Startup studios in a down market?

As an investor I meet many startups that have got their initial funding from startup studios. Startup studies are here defined as companies that aims at building several companies in succession, typically in collaboration with external entrepreneurs.

First, I fully understand why it makes sense for many founders to collaborate with startup studios. The entrepreneur might have a strong vision of a problem to solve but lacks the human resources and know-how to build it. This is what I see from my teaching at multiple business schools where business students often have dreams of building software companies but without the technical co-founder in their network. Here the startup studio can provide exactly that to get the project off the ground.

Such collaborations can provide immense value. An example I know of is Pleo , which is the result of the collaboration between the entrepreneur Jeppe Rindom and the startup studio Founders. Together they have built a scaleup in hypergrowth worth several billion Dollars. (Disclaimer: I only know the company from the outside/media).

But as a pre-seed/seed investor I also see many situations where the startup studio might become a long-term liability for the startup. This can be caused by the business-model of the startup studio, which takes a significant share of the equity of the startup. I have seen cases where the startup studio, even in pre-seed cases, own +50% of the equity of the company.

That the founders (and other full-time employees) own together less than 50% of the equity is not a problem when the company reaches unicorn status. No one is in doubt that the founders/employees of a 1 billion USD company are motivated for the long haul, even if they “only” own say 30% of the shares.

But we all know why it’s called a unicorn: Such situations are very rare! +99% of all startups (including the ones funded by startup studios) will need several rounds of funding to get off the ground.

So, when I meet a pre-seed startup with limited commercial traction (which is normal), such a startup suddenly turns much less interesting when I found out that the founders have already sold out 30-50% to a startup studio.

I know that the startup will most likely need two funding rounds, each with 10-20% further dilution to the founders, resulting in founders having a too little stake to be truly motivated. I also know that institutional investors (VCs) think the same, so even if I invest in the pre-seed round, it will be very hard for the company to secure future funding due to its cap table.

This was not such a big problem during the “happy go luck days” of 2019-2021. But now the markets have turns and investors are more critical on what they pour money into. This is good!

But I honestly fear that a lot of early-stage startups with messed up cap tables will have a lot of trouble raising funding going forward, even when the underlying technology/product is sound.

Solution?

-?????????Well-funded startup studios can postpone the early-stage fundraising and try to bring their portfolio companies to a point where the cap table % matters less. But this is expensive to do for an entire portfolio of companies!

-?????????I also believe that many startup studios need to restructure the cap table of their startups (read: create significant warrant programs for founders/employees to bring their ownership % up)