Forget the Unicorn: Why Aspiring Entrepreneurs Should Opt for Tech

By Silicon Allee |

This is a guest post by Shmuel Chafets of Hasso Plattner Ventures

A small group of computer nerds drop out of school, set up a tiny business in a garage and conquer the tech world. This is the American Dream, Silicon Valley style. Unicorns (billion dollar and private companies) that turn an idea into a multi-billion dollar business are vanishingly rare. Since a lot of the aspiring unicorns have no viable business model (or none at all) that can justify their valuations, they usually rely on matrices like “eyeballs” or “engagement.” These can be appealingly convincing in frothy times but they are far less exciting in down cycles, which happen on average every five to seven years (and the 2008-9 crisis was how many years ago?).

In contrast, innovation-based tech companies that spend resources on development and the creation of intellectual property (IP) value remain relatively stable in terms of valuation in both good and bad years. Their multi-tiered exit market is less cyclical than the consumer-based companies.

Tech companies also offer investors greater stability. Cambridge Associates has calculated the dollar-weighted internal rate of return (IRR) of VC investments (by investment year) and found that Internet e-commerce companies that won investment money in 2001 and 2008 (when the market was down) returned -21.72 percent and -3.1 percent respectively. Media and communication VC investments returned -5.27 percent and -3.86 percent in those same years.

On the other hand, B2B businesses that secured financing in 2001 and 2008 returned 8.81 percent and 6.16 percent respectively. Hardware upstarts returned 13.08 percent and 7.10 percent. Software and services companies fell somewhere between, at -3.83 percent and -0.65 percent.

This wide discrepancy in IRR can be explained by three basic factors:

  1. Technology-driven startups produce real solutions to real problems.
  2. These companies have a clear revenue model that can be priced at a relatively early stage.
  3. If things go bad, there is still a technology asset to sell.

By comparison, pure consumer-driven companies tend to have products with marginal value contribution; depending on revenue model, it can be expensive to scale and predict their performance. If things go bad (and they usually do), they don’t have much in the way of real assets to sell.

Data shows an upward trend both in the number of tech, software and related deals and the total value of tech/software companies in the global economy. There was no significant dip in the number of software-related investments, even during the 2007-09 period.

In short, B2C apps may be great strategies in good times, but when the market takes a downward turn, companies with no innovation and no clear business model lose their charm for investors, and many fail.

Of course it’s easy to see why so many people are attracted to the consumer space – particularly in Berlin. There is much more know-how, experience and expertise in the B2C space throughout Europe, and that tends to make local investors comfortable.

But, with the right idea and the right team, great B2B startups can also be formed, built and sold in Berlin. The time is right and the opportunity is here. Mark Zuckerberg is great, but I hope some people working away in their garages will emulate the Hasso Plattner approach instead.