Michael Lepech, Professor of Stanford University, defines Silicon Valley as a “risk reduction ecosystem” – an ecosystem organically created to drastically reduce the risk of failure in entrepreneurship.
For ecosystems to work, there has to be a thriving supporting ecosystem of legal, financial, and technical support. In Silicon Valley, supporting service provider companies are formed to solely focus on supporting these ancillary services for startups.
Granted, that the only way this works as a business model is at critical mass, the more clients these supporting companies have, the less they can charge, and thus become an almost “subsidized shared resource” for startups in the valley.
This has worked for the valley, because over the almost 80 years of existence of Silicon Valley, the multiple generations of companies that have been formed, have created the critical mass of demand to justify the creation of multiple focused service provider companies.
With the rise of startups in newly formed ecosystems around Africa, there is a need for focused specialized support, to reduce the cost of running the business, and free the entrepreneur to focus on their core business.
If a lawyer with no experience working with startups reviews a term sheet for a company, their chances of getting it right the first time are slim. Sadly, this company will not feel the consequence of this inexperienced lawyer till much later, when it tries to raise follow on funding and experiences first hand the result of it’s exposure, or shoddily done cap table.
Now picture a lawyer that has worked on term sheets for over 10,000hours reviewing only technology startup investment term sheets, this lawyer is more likely to get it right the first time, and will be experienced at spotting red flags, and properly advising the start up on what the terms actually mean!
I have read investment terms for startups reviewed by “their friend who is a lawyer”, or “my mother’s brother is a judge”, and seen terms that the entrepreneur would have been better off if they had just picked up the chain, put it on their necks themselves, and walked onto a ship!
How important is your choice of a lawyer? Mike Lyons of ePlanet Capital, a fund based in Silicon Valley, who has invested over a billion dollars in multiple startups, said this of due diligence style: “the first question I ask a startup is “who is your lawyer?”- if I do not like the answer, I end the conversation right there!”
The reason this is so important in more developed markets, is they have experienced the complete investment chain, from seed, to series A, and eventually exits, and felt first hand the effects of poor legal structures, damaging the position of founders, and stymying the companies chances of follow on investment.
The industry in Africa is still nascent, and so many startups do not yet understand the implications of the term sheets they are signing, the poor accounting they are keeping, or the strength of the financial advisory they are getting. We have the unique opportunity to learn from other market’s experiences.
The legal example is an extreme, but the need for service providers with a lot of experience in a focus field, improves general success. This includes service providers like PR firms, HR companies (that specifically hire for startups), accountants, financial advisors, and even focused capital sources (VC’s that only invest in specific areas, loan companies focused on startup loans, etc).
The 10,000 hour principle holds that 10,000 hours of “deliberate practice” are needed to become world-class in any field.
The importance of supporting service providers who are niche focused on startup business models, and understand the business structure and resources of startups at different stages of their life cycle, is that the more they hone their skills practicing a specific skill set, the better they become at it, leading to supporting services that become risk mitigators in the startup ecosystem.
Once an ecosystem is bolstered with these supporting services, it will naturally attract more innovative startups to the area, who realize that their chances for success are markedly increased when operating in an ecosystem which actively works to reduce risk! This attracts more talent and innovative entrepreneurs to that ecosystem.
Large service provider companies do not have to now change their business model to completely focus on the startup space, as local ecosystems do not yet have the “critical mass” needed to make a solid business case for this. However, a solution is they can simply create branched out departments that solely focus on the startup space.
I encourage and hope that more companies will see this trend forming, and start to create focused departments that service the startup ecosystem for favorable rates.
To build a successful ecosystem, it needs good service providers who can align their economic compensation to the long term success of the startup, and the only way to do this, is with more service providers who understand the unique needs of startups at various stages, and create favorable economic compensations that can support the start ups at various stages.