Supercharging start-up investment: risks and rewards

Businesses that achieve astronomical growth in short periods of time inspire other entrepreneurs to come out of the shadows and have a go.

In today's data-driven environment, a massive injection of funds into a promising start-up to promote rapid growth and market domination is increasingly common.

At a glance

  • In less than two months, WeWork's valuation fell from almost US$50 billion to about US$8 billion.
  • “Blitzscaling” needs a large market, potential for widespread distribution, high gross margins, and “the network effect”.

The dramatic struggles of one-time market darling WeWork have been well documented, as have the resulting problems for its majority investor SoftBank, which has pumped almost US$20 billion into the co-working business.

In less than two months, WeWork’s valuation fell from almost US$50 billion to about US$8 billion. At one stage, it was reported, the company had to delay staff layoffs because it lacked the cash flow to pay severance packages.

It is an excellent case study of a struggling business that attracted massive investment and caused great excitement in the finance world, only to let down investors with poor governance and defensibility, and very little market differentiation.

As such, some say it’s a poster child for the foolishness of “blitzscaling” – the sudden and dramatic investment of funding in order to create fast growth and market dominance.

Actually, it’s not. Blitzscaling is defined quite differently to the get-big-fast business philosophy that led to the dotcom boom and bust. According to the blitzscaling framework, recently developed by Chris Yeh and Reid Hoffman, co-authors of Blitzscaling: The lightning-fast path to building massively valuable companies, WeWork should never have attracted such investment.

There are four key growth factors for successful blitzscaling, Yeh says. They are:

  1. The potential market must be enormous.
  2. The potential for massive distribution must be real.
  3. There must be high gross margins.
  4. Each new node added must increase the value of the network to the other nodes – also known as “the network effect”.

WeWork only had the first two covered. The experience of WeWork’s more conservative competitor IWG showed there was profit to be made, but it also indicated that WeWork’s early valuations were comically high. This knocked out the high gross margins requirement.

The network effect was also questionable – would adding a new co-working space in another city create significant extra value for the existing offices?

Importantly, a final requirement for blitzscaling success is responsible business practice, Yeh argues.

“We believe the responsibilities of a blitzscaler go beyond simply maximising shareholder value while obeying the law; you are also responsible for how the actions of your business impact the larger society,” Yeh and Hoffman wrote in their book.

CPA Library resource: Blitzscaling: The lightning-fast path to building massively valuable companies. Request now.

New business environment - new investment strategy

The potential for positive blitzscaling, Yeh says, is largely driven by technology.

“Traditional, industrial businesses, like the railroads, began when everyone had their own width of track,” he says.

“The thing that caused everything to consolidate and which allowed for mega railroads was the standardised gauge and the interoperability that it allowed.

“Similarly, Cisco Systems became one of the most valuable businesses because it provided a language that allowed all computers to talk to each other. It became a standard. These dynamics simply play out faster with technology.”

Now, more than ever, it's the investors' job to run a reality check on whether a  business should attract professional investment, and at what level.

Yasser El-Ansary, chief executive of the Australian Investment Council, agrees today’s technological environment allows for larger investments to be made with greater confidence.

“In many respects, today’s fast-paced, highly connected business world does provide a platform for growth in ways that historically would not have been possible in the same timeframe,” he says.

“The sheer volume of information that entrepreneurs and investors have access to has changed in a dynamic and significant way. That information empowers decision-making at a variety of levels.”

What does blitzscaling look like in Australia?

Blitzscaling is not a term commonly used in Australian investment, El-Ansary says. However, it is a concept with which the industry is familiar.

“The idea that you can exponentially and rapidly scale up the growth of a business is the one thing that distinguishes venture investment from other forms of investment.

Ultimately, rapid and sustainable growth is what private capital investors are seeking to do,” he says.

Now, more than ever, it’s the investors’ job to run a reality check on whether a business should attract professional investment, and at what level, he says. The available technology has made blitzscaling possible, so it must also be used to ensure such investment is correct.

“Even if a business does not attract venture or private equity investment, that doesn’t automatically mean it’s a bad business proposition,” El-Ansary says. “In fact, that conversation with potential investors may well open up other opportunities to think about whether the core business strategy could pivot towards something slightly different that might address a larger market, or that might find it a niche within a global market.”

Yet doesn’t blitzscaling drain the start-up market of essential funding for smaller ventures? Actually, El-Ansary says, the truth is the opposite.

“Businesses that achieve astronomical growth in short periods of time inspire other entrepreneurs to come out of the shadows and have a go,” he says. “Such successes can have a deep and profound psychological effect.

“In 2013, the start-up sector here in Australia was on life support. We were in a dire position. There was very little capital available for great business ventures, which meant in many cases those entrepreneurs had to relocate offshore.”

Today, El-Ansary says, there are world-beating, Australian-grown businesses conquering markets globally, as well as billions of dollars of investment capital available for innovative, fast-growth business ventures.

“It’s a remarkable turnaround,” he says. “The innovation ecosystem here in Australia is in a very strong position. While we still have lots of work to do, I’m confident the momentum we have right now can be sustained over the long term.”

Read next: How accounting firms are connecting with start-ups

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