In the age of digital disruption, are investors caught in deceptive startup growth? There seems to be an unhealthy race among the Venture capital funds (VCs) for fueling unsustainable startup growth. VCs are in the business of raising funds from net-worth individuals and institutions and investing them in Startups to collect commission and success fees. For tempting investors, they show past examples of exponential growth of valuation of startups such as Amazon, Apple, Microsoft, Google, Netflix, Facebook, Nvidia, TSMC, and a few more. Most importantly, they cite valuation examples of recent Unicorns—startups having more than a billion-dollar valuation. However, most of those loss-making unicorns suffer from sudden valuation fall, leading to collapse. Surprisingly, despite revenue growth and loss reduction, such a valuation avalanche has been taking place in the VC-backed startup space, raising concerns about deceptive startup growth.
For example, the valuation of India’s microblogging startup Koo came down from $5 billion to zero within three years (Economic Times of India). Similarly, once valued at $22 billion, HSBC recently estimated the valuation of EdTech startup icon Byju to zero (Source: TECHNASIA). Such a reality raises a vital question: are VCs fueling misleading startup growth? Subsequent questions are: why and how are VCs misleading startup growth?
Unicorn Situation in India—giving a deceptive startup growth scenario
In 2022, among 74 Indian unicorns, 55 were incurring losses–the remaining 19 were just operationally profitable. To generate $13.3 billion aggregated revenue, these unicorns incurred $18 billion in expenditure and $2 billion in advertisement (source: top 200 Financial Index Report 2023). Hence, it’s evident that once VCs stop giving subsidies, their staggering valuation suddenly disappears, and unicorns collapse.
Global inflated startup growth—the age of unicorns is over!
In 2024, The Economist published an article titled: “The age of unicorn is over.” Despite propelling the combined market value of Alphabet, Amazon, Apple, Meta, and Microsoft by 70% to over $10trn, from the start of 2023 to the middle of 2024, venture capital fund invested only $170b in the USA in 2023–down by half from 2021 (according to PitchBook). Such a contrast raises a critical question: despite staggering growth of market capitalization in the secondary market, why are VCs not increasing funding to create future tech giants?
Wrong thesis of creating scale effect
Startups pursue taking over the mainstream market of incumbent products and creating new markets by reinventing matured products by changing the technology core. Hence, startups are supposed to scale up rapidly. However, despite the uniqueness of digital technology, their reinventions have not shown up as far better alternatives. For example, despite the possibility, digitizing medical images and developing AI tools to inspect them have yet to become better alternatives than expert radiologists. Similarly, online education has yet to be a better alternative to physical campus-based education. Hence, the mainstream market still rejects the initial emergence of reinventions made through the digital technology core.
However, to show the scale effect, venture capital fund managers have come up with a massive subsidy that has led to the push for premature reinventions. Besides, they take into consideration increasing valuation based on subsidy-based customer acquisitions. As a result, although valuation has increased, those startups cannot sustain their operations. Hence, once the subsidy is withdrawn, those high-growth startups face an inevitable reality—bankruptcy. Consequentially, VC-backed startup growth has been caught up in the wrong thesis of creating a scale effect.
Why and how have VCs backed deceptive startup growth
Due to ignorance, maliciousness, or both, venture capital fund managers have been fueling deceptive startup growth. Here is further detail:
- Selling temptation of high capital growth—for raising funds from high-net-worth institutions and individuals, VC fund managers created the temptation of rapidly growing investment by investing in startups pursuing digital possibilities. On the other hand, by developing and demonstrating minimum viable products (MVPs) out of digital technologies, startups created the belief that those MVPs would take over the mainstream market of matured products and develop new markets. Hence, by promoting those premature products, VC managers succeeded in raising funds. For example, in 2016, SoftBank secured a $45 billion commitment from Saudi Prince for its $100 billion tech funding. Unfortunately, in 2023, the Saudi Wealth fund got a $16 billion hit from SoftBank tech fund.
- Incorrect understudying of digital possibilities—initial demonstration of digital options created the impression of imminent takeover of the mainstream market of matured products. For example, Elon Musk predicted in 2015 that self-driving cars would be mass-adopted within two years. Similarly, experts predicted in 2016 that radiologists would be obsolete within five years.
- Deceptive promotion of digital disruption—upon demonstrating initial success, startups started prematurely promoting digital disruption in various products, from EdTech and autonomous Driving to Digital Health. Due to ignorance, maliciousness, or both, VC fund managers began believing in the deceptive promotion of digital disruption. Consequentially, they started pumping tons of money into pushing premature digital alternatives in the mainstream market of matured products.
- Earning commission—the immediate incentive for the VC fund managers has been to earn a certain percentage (say 2%) commission on the invested fund. Hence, the race started among the VCs to pump tons of money to startups to capture the growing market shares through subsidies.
- Pocketing success fees by passing hot potatoes—passing shareholding of loss-making startups at an inflated valuation to follower VCs has become a lucrative exercise to earn success fees for existing.
By pursuing Reinvention, startups offer opportunities to find high-growth firms. However, their reinventions must grow as Creative waves of destruction—taking over the mainstream market and creating new ones due to offering higher quality at less cost. However, to attain such success, the primitive emergence of startup reinventions must be grown through a Flow of Ideas. Initially, those reinventions are like foals of racehorses. They have hidden potential. Hence, instead of pushing foals with VC-backed subsidies to create deceptive scale effects for startup growth, the focus should be on developing the hidden potential and pursuing a suitable attack strategy.
