Thrive, Consolidate or Die
Thrive, Consolidate or Die
What happens when startups try to compete
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There are currently 56,000+ VC-backed businesses operating in the US as of 30 June 2024.
The number of startups clamouring for attention, revenue and relevancy has never been higher.
Given the plethora of accessible tools and the myriad of funding options, it's no surprise that startups face stiffer competition than ever before.
However, despite the obvious level of competition, as a VC it’s incredible to see the volume of pitches that look almost identical to each other.
There are some pretty clear startup honeypots where it seems that many generalist founders tend to flock. AI-enabled productivity tools, personal finance apps, reselling marketplaces etc.
The size of the prize for many of these honeypots is undoubtedly large. But, if you're looking for an enormous business outcome, the overwhelming competition that exists means the odds are heavily stacked against you.
In a hot funding market, this might be okay.
If you're showing any sign of growth at all - VCs will chase after you and try and give you a ton of money.
If you're growing decently with some wonky metrics, you might find that you're still able to raise some capital to rectify this and get on a strong pathway.
If you're growing slowly or just staying afloat, existing investors might be forgiving and give you a little bit of capital to bridge to get to profitability.
In 2024 - with a mixed funding market, startups have three potential pathways:
Thrive: If you have strong growth and strong metrics, VCs will happily give you 100s of millions of dollars.
Consolidate: If you have strong growth and a handful of decent metrics, consolidating with a potential acquirer is the easiest pathway forward
Or Die: If you are struggling and not really growing, you're going to find that no one will be willing to keep you alive
Consolidation is Complex
Traditionally, M&A has been used for the following:
Expand into a new market or launch new synergistic product lines
Capture more market share by acquiring a competitor
Acquire talent and IP to accelerate internal R&D efforts.
And historically, startups didn't necessarily want to get acquired at all.
An early exit meant that the startup was more likely than not leaving money on the table, with founders and employees locked in for a few years at the acquiring firm.
In 2024, this is no longer the case.
With fundraising turning into a slog, companies that might have raised a substantial amount of capital previously and weren't able to grow quickly enough to justify these valuations are more than happy to get acquired.
However, the acquisitions don't exactly look like acquisitions.
Earlier this month, Google entered a licensing agreement for Character's technology valuing the company at around $2.5B, in addition to hiring the co-founders back to Google Both Noam Shazeer and Danaiel De Freitas used to work at Google in 2021 before starting Character), alongside 20+ AI researchers.
This is similar to deals struck by Microsoft to hire Inflection's co-founders and senior staff in March and Amazon hiring Adept's co-founders in June.
In all three of these cases, the licensing fee paid by the big tech company is to be used to pay out venture investors.
Whilst the structuring of these deals is largely down to regulatory scrutiny, what is notable is that all of these companies raised substantial amounts of capital to only end up getting acquihired for enough to make investors whole.
Effectively, these founders weighed up the opportunity to potentially make it big in a ridiculously competitive arena with the added bonus of having to fundraise billions of dollars to keep up with their competition versus taking a likely 7-8 figure compensation package from a Big Tech firm.
When you put it that way, it’s not surprising why these AI businesses never stood a chance at long-lasting success.
Imagine these founders continued on their mission and tried to out-raise and out-compete the other competition.
The prize at the end of the journey might just be what happened to Tally, a high-flying FinTech funded by deep-pocketed VCs such as a16z and Kleiner Perkins. Last week, the nine-year-old company announced that it was shutting up shop as it wasn't able to raise further funding to keep its lights on.
There is a chance that these investors might see a few cents on the dollar if a large incumbent is willing to purchase Tally's IP for a nominal sum. In this case, the founders and employees will likely get no reward for all their hard work and effort.
Competition is for Losers
So far, I've been all doom and gloom and no fun at all. However, for founders, understanding the dynamics at play in the broader market is valuable information when thinking about the potential journey your business might take.
Not enough founders truly think about their competition.
Some people like to ignore competition, under the guise that you should focus on yourself and what you're building, but I largely disagree here.
(As a quick aside, one of my favourite startup videos on Youtube is Peter Thiel’s lecture on why Competition is for Losers)
Inevitably if you're building the same thing as someone else, you're likely to run into them at some point.
Lots of founders think about this head-on collision from a product perspective.
In countless pitches, I've heard founders talk through why the architecture they are using is far superior, or why X startup's product will never be able to do what they can do.
Whilst they may be right, and these are important points, what these founders fail to consider are the other impacts that competition can have.
Building in a competitive market makes it harder to truly build momentum in your business. You'll find that customer acquisition costs go up and salaries for talented employees skyrocket.
You'll get forced into playing games that distract you from actually building a sustainable business, pushing you towards a sub-optimal exit or even worse, death.
For startups, navigating through competition has historically been to focus on a specific niche.
However, I'd say now, with even more competition than ever before, it goes deeper than that.
Most founders have figured out that going deep into a niche is paramount. What many founders miss is the crucial interplay between quickly monetising a niche and ensuring the unit economics work in their favour.
Monetising a niche quickly relies on having an understanding on sales velocity and building a product where the ROI is high in dollar terms and obvious in output to customers. By doing this, you're able to appropriately price the product such that the unit economics make running the business viable regardless of whether you raise capital or not.
To put this in clearer terms, let's look at Leonardo.ai, the generative image AI startup competing with the likes of MidJourney and OpenAI. The company was acquired last month by Canva, only 18 months after it completed its Seed round, having quickly grown to $15M ARR.
As noted by early investors in the company, whilst early customer acquisition was quick, the rate of growth and the ability to retain these customers dwindled even quicker. Whilst Leonardo was able to monetise customers quickly, it wasn't able to make the unit economics work due to poor retention and high customer acquisition costs.
In 2021, a similar company might've been able to raise $20-50M to course-correct. In 2024, that is no longer an option.
The startups that truly thrive will be those that can effectively navigate the complexities of building in a niche and sequencing their way to a bigger prize. This requires a deep understanding of the market, a focus on quickly monetizing a niche, and ensuring that unit economics work in their favour.
Understandably, it can be hard at the early stage to have all the answers. Founders, however, have the responsibility to iteratively define and test hypotheses and experiments, then judiciously demonstrate the ability to double down on what is working.
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Abhi