I recently met with a company that got me thinking about the link between the value a company adds to its ecosystem and its long term share price potential. This may sound trite but in a nutshell it seems to me that the best startups either create value by making something possible for the first time or by radically changing the price/quality dynamic in an existing market.
One example of each from our portfolio:
- graze (in which we invested earlier this year) created a new fresh food delivery service through some patented packaging innovations, creation of a sophisticated production line and a novel business model
- Buy.at (which took investment from us in 2006 and was acquired by AOL last year) drove a cart and horses through the affiliate network market by increasing product quality (zero tolerance for spyware and adware, and high good customer service) and driving price down
Looking more widely it becomes clear that all the best web companies fall into these categories – Google makes the web more searchable, ebay makes it possible to sell things that otherwise remained unused in our lofts, Skype made phone calls free, etc. etc.
I guess the most important part of this post is to list a some types of company and business model that don’t add value in this sense and therefore may not make sense as venture capital investments. (Which isn’t to say that there is anything wrong with them and they won’t make profits and money for their owners. In fact some of the types of businesses listed below can be very fast growing and require little cash to get started.)
- Companies relying on price arbitrage generally evoke the concern that over time the value of that arbitrage will trend downwards, usually to near £0
- Business models based on customers not fully understanding how the company makes profits or what they are getting for their money – one has to assume that over time transparency will arrive, and these days that it will arrive sooner rather than later
- Simple re-sellers of third party products
If you can think of any more examples please let me know.