One of the biggest distinctions in how startups and SMEs operate is exit strategy
Majority of the “startups” I’ve met in Bangladesh are not startups. They’re small-to-medium enterprises (SMEs) — and that is perfectly fine.
There’s no glamour in being a startup. Don’t feed into it. It’s not easy, your chances of success are low and you’ll go through hell before it gets better. More importantly, you can build a fantastic business without being one. Then why does it matter if you call yourself one but aren’t? Because it sets wildly different expectations for how your company should operate, which investors it should pursue and how you should think about the future.
So, whether you’re already a startup or are an SME that wants to transition into one, get to know the ground rules — you’ll be better prepared to raise money while having a clearer idea of what’s required.
What is expected of a startup
If there’s one word to sum up what a startup should be able to do, it’s scale. In fact, not only should it scale, but it should scale exponentially. Every additional dollar put into the business should grow the business more than the previous dollar did. For instance, if the first $1 got you 5 users, the second $1 should get you 7 and the third ought to get you 9. If your unit economics see an improvement in the process, it usually indicates the company has a technology or tech-enabled system in place to grow at an accelerated pace with incremental capital. It effectively validates that you’re solving a real problem with a relatively large market.
Why is this important? Because it leads to our next point:
Startups are expected to at least attempt to win the market. If your company’s vision isn’t to be the market leader in what you’re trying to do (even if it’s in a niche), then you’re not a startup. Again, you may be a very good business — and arguably more profitable than a startup!— but you are not a startup.
In addition, simply utilizing technology (e.g., a website or app) does not make you a startup. On the flipside, you can be in a traditional industry and still be a startup. For example, Zilingo has raised over $300 million because it built a tech-enabled solution for garment manufacturers and fashion retailers to operate more efficiently.
Understanding the role of investors
An investor should only allocate a small percentage of their money to startups. Why? Because they should be willing to lose all of it.
Investing in startups is all about risk allocation. Investors want to spread their risk across 10 companies, for instance, with the hope that two or three give them an “oversized” return while the remainder go to zero.
Example: If 8 of 10 companies go to zero but the other two return 20x their initial investment, the investor’s portfolio actually has a 400% overall return. This is why investors want you to scale and go for the win.
In contrast, if all of these companies just tried to operate conservatively and were able to return 25% each, then the whole portfolio only has a 25% return. If that’s the case, isn’t the investor better off putting their money in something much less risky? For Bangladesh, this is especially important: Why would a foreign venture investor come all the way here if they could get similar returns at home without all the trouble?
There’s a longer conversation to be had here regarding specific roles of angel, seed and venture investors — but that’s a whole other article.
Just remember this: When you take money from an investor, make sure that they themselves want you to be a startup and not just an SME. If it’s the latter, and you’re fine being one (which you should be), then that works too. A simple way of getting to the bottom of it is letting them know, “We may make you a ton of money, but we may also go to zero.” If they’re fine with that, they’re fine with investing in a startup.
Funding, profitability and dividends
An SME will take initial funding and use it judiciously, focusing on the age old mantra of “sales minus costs equals profit.” They can take the profit, re-invest and grow as needed or they can choose to return the profits to shareholders in the form of cash dividends.
A startup will not only require initial funding but also follow-on rounds (Series A, B and beyond) if they are successful. Why? Because being the best in Mirpur isn’t enough. Being the best in Dhaka isn’t enough. And for some, being the best in Bangladesh isn’t enough.
For this to happen, every last bit of capital generated should be plowed back into the company for future growth. Startups do not pay dividends. If a prospective investor is asking for dividends, they should look to invest elsewhere.
And while a startup should aim to be profitable down the line, its shorter-term goal is a higher valuation and an eventual exit. A higher valuation can be dependent on a multitude of metrics, most of which are fundamentally driven: annual recurring revenue (ARR) and customer lifetime value (LTV) are a couple of examples. Actual market valuations are complex and depend on the country, the industry, the product and a slew of other factors, but having strong fundamentals already puts you on the right path.
So, what are some of the ways startups can find an exit?
Endgame for investors and founders
One of the biggest distinctions in how startups and SMEs operate is exit strategy. Most SMEs will simply want to be a continuing business while growing a little every month, every year. If an investor wants to sell shares, they may even sell it to the founder once they have enough money.
A startup, on the other hand, needs a clear strategy for an exit. There are generally three options for investors and founders:
There is no “best” exit option for a company, but at every step of a startup’s life cycle, it’s important to know what the best exit strategies are. For instance, Uber got so big that an IPO was a much easier option than finding an acquirer, since only a few companies globally could “afford” a company of Uber’s size. In short, keep in mind that an exit is necessary as a way for both the investor and you, the founder, to get money back into your pockets. However, there’s no better outcome than to have such an amazing business that everyone will want to buy shares even at increasing prices.
One final note on this front is that it’s also important to know when to recognize that it’s not working. I recently discussed this in light of COVID-19, and I’ll contextualize it a bit more here: If you don’t see a reasonable path to scaling, stop stressing yourself, your employees and your investors unnecessarily. You can either turn your startup into a “lifestyle” company — which is to say you stop chasing future fundraising and exits and instead focus on stabilizing the business — or wind it down instead of burning additional cash that has a minimal to negative return.
Differentiating startups and SMEs
Here are some rough ideas of what separates startups and SMEs:
SME: A digital agency
Startup: A platform to connect designers to clients
SME: A small garments factory
Startup: Enterprise resource planning software for RMG manufacturing
SME: An ecommerce website that sells a company’s inventory online
Startup: An ecommerce platform that creates logistics efficiencies through various supply chains and clientele
Notice that in each example, the startup variation is able to scale exponentially because of a technology-enabled system. Simply using something “tech” is not enough.
The author is the founding partner and CEO of Anchorless Bangladesh, an early stage venture investment fund focused on advancing the local startup ecosystem with access to global resources