Small innovations and trivial startups are a natural part of cycle. A selection from the letters.

Graveyard of the Accomplished, Boston, MA, July 2011

A snippet from letter #52, How Moneyball was the precursor to the Lean Startup Methodology:

… Right now, small innovations abound in many sectors of tech because we’re still absorbing the big structural changes created by the social, mobile and data “revolutions”. And it’s the abundance of small innovations that creates the spectre of a “bubble” and causes some of us to deride the Valley, VCs and entrepreneurs for thinking small, churning out trivial startups based on small innovations. But trivial startups can be a good thing.

The perception today is that too many entrepreneurs are tackling trivial problems, creating startups that are working on minor problems that don’t justify the value that could be created by allocating their time (and investor’s money) on larger problems. The opportunity cost of thousands of developers and millions of VC dollars building new food-sharing or photo-sharing apps is not a trivial amount.

Maybe that’s true. But in a way, it doesn’t matter in the long-run, because the system will adjust. Dollars and people chase perceived returns. Once the apparent returns reduce or disappear, people and capital adjust.

Why invest in trivial startups

How it applies to today’s startup ecosystem: many “startups” today are really just projects, and are started by people that should be working for other startups. That’s ok. We all like apps. But many of these small product innovations should be features of larger startups. And, if the system works, they will be, eventually.

The talk of the rise in seed stage valuations and the rise of trivial startups is a leading indicator of what we’ll soon see: a lot of seed stage companies that can’t raise Series A rounds and will either fold or get bought. I used to think we would see a ton of down rounds in this scenario, but an alternative is a ton of acquhires. The industry will consolidate, with the larger, well-funded startups buying the more successful developers and better features. Some acquisitions will happen because they are great fits, some will happen because the startup couldn’t raise additional funding and it was their best alternative.

That’s how the cycle works. As long as we let it, the system will self-correct. *

Now, what shakes the system into the next part of the cycle? Rather than a cataclysmic event, it will probably be more gradual. Look at the peak times for seed funding, and count out 12 months. The peak will be distributed, the crash will likely be distributed as well.

How to invest in trivial startups

Build and invest in people building features that are perfect acquisition targets for larger companies. Look into the developer ecosystems building around platforms like Facebook, Twitter, Google, Foursquare, Twilio (an up-and-comer with the potential to build a developer ecosystem); look into each company’s product gaps, look into the small innovation ideas being pitched around a particular feature gap. Look at the startups built by the ex-Google, ex-Facebook, ex-Twitter engineers building things that their former companies weren’t prioritizing. Look at which companies have the cash and the ability to buy startups, and build what they need.

And, of course, watch to see which companies realize the value in acquhires and outsourced product development and develop the internal capabilities to buy lots of startups.

And for the investor, structure your investing and operating model appropriately. Build a small investment team with many advisors, invest in entrepreneurs early, help them build features with great retention and engagement metrics, focus on finding product / market fit, and help them build relationships with potential acquirers. Invest before product / market fit into the teams that will be able to find it.

Here’s the key: creating and investing in small innovation works if both parties (entrepreneur and investor) understand and agree on the opportunity and the exit point, and setup the product, business and funding strategy appropriately. Everyone (entrepreneurs, investors, acquirers, society) can win in a small exit if only a small amount of time and money is invested. Know the game you’re playing from the very beginning.

It’s not the traditional “focus on huge opportunities and build a big company” philosophy, but it can work.

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* I can’t imagine any of these startups as too-big-to-fail. The government will not get involved to prop them up. The companies and services that are meant to survive will survive.

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