Did Startups and Venture Become Fraud? What’s Wrong with the Innovation Market

Everyone has heard about WeWork’s failed IPO and the problems of Uber and SoftBank investors. There’s a common sentiment that investments in startups, innovation, and digital transformation do not justify themselves. People write articles about how their company planned to invest X dollars in digitalization to reach the promised land of exponential growth, but nothing came out of it. All while their neighbors keep paying the bill for automation — a trend that preceded the digitalization of businesses.

Overall, it’s not looking good. Where is the disruption, the new Facebooks, the leap into a new technological era?

I am more of a practitioner than a theorist. I run the startup studio Admitad Startups, a small factory producing online businesses, and the venture capital fund Admitad Invest.
There’s no smoke without fire, so let’s get a brief insight into what’s really going on.
First, we need to draw a line between the 2 main directions, or vectors, that are confusing to everyone.

The first vector: macroeconomic. Cannot be influenced

In recent years, there has been more and more money in the world. How it was distributed is a topic for a whole another article, but in absolute terms the surplus of free funds was growing.

Consequently, risk appetite grew, and investors were willing to compete for interesting assets and wait longer for returns. “It’s okay that the project will pay off in 10 years,” they thought. The risk of missing out on an opportunity while having available funds was higher.

Such sentiments caused bubbles to inflate, which then burst or slowly deflated. Frightened, investors would do a complete 180 and start demanding profits.
This is a rather common cycle. The amount of money in the world fluctuates, as well as the investors’ willingness to tolerate risks.

Meanwhile, the media has already made up all sorts of myths around these standard processes: why this was happening, what was wrong with the industry, and so on. Some outlets raised alarms about how horrible it was for the startup world. Others reiterated: if you don’t digitize, you die!

Talking about IT and startups, there was growth till 2000, then the dot-com crisis. Then growth till 2008, crisis, growth till 2014, another crisis, another growth, and now, in the 2020s, it’s a crisis all over again. Even before corona, it was already clear that it was emerging.

There is nothing we can do about it. Such are the conditions and rules of the game.
We just keep it in mind and try to be aware of what phase we are in.

The second vector: internal. Can be influenced

This is where the most interesting part begins.

If you can learn to separate messages and information noise between the 1st and 2nd vectors, I praise and honor you for that.

Back in the 1950, Nobel laureate Harry Markowitz laid out a modern portfolio theory. It mathematically shows that risky investments pay off if it has done in the long run and on a large scale of investments. However, one should never exceed a certain threshold: putting the company on the brink of survival is off-limits. In the worst-case scenario, the income from current activities should at least compensate for the loss, not kill the business.

Now, large companies often refuse to make risky investments at all. They want to know, “Do you have any guarantees of your idea’s success? After all, what if it doesn’t shoot the moon?” And so on and so forth.

In Russia(before the war), the state has only recently allowed state funds to invest in projects, knowing that all bets might fail. They even have this joke going on:

If Elon Musk had been born in Russia, he would not have been able to create Space X, because by now, he would have only done his time for creating PayPal.

With so much risk avoidance, one should not expect breakthroughs. All the resources will go into conservative investment options that are less likely to fail — still, it’s not a cure-all. There was nothing more reliable and less risky than real estate, but after 2008, the tables turned.

So when people say that investors have become more conservative and/or that investments in the digitalization failed, it may indicate two things:

  • The crisis phase has indeed started, and companies are reducing the overall risk they are ready to take.
  • They have a common investment strategy, and there are gaps in the company management at the top level.

It all comes down to managing investment expectations. Pouring money into your own business can also be seen as an investment.

Let’s say, you were thinking of investing in some project, or in digitalization in general. Your advisors have shown you models of the potential ROI, and it looks like this investment will change everything. There will be so much money that you’ll have to give it to charity simply to get rid of it. If your expectations are this high — well, the IT industry will probably have a hard time meeting them. This seems closer to magical fairies than to real-life outcomes.

On a macro-level, the demand for your product is unlikely to increase tenfold simply because it was digitized. And teaching your employees to strive to help customers, keep their promises, and smile genuinely is all about culture. It’s about the people who work for you, which has nothing to do with digitization.

The previous round of development, when everyone invested massively in the automation of production, had seen a similar problem. In order to automate something, it has to work clearly first. And if your business is in chaos, then after millions invested in automation, all you will end up with will be the very same chaos — only now automated.

However, there is another approach.

Dividing the budget in a healthy company

I suggest we look at the entire budget of the company as an investment portfolio and divide it into 3 types: 

  • low-risk investments, 
  • medium-risk investments, 
  • and high-risk investments.

We should understand that the return (reward) from them will be low, medium, and high. As well as the risk of failure.

Here’s the first rule of any CEO: the business must live. That is, to make money and bring in profits. The game of betting ‘all on red’ is not for those who hired people and now have hundreds of families depending on them. 

This means that companies should primarily form their investing portfolios with low-risk investments. Essentially, these will be all the operations, corporate services, and mechanisms that helped you amass a budget to invest. 

One can pay consultants and financiers to get reassured that the best business strategy is to treat companies like ‘milking cows’ — exploit more, but feed less. That said, this approach kills businesses in 1–2 years. But if that happens, it will be written off as your own fault. They’ll say that you followed the given advice poorly, so now you only have yourself to blame.

So how should you break down a budget / form a portfolio? It depends on your situation, niche, and industry. From our experience, I would say that low-risk investments should take no less than 50–70% of your portfolio.

Take Google and Meta as examples. They clearly have no problems with innovation, but they do not forget about their breadwinning cows. So Google still invests most of its money in maintaining contextual advertising and all the relevant services.

Next, we go to the medium-risk investments

Usually, these are significant internal improvements:

  • creation of new products for the existing customer segments, 
  • expansion of existing products to new markets, 
  • or development of new products to compete with old ones*
*since it’s better to cannibalize yourself than to grant this opportunity to your competitors.

In short, these are actions that have more or less understandable outcomes. Do X, get Y. And if you fail, it will be clear why, so you will be able to learn from your mistakes and improve quickly.

These medium-risk investments are where 20–30% of the budget should go.
For example, take Meta when it bought Instagram and started implementing monetization. Generally, it was clear what to do, but the risk of community rejection was still solid.

Another example would be entering a new country with your current product. Even though you know everything in your niche, local specifics might derail some of your plans.

And now we move on to high-risk investments

Here, everything depends on what stage the company is at. Do you want to rush straight into the new century? Or the company feels stable enough, so your primary task is to keep what you have without completely losing your options for the future?
If everything’s a-okay, then 10% is the limit below which you cannot go. Otherwise, your development might freeze, and your company will be good for nothing but feeding its managers. You know these corporations where the management spends 90% of its time self-organizing instead of working with the market and improving its products/services, right?

If you want to speed up because you feel the impending doom, then go for 15–25% of the budget/portfolio.

High-risk investments include internal development with extremely big ROI in case of success, as well as investing in startups, accelerators, mergers and acquisitions, and so on. The main thing to understand is that these are all investments with a high risk of failure. But if it does work out, it will improve your business tremendously.

An example would be any pharmaceutical company that keeps investing in R&D for years because one day, it hopes to invent its own drug.

Or have a look at the graveyard of Google and Microsoft projects.

YouTube was bought for a billion dollars. The company is now valued at $160+ billion.

If even 10% of that sum goes to buying new startups, what’s the chance of getting lucky again? Remember, the average startup value is around tens/hundreds of millions of dollars if you buy the entire company, and millions/tens of millions if you take a stake.

By the time the new YouTube or MS Teams appear, hundreds of investing projects will have been written off. Still, it pays off handsomely when done systematically, for a long time, and without threatening the core business.

Once you’re done with categorizing risk levels, make sure there are people and processes ready for each of them. You can’t work with high-risk investments using low-risk tools and approaches.

As they say, render unto Caesar the things that are Caesar’s.

Otherwise, you can find yourself in a classic situation: a company declares that it wants innovation, transformation, and whatever else, but simply out of habit it puts just as much pressure on its high-risk investments as on low-risk ones. It’s rare for anything to survive under the weight of such ‘love’. So after a while, the company will put out an article or interview saying that a startup hasn’t lived up to expectations, but whatever, it’s all a tech bubble anyway.

Alternatively, companies can only make low-risk investments and then wonder why nothing has changed. How come that the business creeps closer and closer to the graveyard of history, even though an ungodly amount of money was thrown into it? Well, apparently, someone must be to blame!

Times are so unstable and chaotic that you have to balance between low-risk investments simply to survive. Essentially, you are buying time to run a bunch of experiments, eventually hoping to get something bright and new.

Remember Alice in Wonderland? “It takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

To wrap up on crisis management and risks, consider this one last thing. Many companies are now shrinking, and there are two options left for them (don’t mind the figures, just the mechanics).

  • To cut company expenses by 20%.
  • To reduce costs by 25% while additionally investing 5% in the development of risky projects.

What do you think, which option will do better in the next 3–5 years?

Any alternatives?

You can take no risks and make no mistakes. At all. Then you will be spared embarrassment from the fact that your project failed. You won’t have to take responsibility, and the media won’t poke fun at you. This is very easy to achieve, really: just do nothing, and you are guaranteed to be protected from failure! Perhaps unconsciously, but this path is chosen by many.

Strategy & Investments Author content