What porn and ridesharing can teach corporates, investors and startups

Most investors and corporates estimate the potential of a new technology. It’s a mistake. Real disruption comes from the convergence of different technologies. This post will explain how technology convergence creates parallel industries and Startup Tsunamis. Most importantly, it will tell the story of a young stripteasing college student that took down a billion-dollar empire.

In 1953, a 27-year-old entrepreneur raised angel investment from 45 investors. With the money, he pioneered one of the world’s biggest industries and built a true empire. Today, his product is an iconic piece of western culture.

The name of the entrepreneur was Hugh Marston Hefner. His product was a new type of magazine. He called it Playboy.

The world was changing its view on sexuality, and pornography was taking off. It became a billion-dollar industry with companies raking in huge profits.

The pornography studios appropriated most of the profit because they controlled the means of production. Print machines, studio light, cameras and retail distribution were expensive.

At the height of its glory, the industry launched its own award show rivaling the Oscars in glamour. And then one day, in late 1990’s, it was all over.

A young college student had set up a camera in her dorm room. She connected the camera to her computer and created a website she called JenniCam. She started broadcasting for the world to follow. She quickly learned that viewers increased when she did stripteases.

A few years later, Playboy delisted from the stock market. Its stock was plummeting.

JenniCam started a webcam revolution. Today, there are thousands of cam models. They connect directly with viewers thanks to cheap cameras, fast internet connection, chat and digital payment.

The webcam revolution is one of the clearest examples of disruption caused by the convergence of technological innovations. The old companies were built on an infrastructure of professional grade equipment, film studios, and physical distribution.

In contrast, the webcam industry is built on the availability of cheap consumer grade equipment, online distribution, and new communication and payment protocols.

What the pornography studios experienced is the phenomena of parallel industries. Few people understand it. You are about to become one of them.

The difference between competition and parallel industries

The runaway success of Playboy attracted many competitors. Among the biggest was Penthouse. The magazines competed on celebrity pictures and naughtiness. With the emergence of DVDs, the studios competed on distribution and licensing agreements.

But when JenniCam launched, few took notice. To the established players JenniCam wasn’t a competition, let alone a threat. Its young founder didn’t try to muscle them out of licensing deals. She didn’t invest in new studios or steal their models. In fact, she was utterly invisible to them.

The thing is that when certain technologic innovations converge, it creates entirely new industrial platforms. The startups that emerge on the new platform are not competing with the incumbents. Instead, they are building a parallel industry.

A parallel industry is an industry that has been rebuilt from the ground up on a new industrial platform. The new platform provides an infrastructure that is magnitudes faster, cheaper and more effective than the traditional industrial platform.

The new platform enables entrepreneurs to reimagine all components of their business model and apply new technology in every layer of its business. As a result, the startups that emerge are so different from the incumbents, that they go unnoticed by the old industry.

The next thing that happens is that the parallel industry matures. It develops its own suppliers, consultants, and networks. Suddenly, JenniCam had sparked an entire industry of innovative producers of webcam technology, video compression providers, and digital payment solutions.

At this point, the incumbents take notice. But it’s too late.

How parallel industries cause Startup Tsunamis

Parallel industries are supported by underlying technologies that serve as the infrastructure of the industry. Like: production technology, distribution technology, communication technology and financial technology.

When innovations in the different underlying technologies converge, a new industrial platform is born. That happened during the industrial revolution when factories (production), railroads (distribution), the telegraph (communication) and Wall Street (finance) converged and gave us a tsunami of new products.

Startup Tsunamis describe the phenomena of very large number of startups launched within a concentrated timespan, attempting similar business models. One of the latest examples of this is ride sharing.

Much like the pornography studios, taxi companies had enjoyed decades of steady business. But around 2010, a new industrial platform was emerging.

The smartphone converged with advances in payment infrastructure. At the same time, venture capital was reemerging as a source of capital for startups after being decimated by the global financial crisis.

The result was a true Startup Tsunami. Here are just some of the few startups that built their business on the new industrial platform: Uber (2009), Ola (2010), Wingz (2011), Sidecar (2011), Hailo (2011), Grab (2011), Lyft (2012), Didi Chuxing (2012), Careem (2012).

Today, few people doubt that ridesharing will change personal urban transportation for good. When electrified self-driving cars join the convergence to enhance the new industrial platform, taxi companies are history. But the story doesn’t end here.

Blockchains are creating new financial infrastructure. IoT is creating new communication infrastructure. 3D printing is creating new production infrastructure. Individually they might seem like toys. But so did webcams until they converged with high-speed internet, chat and digital payment. The cocktail enabled a young college student to initiate the fall of an empire.

At Accelerace we help both startups and corporates. Check us out at Accelerace.io.

Thank you to Jeremy Rifkin and his great book, The Third Industrial Revolution, to inspire me to write this post. I can recommend his book.

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Why corporates are terrible at assessing startups and how to do right

Many corporates are billion dollar entities in stagnation or decline. So they run startup programs to look for the next big thing. But big corporates need big ideas to move the needle. That is why most corporate selection committees focus on market size. They think big market is a prerequisite for big opportunity. They are mistaken. This post will explain why market size is irrelevant and how corporates should be evaluating startups.

Today most corporates have some kind of startup engagement activity. Like outplaced innovation teams, hackathons, innovation garages, and accelerators. And they should. Startups create much of the innovation today and corporates would be foolish not to attempt to leverage it.

The problem is that it’s not working. The initiatives do bring the sense of innovative spirit and fun for the employees involved, but the billion-dollar success stories keep eluding them.

The problem is that many corporates are terrible at assessing startups. And this problem is magnified because the consultants and service providers helping the corporates design and manage these programs are too focused on getting the contract to question anything. Sucking up rarely produce truth.

The fallacy of big markets

Corporates need billion-dollar ideas and this fact makes them focus on startups with big (adjacent) markets. And it makes sense. Big markets are the prerequisite for big business. Unfortunately, this logic is flawed.

The thing is that startups aren’t really businesses. Instead, they are problem-solving entities. And this fact is immensely important when assessing the potential of startups.

Businesses have markets. Startups have niche products that target niche customers with a problem no one has cared to solve before. Per definition, most startups have tiny or even non-existing markets. Like a young startup called Unity in 2005 that made it easy to create games for Apple devices. There was no market because none played games on an Apple device. That was until Apple launched the iPhone. Today Unity Technologies is a unicorn.

Or Trustpilot (an Accelerace alumni company from 2008), that made it easy to review webshops. Their market was non-existing because they had no customers. Only free users. Today Trustpilot has thousands of business customers and raised $150 million in funding.

The thing is that market size is not relevant because the product evolves and the market sentiment changes.

Still, in most selection committees I’m in, the corporate representatives will regard the current product pitched as a fixed value proposition and estimate the potential from that snapshot. It’s a mistake.

How markets emerge over time

The truth is that most startups radically change their product. It happens because startups are founder driven, and founders can enact radical changes at will. To a corporate, sudden and radical product changes is unthinkable. Thus, corporates tend to gravely underestimate the plasticity of startups products and business models.

When the product change, the potential market changes as well. Like when the high-end limousine ordering app Uber added non-luxury cars to their app and became a taxi killer. The limousine market is small. The taxi market is not.

Just like the product can change, so can the market sentiment. It happens if the product has network effects or product consumption is highly observable.

When products have network effects, the product becomes more valuable over time. In the beginning, the product is only valuable to a small group of people. Like the first computers or an early version of the crowdfunding platform Kickstarter. But as more and more people use the products the relevant market increases. And Metcalf law teaches us it can happen very quickly.

In other cases, the market sentiment changes because of trends. If the product is highly observable, it can initiate a change of perception among potential customers that suddenly redefine the market.  Like electric vehicles, café latte and CrossFit.

For reasons above, market size is a terrible proxy for potential. And corporates need to unlearn the importance of it.

How to do it right

Instead, corporates must learn to construct a thesis about the future of their industry. The thesis must regard how technologies and trends will influence, reshape or even replace their industry. Once in place, corporate must target ideas and startups within the thesis.

They must learn to resist the temptation of attempting to foresee the potential of the individual startup but instead focus on executing their thesis. In all practicality, this means betting on a lot of teams doing similar things but from different angles.

The selection committee must still regard the potential, but the potential is already built into the thesis. So instead of questioning the market size, the committee members should question how closely the startup fits the thesis.

If telcos had done this in 2011, they might have caught either Line, Snapchat, Viper or WeChat. They all launched their chat apps that year, but telcos were missing a valid thesis on the future of communication. This should be a lesson for all.

Conclusion

  • Most corporates look for billion dollar ideas.
  • When assessing startups, corporates question market size.
  • Market size is a bad proxy for potential.
  • Corporates need to create a valid thesis about the future of their industry and start targeting a large number of startups within this thesis.

 

My startup investment outlook for 2018

One year ago I felt uncertain about the future. I know because I wrote about it here.

The era of mobile internet was ending. The decade gave us causal gaming, on-demand services and chat. The successful strategy had been to bet on apps with network effects. But the next wave wasn’t obvious.

Going into 2018, my uncertainty is fading, and I start sensing the contour of the next decade. And it is cute kittens.

In October, the first version of the game Cryptokitties was released. People breeding and trading digital cats. It became an instant success. Its demise will be equally swift. But something important will linger.

Cryptokitties paves the way for something truly groundbreaking. The assignment and trading of unique digital assets.

Bitcoin had long proved blockchain’s ability to assign and trade ownership over digital assets. But until October this year, the digital assets were fungible. Meaning my coin is no different from your coin. This property makes Bitcoin suitable as money. The thing is we already got money.

In contrast, we never really had unique digital assets. But we do now. And that matters because value stems from two properties. The first property is scarcity. The second property is uniqueness.IMG_6309

Bitcoin solved the scarcity problem. But the coins had no meaningful differentiation. Like oil, gold, and energy.

But the underlying blockchain to Cryptokitties added uniqueness as a property. Like art, companies, contracts, and land.

Uniqueness is immensely important because people are different. We like and need different things at different times. A rental contract might be favorable for one person but useless for someone else. A remix of a song might be enjoyed by one person, but disliked by another.

Furthermore, we are creative beings and we like to personalize our world. We develop recipes, produce art, write software and record tutorials.

The smartphone made it easy to create. In 2018, the innovations in blockchain technology will make it easy to own and sell whatever you create.

The combination will complete the economic ecosystem for digital products. The winners will be startups integrating and owning the biggest verticals, and thus benefitting from both economies of scale and network effects.

I would bet on startups with this aim.

Happy new year to everyone.

 

Startup tsunamis and how corporates face them

Most corporates think of startups as small businesses. Everyone knows that small businesses don’t matter. But startups move in waves. Sometimes waves are so big, we call them tsunamis. And tsunamis matter. This post will explain the nature of tsunamis. It will tell the story of a single earthquake that triggered two very different tsunamis. In the end, corporates know how to handle startup innovation. Do it.

In 2011, the most powerful earthquake in Japanese history triggered two devastating tsunamis.

The first tsunami hit the Japanese coast an hour later. A 40m tall mountain of water traveled 10 km inland demolishing everything in its path.

The second tsunami hit the global telco industry five years later. A cohort of chat apps reached maturity and shattered the future of telcos.

What happened was this: After the earthquake people wanted to call their loved ones, but the phone lines failed. Instead, people sought internet access and a group of developers developed a solution. They called it Line.

Line inspired entrepreneurs everywhere to build chat apps. Among these were: WeChat, Viber and Snapchat. All of them launched in 2011. A startup tsunami was in motion.

At this point, the telcos should have reacted. Today, we know they didn’t. The reason is the nature of tsunamis.

The nature of tsunamis

Tsunamis are always proceeded by an earthquake. Earthquakes are easy to read. The ground shakes and our needles move.

In contrast, tsunamis are hard to read. Only a fraction of earthquakes triggers one. When it happens, the tsunami is practically invisible. It travels underwater with the speed of a commercial jet. Just before the coast, it suddenly rises and darkens the horizon. At that point running is pointless.

The same happens in technology. Some big breakthrough occurs. Like an earthquake, the event is easy to read. Academics, research papers, and popular science media cover it in full.

In some cases, the technological breakthrough is practical enough for entrepreneurs to take advantage. In these cases, hordes of ambitious people found startups. The event has triggered a startup tsunami.

Like a normal tsunami, startups tsunamis also travel below eyesight. It moves through garages, co-working spaces, accelerators and obscure online forums. Places that are mostly invisible to corporates. But it moves fast, gain momentum and suddenly rises. At that point, innovation projects are meaningless.

Why corporates are paralyzed in face of startup tsunamis

Startups tsunamis travel for about 7 years before reaching shore. That means we get a rough picture about the future seven years in advance. If telcos had noticed the large cohort of chat apps launched in 2011, they could have saved themselves.

The problem is that most corporates don’t have proper sensors placed to detect these motions. And when they do, they don’t know what to do about the information.

Most corporates have no method to handle startups. Corporates normally have two defenses against competitors. They buy them or compete with them. But none of that works with startups.

Most M&A professionals would never consider buying a startup. It is simply too small. Why go through all the hassle to buy something small, when you can buy something big with the same amount of work.

Competing with startups seem equally silly. They have no market share.

The thing is this: startups are not competitors. In most cases, startups do not compete with the incumbents. Instead, they build a parallel industry that will eventually outperform the old industry.

Corporates have no answer to parallel industries. It’s not part of a standard MBA course. But there is a way.

Corporates must respond to startups by helping them build the parallel industry. Few founders want to disrupt. Most founders want to build. And when asked, an overwhelming majority of startups actually wants to collaborate with corporates.

If corporates help startups to build a new industry, the corporates will be a part of it. Luckily, new tools are available.

How to ride a startup tsunami

Corporates must take part in the startup tsunami. To do this, corporates need a dedicated interface towards startups. The interface can be an accelerator, incubator, VC arm or some other open innovation initiative. The most important thing is that the initiative follows these rules:

  1. It must scout startups globally. Innovation can arise anywhere.
  2. It must engage enough startups. The more exposure to the tsunami, the better you can react.
  3. It must have a value proposition that is attractive to startups. Startups don’t need you, so make them want to collaborate.
  4. It must include and incentivize all the relevant business units. To utilize synergies the startups must get access to operational decision makers.
  5. It must be rebranded. Even though your brand is a hundred years old and worth billions, startups don’t think it’s cool.

And most importantly….

  1. It must be run by people who know how to talk and deal with startup founders. Founders differ from the rest of humanity and disdain people who don’t get them.

Follow the rules above, and certain calamity becomes a possible future.

At Accelerace we help both startups and corporates.

Why all startup founders should understand ICOs

Most people have heard about cryptocurrencies. Some have heard about ICOs. Few actually understand them. This post will tell you why ICOs are important news for startup founders. It will tell you how it all began and why the crowd is the best investor. In the process, you will learn about a prodigy of our time and see what communist regimes did wrong. In the end, founders have gotten a new tool for fund raising. Use it.

In 1997, a new era began.

For the first time ever, a rock band asked their fans to fund their upcoming tour. The fans went online and pledged $60,000. The press called it crowdfunding.

A decade later, crowdfunding would fund everything from paintings to high tech gadgets. In 2012, a dock for iPhones became the first project to raise more than $1 million on Kickstarter. Still, the biggest breakthrough was yet to come.

Crowdfunding mainly benefitted physical products. This makes sense because physical products have tangible value. In comparison, software hadn’t benefitted much. It was simply too hard to define what backers were pre-paying for. But that was about to change.

In 2013, a Russian prodigy named Vitalik Buterin made history. He designed a completely new Blockchain named Ethereum. It would prove to become a breakthrough in crowdfunding. Vitalik was 19 years old.

Ethereum made it easy for developers to create new cryptocoins. And that is immensely important because cryptocoins solves the biggest problem about crowdfunding software.

Cryptocoins allows software projects to provide a tangible asset to backers. The projects can mint digital coins that represent a specific value. A simple example would be a coin that can buy a song in a music app. Anyone wanting a song could buy the coin. If enough people buy the coins, the founders have enough money to build the app. That’s called crowdfunding.

But that’s not all. If the backer no longer wants the coin, he can sell the coin someone else with a click of a button.

Already ICOs have outpaced VC funding. And it is just getting started. I am about to tell you why.

The key to successful investing

Investing is fundamentally about information. The information investors need is this: How big will the demand be?

If you can assess how many people will use a new product, you also know how much to invest in the project.

How accurate you can assess the demand depends on how close the investor is to the demand. In other words, to the users.

The communist experiments of the 1950s show the consequence of making investment decisions too far from the demand. At the time, Moscow and Beijing decided how much food farmers should grow. But the communist elite had little feel for the true need. Economists call it: misallocation of resources. The consequences were catastrophic.

VCs exist because they have better feel for the demand for tech products than the big pension funds. In theory, VCs have superior information and can make better investment decisions.

However, there is a group with an even better feel for the demand. And that’s the users. They are the ultimate source of information because they are the demand side.

Why ICOs are great news for founders

Crowdfunding allows users to vote for products they want with their money. In aggregate, users are the ultimate investor and allocator of resources. If 100 backers need a product, the project receives exactly the right amount of funding to fulfill the demand.

For many software startups, the invention of cryptocoins is heaven sent. Most founders spent an enormous amount of time and effort to convince VCs that they have a market. Sometimes they succeed, but the investor takes a risk premium. The risk premium is unfair terms. Like milestones, liquidity preferences and downside protection.

But thanks to a young Russian prodigy, software startups can do what artists and gadget-makers have been doing for the past five years. To raise funding directly from users. And because users don’t have to guess the demand, they also don’t require risk premiums. The money comes without a nasty set of legal documents and a rigid due diligence.

Luckily, many have already taken advantage. As of this writing, software projects have raised more than $1 billion through ICOs. And many more will follow.

Many critics will point to fraudulent and overhyped projects. All of that is true. But that always happens in the early days of great innovations.

In time, ICOs will mature and software founders will finally have an alternative to the exhausting VC pitches.

At Accelerace, we will do our best to help founders take advantage.

Check out Accelerace. We invest in tech startups.

Why the best founders feel unsuccessful

Many startups look successful, but this post will tell you how most founder really feel. It will tell you how humans are different from other animals, and why this difference distinguishes the best founders from normal people. Most importantly, it will explain what good crazy is. Good crazy is power. Cherish it.

One day in 1982, a group of researchers at Georgia State University experienced something unexpected. A two-year-old chimpanzee by the name Kanzi suddenly started talking.

Kanzi wasn’t being studied. Instead, the researchers had been trying to teach another chimpanzee to communicate via a pad. But they had failed. The chimpanzee had nothing to say.

The experiment was suggesting that apes don’t think. That conclusion would have ended the long-standing dispute: Do animals possess human-like thinking?

When Kanzi accidently picked up the pad and started communicating, we got an answer to the question. But the answer was not: yes or no. It was both.

The difference between humans and animals

The interesting part wasn’t the fact that Kanzi communicated. It was what Kanzi said.

It turned out that Kanzi mostly expressed fundamental needs. Like, give me food.

Kanzi was clearly thinking. However, Kanzi never expressed ideas. And that fact is immensely important for understanding humans.

Human cognition is unique because we are the only animal who have ideas. Only humans imagine things that don’t exists in the physical world. Like God or Harry Potter.

We can describe these ideas and infect other people. When many people have the same idea, it becomes a shared idea.

Shared ideas might be the most powerful phenomenon in the world. Shared ideas power Christianity, capitalism, and the $700 billion market cap of Apple.

A shared idea is immensely powerful because of its intersubjective nature. It exists among people and not just within people. This means that even though you abandon the idea, it still exists and governs everyone else infected by that idea.

Shared ideas create communities of people. Like the urban consumers, Harry Potter fans and the Apple evangelists.

Members of communities want success in their community. Urban consumers want to own and experience more things. Harry Potter fans want more people to read their fan fiction. Apple evangelists want to be first to get the latest upgrades.

Success in communities is defined by ideals. All communities have an ideal that shapes the hierarchy within the community. Ideals describe what a perfect manifestation of the idea would look like.

The perfect consumer eats sushi, owns designer furniture and weekend travel. The perfect christian is virtuous, attends church and lives in a nuclear family. The perfect Harry Potter fan writes fan fiction, plays quidditch and can dress up like a Gryffindor.

The closer you fit the ideal, the more successful other people in your community perceive you to be. The community upgrade your position in the hierarchy. Ascension feels good.

For this reason, most people spend their entire life attempting to fit the ideal of their community. But as you will learn, startup founders are different.

The difference between startup founders and normal people

For most people in developed countries, the biggest community is the idea of the urban consumer. And this fact can course great misery for startup founders.

The problem is that startups require founders to do things that break with the ideal of urban consumer.

Most founders in our portfolio are in their 30s. And for urban consumer, these are the years when the adult hierarchy sets in. The ideal is to buy the first house or apartment in a respectable neighborhood. Fill it with designer furniture. Drive an Audi and go skiing in winter. Kids in designer clothes, cooking gourmet food and keeping a dog give further plusses.

But for founders who choose the path of startups, life is very different. Most startups fail and all startups struggle. Founders usually scramble for two years before raising their first round of institutional capital. Even after raising funding, they still get very little salary.

The financial reality of most founders means that they actually descend on the hierarchy of urban consumers. They live on half the space, drive an embarrassing car and rarely fine dine.

Most founders occasionally feel the sting of inferiority and doubt. It happens when they meet old classmates, park their decade old Hyundai or check their Facebook feed.

To most people, this scenario is so scary that they give up their startup dream. They think it’s too risky. The risk is descending the social hierarchy. It doesn’t mean dying.

But this is where founders are different. They feel the sting, but they don’t succumb to the pressure of the ideal. Instead, the best founders we see have overwritten the ideal by the force of their startup vision.

To reject a pervasive intersubjective ideal is incredibly hard to do. And those who do are often regarded crazy. But at Accelerace, we call it being good crazy.

Conclusions made:

  • Only humans share ideas.
  • Shared ideas create communities.
  • Communities have hierarchy defined by an ideal.
  • In the developed countries, one of the biggest ideas is the urban consumer.
  • Startup founders often descend on the hierarchy of urban consumer communities.
  • Startup founders are special because they don’t succumb to the pressure of the ideal.
  • At Accelerace, we call it being good crazy.

Also visit Accelerace. We invest in startups.

Why startups are safe investments and the stock market is risky

Most people stay away from investing in startups. They believe it’s too risky. This post will tell you they are mistaken.  It will tell you that startups are actually one of the most attractive asset classes out there. It will teach you how to identify markets that bubble and burst, and how to be successful investing in startups. In the process, you will meet a man who escaped death row to become the most powerful man in France and learn about the birth of modern economics. In the end, aspiring startup investors will learn the most important fact about startup investing. Facts are everything. Use them.

About three hundred years ago, a murderer awaiting his execution from a dark prison cell in London would change global financial markets. Forever.

John Law had killed a foe in a dual and received death penalty for murder. But, John Law managed to escape prison and flee to continental Europe.

Law spend his newfound freedom studying finance. He developed the theory that countries should abandon gold and silver, and use paper instead.

At the same time, France was on the brink of bankruptcy. The ruling elite feared revolution and needed a solution, fast.

As soon as the desperate French elite learned about John Law and his monetary theory, they made contact. Law convinced them to establish a central bank and start issuing paper money. In this way, the government could pay back its creditors in cheap paper instead of gold. To the ruling elite, John Law was god sent.

For Law’s theory to work, he needed the paper money to start circulating. To make this happen, he created demand for paper money by offering a unique product that required his paper money to buy. The product was shares in the most valuable company in France. Or so Law made it sound.

The effect of easy credit

The company was Compagnie des Indes and it had a monopoly on overseas trade. The company first issued stocks at 500 Livres per share in 1719.

But Law made it easy to loan paper money to buy stocks in Compagnie des Indes. Suddenly, everyone could buy the stocks. And they did.

Only one year later, the price had soared to 10,000 livres per share. Now everybody wanted to own a piece of Compagnie des Indes, and Law continued printing paper to satisfy the demand for his new currency.

In the end, the bubble crashed. France and most of Europe went into a depression. It was one of the earliest examples of asset bubbles. It would not be the last.

The devastating effect of bubbles

Since Compagnie des Indes, the world has seen one bubble after the other. And for most investors bubbles become their worst nightmare.

Bubbles are disastrous for investors because they deflate much faster than they built. It took Nasdaq five years to go from 1000 to 5000, but only a year to erase most of that gain.

This means that investors spend years on accumulating value and see most, if not all, this gain evaporate in a heartbeat.

For this reason, investors should be wary of any asset with tendency to bubble. And those assets are quite easy to identify. John Law taught us that.

Before Law, Compagnie des Indes was struggling. The company was far from being the hot investment it would later become. So why did it change?

The fundament for bubbles

First, the king and his closest supporters initially funded Compagnie des Indes. If you were not part of this group, shares were not available.

Secondly, it was hard to obtain credit to buy the shares. Only those with enough gold on their hands could afford it.

Law’s invention of paper money and the offering of the stocks to the public changed all of that. Law simply made it easy for everyone to participate in the market for Compagnie des Indes shares.

The story teaches us the characteristics of assets that bubble. Their market is easy to access and it is easy to loan money to buy the assets.

Both characteristics of markets that bubble have roots in human nature. We simply disdain doing anything hard. But as soon as it becomes easy, people flock to play. Furthermore, people hate saving because it delays gratification. We love getting something for nothing, and borrowing money feels that way in the short run.

No other market has developed these characteristics more than the modern stock market. Today, anyone can buy stocks with a few swipes on their phone. Technology even offers automatic investing by algorithms. On top of this, many people are being forced to participate in this market through pension schemes.

The access to leverage your investment in the stock market is equally easy. The same service that allows me to invest with single swipe, also offers me to loan money to buy more stocks. Moreover, large institutional investors, such as hedge funds, uses vast amounts of credit to leverage their bets.

The consequence of the continued development of the access and credit in the stock market has resulted in ever-increasing bubbles and bursts.

Timing not an issue with startup investing

In contrast, the market for startups is very different. (I don’t consider pre IPO companies such as Uber and Airbnb as startups nor the listed internet companies in the late 90’s).

Participation involves tons of friction. Investing in startups still requires lots of research, travel, meetings and due diligence. Worst of all, selling shares is almost impossible. There is simply no established marketplace for trading shares in startups. That’s the main reason why venture funds are much smaller than hedge funds. Venture capital isn’t liquid and doesn’t scale well.

Secondly, it is very hard to obtain credit for investing in startups. The return is extremely asymmetrical which is difficult for loan givers to accept.

But, at the same time these are the exact same characteristics that makes startups undervalued assets. The friction and lack of credit ensure that startups valuations don’t bubble. Obviously a specific startup can bubble, but not the asset class as a whole.

The absence of bubbles ensures an attractive price point no matter when you start participating. Unlike the stock market, timing is not a big issue. This means investors can sleep well at night because the rapid and broad declines in valuations just don’t happen.

Startups built value over time and is perhaps one of the best long-term investment strategies out there. But only if your portfolio is broad enough. And this, I believe, is the most important fact in startup investing.

Conclusions made:

  • Easy access and credit create bubbles. The stock market is a good example.
  • Startup investing has too much friction and lack of credit to bubble.
  • Startups are a great long term investments, but the asymmetric return profile requires investors to have very broad portfolios.

Visit us at www.accelerace.dk. We invest in startups.