The startup conundrum: innovation versus Risk

Knowledge – economy, a phrase often used to describe the current economic landscape, and also as an ideal vigorously pursued by almost all countries to be worked on and improved upon for the prospects of economic growth.

Given that the knowledge economy is characterised with the phenomenon of ‘creative destruction’, rapid innovation is often treated as a central mission to sustain and override the effects of such destruction embedded in the market logic. It is in such a scenario, new entities such as startups came in to the picture as agents fueling the engine of rapid innovation. But looking at startups just through the prism of innovation is a story only half told.

According to a gazette by Government of India (GoI) in 2016, startups are those entities which are up to five years from the date of their incorporation, with its annual turnover for any of the years not exceeding Rs 25 crore and ‘working towards innovation, development, deployment of new products, processes or services driven by technology or intellectual property’.

This definition of startups has been later amended and the time span to be considered as a startup is increased to seven years from the previous five and for biotechnology startups it is extended to ten years.

Generally, across the globe, startups are mostly spin out from academic institutes through their technology transfer offices. Legislations such as the Bayh-Dole Act in the US legitimised the transfer of research results from the federally funded academic institutes and gave rise to a class of entrepreneurs known as scientific entrepreneurs.

These start-ups earn their revenues through the patents they generate by out-licensing them to big corporations. Another strategy usually deployed in the case of successful startup’s is, by integrating themselves in the form of mergers and acquisitions with the big corporations.

This is a win-win situation for the actors involved because startups get a profitable exit strategy and the big corporations who possess capital (social and economic) to convert those innovations in to scalable business models earn profits by bringing the final products into the markets.

One might wonder, why despite possessing all the necessary resources in terms of quality and scale much higher than those small startups, the big corporations themselves do not take up innovation activity? The reasons being, necessity of a huge pool of ideas, and the amount of ‘risk’ involved with an innovative activity. To put things in perspective, for example, if we take the case of pharmaceutical industry in the US, the heavy financialisation of this industry demands a growth rate of 13% EPS annually, while the typical growth rate hangs around 8-10% EPS.

According to NYSE Arca Pharmaceutical Index, between 2002 and 2012, the annualised return on equity was -1.2 %.

Hence, for the pharmaceutical industry to fill their pipelines, it is important that rapid innovation takes place concomitantly with less amount of risk. It is with in such space created by the need for ‘innovation’ and the ‘risk’ associated with it, the emergence of startups can be situated.

While for the big corporation’s startups perform a task of risk reduction, the startups themselves enter into activities of risk that masquerades in the name of innovation due to the much ‘hyped’ success it brings about.

The above mentioned win-win situation is the story of just one out of ten startups, with nine others failing. This implies that the percentage of failure of an initiative taken towards an innovative activity across the globe is an over-whelming 90%.

However, for the big corporations as a part of their risk reduction, instead of investing themselves in the R&D, Human Resource Development (HRD) activity, by encouraging startup’s in the name of innovation gest an opportunity to cherry pick those innovations that can earn them profits by deals such as out-licensing of patents, mergers and acquisitions.

On the other hand, most of these startups which are either funded by VCs or angle investors are subjected to intense pressure to look for a successful exit strategy so that their investments get returns.

A successful exit strategy is generally considered to be one where the smaller entity is acquired by a big corporation. The funding from VC’s come in rounds and for each round of funding by these investors demands certain results from the entrepreneurs -such as filing and granting of patents.

This crisis on further exacerbation results in the failure of the much enthused start-up initiative, a phenomenon highly common and ironically less spoken about.

While today startups occupy an important place in the innovation landscape, it should also not to be forgotten that the success of a startup is entrenched with huge amount of risk in the form of investments, patent litigations and finding out successful exit strategies.

While the celebration of startups in the name of innovation is much hyped and spoken about, their failures and the extent of vulnerability they are subjected to in an environment of risk manifested due to intense financialisation is kept in gloom.

(The author is a Research Scholar at Institute for Social and Economic Change)