What is the economic impact of a Tech Startup? (Part I)

I thought it would be interesting to take a high level look at what the "economic impact" of a Tech Startup is on average. A lot of local economies are suffering because they either depend too much on tourism or real estate - or perhaps their core industries are dying (e.g. manufacturing, etc). Every local economy wants to diversify, but the big challenge is finding the best way to grow new businesses or convince other businesses to move to the area. Many times they shy away from "startups" because they are too risky, or don't present an immediate opportunity for hundreds or thousands of jobs - but in my opinion investing in startups is the best and ultimately the quickest way to creating the right kind of jobs, and boosting a local or State economy.

Here is my logic:

Lets start with the micro-economics of an average Startup. Most tech startup acquire venture funding. On average I would say 80% or so raise around 500k to 1M in funding (even the bad ideas get money in the beginning). The other 20% usually go on to raise more money - up to 5M or more. In States with concentrated Venture Capital, these stats change quite a bit - but I am being conservative in my estimates because my experience is in Florida (which is not strong in later stage Venture Capital).

So where does this money go? Well it goes to people, services, rent and marketing. And it is spent quickly. This is what makes a Startup an interesting catalyst for economic growth. Even though they don't have a lot of money in the bank - they spend it quickly (unlike larger more established companies).

So for example. compare an established 10M revenue 'non-tech' company, and a startup that has 1M in the bank for growth. I would argue these two companies have a similar economic impact in non-payroll type investments - e.g. Marketing, Outsourced Services, etc. Ofcourse the 10M company has a bigger payroll, but they most likely are not spending a large of money locally in new development, marketing or other services. So the startup may spend 250k-500k in these services in the first year or two, while the more established company has reduced its "growth spending" and is simply trying to find ways to cut costs, and maintain profitability.

So, then the natural discussion next is about jobs? Does a company with 30 employees (low-paid manufacturing, etc) have a bigger impact then a tech startup with 4 (high-paid employees)? Of course the amount of payroll is bigger with 30 employees - but my argument is that they make less of an impact, because they have less of an economic impact, because they are not spending outside the basic living expenses (house, food, clothing, etc). The higher paid employees are going out for dinner, buying big screen T.V.s and paying for dry cleaning. So although the non-tech established company is spending 100k per month on payroll, most of it is going to mortgages, groceries and gas.

So by now, you should see my position clearly - Size doesn't matter - Spending does.

POINT: Tech Startups and their employees' money has more impact on a local economy.

Now, lets look at long term impact. Obviously, the Non-Tech company will start to face more competition, and their product margins will shrink, and ultimately they will either need to move most jobs overseas or downsize. So now, the 30M revenue company is spending much less in the local economy. On the flip side - the Tech Startups will continue to grow (and yes, a few will die - but not until they spent all their money). Those that do survive, will grow quickly and become 5-10M revenue companies, with 10 times the economic impact of the 30M non-tech company.

So now you have a 10M revenue tech company - who needs to hire more high-paying jobs, and is spending more on local economic services - and ultimately will also spin off new companies as employees leave with their ideas and start new companies.

Final Breakdown

Take any local economy that wants to grow, diversify and make a real investment in building a strong business community - I would argue that putting 50 Tech Startups in that city, versus trying to get 10 established "non-tech' companies each having 20-30M in revenue to move to the area is the better choice.

At first glance, you would think its a no-brainer to choose the established companies. 50 Tech Startups = less than 100 jobs, no revenue versus 10 companies with 30M in revenue each = 300M in new revenue and probably 1,000 jobs.

For me, I would take the 50 Tech Startups - anyday. Even if they all fail, the economic impact over the short term will be greater than the established companies - and all the "jobs lost" if they did fail, would be entrepreneurs that would turn-around and startup something else.... and the cycle would be never ending as long as the local community supported them.

POINT: Failed Tech Startups does not mean jobs are lost - they just start something else and continue the cycle.

What does it take for local community to build a Startup Community. Simple.

1) Incubator run by entrepreneurs

2) Angel Investment Fund

3) Supportive Business Community

4) Strong Entrepreneurial community

5) Local Government support

(I'll save the details for next blog post)

If I were going to start a company...

I spend a lot of time talking with entrepreneurs online and offline, and many times the conversation ends up being about what types of companies would be good to start during these rough "economic" times (where investors and customers are hard to come by).

So, I decided to through some ideas into this blog -

First lets talk at a high level about what "type" of company would do well (before we actually throw out some business ideas).

First, the startup costs need to be low. It's a hard environment to raise money, especially around an idea with no product. So your best bet is to stick with Internet-based businesses. Second, the overhead needs to be close to zero. You can't have fixed costs killing you every month. Third, no inventory or big cost of sales. Fourth, the price point needs to be low (both business and consumer products).

So now, that we have a framework to work with, here are some ideas that I think have some potential (but still need some fine tuning):

1. WEBCASTING - This is the future of video on the web, and there is something intriguing about live video over the web. Companies like Stickam and UStream launched platforms that allow your to stream - but this is just the beginning. There is money to be made here in both consumer and business markets.

2. SOCIAL MARKETING - This to me is a no brainer. Anyone with some basic internet skills can build a nice business offering services to businesses by managing and marketing their social networking profiles. This includes mySpace, LinkedIn, Facebook, Twitter, etc. Every company should have an active presence on all these social networks, but they don't have the time or know-how to effectively build networks, communicate news and events and turn connections into profit.

3. PHONE APPS - If you have the technical know-how (or a friend who does) get working on building apps for the new generation of phones like the IPhone and G1 (Android) Google phone. This is a new frontier with limitless possibility. There are so many application ideas yet to be had. There may be a hurdle making money (unless your app takes off) - but eventually the model will mature and there will be "gold in them hills".

4. GPS (Where are you?) - GPS is now everywhere (phones, cars, etc). The idea of "location" is big and has a lot of potential in being the base for millions of application. Anything from "where's my kid" to "where was this picture taken" will be killer apps of the future. Everything will tie into GPS - and location will be a new piece of data we come to expect with anything and everything we see on the web.

5. IPTV - Youtube is just the beginning. Start thinking more about the content than the delivery of content. Just like industries of past, you need to learn that content is king, and platforms become commodities. Find ways of creating or getting your users to create dynamic content. Build a brand, and launch a media company that is 100% Internet. TV over the Web ("IPTV") will change the way all of us think about television in the future.

There you go... Five reasonably good ideas (or at least directions) where I could see real potential, and they are all somewhat market-proof. You can provide a lot of value for little cost, and ultimately scale the business as much as you can in this climate.

We are entering into a new phase on the web - and it is shifting from one side of the brain to the other... the "Creative Web" is rearing its head - and I think we will see the next set of millionaires and billionaires spawned from the Creative Side, and not the Plumbing side.

Why "Bailouts" don't work - D.C. is not a V.C.

I find it somewhat entertaining watching CEO's of billion dollar companies like GM and Ford sit in front of Congress pitching their "business plan" and asking for money. This scene is all too familiar to me (and probably most startup entrepreneurs). The moment of clarity (and to some degree irony) for me was when the CEO's were asked if they could produce 3 year Pro-Forma financials for their business.

WHAT?

Are you kidding me? They flew to D.C. to ask for 35 Billion dollars and they didn't even bring a business plan that gave detailed financials? Are you ******* kidding me?

When any startup looks to raise capital and is asking investors to put in 25k or 50k, they show 3-year financials - and they don't even have any historical data to base it on.... so why on Earth didn't these guys bring it with them when pitching their "deal" to D.C.?

This is an absolute joke.

This is why Bailouts don't work

(believe me, as an early stage investor who has invested in many different companies that face bankruptcy often - I know a few things about bailouts)

1. Bailouts prolong Change. I have seen many startups continue to raise capital because they can't seem to reach profitability and they can't seem to gain traction on their business plan. Guess what. 99% of these companies fail (even after they get more money) because they refuse to change their business model. If you keep giving them money, they won't change.

2. Bailouts keep them Fat. Many times a business is gaining traction and closing sales, but their expenses are too high. They either hired too many people because they didn't run efficient, or they just don't know how to manage expenses. If you give companies more money to make ends meet - they won't ever make the hard choices to cut staff, improve efficiencies and reach profitability.

3. Bailouts reward Failure. Anytime you write a check to a company that is failing - you have to wonder why you aren't writing checks to those companies that are succeeding. This is a classic problem venture capitalists face when they look at their portfolio and consider follow on investments in their companies. They may have 3 companies dying and 3 companies are succeeding. Do you give your money to the ones failing (so you can hopefully turn them around) or do you give the money to the 3 that are growing (even though they may not need it - but you know it would help them grow bigger and stronger?)

4. Bailouts make Customers, Employees and Shareholders nervous. Anytime a business needs more money to survive, everyone starts to question the future. When you have employees nervous, then customers get nervous. When you have the CEO nervous, shareholders get nervous. The end result - you may have some money in the bank, but the company's brand is bankrupt. It becomes harder to convince shareholders to invest, customers to buy more product and good employees to stay.

5. Bailouts don't solve the problem. It is funny to me, that the Congress can question the CEO's of the car companies for days, but no one seems to address the real problem - Why are you going bankrupt? They dance around the question, but ultimately focus on why they should get the money. I believe the problem is that the car companies don't make a competitive product and they have fallen behind in technology and innovation. So does giving them billions to make payroll solve the problem? No. Does showing pictures of an electric car solve the problem? No. What will solve the problem? I have one idea - maybe we should try to get Americans to buy American made cars? Maybe that would help their business? If the Federal Government wants to see the car companies succeed - maybe they should focus on giving us (the consumer) reasons to buy American - like tax incentives when you own an American automobile. For example for businesses - allow any US corporation to write off any American vehicle. (I don't claim to have all the answers, but this would be a lot cheaper of a bill to pass - and it actually may sell a few cars).

Overall, we live and die in the Free Market system, and whether you are a 2 man startup or a billion dollar car manufacturer - I believe you live and die by the same principles. You have to make a competitive product, meet a market demand, and listen to your customers. If your business fails, then someone else will pick up the pieces, grab the marketshare and deliver product to those customers. This will happen in the car industry as well.

Millions of people may lose their job, and that is probably the hardest part about dealing with this crisis - but at the end of the day - they were going to lose their job eventually because they worked for a company that had shareholders that ignored poor management, outdated products and an inefficient operations. Why should I have to pay for some guys job in Detroit, when I could use that money to support my successful business?

I hope we learned at least one lesson in all of this - Management matters. The people we choose to run this country, run our corporations, run our schools, hospitals and military matter. Perhaps we will make better choices as voters and shareholders going forward. There are people to blame on both sides of aisle when it comes to our economic downturn - and my only hope is that this pain turns into action - and we make the changes we need to build a stronger future.