The Roast of A Startup Studio Model - Denis Kovalevich
The Roast of A Startup Studio Model - Denis Kovalevich
The Roast of A Startup Studio Model - Denis Kovalevich
DENIS: Both parties sometimes speak about different things but use the same
terminology.
DENIS: Are you then striving for the purity of the venture industry?
DENIS: The main working principle that distinguishes a startup studio is that it does
not seek or consider startups from outside but decides what new companies to create
on its own. The studio itself creates the hypothesis of new businesses and gathers the
necessary technologies. It also creates the legal entities for its startups and the
majority of the startups could be subsidiaries. The other segment is made up by
companies whose co-founder is a partner of the studio, but the challenges of working
with co-founders are pretty obvious.
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DENIS: What indicators do you use to describe such a holding model as a
corporation?
INTERVIEWER: For example, your startups have the same
shareholder.
DENIS: Yes, all of the startups have one main shareholder – the studio. However,
in some startups, here are private or corporate co-shareholders. Having the same
shareholder doesn’t typically raise suspicion that different companies, legally, are not
independent. What confuses you?
DENIS: Yes, they do share these. But tell me, if different companies situated in the
same town, have same technology domain, same cluster, share products and close
deals with each other, if their staff discuss some common industry issues, does it also
make them all just one corporation?
DENIS: I guess you suppose that the startup studio’s companies have a common
“planning department”, instructing them what and how much to produce, who to
sell it to, and for what price. You may think that these companies cooperate beyond
the economic sense, making deals with prices lower than the common market ones
and so on. That is not actually the case with startup studios. There are some
information channels that exchange some of the knowledge accumulated by the
startups. Even the smallest startup does only regular market deals with no discounts
that may distort it economy. Just like any other companies in relations with each
other.
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INTERVIEWER: You said almost all startups could be
subsidiaries. In many of them there are no founders at the
beginning. Only the founding owner is the guarantor of business
frames within the startup. There cannot be hired founders. And
the startup’s independent economy does not change a thing, as
this is not free entrepreneurship as such.
DENIS: That always happens when something new comes up. From a purely
statistical point of view, new things are extremely rare. It is therefore more common
to hear about more familiar, well-established, and widespread approaches and
models. I believe the transition from a founder-generated model of startup to a
model that begins with a hypothesis and investments in trial is the basic innovation of
a startup studio. A business model innovation.
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JOB OR MISSION?
INTERVIEWER: Do you call them founders?
DENIS: I call them venture builders. My colleagues from Cambridge call this
position “entrepreneur-in-residence”.
DENIS: I see very well what you mean. But it brings up a big problem. Business
becomes fully dependent on the current level of knowledge and understanding of its
founder, as company is de facto inseparable from him. I believe this is a negative
thing for a business. A startup studio model will decompose entrepreneurship the
same way as transnational corporations decomposed management. 150 years ago,
management was seen as art, but it is now nothing more than a routine job. As far as
technology entrepreneurship is concerned, we are currently in the same situation as
professional management was in 1873. This was when it just began developing. We
see the same thing today. Ever been interested in the history of management?
Entrepreneurs decided to alienate it from themselves and draw it as a special
function so as not to run around their factories every day. They needed people
called managers, and this is how the profession was created. It was the entrepreneurs
that ordered Taylor to develop standards for this profession. Now, the profession of
venture building, creating new companies from scratch, is being developed in the
same way.
DENIS: You are right that that’s almost impossible outside a startup studio. This is
what the studio is needed for. It takes over a part of the regular hero entrepreneur’s
work. I can say that studio partly substitute entrepreneur.
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DENIS: For some reason, the studio discussions often get stuck at the first point –
hypothesis generation. In fact, it was discovered in recent years that it was not about
WHO formulated the new business concept. It matters only the number of man-
hours behind the hypothesis formulation. In any decent startup studio, as it evolves,
forms a group of people, capable of generating quality business hypotheses. And
these are not some superstars, but just people who know their industries. They are
all venture builders deeply committed to their domains. Their shared experience,
the man-hours they spent studying the subject, mean much more than any founder’s
experience and knowledge.
DENIS: The venture builder does the work that neither engineers nor managers can
see. This position is continuously acquiring knowledge about how the industry
operates. Take responsibility for making decisions about changing the hypothesis
implementation methods and the technologies employment at the right moments.
All this requires to be deeply immersed into the technological aspect. A venture
builder estimates the required investment and monitors expenses of development
and production of technological product. Then finds ways to reduce expenses, or
looks for technologies to make the product cheaper. Makes pilot projects and
releases the first batches long before the first sales. Performs functions that are not
obvious to engineers and managers.
DENIS: This is because a manager operates processes that are already exist, while a
business builder starts these processes from scratch. You see, many individuals with
a serious management experience usually fail to succeed in startup building.
Managing is not the same as venture building. I would even say that managing is the
opposite of company creation. That’s the first thing. Secondly, the venture builder is
constantly stitching up the startup economy, interested in completing the building as
soon as possible to get a return on the investment. The venture builder always saves
investments, while a manager always calls for an extra budget for the project.
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WHO INVESTS INTO WHAT?
DENIS: I had a long experience in such search and investment within a huge
corporation, then in a large innovation hub. There is always a lack of experienced
technology entrepreneurs, almost everywhere. All the investors, operating outside
the leading regions like the Valley, are facing a situation where they have to deal with
ordinary people, not with super-experienced entrepreneurs. But ordinary people
cannot manage the entire scope of works individually. They can only come in
distribute eco-systems and work in wide partnerships.
DENIS: You are now talking about the investors seeking projects with the «hero-
type» founders, who estimate hundreds of projects and then invest into dozens for
only one of them to take off. And, of course, such an investor expects that one to be
his «unicorn». Because this is the only situation when his investment makes financial
sense. However, I believe that such a venture fund looks like a Medieval workshop.
It has a strikingly low productivity. No other industry in the world operates with such
productivity. Even in the creative domains such as movies or music, the productivity
has long risen.
The venture industry still hits only one in a hundred. But this is not a problem of the
people. This is a problem of mindset and method of thinking.
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DENIS: Everything the startup studio does is designed to later separate from the
startup and be sold as an independent product. Therefore, the studio is actually
ready to detach the startup at any moment of its life.
DENIS: Zombie products is another phrase for venture investors whose investment
pays back only when they sell one in a hundred startups at 50 times what it costs.
Or if they capitalize it over the top. Then they lose their interest in the remaining
startups, meaning that in their minds these will simply turn into those zombie
projects. In this regard, studios are on the same side of the fence with venturers.
They do not live off the capitalization growth. It contradicts their business model.
The financial concept of the studio is in seeing the venture investment as long-term
working capital.
DENIS: They make money from getting let say a 50% return on their investment.
DENIS: It does. But this is not exactly the same as what the venture fund does. In
making a decision on opening a startup, the studio immediately assesses the amount
of the capital required to take the startup to the business. Meaning, until we can be
sure that the startup can be sold. Or until it gets to its first pilot project or a large
contract. It all depends. But up to that point, the studio does not engage any other
external investment in the startup. Studios can work with investors by opening
investment windows. For instance, the studio says that one of its startups doing this
and that has one investment window open. This window will be open for two
months, the investment value is this, and the dilution is that. A year after, another
window for a different interest, different amount, and different value may open.
Therefore, practically, from the moment of its opening, the studio is gradually
making its way out from the startup. At that moment, it begins negotiating with
strategists, i.e., funds, corporations, or major entrepreneurs.
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INTERVIEWER: Meaning the studios finance pre-seed and
seed. But this is still not the «A» series, as there are no system
sales.
DENIS: Classical venture world terminology hardly fits this type of activity. I believe
it applies more to a different position. This is the venture fund that needs to
separate, draw a strict line between the seed-capital and the «A» round.
DENIS: The first investors could come to the studio startups even at earlier stages. It
all depends on the subject matter and the industry, not on the startup stage. This is
why I cannot agree that the studios only deal with pre-seed and seed, not with A.
This is not the case. The startup studio model busts the regular venture process
structure you are talking about. The decision on when to enter and when to leave is
made differently.
DENIS: Do you mean, for regular venture capital? When it is about 99 failing and 1
profiting, that is true. And this profit must be really over the top as far as the
investment marginality is concerned. The studio has a different logic, and its
profitability range is much humbler. If you bet on one mega-startup, you cannot
avoid crazy Xs when you capitalize it. When you do 100 startup, it is the capital
turnover that matters instead of the profitability of each deal.
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WHEN IS IT NOT ABOUT THE UNICORN...
INTERVIEWER: Startup studio stays away from big risk and big
profit. It pulls studios out from the zone, turning it into a big
organization with its own internal projects.
DENIS: You seem to think that the studio reduces the risks only by keeping its
money away from random projects.
DENIS: What I said about the startup studio and venture builders is special work
that allows minimizing the risk of losing the invested capital. As I see it, there are
other risk types the venture has to face. Such as technological risks. The studio
opens a company to external investments when it believes it no longer faces any
technological risks. But they may still remain, as this is not always possible. The way
I see it, the venture concept inherently carries this risk component.
DENIS: Indeed. Or the risk of failing to arrange a mass production system due to a
bottleneck. Let’s see the example of our logistic robots. Their bottleneck was the
lidar. Fifteen years ago, it was impossible to do mass robot production, as there were
no affordable lidars – they cost several thousand dollars each. After ten years their
price dropped to $600 a piece, and eventually, they will cost $100 or less. That's why
logistic robots in the late 2000s cost over a hundred thousand USD – partly due to
the expensive lidars. Do you think mass production was possible? Practically no.
And this is only one example of a bottleneck.
DENIS: You are again speaking from your usual perception of venture funds. At the
conference where we met, a representative of one venture fund said, “We have a
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vibrant law department to ensure the security of all intellectual property possible”.
And this is what a different approach is about.
DENIS: The patenting logic lies in the domain that studios are trying to abandon. If
you do a startup expected to be your “unicorn”, i.e. its value must exceed almost
impossible thresholds, then, to convince your investors that their investment is
secure, you need IP protection. The entire intellectual property thing developed a
long time ago as a way of motivating foreign entrepreneurs to enter new countries,
not as a protection method. England would offer patents to Dutch entrepreneurs,
opening its domestic market to them and even giving them a temporary monopoly
by issuing patents, as England needed Dutch products at that time.
You understand that as far as the spread of knowledge is concerned, there is no
difference between protected and unprotected IP. Because it occurs outside the IP
protection channels. I believe that the protection does not prevent your IP from
being copied. It will be copied anyway. Copying is faster than patenting. Traditional
venture investors need IP registration for a different purpose: to justify the
capitalization estimate by giving the intellectual property a special value.
DENIS: You are now referring to another regular successful startup indicator, which
is claiming for huge markets. This is what people usually say in their presentations to
investors: our market is half this world.
DENIS: A unicorn is not the one who dominates the market. A unicorn is the one
valued by investors at over a billion dollars. And this doesn’t directly depend on
one’s market position.
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INTERVIEWER: If you look at unicorns like Facebook,
Google, Uber, and all others, you will see that these companies
created giant markets from scratch.
DENIS: This is the survivorship bias. This is what it looks like now. We thought
differently when they were built. They didn’t hold the dominating share of the
market, just as those who will turn out the same as Google in 20 years.
DENIS: Quite the opposite. The entrepreneur’s venture-building efforts is the key
here. I am speaking about separating business from engineers and engineering
knowledge. The company of the studio is separate from the engineers that work
there. If the senior engineer leaves the company, the company wouldn’t die. There
is a base of knowledge, a decision log, etc. This is the kind of internal work that
protects the company from specific engineer’s random career trajectory zigzags. The
venture builder is constantly working on it. Ideally, the company must be ready for
sale any moment an inquiry may come up. Everything must be transferrable.
DENIS: People at a company are the same capital as technology and finance.
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INTERVIEWER: At least, are those engineering technologies
unique? Does an unpatented startup at least reach the market
with its unique offer?
DENIS: It does not really matter how unique a technology is. What really matters is
whether it fits the new place in the industry. Rocket Internet, one of the most
successful startup studios in the world, in fact does nothing but copies
other businesses.
DENIS: But the historians will write that Rocket Internet were pioneers and the
greatest of entrepreneurs. Do you know why they appeal so much to me? I believe
that copying is one of the best mindset technology that has ever been developed in
human history. Those who don’t know how to copy quite often present their
incompetence as creativity. A child at elementary school cannot copy a simple
pattern on a graph pad but produces plenty of “creative stuff”.
What’s great about Rocket Internet? They found their model, technology and action
blueprint, which is copying. I’ve always liked how straightforward they were. “We
copy. We do not invent any unique new hypotheses. We do not compete with
Google, or others Silicon Valley entrepreneurs who indeed see things differently
than we do here in Berlin. We are fine with using copying as main method of our
venture building” – that is what guys from Berlin say.
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WHO WORKS AT THE «STARTUP FACTORY»?
DENIS: Yes, it’s expensive in the corporate world; they call it the skill of working
with uncertainty, and they pay well for it. I believe these managers are so well-paid
because the corporations use them to compensate for the entrepreneurship spirit
they have lost. This is a sort of believing in miracles. Where do studios find
founders-in-residence? 300 years ago, if an entrepreneur needed people for his new
textile factory, what would he need to do?
DENIS: Yes, startup studios apply the assembly line principle to our startup building
process. They produce startups. Of course, the process will be the same as in the
emergence of textile factories in England. Before they appeared, there were
individual skilled weavers who could make amazing materials. But how much did
the dresses cost? Who could afford them? Only extremely rich people. What
happened when textile fabrics appeared? There were now cheaper fabrics. Who
could buy a cheaper fabric and set up a sewing workshop? Quite many
entrepreneurs. Did that happen? It did.
DENIS: The entrepreneur Richard Arkwright. Together with his partner engineer,
he invented both the special production machines and, as we say today, a business
model of a factory. How can textile be produced at an industrial factory instead of a
small workshop? He invented a different weaving process structure. And startup
studios are also inventing a different startup building process. Like it or not, all
those who build startups in the old-fashioned “individual” ways will look like
absolute outcasts in 20 years to come. The vast majority of startups in the world will
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be built by such systems as startup factories. These factories will be built as part of a
flow production. In a sense, an operation-building ability turns from a skill into a
production, construction process. We didn’t even have that just 20 years ago.
INTERVIEWER: But you still haven’t said where you find the
people capable of doing such work.
DENIS: Who do you think Arkwright called to work for him when he built the first
factory? At the beginning, many studios invited experienced and well-paid experts to
work. So did Arkwright: he called some experts first. But only a few of them
accepted the offer. Many of them turned it down, saying, “Why would we work at
your production site? We can make beautiful and expensive textile on our own. We
are doing fine this way”. Here, we got the same answers, “We work for corporations
or for VCs, and are doing just fine”. Those who agreed demanded salaries that
Arkwright’s factory business should not pay. The same happened with startup
studios. But who, after all, worked at Arkwright’s factory? Women and the youth.
Similarly, venture building in done by ordinary people. The studios pick those who
have any critical competencies for venture building. There are just several of them,
and there is generally nothing so special about them. Most of them are self-taught.
But importantly, these skills are enough when a person gets to a startup studio where
he or she or they are not alone any more, but in a partnership.
It is true that startup studios usually do not pay salaries typical for corporations. It is
important that venture builders have the right to earn out. Earn out is not an option
for already traded shares; this is the opportunity to generate entrepreneurial income
from selling your company if you have succeeded to bring it to that point. For
instance, in the form of vesting.
DENIS: There is nothing strange about working for ten years as an official
employee, getting the right to spend your bonus on buying some shares at the cost of
the money invested after five years out of ten, and in ten years, getting your earn-out
income. I mean, getting a share of the worth that will develop after selling the
company you were engaged in. You may already be building a different company,
but if you spent five of ten years building this company and you are creating new
ones within the startup studio, you may get a share of the income from selling your
first startup.
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INTERVIEWER: So do the people mostly come to startup
studios from very low-paid jobs?
DENIS: Depends. Some people come from much better-paid jobs. There are two
typical motivations people may be driven by at the beginning. The first is the
unbearable quality of management in corporations. Some people just cannot take it.
You see, these are former managers. They get pushed out by the culture
incompatibility. People who come through this channel often downshift their current
income.
The second is people who wish to do business and be technological entrepreneurs
but understand that they cannot succeed on their own. Or they see that what they
can do alone are only the simplest types of business that they are not much
interested in and that do not bring much profit. Opening a grocery store is not a
problem, opening a car wash is not a problem, but building a company that
produces robots, genetic services, solar panels, or 3D cages for spine surgery is a
problem. In this regard, the startup studio model opens the door to technology
entrepreneurship for many more people compared to how many can access it
“naturally”.
DENIS: These are not the competencies that are valued. Strictly speaking, the
entrepreneur’s income must be zero until the startup becomes profitable. So, there
are two basic options available for them: either they have some capital from their
family, or the project is not their first and they have some profit from the previous
one. But, of course, it can be different: someone builds a startup in his time off from
the full-time job. He works for a corporation and do his startup in the evenings. So,
he has a good time and don’t feel ashamed in front of his friends. But it all sounds
fake. There is a compromise financial option when a founder combines an
entrepreneur function with some function within a startup, when he becomes its
financial director, CTO, or most frequently, its CEO. This function can yield some
regular income.
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DENIS: One guy opened a business of selling takeaway coffee from vans by the
riverfront when he was a student. He expanded it to three vans. But it was a middle
size town with hardly any technology business, so he had no chance of learning
about or having experience in it. He also wasn’t ready to give it all up and head for
Silicon Valley. So, he went through the admission procedure and did a ten-months
internship at one of the startups. He became a venture builder of two technology
startups, one dealing with composite bicycles and the other producing additive
components for reducing the weight and improving the maintainability of regular
bikes. I believe he might start more soon. For him, this is a real breakthrough.
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WHEN THERE ARE MORE WORLD OUTLOOKS
THAN ONE...
DENIS: I think a platform may be not an analogue, but quite a close metaphor for
it. For the people who come to startup studios it works as a platform that opens up
entrepreneurship vacancies for them. Just like Uber to drivers or Amazon to
millions of private manufacturers and vendors.
What does the startup studio have to offer besides that? It offers access to several
new technology domains, getting in contact with the industry, accumulated
technology and business knowledge, and lots of services to relieve you of the job-
specific routine, sometimes even labs and equipment. Many people who work as a
venture builders wouldn’t ever do the project they make inside studios on their own.
This is a promotion and not demotion model for the people! Exponential
promotion! These are people who used to be regular managers or small business
owners. All they need is to be rational about their capabilities, to be highly self-
organized, and show some competencies that are checked through a specially
designed assessment procedure.
DENIS: True, the work is not easy. But what’s important is it’s a lot of work.
Because it takes a long time to build a startup in deep tech. Imagine yourself as a
studio resident. Just imagine yourself joining startup studio platform at the age of 25-
30 years old. Today, at 40, you would have built five startups, in three of which you
would have had shares that you would have sold or would sell in the future. That’s
what I’m talking about. It’s about the chances you take. People who consider
themselves capable of doing entrepreneurship on their own do not go to studios. But
statistically, there is only one person in 10 thousand who is really an able and gifted
entrepreneur. In many ways, the model I’m talking about is designed for situations
of a lack of entrepreneurship.
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INTERVIEWER : Could you briefly explain to me once more
again what is a startup studio is?
DENIS: Yes, if the simple structures do not bring a good result, you have to build a
complicated one. That’s what technology entrepreneurs have always done. And
Arkwright’s fabric was also a much more complicated structure than the weavers’
workshops.
DENIS: Our conversation began from that simple com- parison. Remember, you
expressed doubt that startups in studio are businesses, not departments of the same
corporation, because they have too much in common. Now let me make it even
more cohesive: one studio often does joint startups with other studios. One part is
invested by one studio, and another by the another. Now, does this automatically
lead you to conclude that they all belong to the same corporation?
DENIS: Because they are not just rookie founders, they are also startup studios. So,
as far as the shareholding is concerned, the stock of shares in the startup belonging
to one studio and to another create the same type of motivation. It becomes
different when there is a share of the founder as an individual.
Why is working together so important for startup studios? Because, of course, the
economically rational partnership is normal for a platform, and so is the joint
acquisition of knowledge. At some point, the number of man-hours accumulated by
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the platform becomes unachievable for both individual entrepreneurs and portfolio
venturers. And if you remember, I did mention that the investment capital turnover
matters to the studio much more than a high-margin income from single startup
sales. One reason is that each turnover yields new knowledge. As a platform, the
studio learns something new about technology and business every time. And this
knowledge becomes an asset of the platform.
DENIS: Every real, not mythical, studio operates within an absolutely certain
situation. A – it has access to a set amount of capital. B – it operates within the given
context of a region with its qualification structure, and some industries are
impossible to start without the required engineering qualification. C – it belongs to a
system of partnerships with entrepreneurs and R&D centers. And so on. Such a
conversation is therefore always extremely specific, and not abstract. On one board
is a specific situation; on the other is a couple of dozen interesting new product and
technology options. And your choice is not a result of making priorities; it is a
situation-based decision. Chances buzz by; you either catch them, or you don’t. This
is not even about high intellect, but about self-organization.
DENIS: This is why the studio is developing its industry knowledge. This is
knowledge from action, not from the Internet, knowledge from right and wrong
hypotheses, from business transactions and communication.
DENIS: Yes, there will be. But what is competition like in the new deep-tech
markets that I know well? It’s all quite simple. If you created something producible
that more or less belongs to the economic admissibility limits of this market, then
one of two things will happen to you. Either your company will be bought, or you
will get your 10% of the market and then it will be up to you to sell it or continue
growing.
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INTERVIEWER: For example, a thousand companies appear
in the same domain...
DENIS: I believe such situations are mostly impossible. Perhaps, in the Internet
sphere, there were some periods when hundreds of similar companies would
appear, just because they were cheap to copy. But the situation is generally different.
For example, there are only 50 visible startups in the world that deal in logistic
robots. This way, a startup from a small European city has the potential to get in the
Top-10 in the world.
DENIS: The questions you ask also consistently describe your economic viewpoint.
It has the right to exist, but it is not the only one. If you are the one charging a
management fee, then, of course, you do not like what I’m talking about. Just as it is
not liked by people whose activities and income are arranged as a trading business or
as a lease of some resource, or as income from using insider information.
I do not want to impose my world outlook on you or any other entrepreneurs. I just
want to say that it exists just as well as the others. I do believe that the current
economy development logic is taking us to the point where startup studios will
become as common as 300-years old textile factories are today. But if you continue
making your money following the philosophy where businesses are built by hero
founders, that is not something you will value. It is only important that the difference
between the worldviews and logic of the economy don't interfere with our ability to
work and communicate productively.
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