.
It’s true innovation when a business builds something for themselves and then realizes there’s a potential application beyond internal needs.
Take, for example, a company like Apple that started predominantly as a hardware company making computers and other peripherals. Years later, when they created the App store it was originally conceptualized as a platform to deliver programs directly developed by Apple. But they realized that there was a much bigger opportunity here to create a marketplace model and the App store of today was born. In 2019, this line of Apple’s business contributed over a half a trillion dollars in billings and further reinforces the stickiness of their hardware business. If Apple had kept this ecosystem truly closed for fear of losing control, then their market penetration would be significantly less.
This is a period of immense uncertainty but also a time for great opportunity. Some of the most well known companies were created during past periods of volatility. Apple and Microsoft were born during the OPEC induced recession of the 1970’s. Netflix survived the Dot.com bubble and came out stronger than ever, and Airbnb was born during the 2007-2008 recession. Fast forward to today and there seems to be two schools of thought on investing during the current Covid-19 pandemic. Either it’s batten down the hatches and conserve cash or let’s use this as an opportunity to double down on our winners and also invest in other startups that are booming due to stay at home restrictions. As we’ve seen in the public markets there are multiple bulls out there in certain sectors and the same theme applies to venture.