2021 was a sensational year for the Venture Capital industry. In 2021, 730 funds raised around USD $128bn. Startups, meanwhile, raised more than USD$600bn. The pandemic was probably a catalyst for the explosion of Venture Capital, as virtually any startup was able to raise large rounds of capital at valuations never seen before. VC investors acted with little diligence and limited rigor in their investment process, not really considering the startup’s strategy and above all its competitive advantages.
The year 2022, however, has put a halt to the ferment in the Venture Capital world. Both VC funds and startups are finding it more difficult to raise capital. Thus, it is important to make a critical analysis of the startup and its business model when investing.
Investors could first analyze the startup’s strategic capacity based on the resources and competencies it must survive and thrive. This should be analyzed considering the capabilities that any other organization should have in the same industry sector and those capabilities that provide a competitive advantage. Organizations resources can be categorized into physical resources, financial resources, human resources, and intellectual capital.
Physical resources are material elements such as infrastructure, machines, buildings, or production capacity. For example, Jüsto, an e-grocery shop company with operations in Mexico and Latin America, has physical resources whose age, condition, capacity, and location compete assertively against traditional retailers.
Financial resources are basically the way a startup funds its balance sheet using a combination of debt or equity. To the extent that the startup can raise resources and strengthen its capital structure, it is likely to survive and advance. It is not necessarily the startup with the best technology or value proposition that will survive, but the one that can raise capital.
Undoubtedly, human resources are perhaps the most relevant element in a startup, especially if it is newly created. The mix of people tied to their skills, knowledge, experiences, and networks makes it valuable.
The intangible resource of any organization is its intellectual capital, which includes patents, trademarks, business systems, databases and, above all, industrial secrets. This element is what gives some businesses a competitive advantage over their competitors, such as Apple and Tesla.
This is linked to competencies which are the skills and abilities by which resources are effectively implemented through an organization’s activities and processes. Within these activities and processes it is relevant to consider the process of strategic definition, the process of recruitment, training and retention of personnel, and the multiple administrative processes (e.g., operations, finance, accounting, tax, suppliers).
Companies also need minimum capabilities (resources and competencies) to meet the requirements necessary to compete in each market. For example, if you are launching a Fintech, you should have the technological infrastructure, human, financial and intellectual capital, as well as the license that applies in the jurisdiction in which you are going to operate to meet the minimum requirements of your customers.
However, Venture Capital investors should focus their vision on the unique resources the startup has to critically sustain its competitive advantage that others cannot easily imitate or obtain. In addition, they should focus on core competencies as those skills and abilities to deploy the resources to achieve an unparalleled competitive advantage.
Within this analysis the investor might consider cost efficiencies, which are derived from economies of scale, supply chain costs, product or process design and the experience or learning curve.
Some elements to consider for building a competitive advantage is having the ability to add value to the customer, for example, with unique resources that might be a product or service that only that startup has. Its rarity depends on the transferability there might be, e.g., professional services are unique as they depend on the specific competences of individuals. Another element is sustainability, i.e., whether or not this competence can be maintained.
Furthermore, it should be considered how imitable these strategic capabilities are. For example, the use of a technological system does not in itself provide a competitive advantage, but its interaction between customers and activities. Another reason to consider is the complexity of imitating or replicating capabilities based on internal and external linkages, organizational culture and those organizational characteristics that are difficult for competitors to process.
Any startup may face substitution in its product or services, or in the way it competes. Therefore, the capabilities to be considered are valued by the consumer, rare, non-imitable and non-substitutable. All the above must be understood in a framework where organizational skills can be renewed or recreated to meet the needs of the changing environment.
For example, ten years ago blockchain-based companies might have been considered a rarity as they had a differentiation “edge” over others with traditional technology, yet their market was still limited. Today, many blockchain-based companies have emerged in various industries, and it is not only the technological factor that has made them different, but they have worked to make it accessible to their market to understand and adopt the solution.
What happened in the year two thousand with the growth of the internet, in the year two thousand eight with mortgage securities and in the year two thousand twenty-one with the pandemic, forces Venture Capital investors to really evaluate the competitive advantage of startups and not just get caught up in the hype of the market.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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