We live in transformative times. Never before has it been so easy or quick to turn an idea into a real business. From start-ups to the middle market, competitors are rising up to challenge the status quo across many major industries. One need only glance at the apps on our phones to see how radically consumer behavior is changing.
But what distinguishes disruption from regular innovation? On first glance, these concepts may seem like two sides of the same coin. Certainly, many companies both new and established are breaking ground within their sectors. To truly disrupt, though, means going a step further; it’s using a technology or idea to build a sustained structural advantage over rivals.
In this sense, real disrupters aren’t nearly as common as you might think. For every shining star like Netflix or Snapchat, there are dozens more that have fizzled out, only to fall from the sky. But it is worth noting the key attributes common to many of these breakthrough organizations when they do succeed.
Disruption requires ingenuity, nimbleness and vision — traits we often associate with start-ups and fast-growing smaller firms. It also requires industry expertise, scale and financial strength — more often the domain of large enterprises. At the same time, we must understand that innovation is often coming out of that in-between space where industries collide. As a result, the breadth of complexities one must navigate to succeed is expanding exponentially.
At EY, we think more disruptive businesses can be cultivated by bringing these different companies together to leverage their respective strengths and capabilities. We surveyed more than 100 start-up leaders earlier this year to better understand their perspectives and plans.
As it turns out, many of these young companies have surprisingly open attitudes toward capital raising and partnerships. At the same time, many of our large corporate clients are increasingly open to or actively investing in start-ups on a recurring basis.
A venture state of mind
Most start-ups understand growth is highly reliant on financing, whether to scale up their ideas or to attract top-notch talent and resources. Unsurprisingly, two-thirds of the start-ups we polled said venture capital (VC) is their financing partner of choice. To a degree, the reasons behind this are quite structural: venture capital firms tend to move quickly on due diligence, invest sizable amounts of cash, and don’t insist on collateral or onerous repayment schedules.
Another reason venture capital is so popular is the value-add these investors offer. Portfolio companies typically gain access to their VC’s broader professional network, which can dramatically improve a start-up’s ability to screen and hire the right talent. This is especially critical when your team is limited to just a handful of people. It also helps them to connect with the right people and grow their network which enables them to gain reputation and recognition in the market at a faster pace. Another reason is the mentorship and strategic perspective VCs offer, while not interfering with the company culture. Finally, VCs tend to have a good understanding of the challenges start-ups face and how to work around them.
The art of adding value
That’s not to say big companies are out of the running. After venture capital and private equity, our survey showed corporates were next in line as preferred funding sources. The small companies that favor corporates as investment partners told us they do so for access to marketing muscle, management talent and wide-reaching distribution networks.
Also, large companies have in-house regulatory knowledge, which gives them another edge. Half of the start-ups we polled rated regulation as one of the top two factors central to their long-term success. Big corporates with supervisory relationships across multiple jurisdictions can offer unique insights and strategic advice invaluable to new entrants.
At the same time, enterprises that open up their own value chain and offer true mentorship may gain a leg up at the bargaining table when courting start-ups. And establishing a constructive relationship early on dramatically raises the odds of a successful result for both parties.
Making M&A meaningful
“Creating strategic partnerships and alliances gives access to newer market segments and paves the way for acquiring an extra group of customers. This would help in achieving the strategic objectives of the company.”
— CFO, US start-up
Before investing, big companies should have a clear idea of their own goals when partnering with smaller firms. Are they looking for a strategic investment or a financial return? Do they have the stomach and longevity to lock capital into a company for 5 to 10 years? Are they prepared to walk away and lose it all if they back the wrong horse? Corporate cash may be plentiful, but so are competing business opportunities and quarterly investor expectations.
Large corporations with limited research budgets should consider framing venture investments as buying optionality on promising R&D. In this sense, M&A opportunities can be weighed not only in terms of revenue streams or technology acquired but also in terms of human capital and even culture.
Whatever the case, this clarity of purpose is important on both a strategic and a functional level. If you know exactly why you want to buy in, you can build the best valuation framework and partnership structure to achieve your goals.
We are in a renaissance of entrepreneurship, with tens of thousands of talented firms sprouting up across the globe. EY research that one-third of these firms are open to exiting their business during the growth cycle. The gulf between traditional corporate giants and sprightly start-ups can seem daunting at times. But on both sides of the equation, a strategic partnership or sale might be just what’s needed to transform regular innovation into real disruption.
Ryan Burke is EY Global Middle Markets Leader, Transaction Advisory Services. He is based in Dallas. Connect with him on LinkedIn or follow his twitter @burkeryan1 or meet him at EY’s Strategic Growth Forum.