Using Planetary Motion to Spot Bad Startups

Non-performing startups are not always easy to spot.  From a distance, some of the very worst can appear to be doing everything right - charming founders, great product, nice office, lots of press - and a business objective that promises massive returns to the shareholders.  

So how can we spot the bad ones?

First of all, let's define what a bad startup is.  This is easy enough: every startup has a published goal.  A bad startup is a company that has promises to move closer to that goal according to certain timelines but never actually does so.  Or does so in very small, meaningless amounts.

I have a trick I use to spot these bad startups.  I look for evidence of two things: a) evidence that the startup is circling its business objective at roughly the same distance it was the last time I talked to the founders, and b) small requests for capital.  As in, just enough capital to last a couple of months.

I call this the "planetary motion test".  Because bad startups resemble planets in motion: by remaining at a fixed distance from the large, shiny object that is their business goal, and moving at the same speed relative to it (courtesy of a continual flow of small, unnoticeable amounts of capital), they can avoid the kind of solid diligence that inevitably accompanies large amounts of capital. Doing this allows them to continue to keep stakeholders entranced, money flowing, and the bills paid. 

[Science buffs: yes, I know, elliptical orbits exist - but the truly bad startup founders (and Ponzi schemers) are experienced enough to be able to move in and out from their mission goal - and still pull in more small amounts of capital - so I say that the analogy still holds.]

What to do? Bernie Leong published a Buffet quote in his LinkedIn feed earlier today that basically amounts to: "if you find yourself in a chronically leaky boat, don't try and fix it, change boats."

My advice is similar: Investors, if you find yourself in a startup that is maintaining a fixed distance relative to its goal, and surviving on incremental payments from you or an ever-growing list of shareholders... get out, fast. That planet may not yet be Krypton, but it is almost certainly going to blow up.

John Sharp

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