Startup Clone Wars

It’s not uncommon for an Investor to chat with an early-stage Startup and within weeks get introduced to 3-4 other Startups tackling the same opportunity at the same time. When this happens it’s rarely coincidental and definitely worth paying attention to.

Let’s start with a generalizable truth that Startups form to attack market opportunities. Businesses sell products, deliver experiences and solve problems, and Startups attempt to deliver vastly superior products, experiences and solutions to those that currently exist in their markets.

And three basic “beliefs” are almost universally held by Investors as a precursor to backing unproven businesses.

Belief #1: Operational Risk can be overcome by the team

An Investor has to believe that given the right resources a team can be assembled to execute on a multi-year plan full of unknown obstacles.

Belief #2: Technical Risk can be overcome by the team

An Investor has to believe that what’s been described can actually be built with a reasonable expenditure of money in a reasonable amount of time.

Belief #3: Market Risk can be overcome by the quality and price of the solution

An Investor has to believe that a significant number of customers can be found who are willing to pay more for the solution than it costs to produce.

Venture Capital exists to provide the financial resources needed for an unproven business to prove out its assumptions around these three forms of risk: Operational Risk, Technical Risk and Market Risk.

And Venture returns are created when high variance drivers of a business collapse to the all-important “it’s working” state. String together enough things that work and a business emerges from nothing and value is created for everyone involved.

This framework can predict when a Cambrian Explosion of similar companies is likely to form at the same time:

The more obvious Market Risk = Zero the more likely it is for a startup to materialize.

And when Market Risk AND Technical Risk = Zero then the gold rush begins.

And guess where there’s a gold rush happening right now? Just about everywhere that old business models can be redesigned using AI technology. Market Risk and Technical Risk are quickly approaching zero for dozens of interesting problem statements in dozens of very large ecosystems!

Companies are popping up and incumbents are scrambling to modify their offerings to tackle these problems. The “why” is obvious. Technical risk is being reduced with each generation of foundational AI model that becomes available in the market and there’s ZERO market risk for AI offerings that are superior to incumbent solutions. The market exists and will pay a fair price for next-generation AI products.

But when an Investor is evaluating a “zero market risk opportunity” there are dynamics that are important to internalize because competition can and in many cases will ruin markets.

How to Ruin a Market Opportunity: Zero Differentiation

There are times when the solution the market is willing to pay for is so obvious that differentiation is nearly impossible to create. In these situations, the market may evolve into one with many solution providers each commanding a fraction of the market. Margins tend to collapse because price can always be used as a differentiator for commoditized products/solutions.

How to Fail When the Market is Crying for a Solution: Be Slow Out of the Gate

There are times when size and scale are critical criteria that define a superior solution. Marketplaces models depend on size and scale. The economics of businesses with significant overhead or manufacturing costs typically improve with size and scale. Businesses that provide services become more reliable with size and scale.

In these situations, the easiest way to burn a lot of cash and destroy a lot of shareholder value is to “chase the winner”. Selling to the winner or merging with a smaller player to create scale is almost always better than just missing the podium.

Another critical point to internalize in “zero market risk opportunity” situations is that early traction doesn’t directly correlate to a startup’s probability of ultimate success. The biggest mistake an Investor or a Founder can make is to become overly confident based on out-of-the-gate adoption.

So while “zero market risk opportunity” companies have been de-risked due to market appetite and have high odds of achieving amazing early results, it’s incredibly difficult to pick a long-term winner out of a batch of similar startups.

The TL;DR is that it’s worth paying attention when multiple businesses are emerging to tackle a problem at the same time.

But in the immortal words from every Scooby Doo episode: “And I would have gotten away with it if it weren’t for you meddling kids.” (Competition sucks!)