Hamburg’s Entrepreneurial Ecosystem and the Next Media Initiative

Based on research into entrepreneurship policy done at UNSW in 2016, I completed my graduate studies at Hamburg University of Applied Sciences in December 2016 with a master thesis on the entrepreneurial ecosystem in Hamburg, Germany, and the entrepreneurship policy approach by the regional government.

The thesis is called “Hamburg’s Entrepreneurial Ecosystem And The Next Media Initiative – Public Policy Towards Entrepreneurship” and focuses on Hamburg’s regional innovation strategy 2020 and the dedicated media/IT industry cluster initiative nextMedia.Hamburg. The abstract of the thesis can be found below.

master thesis


Introduction

Entrepreneurship, more specifically the formation of tech startups, is often attributed with economic growth and job creation due to their high-growth potential by many policy makers in the world. This link is widely debated in scientific literature, which does not necessarily seem to inform public policy.

The City of Hamburg established a Next Media Initiative – nextMedia.Hamburg – in 2014, focusing on media/IT industry related innovation to nurture the future development of this industry cluster with the help of high growth ventures.

This master thesis explores the composition of Hamburg’s entrepreneurial ecosystem, local government efforts to facilitate its development and the (dis)connect between municipal innovation policy and academic literature.

Method

With its nextMedia.Hamburg initiative within the media/IT industry cluster, the City of Hamburg aims to support the entrepreneurial ecosystem as well as the media and creative industry in general. In various official documents and on a dedicated nextMedia.Hamburg website the efforts to nurture innovation, to create more ventures and maintain Hamburg as a media industry capital are published.

This thesis will introduce the local entrepreneurial ecosystem along with its most relevant stakeholders and review the regional innovation strategy and nextMedia.Hamburg initiative in 3 parts.

Taking into consideration the current setup of Hamburg’s entrepreneurial ecosystem and its various entities, the first part will summarise salient points of the innovation strategy outlined by the City of Hamburg as well as key elements of the nextMedia.Hamburg initiative’s activities by which the regional government aims to attain its goals.

The second part takes relevant aspects of the outlined strategy and activities and reviews them from an academic perspective, considering arguments presented by Shane (2009), Audio et al. (2007), Morris et al. (2015), and Brown & Mawson (2015).

The third part draws on research findings to classify the outlined policy agenda and its measures to support the entrepreneurial ecosystem in Hamburg and discusses them in regards to Regional Innovation Systems (RIS) analysed by Moutinho et al. (2015) and the Triple Helix Approach (Ranga and Etzkowitz 2016) to asses their possible impact on the entrepreneurial ecosystem in Hamburg.

Results

This thesis makes 4 contributions. Foremost, several disconnects between local entrepreneurship policy in Hamburg and academic literature on entrepreneurship policy are explored by analysing both the regional innovation strategy and nextMedia.Hamburg initiative’s documents and activities. Additionally it is shown how relevant scientific findings have not been taken into consideration despite collaboration with research facilities at local universities.

Third, it is illustrated how the activities to nurture entrepreneurial activity by the nextMedia.Hamburg initiative lack a connection to actionable metrics to successfully measure results and adapt for change. As a fourth contribution, this thesis draws on common challenges in developing regional entrepreneurship policy and proposes closer collaboration between the research community, industry and policy makers.

Source: Recke, M. P., 2016. Hamburg’s Entrepreneurial Ecosystem And The Next Media Initiative – Public Policy Towards Entrepreneurship.


Next Steps

I plan to take this research further in the future. Considering research findings on entrepreneurship policy effectiveness, emerging new transdisciplinary approaches can be utilized to develop a better understanding of underlying mechanics within entrepreneurial ecosystems and their impact on economic development.

For more information, feel free to contact me directly.

How Peer Reviews for Scientific Journals and Conference Papers Work

In case you ever wondered, how peer reviews are usually done in context of academia,  scientific journals and conferences, there are some short but informative posts by Peter Casserly (and others) on Ex Ordo for Academics explaining how it works.

Ruffly, there are single-blind peer reviews (which are still most common), where the author is known to the reviewer but the reviewer stays anonymous, double-blind peer reviews, where both the author and the reviewer remain anonymous and open peer reviews, where everything is kept transparent. In the posts the basic workflows are explained and research studies are citied to elaborate on the advantages and disadvantages of each process.

In my personal opinion, double-blind peer reviews are most suitable within a scientific context. Although there are large benefits in having full transparency, it might add bias and peer pressure to the process and reviewers might feel the need to work more on their personal profile and alignment of their then public commentary than the actual scientific research in review.

Although it is rather hard to make double-blind reviews truly anonymous, since authors can often be inferred from the content of the article, I consider this the best way to go.

Submission and Rejection

For anyone interested in submitting a paper to a journal for review, it might be important to know, that it will probably be rejected and might take some additional work to be saved (or published for that matter). If you might feel that this can be hard to bare, I can recommend getting used to rejections to better cope with the process in the future by submitting your paper to The Journal of Universal Rejection (JofUR):

“The founding principle of the Journal of Universal Rejection (JofUR) is rejection. Universal rejection. That is to say, all submissions, regardless of quality, will be rejected.”

Entrepreneurship Policy Case Study: City of Sydney’s Tech Startups Action Plan

During my time at UNSW in 2016, I worked on a case study to review Sydney’s entrepreneurship policy approach. The case study was presented in February 2017 as a peer reviewed paper at the ACERE Conference in Melbourne, Australia.

ACERE
Australian Centre for Entrepreneurship Research Exchange

In reviewing the City of Sydney’s Tech Startups Action Plan, a comprehensive document, outlining the city’s strategy towards the entrepreneurial ecosystem and measures undertaken to stimulate its growth, several disconnects between entrepreneurship policy and academic research findings have been discovered:

“Abstract: Public policy can shift the economic composition of a region. Many policy makers promote entrepreneurship under the assumption of a link between new ventures and economic growth and job creation. While this link is hotly debated in scientific literature, this literature and evidence base does not necessarily inform public policy. This project explores the (dis)connection between municipal innovation policy and the academic literature, using the City of Sydney’s recent Tech Startups Action Plan as a case study. This paper makes four contributions. First, comparison of the first and second parts of the review reveals several disconnects between the plan and the literature on entrepreneurship policy. Second, the origins of these disconnections are traced back to how relevant scientific findings had not been considered in the composition of the Tech Startups Action Plan. Third, this review reveals further deficiencies regarding the plan’s proposed implementation. More specifically, although the plan attempts to consider the entire ecosystem and its challenges, and introduces metrics to track the ecosystem’s growth, the plan lacks concrete implementation methods. Overall, this plan exemplifies challenges in developing municipal entrepreneurial policy. As a fourth contribution, this paper proposes means for closer collaboration between the research community and policy makers.”

Source: Recke, M. P., Bliemel, M., 2016. The City of Sydney’s Tech Startups Action Plan: A Policy Review.

The peer reviewed paper was used as a basis for further development of the research as well as for a similar case study of the innovation policy in Hamburg, Germany, and its impact on the regional entrepreneurial ecosystem.

Impressions from ACERE conference 2017 in Melbourne

In February 2017 I attended the ACERE conference 2017 in Melbourne as a speaker to present a case study on the entrepreneurial ecosystem in Sydney and the regional entrepreneurship policy. The paper was created in 2016 during my time at UNSW Business School in Sydney.

“ACERE stands for Australian Centre for Entrepreneurship Research Exchange, an annual conference in its 11th year. Initiated by Professor Murray Gillin AM and inspired by the Babson College Entrepreneurship Conference (BCEC) in the United States, these conferences were organised annually by Swinburne University (and co-hosts around Australia and New Zealand) under the label “AGSE IERE” (2004-2011). Queensland University of Technology (QUT) Australian Centre for Entrepreneurship (ACE) has produced the ACERE Conference since 2012.”

Source: ACERE conference

It was the first time I attended the ACERE conference and it was a very interesting experience. The discussions around presented research papers were both constructive and inspiring and I certainly met some very interesting people over the course of the conference.

The conference was held at NAB’s The Village and was hosted by QUT (Australian Centre for Entrepreneurship Research at Queensland University of Technology) and RMIT University. The location itself was kind of interesting as well and certainly the most open corporate bank office space I have ever seen.

For anyone interested on what kind of papers were presented, I attached the conference schedule: ACERE 2017 Program

Joining ACERE Conference 2017 to present research findings

In February 2017 I will be at ACERE Conference (Australian Centre for Entrepreneurship Research Exchange) in Melbourne, Australia, to present research findings as a speaker. The conference will be held at NAB’s The Village and is hosted by QUT (Australian Centre for Entrepreneuship Research at Queensland University of Technology) and RMIT University.

I worked on a case study of Sydney’s entrepreneurship policy and strategy towards the regional entrepreneurial ecosystem, outlined in the City of Sydney’s Tech Startup Action Plan, a comprehensive document created in collaboration with entrepreneurial ecosystem stakeholders as well as industry consulting entities over a period of at least 5 years. The plan was adopted by Council in June 2016 and builds on premises such as links between entrepreneurship and economic growth:

“Encouraging tech startups will create more jobs, boost Sydney’s economy, strengthen global connections and make the city a more desirable place to live, work and visit. Our tech startups action plan details how we will work with industry and government partners to create an environment that enables technology entrepreneurs to start and grow successful global businesses.”

Source: City of Sydney – Tech Startups

The case study was done in 2016 during my time at UNSW (University of New South Wales) in Sydney as an international research student from Hamburg University of Applied Sciences in collaboration with Dr. Martin Bliemel, senior researcher at UNSW Business School, and also consists of input by industry stakeholders, policy makers and startup advocacy groups.

The peer reviewed paper will be presented during the conference and might provide an ample starting point for discussions on effective entrepreneurship policy and additional academic work in the future.

Literature research done in this context also provided a basis for further research and a master thesis on entrepreneurship policy implementation in Hamburg, Germany, that was completed in December 2016.

How to Start a New Venture in 12 Weeks

While being in Sydney in early 2016, I joined a team to create a food delivery startup as part of a Management & Innovation workshop at UNSW Business School in conjunction with Michael Crouch Innovation Centre. I worked on this project part time while conducting research at UNSW into policy towards entrepreneurship and innovation and drafting a policy review of the Tech Startups Action Plan by the City of Sydney.

The workshop was organised around the structure of typical startup accelerator programs, working on specific challenges while developing a working business model over a period of 12 weeks. It was a 5 person team with local ties in Australia, Denmark, Germany, Spain and the U.S. and backgrounds in engineering, marketing, business and process management.


The Lean Startup

As one might expect, the workshop was organised around methodologies postulated by Eric Ries in his book “The Lean Startup”. Based on lean principles such as validated learning and innovation accounting, the team worked through several Build-Measure-Learn feedback loops to iterate the main features of the business model, especially the value and growth hypothesis’.

lean methodology diagram
THE LEAN STARTUP PROCESS – DIAGRAM by theleanstartup.com

The team utilized design thinking methodologies, experimented with real life feedback and consulted with industry mentors. While defining and differentiating the product, support and feedback on topics such as design, financials, financing, valuations, growth, IP and pitching to investors was provided by UNSW staff and additional industry professionals.


Business Model Canvas

Key element of the 12 week program was the business model canvas, a strategic management template for developing and documenting business models. It helped the team to visually describe all important elements and to iterate through various versions of the business model while working through the Build-Measure-Learn feedback loop. Also it allowed to sketch and discuss the business model on paper within the group, which made it very easy to discover flaws and potentials for further improvements.

the business model canvas
THE BUSINESS MODEL CANVAS by strategyzer.com

As could be expected, the business model changed from week to week and many apparent problems were eliminated through validated learning and evidence based iteration. By getting user feedback as early as possible and accounting for every change made to the business model, waste of funds while developing the minimum viable product was minimized as much as possible.


Fantastic Five – B2B Breakfast Delivery Service

In week 12 the team pitched the state of the startup, its business model, go to market strategy, key metrics and financial projections to real investors within the local startup scene in Sydney and was offered to talk about possibly joining food delivery startup activities currently active at a local accelerator program in Sydney.

Fantastic Five
Fantastic Five

The pitch was presented during a demo day at the Michael Crouch Innovation Centre within a lineup of several other startups with a pitch deck of 1o slides in a time slot of 3 minutes with an additional 3 minutes for questions by the potential investors. The jury was made up by prominent members and angel investors of the Sydney startup community.


How much time and money does it take to start a new venture?

All in all, it was a very interesting experience. Considering the effort put into the project one can only imagine the results if one would be committed full time. I spent roughly half a day to a day per week on this project and expect the other team members to have been involved in a similar or slightly deeper manner.

So basically the business pitched to the investors was the product of 250-500 hours of work with no significant additional budget. All templates and tools used were free and everything surrounding the actual product was designed, developed and tested by the team members.

So as all of you know, it just takes a lot of effort and the willingness to put in the time to ideate something of value. It certainly is feasible to create a venture with high-growth potential within a matter of 3 months. In fact, considering the experience of this workshop, it might be possible to do it a lot quicker if the commitment and skill set of the team members match up.

How Recent Changes In The Social Media Landscape Further Compromise News Corporations’ Efforts To Monetise Their Social Referral Traffic

This essay will elaborate on recent changes in the social media landscape, specifically changes in social traffic referrals and the persistence of social media, and their subsequent implications for digital business models of newspaper publishers. Taking into consideration that social referral traffic is becoming the main source of referral traffic for many media and news publishers, changes in the persistence of social media have the potential to largely compromise the publisher’s efforts to monetise their web traffic through advertising.

-> tl;dr


A definition of social media

In order to classify changes in the social media landscape it is sensible to define the term for the current state of its development. For the purpose of this essay this can be done without illustrating the historical evolution of aspects, features and characteristics. Since social media have changed drastically over the past years, many attempts of defining the term have been made. Due to the ever-changing landscape and the rapid technological development of social media, many of these definitions seem out of date or imprecise. For the purpose of this essay the definition by Carr and Hayes (2015) will be used, since it provides an accessible explication for the long-term future, considers recent changes in technology, interaction and organisation as well as anticipates future challenges in social media. They define social media as follows:

“Social media are internet-based channels that allow users to opportunistically interact and selectively self-present, either in real-time or asynchronously, with both broad and narrow audiences who derive value from user-generated content and the perception of interaction with others.”

(Carr C T and Hayes R A, 2015)

This definition allows to include a wide variety of services, ranging from obvious social networking sites such as Facebook and Twitter, business networking sites such as LinkedIn, video sharing sites such as Youtube and Vimeo to live streaming services such as Twitter’s Periscope as well as old and new messaging services such as WhatsApp and Snapchat among many others. It also allows for future social media services to be included, as long as they are user-centric and interactive channels organised around content sharing, characteristics that are shared among all social media channels to date.


Changes in social referral traffic

One industry relying heavily on shared social media content is the media and newspaper publishing industry. Newspaper websites are largely monetised through advertising and rely on visits and page impressions on their actual web property (Ju, Jeong and Chyi, 2014). The sources for such website traffic can ruffly be divided among direct traffic (users accessing the website directly by entering the url in the browser) and referral traffic (users accessing the website through search engine results such as in Google or through a link on another web property or within social networks). Every user visiting a publisher’s usually free to use website generates page views while accessing different resources on the web property. With every page load advertising inventory will be displayed for the user to generate advertising revenue for the publisher. In conclusion publishers’ digital business models rely heavily on page views and ad impressions to monetise their inventory.

Over the past years the importance of social referral traffic for media and newspaper websites has changed dramatically. In August 2015 it was reported by FORTUNE that traffic analytics firm Parse.ly’s data showed social media as the largest provider of all website referral traffic with about 43% of the total traffic, while search traffic through Google accounted for just 38% (Figure 1). Facebook is by far the largest provider of social referral traffic in this dataset with close to 40%.

To emphasise the dramatic trajectory of this change, Facebook’s share grew rapidly from just 20% in January 2014 (Figure 2). For larger news and media sites, more than 50% are reported to get more traffic from Facebook than from Google (Ingram, 2015). This development could very well be considered a tipping point for the dominance of Facebook as the main source for news content on the internet.

Figure 1 - Top Traffic Referral Source May - July 2015
Figure 1 – Top Traffic Referral Source May – July 2015

 

Figure 2 - Parse.ly Network Traffic from Google Versus Facebook
Figure 2 – Parse.ly Network Traffic from Google Versus Facebook

With social referral traffic accounting for such a large portion of traffic for major news and media websites, it is clear that the monetisation of this traffic is crucial for the publishers’ business model. Unfortunately for publishers, recent research by Ju, Jeong and Chyi (2014) showed that users accessing news websites via social networking sites provide fewer page views and higher bounce rates than other website visitors. The authors examined 66 U.S. newspapers’ efforts to distribute their content via social networking sites such as Facebook and Twitter and the effectiveness of these services as news platforms. The social media presences of the newspapers were analysed and the impact to the newspaper’s website traffic and therefore their advertising revenues examined.

The results of the efforts to drive social referral traffic have proven to be largely underwhelming, despite the hype about the business potential for newspapers (Ju, Jeong and Chyi, 2014). The research clearly illustrates the limitations of creating new advertising revenue streams through social referral traffic for newspapers. With an increasing number of visitors being referred through social media, the average page impressions per visit are shrinking on publishers’ web properties. This development has direct impact on the publishers’ ability to monetise their web traffic and is consequently accelerating at the same pace as the amount of social media referral traffic is increasing.


Changes in the persistence of social media

An important element of social media has been the persistence of content, may it be used in real-time as in Twitter’s Periscope or asynchronously as in WhatsApp. For many years it has been a crucial aspect that any content within the social media landscape remains persistent (Dewing, 2012), meaning accessible and searchable via the web for ever, even if the users’ practice focuses more on the shared present (Hogan B and Quan- Haase A, 2010).

Although the persistent element is still existent in lots of social media channels, recent services like Snapchat introduced channels which delete content shortly after consuming it (Carr C T and Hayes R A, 2015). There are more and more new services focussing on the “present moment” and deleting content after its consumption, e.g. Beme, Tiiny, Vine or Wickr, to name a few.

In conclusion non-persistent content is already an established element of the social media landscape at this stage. The result of content not being accessible after the “present moment” has direct implications for publishers’ business models relying on monetising of shared and long-term accessible social media content.

As the longevity of social media news shortens dramatically by recent shifts in persistence within social networks, meaning content being accessible and shareable for shorter periods of time, the time to generate social referral traffic for news sites is getting shorter as well. The long tail effect (Andersen, 2004) for news articles in this category may be diminished completely if the content is no longer persistent within the social media landscape. With social referral traffic only being generated on a short term basis, a large portion of monetisation potential is lost for older news articles. This increases the pressure on publishers to refinance their articles on a short term dramatically.

Things might get even worse for many publishers with Facebook’s latest publishing feature, Instant Articles. Instant Articles allow publishers to display content in its entirety directly within the Facebook stream (Groden, 2016). The user does not have to leave the Facebook platform and can consume an entire article, including videos and interactive elements, seamlessly within the Facebook experience.

Although this makes sense from a user’s perspective, it increases the publishers’ dependency on Facebook drastically. With Instant Articles the amount of off-website content and with it the difficulty to monetise this content is increasing. Publishers may sell their own advertisement for Instant Articles but in the end Facebook is in charge of the platform (McAlone, 2016), a drastic difference from the publishers’ own web properties. As well as it may be a chance for smaller publishers with no large sales force in place to use Facebook’s ad sales in Instant Articles, it may just as well be a huge problem for larger media and news publishers.

With these developments in mind, many publishers would have to change their social media strategy drastically if they decide to change their business model from free websites with advertising revenues towards closed websites with paywalls. Since news content tends to be free within the social media landscape and certainly will remain free within Facebook Instant Articles for the time being, it is doubtful that publishers can drive many users into their paywalls through social referral traffic.

Especially with content being integrated in platforms like Facebook in better ways, the lock-in effect for most users is increasing. This development makes it more and more unlikely that users are willing to tolerate a disruption in an otherwise seamless social media experience just to consume content elsewhere, not even considering paying for it.


Conclusion

Summarised it can be stated that social referral traffic in general is worse for media and news publishing websites than other kinds of traffic and leads to fewer page views and higher bounce rates. This leads to a direct threat to advertising revenues for most publishers as the percentage of social referral traffic increases. As a result the current business model of many media and news outlets is in jeopardy.

With recent changes in the percentage of social referral traffic as well as in the persistence of social media content, the pressure on publishing companies to find alternative ways to monetise their inventory increases rapidly. If content is no longer available within social media after it has been consumed in the “present moment”, the potential to drive traffic with this content is very limited and short-term.

Additionally with Facebook latest publishing feature, Instant Articles, many users are kept out of the publishers’ web properties. Therefor it seems unlikely that the quality of social referral traffic, meaning its page views per visit ratio, is increasing for publishers’ any time soon.

Taking into consideration the rapid growth of the percentage of social referral traffic over the past year, it is clear that the pressure is increasing for many media and news publisher with no deceleration of this trend in sight.

Lastly, publishers’ actual or conceivable efforts to erect paywalls for compensation of underperforming advertising revenues on their websites might be compromised by new publishing features such as Facebook’s Instant Articles, which largely contribute to keeping users within the social network and off third party web properties.

Since the illustrated parameters have a tremendous effect on the bottom line for news websites and tend to change very quickly, it is more important than ever for publishing companies to act swiftly if they want to avoid impairing their market position any further.

Unfortunately, all attempts as of today do not seem to provide evidence for any extensive success. Therefor a prosperous step into the future requires rapid and substantial business model innovation.


tl;dr

Due to recent changes in social referral traffic to news websites and in the persistence of social media, current business models of digital news publishers are in jeopardy.


DISCLAIMER: This essay has been written for the seminar “Online and Mobile Media” during an international research exchange at the University of New South Wales (UNSW) in Sydney, Australia, within the “Next Media” master program at the University of Applied Sciences Hamburg (HAW Hamburg) in 2016. For more information or any questions please contact me at mail@moritzrecke.com.


Figures

Figure 1: Top Traffic Referral Source May – July 2015, Parse.ly Authority Report 8, The State of Tags in Digital Media

Figure 2: Parse.ly Network Traffic from Google Versus Facebook, Parse.ly Authority Report 8, The State of Tags in Digital Media

 

Startup funding and signs of a new dot-com bubble

Startups and their highly innovative potential (Bundesregierung 2013, bundesregierung.de) are considered to be of great importance for the economic development in the US, Asia and Europe due to their unimaginable scale effects and enormous valuations as well as their high media attention (Austin, Canipe, Slobin 2015, wsj.com). This paper will provide an overview of means for international startup funding and will examine current changes in startup funding and developments in regards to concern about a new dot-com bubble.

-> tl;dr

Startups and their growth path

The term “startup” is most common for young, newly founded companies and well established in the mainstream media since at least the dot-com bubble in 2000. But not any new company constitutes a startup. Startups are characterised by low seed capital and the goal to implement an innovative business model (Bundesregierung 2013, bundesregierung.de) that can be easily replicated in order to scale the business quickly (Blank 2012, steveblank.com).

For a better understanding of the possible growth path for startups, the approach by the German Startup Monitor (Deutscher Startup Monitor), initiated by the Bundesverband Deutsche Startups e.V. (BVDS) can be used. The model distinguishes 5 phases: the “Seed-Stage” as a conceptional phase, the “Startup-Stage” with a working product and first revenues/users, the “Growth-Stage” with a mature product and strong growth, the “Later-Stage” with a planned sale or IPO and the “Steady-Stage” as a stagnation phase (DSM 2014, p. 14, Kohlmann 2011, p. 90, Ripsas 1997, p. 133)

Figure 1: 5 Startup Stages in terms of the DSM 2014
Figure 1: 5 Startup Stages in terms of the DSM 2014

A scalable business model is at the core of a startup and needs to be examined for its potential for success at preferably lowest cost. If the business idea assumption is verified, the continued success of the business model is highly dependent on market situation and the ability to adapt the product in the process. Typically this requires much larger funds and therefore different kinds of funding than before (Kollmann 2011, p. 90).


Startup funding

Startups are dependent on different kinds of funding in their growth stages. In addition to financial means other aspects of support like consulting, networking, access to markets etc. are essential. Also the particular interests of all people involved (e.g. founder, employees, investors, banks, etc.) need to be considered (vgl. Ripsas 1997, p. 133)

During its lifetime a startup potentially runs through many rounds of funding to reach the next stage of growth. These rounds can be described as “Seed Round” and “Angel Round”, typically after starting the company, and “Series A Round”, enabling the company to scale towards a possible IPO or sale of the business (Graham 2005, paulgraham.com).

Considering the shareholders of the startup in each stage, the process of continually changing equity structure can be described in stages such as “Idea Stage”, “Co-Founder Stage”, “Family & Friends” and “Seed Round, “Series A” as well as an “IPO” as the final stage (Vital 2013, foundersanddounders.com).

Figure 2: How Startup Funding Works
Figure 2: How Startup Funding Works

Starting the company: Idea & Co-Founder, Family & Friends Stage

As shown in figure 2, a startup starts out with its founders, in most cases equally sharing the equity. The first five-figure capital requirements are usually met with their own money, via bank loans or through their family or personal peer group.

If the startup decides no to go with a bank loan, a new shareholder structure for the company is established, making “Family ” Friends” the first investors in the business. This might lead to problems down the road due to the lack of investment experience, nevertheless it is a very common form of first funding for startups (Graham 2005, paulgraham.com).

Another alternative are so called accelerator’s, offering a five-figure to low six-figure investment for usually 5-7% in equity of the company and allowing startups to participate in a typically 3 month program to get prepared for the next round of funding (Altman 2014, ycombinator.com und Springer 2015, axelspringerplugandplay.com). During this period the startup can make use of the accelerator’s offices, coaches, market insights and workshops. After completing the program and showing off the developed product during a “Demo Day”, the startup leaves the accelerator. Slots within these programs are highly limited, so there are demanding application requirements to be met. Accelerators are usually private companies with their managers being angel investors themselves (Cohen 2013).

Some of the most important accelerators (The Economist 2014, economist.com) are Y Combinator (USA, ycombinator.com), TechStars* (USA, techstars.com), AngelPad (USA, angelpad.org), 500startups (USA, 500.co), Seedcamp (UK, seedcamp.com) und Startupbootcamp (EU, startupbootcamp.org) among many others. In Germany there are accelerators operated by Axel Springer (axelspringerplugandplay.com), ProSiebenSat.1 (p7s1accelerator.com) as well as the German Accelerator (germanaccelerator.com) and the Next Media Accelerator (nma.vc).

In addition startups can apply for aid or sponsorship from official funds. The number of support programs is extensive. In the EU and Germany alone, there over 2,000 specific programs for startups (FÜR-GRÜNDER.DE 2015, fuer-gruender.de). The programs can be divided between special loans, aid money, investments and non-cash benefits. The German business development bank KfW offers advantageous loans, provides grants for consulting services and provides access to equity capital (KfW 2015, kfw.de) via the High-Tech Fonds (High-Tech Gründerfonds), financed by the German Federal Departement of Commerce (Bundesministerium für Wirtschaft und Energie) and 18 major German corporations (High-Tech Gründerfinds 2015, high-tech-gruenderfinds.de). In addition there are the founder aid program (Existengründerzuschuss) and the founder scholarship (EXIST-Gründerstipendium) as well as regional business development programs within the federal states of Germany. All these possibilities for aid provide support for any startup growth stage and will not be discussed in further detail (FÜR-GRÜNDER.DE 2015, fuer-gruender.de).

If a startup manages to secure a first round of financing either trough their founder’s means, Family & Friends or an accelerator program, it reaches the “Seed Stage” in terms of the model by Deutscher Startup Monitor (DSM 2014, p. 14). It is also common to set aside an options pool for selected employees, who consider a rather small salary and join the company for the personal opportunity to shape its future. These employees also hope for a substantial growth in value of the company for a potential exit in the future (Vital 2013, foundersanddounders.com).

Seed Round

The “Angel Round” and “Seed Round” mentioned by Graham are shown as “Seed Round” in figure 2. The most important aspect of this round of funding is the six-figure to low seven-figure size of the investment. Angel investors, also called business angels, are often entrepreneurs investing their own private money and supporting the startup through their personal network. Beneath angel investors and angel syndicates there are also seed funding firms, usually called incubators (Graham 2005, paulgraham.com).

Incubators work in a similar manner as accelerators, but with much larger investments and higher equity shares.  They provide more support during the buildup of the company, e.g. by providing access to developer teams or marketing assets. A startup usually stays within a incubator program for one to five years and has to go through a challenging application process as well. Incubators are often associated with venture capital investors and are operated by managers that are not necessarily active investors (Cohen 2013).

Companies such as Microsoft (US, microsoftventures.com), Deutsche Telekom (DE, hubraum.com) and Telefónica (EU, wayra.co) are operating incubators. Some others are idealab (USA, idealab.com), Rocket Internet (DE, rocket-internet.com), Team Europe (EU, teameuopre.net) and Project A Ventures (DE, project-a.com).

Over the past years more options for funding came up. Platforms like AngelList (US, angel.co) enable startups to make direct contact with potential investors. In addition crowdfunding became quite popular, enabling people to preorder products that still need to be produced on platforms like kickstarter (US, kickstarter.com) and indiegogo (US, indiegogo.com) or enabling people to invest in companies on platforms such as fundersclub (US, fundersclub.com), fundsters (DE, fundsters.de) or seedmatch (DE, seedmtach.de).

If  a startup manages to secure a seed round, it reaches the “Startup Stage” in terms of the model by Deutscher Startup Monitor (DSM 2014, p. 14).

Series A

The “Series A Round” in figure 2 is a placeholder for more substantial seven-figure or larger investments. In this round specialised venture capital investors, also called VCs, are using their investment funds to buy large shares of the startup. Typically a VC holds at least 33% of a company and will have a much more prominent role in the strategic direction of the company (Graham 2005, paulgraham.com).

Some of the top VC investment firms in the US are Andreessen Horowitz (a16z.com), Khosla Ventures (khoslaventures.com), SV Angel (svangel.com) and Accel Partners (accel.com) of which several are actively investing in Europe as well (Benedicto Klich 2014, entrepreneur.com). In Germany the most important VC firms are Bertelsmann Digital Media Investments (bdmifund.com), e.ventures (eventures.vc), Holtzbrinck Ventures (holtzbrinck-ventures.com) and T-Ventures (t-venture.de) among others (Li 2013, venturevillage.eu).

After a successful Series A round of funding, the startup reaches the “Growth Stage” in terms of the model by Deutscher Startup Monitor (DSM 2014, p. 14). The immediate goal is to accelerate the startup’s scale process for a optimal growth in value and to prepare the company for a sale or an IPO, also called exit. On this path many more rounds in funding are possible and often common. These are called Series B, Series C etc.

IPO or acquisition

An Exit after a Series A round (or any other subsequent round) can be accomplished via an Initial Public Offering at the Stock Exchange, also called IPO, or via an acquisition of the startup by another company (Vital 2013, foundersanddounders.com). With an acquisition all shareholders can sell their shares, liquidating their equity. With an IPO, which is typically made possible with a large investment bank, the shareholder can sell their shares publicly for the first time as long as they are not bound by any contracts or vesting regulations. Until one of these exit scenarios is met, the sale of equity is rather difficult and can usually only be made to other investors (Graham 2005, paulgraham.com).

If a startup is working in a IPO or is an acquisition candidate, it has reached the “Later Stage” in terms of the model by Deutscher Startup Monitor (DSM 2014, p. 14). If the exit is implemented, the company ceases to be a startup.

Figure 3 shows the entire process of possible funding rounds as described by Graham and Vital in context to the model by Deutscher Startup Monitor. The “Steady Stage” as a stagnation phase has not been discussed in terms of startup funding.

Figure 3: Funding For Major Sartup Stages
Figure 3: Funding For Major Sartup Stages

Significant changes in startup funding

Looking at investments made by venture capital firms in the US, investments decreased rapidly after the dot-com bubble in 2000. But over the past years the investments grew steadily despite the economic crisis and a short setback in 2009 and show a distinct increase compared to the 1990ies. In 2014 a very substantial growth in investments can be identified as shown in figure 4. This rapid change causes concern about a new dot-com bubble.

Figure 4: Startup Funding Shows Signs of New Tech Bubble
Figure 4: Startup Funding Shows Signs of New Tech Bubble

Signs of a new dot-com bubble

The venture capital investments of $ 12.97 billion in Q4 2014 are the highest ever since Q1 2001 and grew 81% in Q2 2014 compared to Q2 2013. This represents the largest growth in year-to-year comparison since Q3 2000. In addition the average investment size of $ 11.64 million in Q2 2014 is as high as in Q4 2000 (Richter 2014, statista.com).

Investments differentiated by industry show the software sector is outpacing all other industries. In 2014 this sector reached the highest investments since 2000 with $ 19.8 billion, making up 41% of all investment, the largest share since the beginning of the yearly MoneyTree Report in 1995 (PwC 2015).

Figure 5: PwC MoneyTree Report Q4 2014/Full-year 2014 - Investments by industry 2013-2014
Figure 5: PwC MoneyTree Report Q4 2014/Full-year 2014 – Investments by industry 2013-2014

These market movements are highly reminiscent of 2000. In addition acquisitions of companies like WhatsApp with an valuation of $ 345 million per employee are leading to concern as well, since metrics like this were common for investments just before the dot-com bubble burst on the turn of the millenium (Heskett 2014, hbs.edu).

Another indication for a new bubble might be the average valuation of startups, which already exceeded the values of 2000 in 2012 considerably (figure 6). Furthermore the valuations are rising faster than investments (figure 7). Also the average valuation at the time of the IPO is not growing as fast as the “Later-Stage” valuation. This proportion is deteriorating since 2009 and leads to shrinking returns on investment (ROI) for investors joining a startup in a later stage (Maris 2015, techcrunch.com).

Figure 6: Median post-money valuation of investment rounds
Figure 6: Median post-money valuation of investment rounds
Figure 7: Late stage valuation compared to VC fundraising
Figure 7: Late stage valuation compared to VC fundraising

Differences between the dot-com bubble in 2000 and today

Nevertheless, there are some distinctions to the developments from 15 years ago. The total sum of investments in 2014 is just at 1/3 of the sum in 2000. In addition many companies went to an IPO much quicker than today (figure 8).

Also many classic IPO candidates are bought by companies such as Google these days. Among many things this is also due to stronger regulation, e.g. “Sarbane-Oxley Act” from 2002, providing compliance obstacles for smaller companies. In addition “Regulation Fair Disclosure” from 2000 lead to considerable requirements and risks for the information policy of publicly traded companies, making a premature IPOs far more unattractive (Lee 2014, vox.com).

Figure 8: Years from founding to IPO (mean)
Figure 8: Years from founding to IPO (mean)
Figure 9: Number of VC investments
Figure 9: Number of VC investments

In addition, VCs made more than 2,000 investment in the year 2000. Over the last few years the number of investments is between 1,000 and 1,200 (figure 9). This indicates that investors are far more picky and concentrate on fewer but much larger deals. Even when considering the growth of investments in 2014, the number of deals remains stable (Maris 2015, techcrunch.com).

The number of seed round funding did in fact shrink in 2014 with a stagnating overall investment sum (figure 10). Investments are moving towards more Series A rounds and average investment sums are rising. This indicates that the early stage investment boom is cooling of (Morrill 2015, mattermark.com).

Figure 10: US Seed Deal Volume Vs Dollars Invested 2005-2014
Figure 10: US Seed Deal Volume Vs Dollars Invested 2005-2014

The huge growth of investments in startups can also be attributed to the stable and long-lasting low interest rates ever since the financial crisis in 2008 and the continuous market flooding with cheap money. In order to achieve attractive returns (interest rate), far more high-risk investments need to be made.  This directly correlates with the high startup valuations over the past years.

Therefore further growth of the startup industry and the correspondent investment industry can be expected as long as the interest rates remain low and the economy is not recuperating considerably (Wilson 2014, avc.com).


Conclusion

With the shown market data and media reports it is obvious that the startup industry and its investment industry is still booming will continue to do so for the time being. Due to the low interest rates the investment sums can not be expected to flatten any time soon.

The options for startup funding did evolve considerably over the past few years. Therefore conditions for starting a startup have never been better. This also explains why there are more startup than ever before and leads to fierce competition and overall no better chances for success. This is also acknowledged by investors who are increasingly willing to invest larger sums but are very choosey while at it.

There is another trend which might be very interesting for the future, micro startup acquisitions. Established former startups such as Facebook, Google, Twitter and Apple but smaller startups as well such as Pinterest are buying tiniest startups with team sizes as small as 2 people. This is radically different from usual acquisitions of established products or revenues. The goal is rather to gain access to talent, product prototypes or innovative potential of these small teams (Paka 2015, techcrunch.com). For many founders this might actually be one more additional option for an early exit.

The risk of a new dot-com bubble is raising concern with many experts. However the surrounding conditions are very different from 15 years ago. Even if the system would crash and the new bubble would burst, the mechanics of the crash would be very different from the dot-com bubble in 2000.

Due to the recent trends in 2014 and the sudden rise in investments, the developments of 2015 need to be monitored to collect more indications for or against a new dot-com bubble. As of now there are scattered concerns but concrete indications for a foreseeable burst have not surfaced.


tl;dr

Even if a new startup bubble would burst, the mechanics of the collapse would be largely different from the dot-com bubble in 2000.


DISCLAIMER: This paper has been written for the seminar “InnovationCity 2030″ within the “Next Media” master program at the University of Applied Sciences Hamburg (HAW Hamburg) in May 2015. Supervising Professor: Prof. Dr. Kai von Luck. For more information or any questions please contact me at mail@moritzrecke.com.


Sources

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Figures

Figure 1: 5 Entwicklungsphasen eines Startups nach DSM 2014 – KPMG (Hrsg.): #DSM : Deutscher Startup Monitor 2014. Retrieved: 29.03.2015.

Figure 2: How Startup Funding Works – Vital, Anna: How funding works : splitting the equity pie with investors. Retrieved: 30.03.2015

Figure 3: Funding For Major Startup Stages – own representation, quoted from DSM 2014, Graham 2005, Vital 2013

Figure 4: Startup Funding Shows Signs of New Tech Bubble – Richter, Felix: Startup Funding Shows Signs of New Tech Bubble. Retrieved: 02.05.2015

Figure 5: PwC MoneyTree Report Q4 2014/Full-year 2014 – Investments by industry 2013-2014 – PricewaterhouseCoopers, National Venture Capital Association: MoneyTree Report Q4 2014/ Full-year 2014. published in February 2015. Retrieved: 02.05.2015.

Figure 6: Median post-money valuation of investment rounds – Maris, Bill: Tech Bubble? Maybe, Maybe Not. Retrieved: 16.04.2015.

Figure 7: Late stage valuation compared to VC fundraising – Maris, Bill: Tech Bubble? Maybe, Maybe Not. Retrieved: 16.04.2015.

Figure 8: Years from founding to IPO (mean) – Maris, Bill: Tech Bubble? Maybe, Maybe Not. Retrieved: 16.04.2015.

Figure 9: Number of VC investments – Maris, Bill: Tech Bubble? Maybe, Maybe Not. Retrieved: 16.04.2015.

Figure 10: U.S. Seed Deal Volume Vs. Dollars Invested 2005 – 2014 – Morrill, Danielle: Why Is the Number of Seed Rounds Raised in 2014 Down 30%?. Retrieved: 31.03.2015.