Sunday 29 August 2010
Collaborating your way out of the valley of death
The valley of death is a generic term that has been used a lot in relation to start-up and early stage companies. It is sometimes used to describe the fact that there is a funding gap between where angel investment stops (at several hundred thousand dollars) and where venture capital starts (at around $2m).
What it ultimately describes though is the fact that a lot of companies die due to a lack of funding, not just when they are pre-revenue but before they are profitable and therefore still reliant on outside capital for operational funding.
This situation can last for a very long time and in fact we have clients with companies that are 10 years old that are still in this situation. This is actually quite common with biotech companies, particularly in drug development, as the pre-market phases take so long. It is also surprisingly common with other companies. It takes a long time to take a product to market and 6-8 years in not uncommon.
What we are not talking about here is the internet start-up that you can setup in a few weeks and have online soon after. Some of these companies get huge critical mass and become cash positive very quickly. However, the fact that you can get a product to market in a few weeks shows that the barriers to entry are low thus high levels of competition may be faced. It also probably goes some way to explaining why so many internet start-ups fail.
The best data on angel investor outcomes in the US shows that 50-70% of them are losing some or all of the money they invest. Some are, of course, making huge returns, but this is actually not particularly common. Many internet companies graduate from the valley of death to what investors call 'the walking dead'. This means that they are not making enough money to be interesting enough to anyone that they might get an exit nor pay much in the way of dividends, but not doing poorly enough that they need additional capital. These so called 'lifestyle businesses' are failures for early stage capital and whilst they may be out of the valley of death as such, they aren't ever going to justify their start-up capital.
A lot of companies do not make it through to even being lifestyle businesses and their products do not ever make it to market. In the case of a manufactured product (unlike the early life of a lot of internet companies) it is a very expensive path to market.
One of our clients built their new product proof of concept for about $25,000. Their cost of actually having a product on the shelf however will end up being around $3-4m. With $1m in engineering design for manufacture, $1m for manufacturing setup, another $1m in setup and early operating costs and hundreds of thousands of dollars in patent costs it is an expensive and high risk exercise. What this company is doing though is looking for ways to collaborate their way forward with established players.
Something that we are seeing more and more, and in fact are having some success in assisting customers with, is finding ways to collaborate their way out of the valley of death. This involves finding different potential partners that can assist in finding ways forward.
One recent example was a very small local start-up company that has developed a clean technology innovation. We introduced them to a very large German engineering company that has an office in China. They were referred to the Chinese office that has a Malaysian customer that is looking for a solution. No deal is done yet, but there is interest and the alternative at this time is languishing in the valley of death trying to find a way to market single-handedly.
In order for these collaborative arrangements to happen, you need to locate the right partner who has identified a market need for your product, or is at least prepared to do some research to see if there is a market. On the start-up side, you also need to have realistic founders, directors or shareholders. Nobody is going to drop a sack of cash in your lap at this point, or it is at least extremely unlikely. What they might do though is give you a path to market that ultimately gives you a way out of the valley of death.
A client recently had a meeting organised with a potential collaborator and were considering being quite demanding in their negotiations. We advised that given it had taken 4 years to get the potential collaborator engaged (who was the no.2 in their market), it wasn't a good time for a surge of adrenaline. You do not want to give away the farm, but it is always good to consider what your least preferred outcome is in a negotiation. If no deal at all is not an outcome you want, and there is no competition for your 'deal', you probably want to tread extremely carefully.
To find out more about the AIC’s collaboration services, visit our website, e-mail info@ausicom.com or call (07) 3853 5226.
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