Why This VC Won't Fund Startups That Serve Startups

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As the startup gold rush grows, I’ve noticed a scary trend: Startups with questionable finances are being launched to service other startups with questionable finances. These take many forms, like exclusive property-management software for Airbnb hosts, or specialty car-leasing arrangements for Uber drivers. Sure, these new marketplaces are awash in cash, but many VCs consider this risky business. If you’re tempted to join the crowd, here are three questions you must consider.

1. How dependent are you?

Some startups enable their host companies -- helping the bigger company grow, and therefore helping everyone. Other startups are simply dependent on the host company’s status quo. You need to be the first kind. Consider the history of PayPal and eBay, for instance. Without the advent of PayPal, I’d argue, there’s no way eBay would have become the juggernaut it is. PayPal enabled millions more people to use eBay, which is why they found such synergy. Contrast that with the once-hot trend of retail processing and shipping centers for eBay sellers, a market with no room to grow. Remember those startups? Neither do I.

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2. Are you worth buying?

When you rely on another startup to make your business model work, you’re stuck with only one potential partner, which means you have no leverage. Maybe the host startup will launch its own version of your product. Maybe it will cut you out of its software. All of this is beyond your control -- so how sure are you that your product is worth acquiring?

3. Can you think bigger?

PayPal expanded past eBay, helping to jump-start many e-commerce startups and becoming a new way for people to exchange money. More recently, SherpaShare originally started to support a growing number of Uber drivers in managing their ride-sharing profitability but has since expanded to competitors Lyft and Postmates, and is now targeting independent workers throughout the on-demand economy. Can your idea evolve beyond the initial host company like this? It needs to.