Entrepreneurs : is there a way to “safely” cross the valley of death ?

The “valley of death” is ” the “dragon” of most entrepreneurs, a phase one dreads the most. It is the period during which an early stage company is developing its technology (or a proof of concept), its market, its offer and strategy, burning the few dollars it has in the bank at a high rate while not fueling the tank at the same time. At that time, the company is at its most vulnerable state financially, and in order to survive has to attract enough customers or investors to help it “cross” this valley of death.

As a sign that times are getting harsher for entrepreneurs, the height of the valley kept growing for the past 20 years. While the cash needed to cross this phase was about $500k to $1M in the 90’s, the gap widened to $2 to $10M in 2012, exposing the new companies to higher risks. Even though the needs in capital can vary a lot between industries (biotechs evidently consumes more cash than web development) the trend has been observed for all industries. Why is that phenomenon going on ?

Too much startups or not enough money ?

The answer probably lies in the confrontation of two trends : the lack of financing coupled to the presence of too many startups. Venture capital alost never financed the “valley of death” of startups. Interested in bigger (several millions) and more profitable bets, the VC industry will actually finance companies that are one step further than valley of death, increasing their chances of success.

What about angels and federal grants ? They are the “traditional” opportunities seed and early stage companies turn to at the beginning of their development. If the funds awarded can be sufficient to cross the valley of death in companies that are not really capital extensive, such as web or some IT areas, this is never the case for companies evolving in biotech, medical devices or clean tech industries, that need large amounts of investments right from the start, mainly to cover their R&D expenses.

Latest analysis and articles by experts keep suggesting that not enough funds are available for startups, but one rarely points out the growing number of startups in need of financing these last years. As an example of this, 651 companies were spinned off of U.S universities in 2011, a growth of 10% compared to 2010, while the number of patent applications doubled ! This spectacular jump isn’t matched by a similar increase in investments, that can’t keep the pace ! That’s why some experts want to demystify the valley of death, that would be nothing short of an inevitable phenomenon of shortage of supply facing a growing demand.

The experimented solutions have controversial effects

To solve this problem, the federal government, as well as states, have mostly taken a financial approach, trying to attract more investments in early stage startups by creating tax incentives for investors as well as entrepreneurs.  The results of these incentives are pretty difficult to evaluate and most of all, they don’t solve the problem as they mostly try to shift the existing financing to early stage startup, instead of increasing the overall available amount.

Crowdfunding has been under the spotlight lately too, as a credible alternative for traditional funding and has been presented as very promising for young companies. A bill was even supposed to be adopted by the US congress, but it is actually stuck in the US senate, as some congressmen raised concerns that crowdfunding could give way to multiple frauds.. Also some experts expressed distrust in this new method, arguing that investing in young companies is a job of experts, and should not be allowed to anyone. We will probably have to wait for a couple years for the crowdfunding to mature and sweep the doubts it generates now.

Finally, some companies have been experimenting the lean development method, codified by Eric Ries, a serial entrepreneur living in the Silicon Valley. The idea is to bring a product, even not finished, to the customers and interact as much as possible with them to refine the features and come up with an efficient result, saving money along the way by adopting an iterative development method. If this method is very much used in web or It sectors, where customers can drive powerfull feedback and feel proud to be part of a product’s development, Lean Development is mostly a misfit for industries such as healthcare or cleantech, whose customers expect a fully functional product right from the start.

Do we have to change our approach ?

It seems that none of the previous solutions bear total satisfaction. Except the crowdfunding, none has open a new funnel for sustainable investments in young startups. Duane Roth, CEO of Connect, proposes a radical U-turn in our approach of startup financing. Instead of increasing the amount of available financing, he argues that instead the number of startups should be smaller, especially those created from universities technologies ! His alternative would be the creation of companies specialized in prototype development (PDC), that would be tasked with evaluating the market potential of universities’ technologies and develop proofs of concepts only for those with a great development potential. These proofs of concepts would then be handed to startups that could pretend to be backed by VCs or angels, and would have far better chances of success than original startups, thanks to the preliminary work of PDCs. That’s a radically different approach ! The PDCs still have to be tested to evaluate their impact.

Still, it forces us to reinvent the way we think about company development, financing and innovation. Instead of fixing our old models, shouldn’t we reinvent everything ? The debate is launched !


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