You don't have to search far to find an article on how startups face a more challenging funding environment than in recent years, how IPOs have steeply dropped off, and how funders are calling for a reliance on revenue rather than raising more money.

A more reasonable approach to valuing startups is a good thing - for everyone involved. I'm not an economic historian, but I'm pretty sure that being able to sell a failing startup for $850 million and then re-purchase it for $1 million a few years later is not a sign of a healthy, sane, and thriving business climate.

In fact, the startup environment of the past few years reminds me of the NBA Draft.

In the late 1990's Kevin Garnett and Kobe Bryant entered the NBA Draft immediately after high school, and quickly became superstars. I remember watching and reading about subsequent drafts, where, as a result of Bryant and Garnett's success, the whole discussion became about upside vs. proven preference.

A player with high "upside" was usually one who was coming straight out of high school, and a player with proven performance was usually a college junior or senior who had some track record of proven performance against a much tougher level of competition.

NBA general managers selecting at the top of the draft almost always preferred "upside".

Drafting players without a record of proven results at a higher level of competition often didn't turn out well. In the 2000 NBA Draft the Los Angeles Clippers selected Darius Miles of East St. Louis High School with the third pick in the draft. The Cleveland Cavaliers would select Jamal Crawford from the University of Michigan with the eighth pick.

Darius Miles would play 2 full seasons in the NBA before his career sank into an abyss of injuries and legal trouble. This year, in his 16th NBA season, Jamal Crawford would win his third "Sixth Man of the Year" Award.

In 2001, as an executive with the Washington Wizards, Michael Jordan would select high school senior Kwame Brown with the first pick of the draft. Brown would go on to become a career role player, never averaging more than 10 points per game.

Kwame Brown was drafted ahead of foreign pro players Pau Gasol and Tony Parker, and ahead of college players Shane Battier, Joe Johnson, Richard Jefferson, and Zach Randolph. Each of those players would go on to be stars or valued contributors to championship teams.

With the exception of Battier (who is retired), all of those players continue to be stars and/or valued contributors to some of the league's best teams.

After Kobe Bryant and Kevin Garnett made an impact, teams assumed that several other talented high school players were "unicorns" as well.

The insanity of disproportionately valuing upside at the expense of fundamentals and proven performance did a lot of damage to teams, players, and the league.

That damage eventually led to the NBA requiring players to get a minimal level of college experience before turning pro - though not before LeBron James joined the league straight from high school, and became perhaps the biggest straight from high school "unicorn" in league history.

A few very special startups will be the business equivalent of a player who goes on to become an iconic global brand.

Others will be the business equivalent of Darius Miles, and (metaphorically speaking) bring a gun to the airport during their premature downward spiral.

Assuming all startups are going to be LeBron James is crazy--just as crazy as assuming all startups will be a time bomb like Darius Miles was.

Ignoring proven results is also crazy. As a part of the thriving startup community in the greater St. Louis region, I've seen instances where funders preferred businesses who were light years away from even having a minimum viable product on the market to profitable, thriving startups.

All because of "upside".

Ask the Los Angeles Clippers (Darius Miles) and the Washington Wizards (Kwame Brown) how that turned out.

 

Published on: May 25, 2016