Ideas aren’t the issue – OPINION

Published at Apr 8, 2016, in Features

Think about the sheer amount of ideas which are dreamt into existence each day; the millions of ‘Uber but for...’ sentences which are started. Right now, those ideas aren’t enough to kickstart a new industrial revolution or advance the economy in any meaningful way.

If anything is emerging as a theme in the start-up space, particularly in the tech space, it’s the seemingly widening gap between an idea and the ability to actualise the idea to the point of profitability.

In a note released earlier this week, Foster Stockbroking suggested that much of the headwind related to the poor performance of start-ups, particularly in tech, was more about macroeconomic nonsense than the hustle and bustle of daily trading.

But, it would be folly to suggest that there isn’t a deeper malaise at play in the sector right now driving down valuations – and it mostly has to do with business models.

Or, rather, the lack of them.

There are countless start-ups with ‘cool’ offices, a good marketing budget, and massive projections around the size of market which don’t necessarily want to share numbers about revenue projections, cost runways, and other nuts-and-bolts issues.

Instead of projections being presented to potential investors, it is the big ideas driving the presentations.

To the broader market, these presentations play out for what they are: another start up with very little idea of how to make money.

We’re going to disrupt a multi-billion dollar market is often usede catch-cry, but there’s little by way of a commercial roadmap to success.

Earlier this week, the Australian Financial Review published remarks from Innovation and Science Australia chairman Bill Ferris indicating that there was a massive disconnect between idea generation and idea monetisation in Australia.

“We have this riddle of a first-rate record in research excellence, but we are at number 33 in 33 countries reporting on [their] collaboration [success],” he was quoted as saying.

“There remains a gap between turning those inputs into outputs and turning a good idea into a business.”

He was talking collaboration between research centres and the commercial world, but he may as well have been talking about the tech space.

Rory O’Driscoll from Techcrunch has previously suggested that in recent years the tech scene has gone through something of a valuation vicious cycle, where a company will be given a massive valuation based on hype, get backed from a venture fund, spend that on customer acquisition, score a higher valuation based on that growth rate, spend that on customer acquisition and marketing...

This leads to a massive uplift in initial growth which informs the valuation of a company, and the start-up receives even more cash. Yet, the company isn’t actually making that much revenue or profit.

Eventually a point comes, O’Driscoll suggests, where channels for the massive types of growth which informed the valuations (and which key backers expect to continue to see for their buck) start to peter out. It then becomes about building a stable-footing business and getting margin from each customer – which is decidedly less sexy for valuations.

So a clear picture is starting to emerge that the valuations game is based on false economy, and punters are starting to pick up on the theme – they want to see revenues and margins.

It’s why Fosters says this is a good time to pick up a bargain in the tech sector, but it needs to be geared towards companies which have existing revenue, market share, and good balance sheets.

They already have the business aspect of the game in-hand, and are therefore better placed to have a roadmap to growth in place.

Better yet, this will be sustainable growth not based on massive valuations but rather the fact that there was a business there to start with.

Fosters has picked out companies such as Activistic (ASX:ACU) and Kabuni (ASX:KBU) as bright spots in the space.

The discussion around what has led to runaway valuations in recent years is leading to a new conversation around how to derive value in a tech play.

It has become less and less about the idea and the market it’s playing in, and more about demonstrating that the business is a sound one.

So companies which quietly build their business and model may be better placed in the future to grab investor cash in the future.

Invariably, it’s not about the idea anymore – it’s about the business.

S3 Consortium Pty Ltd (CAR No.433913) is a corporate authorised representative of LeMessurier Securities Pty Ltd (AFSL No. 296877). The information contained in this article is general information only. Any advice is general advice only. Neither your personal objectives, financial situation nor needs have been taken into consideration. Accordingly you should consider how appropriate the advice (if any) is to those objectives, financial situation and needs, before acting on the advice.

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S3 Consortium Pty Ltd does and seeks to do business with companies featured in its articles. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this article. Investors should consider this article as only a single factor in making any investment decision. The publishers of this article also wish to disclose that they may hold this stock in their portfolios and that any decision to purchase this stock should be done so after the purchaser has made their own inquires as to the validity of any information in this article.

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