Challenges for Startups Ahead: Two Hurdles Stifling ISVs

sharks swimming in the ocean

Most Americans know how rare it is to find a successful small business these days. Mom-and-Pop stores around the country continue to close while big chains move in on their territory.

The buzz coming out of Silicon Valley may lead many people to believe that tech startups are one exception to the trend. But that is an illusion.

The cold, hard fact is that tech startups have been riding a steady downhill climb for nearly two decades. A recent research paper by the National Bureau of Economic Research (cited in Bloomberg) claims that in the U.S., the share of high-tech “young” businesses as a portion of the entire sector sunk from a high point of around 16 percent in 2001 to less than 10 percent in 2013.

The downward spiral can’t be explained by the 2008 economic collapse alone. So what are the culprits, if not a general economic downturn? It’s the usual suspects: big businesses, and investors addicted to doing business as usual.

Giant FANGs Are Devouring Startups

Five of the biggest factors stifling startup business growth: Facebook, Amazon, Netflix, Google and Apple. These companies have staggeringly sized war chests. They use them to throw their weight around, often acquiring companies that pose a potential threat.

When Instagram began to edge past Facebook in popularity just a few years after its launch, Zuckerberg snapped the company up for a cool $1 billion in cash and stock. In 2013, the social media behemoth tried to do the same thing with Snapchat. When Snapchat’s owner Evan Spiegel turned down their offer, Facebook turned around and began implementing features that have slowly nibbled away at Snap’s market growth.

In total, the likes of Microsoft, Amazon, Facebook, Apple and Google parent company Alphabet spent $31.6 billion on acquiring tech businesses last year alone, according to the Economist. Looking just at Alphabet, the company has spent $12.1 billion since 2013, investing in 308 startups.

Many of these acquired startups go on happily running their companies independently, but countless others are gutted and either sold off or merged into the parent company’s product.

Investors Squirrely on Taking Risks

Another issue limiting startup growth is how skittish venture capital backers have gotten towards what they perceive as risk. Contrary to all the talk about “disruption,” most VCs only invest in firms that they expect will scale. We mentioned this in our recent post quoting Moz’s Rand Fishkin. VC firms are interested in hunting unicorns. They aren’t looking to back firms that are going to establish a decent niche and grow incrementally.

As a consequence, often VCs lose interest when they sense that a startup could be eaten alive by a tech giant. According to research firm Pitchbook’s data cited by The Economist, overall first-round funding for startups slid 22 percent from 2012 to 2017. It’s virtually impossible to get serious startup funding in many consumer-facing tech sectors, especially search, social media and e-commerce.

Making matters worse, the reactionary outlook of many VCs extends beyond fear of big tech competition. It causes them to regularly overlook minority- and women-led startups, for instance.

In total, female entrepreneurs earned just 2.2 percent of overall VC funding in 2017. The average woman-founded startup receives less than half of the $2.1 million average that male-led ones do. This is despite the fact that the average female-founded startup brought in 47 percent more return on investment compared to male-created startups.

Combined, bloated tech enterprises and antiquated approaches to investment stifle innovation and serve to shut out startups that could be making their mark in the world. Those that do innovate and make a name for themselves, such as GitHub, are often eventually brought under a larger company’s wing.

Naturally, there are exceptions. Platforms like Slack and Airbnb came from nowhere and have managed to persist while scaling. ISV founders must prepare for headwinds, though, if they expect to lead the pack in an era where small businesses are a threatened species.

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