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Whether you are a would-be founder looking for your next startup idea, or someone looking for your next startup job – this article is essential reading. By the end of this article you will understand how best to manage the significant risk of failure that exists in every startup, and ensure that your time was most impactful in terms of building your personal wealth.
When it comes to generating meaningful outcomes from your stock and options – the market, people, macro trends, business traction, funding, and quality of investors that you choose to work and associate with are all critical factors. And yet, there are two significantly more powerful factors that you simply can’t account for: Luck and the Unknown.
While the headlines are full of the winners (Musk, Zuckenberg, Bezos, Page, Buffet and Gates), history is full of the losers. There are around 5 million new startups started every year in the US alone and the vast majority will never be worth anything.
This article explores periods when lucrative, global investment trends were about as clear as they could be, with winners yet to emerge and a number of promising companies to choose from that appeared to be best-poised to capture this value – and in spite of this, picking winners during these times was close to impossible.
To profit with greater certainty from our time and investments, we need to fundamentally rethink our willingness to live with extremely concentrated bets on equity, as well as how we pick the companies that we work for.
In a missive entitled Welcome To A Brave New World — A Multi Trillion Dollar Disruption Journey, Dovi Francis, the Founding Partner at the VC fund Group 11 lays out the challenges and opportunities that he sees facing the world at this time. He summarizes his view of the world by saying:
“The big change is…. moving from a stable, global, consumption-driven Boomer economy to an unstable, localized and investment-driven millennial replacement.
The last 40 years were fun, for Boomers at least and for some of the Gen X’rs, who have taken advantage of low interest rates in a predictable market, but they have left us with depleted resources that include a wasted and angry planet, rotting infrastructure that has turned lethal (think Santa Rosa and Lahaina), embedded and costly monopolies (think health care) along with upside down demographics and high debt levels.”
In other words, we are staring at some very clear, immediate, important, and lucrative trends. Just like in the dawn of the Web 1.0 era. Structural challenges are forcing the fundamental generational restructuring of the economy. Here will be a significant opportunity for AI-enabled companies to shape the new world order. Having a form of intelligence that supersedes that of humankind opens up many possibilities.
On the back of similar investment theses (seeing as they are manifestly obvious to most private market investors) many VCs will invest in variations of this vision and similar futures. Massive opportunities are clear: the need to fix and maintain the planet; the need to sustainably upgrade infrastructure; AI. And the emerging leaders seem self-evident (OpenAI, Anthropic, Microsoft, etc.).
Per Pitchbook data, the real performers in the VC community are small, anonymous funds - not the well known brands with the outsized deal flow and the incumbent advantage in closing deals. This is counterintuitive. If there are periods where the writing is on the wall, it should be the bigger funds, that can back industry trends and have access to the best quality cohort that provide the best returns. It turns out that it is really difficult to pick the winners.
The chance of picking a winning startup is significantly lower than picking a winning number at the roulette table, even for a professional investor. On top of that, it takes a decade-plus for that bet to play out.
For investors, this is easier. Placing multiple bets in parallel is simply a function of wallet size and check size.
For founders and employees, the calculus is different. Founders and employees earn their stock over time. If they have received options, they need to fund the exercise price. De facto, they can only place one bet every few years. The reality is the same. Even if you think you have crystal clear clarity on how the future plays out, you have likely picked a loser. Your ability to diversify or hedge your bets are opaque and extremely complex.
As mentioned – 2023 is not the first time that the broad investment trends of the future were so crystal clear.
In the 1990s, the personal computer was beginning to be a household item, the world was migrating to cell phones, and the still-embryonic internet was already a clear once-in-a-generation game changer. This fledgling internet era was a time of clear opportunity.
The internet was going to be a tool which changed forever how mankind consumed media and engaged in commerce. The companies that enabled internet utilization would become immensely powerful and valuable. The companies that succeeded in taking retail share of wallet on-line would be able to sell to an unlimited audience, without the need to invest in physical stores. And, of course, the companies that provided access to the internet, be it the hardware that powered this or the services that connected you, would be sitting on a gold mine.
So clear was the opportunity that investors large and small flocked to these investments in droves. Cash was deployed to take advantage of the crystal clear global trend, in what would later be known as the Dot.com boom (and later, as the Dot.com crash).
Despite billions of dollars being lost, ultimately everyone was right about the trends and about the signs of certain emerging leaders …. and yet, nearly everyone had the wrong investment outcomes.
Access to the world's information would become a gold mine. It turns out that it became dominated by a single company, Google, that as of time of writing, handles around 90% of the world’s search queries.
Of course, 25 years prior, no-one knew that the winning UX to the world’s information would be search. Companies such as Yahoo! championed portal access. And there were many search companies that seemed as promising as Google, if not more, and who were earlier to the market than they were. oAnd no one knew that there would be such a dramatic winner-takes-all dynamic.
A similar winner-takes-all dynamic unfolded in e-commerce. Over those same 25 years, per Statista, 20% of retail sales would move online. Of those transacted in the US, almost 40% would be accounted for by Amazon, with the next largest e-retailer being Walmart at just 6%. Retail incumbents would succeed in shifting some of their sales online with Walmart, Target, Home Depot, Best Buy, Cosco, Kroger accounting for 15% of online sales. Besides Amazon, few newcomers would make their mark, with one remarkable exception of Apple, who on top of owning 3.9% of online sales would also own a significant portion of the new telecommunications market. E-bay and Wayfair made a mark, but their market caps of $23B and $5B respectively cannot compare to Amazon’s $1.3T.
In contrast to these other sectors – in telecommunications, despite massive investment in new businesses, it was ultimately the incumbents won the emerging telecoms markets. Telecommunications would indeed go through a massive transformation. Dial-up over traditional landline phone lines would move to a world of Broadband, Fiber Optics and Cellular communications. Many companies pioneering these services and hardware to support them would raise $1.6T on Wall street and a further $600B in debt. Most of these names would not survive. Hardware would become a commodity manufactured by the incumbent, Cisco, or in the Far East. Internet services would be provided by the legacy telecommunications providers in AT&T, the descendants of the Bell Corporation and others.
Two marked exceptions would be Apple and Nvidia. Apple too was an incumbent that reinvented itself as the leader in mobile communications. Nvidia was founded in 1993 with the vision of creating processing power to manage graphics that it predicted as necessary for a world of home computing and the internet. Until 2012 Nvidia did exactly this and was worth several billions of dollars. In 2012 it repurposed its silicon to power AI a decade before the explosion of this technology. This foresight would drive Nvidia to join the Trillion dollar club a decade later.
Outside Google and Amazon, few Internet 1.0 companies would survive independently, despite their massive promise, the substantial opportunity set, and their extraordinary financing. The world indeed changed. – but ultimately, they manifested themselves in ways and winners that few predicted – even the strongest professionals. Of the top ten companies by market capitalization as of writing this article, five were founded in the 1990s or later. Besides Alphabet (Google), Amazon and NVidia discussed above, the list includes Meta (Facebook), founded in 2004 and Tesla, founded in 2003.
Had one correctly identified three vectors resulting from the internet revolution - namely the need to access the world’s information, the shift to ecommerce, and the telecommunications boom – one would still have had an incredibly hard time picking winners.
Had one foreseen the need for a product to access the internet’s information there were a multitude of companies to invest in back in the 1990s. Webcrawler, Lycos, Excite, Altavista, Yahoo! and AskJeeves all had search engines or portals before Google was founded in 1998. These are just the well known search engines, and not the plethora of startups that never made it into the limelight.
Altavista filed for IPO however never completed due to the Dot.com bubble explosion. In it’s SEC filings it had recorded an accumulated $765M loss. Ultimately Altavista sold to Overture (and later Yahoo!) for $140M. Most investors would have made a loss. Certainly the founders and employees would not have made any money on the transaction.
Lycos timed the Dot.com boom much better. They IPOd at a market cap of $1.4B. Early employees and early investors would have made money at the IPO, and then again when it sold to Spanish Terra Networks for $12.5B. A decade later Lycos sold for just $35M having been beaten by Google.
E-commerce fared a lot worse. The number of companies that raised tremendous amounts of capital and went out of business are huge. Boo.com is a famous example that raised and burnt through $185M in just a few short years. Boo.com had excellent backers, with much of the money invested by JPMorgan and Goldman Sachs. Pets.com, eToys, HomeGrocer and WebVan are all e-commerce companies that reached an IPO and filed for bankruptcy just a few months later. There are far far more that never reached IPO.
The telecommunications sector that would provide the infrastructure to power the internet revolution fared worse still. There would be no Cinderella such as Google or Amazon that would provide returns worthy of the entire sector. Countless companies would file for bankruptcy and incumbents such as AT&T and Verizon would pick up their assets for pennies on the dollar. 360networks, once valued at $13B, sold its Canadian business to BellCanada for $275M C$ and finally sold its remaining assets to the Zayo Group for $318M per SEC filings. Airspan Networks raised well over $100M in capital, listed, delisted, and ultimately relisted through a reverse merger during the SPAC craze of 2021. After 25 years of operations and well over $100M of capital invested, the company is now trades as MIMO and has a market capitalization of $10M.
Freei, a free internet provider, raised tens of millions of dollars from investors, to acquire 3.2M subscribers. After its failed IPO in October 2020, it filed for bankruptcy, and its assets were sold at auction. Gadzoox, a data storage company, would raise $16M from venture capital, IPO raising tens of million more in multiple rounds, and file for bankruptcy. Its assets were sold to Broadcom for $5.3M.
Global Crossing, a tier one carrier, raised tens of millions from venture capital, and $400M in its IPO in 1998. At its peak valued at $47B. In 2020 the company lost $1.4B alone. This loss ballooned to $3.4B in Q4 2001. In January 2002, having bought overvalued assets for tens of billions of dollars and having burnt through tens of billions more, finally filed for bankruptcy.
The internet revolution unfolded in an era where investments and startups were not memorialized on the internet. The graveyard of venture companies that never made it into the Dot.com bust eulogy is voluminous. Yet even of those companies that were worthy of record, extremely few were worth anything or returned money of significance to their shareholders.
“Company-building” is a narrative that is embroidered rich with luck. Timing is critical. Geocities failed, whereas Wix and Squarespace succeeded, because the internet was then part of the world’s daily habit. Beenz and Flooz never got traction as digital currencies, yet Bitcoin got traction after launching in 2009, immediately after the world lost faith in traditional central banking institutions. Telecommunications startups never got traction, because whilst the need was real and timely, it was a market evolution of incumbents rather than a revolution. This was largely because they didn’t own critical pre-existing infrastructure. Google won the war for access to the internet. Google almost sold to Excite for $1M but were turned down, only to chance on a monetization model that would power them into being one of the most valuable companies of all time. Other search engines were early and even better. Almost every bet on the internet revolution would have lost money.
This is unsurprising. At the peak of the 2021 tech bubble, Angelist data had the chance of becoming a unicorn at 2.5%. Outside bubble periods, this is lower. But worse still, even once a company is a unicorn, much of that value can be wiped out and returned to the preference stack. A company growing at 60% a year at some point will slow in its traction. When that happens, its revenue multiples could fall from 20X and unicorn status to just 4X. Depending on how much that company raised and when, this could wipe out value held by ordinary shareholders, and even some investors.
Nobel prize laureate and economist Harry Markowitz famously said that “Diversification is the only free lunch”. Economic seismic shifts and category creation are, by definition full of uncertainty. And in those environments, a chip on a single number at the roulette table is a high-risk strategy. Indeed, even if during the internet revolution one had bet on infrastructure startups in a systematic manner, such an investor would have likely lost money, had they not bet on the incumbents.
The world and the economy will continue to change and be disrupted. There will be winners. But by far more losers. The only way to guarantee some sort of return is to diversify. If you want to learn more about how to diversify your startup equity position you can book a call with us.
Alon Zieve is the CEO and Co-founder of Aption. Apeiros is dedicated to providing diversification solutions for founders, executives and employees and providing sophisticated solutions across the entire Venture ecosystem.