The startup bias: How American consumer product innovation and exports are being hindered

By Sindhya Valloppillil , written on June 25, 2013

From The News Desk

"Running a startup is like being punched in the face repeatedly, but working for a large company is like being waterboarded." - Paul Graham, co-founder of Y Combinator

Just as product managers leave Facebook, Apple, Google and Microsoft to start innovative startups like Instagram, the same phenomenon happens at behemoth consumer companies such as L’Oreal, Starbucks, and Kraft. The only difference is that the domain expertise of these entrepreneurs with a strong consumer background isn’t valued or understood by VCs and angels, and entrepreneurship isn’t encouraged in the incumbent consumer world. Although New York is the beauty, fashion, and consumer goods capital of the world, industry support networks, incubators, and Y Combinator-style accelerators don’t really exist at the seed stage here.

The inclusive culture of money

The advent of ecommerce and social media leveled the playing field for entrepreneurs by enabling startups to bypass Goliath retailers and sell directly to consumers without spending hundreds of millions of dollars in traditional TV and print ads. Although ecommerce leveled the playing field for entrepreneurs, seed stage VCs and angels have unleveled the playing field with their obvious funding biases.

Without question, there is a startup bias that favors founders from tech companies, even when they don’t have a solid tech background. Apparently, someone with business development experience from Foursquare can get venture funding to launch a consumer products brand easier than a former marketing executive from Starbucks.

This bias for tech founders makes sense, since many investors come from the tech world and know and respect its leaders. However, this bias doesn’t make sense for a consumer-facing ecommerce company, especially one with physical products, since domain understanding -- specifically understanding of brand, product, and retail, as well as industry relationships -- are necessary for the proper execution of this type of business.

The access to money is skewed. A former VC from Bain Capital or Entrepreneur-in-Residence from Andreessen Horowitz with no traction, no domain expertise -- or even understanding -- of consumer brand building and product creation have carte blanche. Funding is the least of their worries -- pre-revenue, pre-launch, pre-business plan even. They can easily launch a bra company with a senseless algorithm or try to launch a CPG brand without a single product prototype or an iota of real traction.

The initial barrier to entry in a consumer product startup is relatively cost-prohibitive. Costs for building prototypes, production runs, stability testing, insurance, trademarks, and legal fees quickly add up. Unless a founder has significant savings from a former career in banking, a network of rich friends (perhaps from a former career in banking or Summit Series), a trust fund, a wealthy spouse, or a “Daddy” Warbucks, it’s really hard to bootstrap a consumer products company.

Some great new American consumer brands -- A rare breed

Historically, the US has been great at creating iconic, global consumer brands across categories. People all over the world have fond memories of their first pair of NIKE shoes, or their first Apple product. These brands deliver more than just great products, they mean something. In the last seven years, I’ve noticed a fewer number of successful American brands emerge despite the increased volume of venture-backed ones launched online.

Among new consumer brands that have launched recently, there are only a few that are primed to be global leaders and even US market leaders: Julep, Nasty Gal, Spanx, and Happy Family. Happy Family, an organic baby, toddler and children’s food, is poised to be the next Gerber. Happy Family’s Founder Shazi Visram won the Ernst & Young "Entrepreneur of the Year" award and the "American Dream Award" in 2012. Happy Family is distributed in 17,000 stores and 30 countries, and it is the leading, premium organic kids food brand in the US.

In a series of very candid articles titled Fundraising Saga of a Desperate Entrepreneur in Inc. Magazine, Shazi said, “Of course, the process would have gone a lot faster if we had been able to leverage a VC relationship. Even as our business started to boom, there was an evening when I got to the subway with nothing in my wallet but maxed out credit cards and no way to pay for my ride home.”

I’ve been in this situation. Most entrepreneurs would’ve given up at this point. Shazi didn’t. Happy Family’s revenue nearly quadrupled in two years to $64 million as of February 2013, and it was recently acquired by Danone because of its rapid growth and innovative products.

These great new American brands are a rare breed, and they didn’t have VC funding early on. Nasty Gal’s founder Sophia Amoruso also struggled for a long time before finally being courted by VCs. How can seed stage investors learn to recognize true talent of founders like Amoroso, Shazi, and Julep’s Jane Park sooner? These founders are true innovators, not opportunists. They didn’t start their companies because they knew that they could raise money.

The current system of funding isn’t working -- American innovation is being hampered

While some older existing brands struggle to understand how to adapt and are late to adopt ecommerce and social media, many new brands that launch online think that they can build a brand and product after launching and just spend money to acquire customers. Many outsource branding and product development, because they don’t know how to do it. (Dollar Shave Club resells Dorco blades. Harry’s was sued by Gillette for patent infringement. The case was dismissed, but that doesn’t mean it won’t resurface, or that Harry’s didn’t settle out of court.)

The net effect is that these startups are nothing more than VC-funded customer acquisition vehicles with no special brand or products. In the same way you cannot fly a plane that hasn't been built first, you cannot launch a brand without building it first -- even with massive amounts of VC funding.

There’s a difference between a real brand, a label and a mere business name. With the exception of BarkBox, which is generating $1 million per month with a plan to become a $5 billion company in five years, and a few others, most of the brands launched online these days may have VC funding at very healthy pre-money valuations. But they lack soul, great design, and product. Often the founders lack business sense too. Many of the VC-funded ecommerce startups are not even cash-flow positive after multiple rounds of funding. Earlier this month, Totsy shut down after burning through $34 million in VC funding. Not only is consumer-facing ecommerce broken, American innovation is being hindered.

Crowdfunding and AngelList aren’t a solution for all

Crowdfunding and AngelList aren’t really an option for all startups. Kickstarter, the most popular crowdfunding site, bans personal care goods and beauty. With Kickstarter, Indigogo, and AngelList, you cannot control confidentiality either. On the Indigogo website, it even suggests that people “browse the site and look for inspiration.” Who wants their creative blood, sweat, and tears appropriated by other people before they’ve even launched?

In the case of Pebble (one of Kickstarter’s most successful campaigns), their crowdfunding campaign immediately resulted in many imitators including Apple, Samsung, and Microsoft. Meanwhile, many companies funded via AngelList share one common trait: social proof with the same founder biases seen among VCs.

Shady angels, “feign”-gels, and senile angels -- Finding good angels is tough

Early in my fundraising journey, I met some shady angels, “feign”-gels, who feigned having money, and even a senile angel. One shady angel I met was involved in the Galleon insider trading case. Another who happened to be a professional NBA athlete was busted in a shady gold deal. The third shady angel, who was a VP of Operations at one of largest global shoe manufacturing companies, tried to pull a bait and switch on me and demanded double the amount of equity we had agreed upon at the last minute. No thanks.

I also met a few “feign-gels” who never had the amount of money available that they discussed investing. After a few of the exact same meetings with a senile angel, who happened to be a retired beauty industry executive, I gave up on him. I’ve met some world-renowned beauty entrepreneurs who are barred by non-competes from investing in my startup and even advising me officially. Consequently, I switched gears and then tried to focus on VCs.

For a consumer product business, the focus should be product and brand first, not customer acquisition

Investors are used to valuing companies with traditional metrics like customer acquisition cost and lifetime value, but do VCs know how to really measure and value a brand? Bonobos’s Nordstrom partnership deal has “helped with the biggest problem modern ecommerce companies are having: Customer acquisition costs. Nordstrom has effectively given Bonobos an acquisition channel that it also gets paid for. “ Despite that, getting a purchase order or an exclusive in-store national distribution deal, which would help scale a business, may not be enough “traction” for a new brand seeking funding from VCs.

VCs often fail to consider the power and soul of a well-built brand. When Steve Jobs died, many people all over the world who didn’t know him, including me, cried. I normally don’t care about celebrities, but Steve Jobs inspired me. I admired him as a marketer, brand builder and an entrepreneur. He built one of the greatest American global brands of the decade. An iconic global brand that inspires us to "think different."

Sure, Apple sells great tech products, but it is a brand that has brilliant marketing and design. It’s an edgy brand with global appeal. There aren’t a lot of great new American brands like that anymore. Before helping create Apple commercials, he helped build and market products -- great products. Steve Jobs was a brilliant marketer and innovator, not a customer acquisition guy.

Time for a change

Most first-time, non-crony founders are climbing up a very steep slope. Every once in a while, however, a new, talented entrepreneur breaks out of this very closed, inbred startup ecosystem. As John Maynard Keyes once said, “The difficulty lies not so much in developing new ideas as in escaping from the old ones.”

Isn’t time for a change?