The market of Art+Tech startups. Part 2

In the first article we looked at the main facts and figures of the ArtTech startup market as of the beginning of 2020. Today, it's time to dive deep into seven main mistakes that ArtTech startups make, which we know from personal experience dealing for the last two years with both camps of the market - project founders and investors:

1. Wrong problem setting

It's the first recipe for failure in the chronological order - blindly believing in our own idea. There is an important catch though: belief is necessary for motivation and moving forward, but blindness - is a companion of ignorance which negates any progress already at the start. Nanne Dekking, the chairman of the TEFAF advisory council and the founder of Artory, an ArtTech startup, said it right at the Christie’s Art+Tech Summit in 2018: 'The majority of startups care more about their own product, turning a blind eye to the market demand. The reason is that they are unaware of its real problems.' Unfortunately, the majority of educational institutions in the art business sphere are more focused on the outside of the market, paying no attention to the inside, while the invited officials tell stories about their own successes with a big smile on their face. It bears mentioning that the majority of ArtTech startups make their way to art from other industries - financial, legal or technological, in the best case they are familiar with the art market mechanisms from Donald Thompson and Philip Hook books. There are four questions that any hopeful entrepreneur needs to ask himself or herself.

• Is there really a market pain that my solution tries to solve?
• Will my solution be able to solve the existing pain in the art market?
• How have the art market been without me before today (how is the pain solved now, without my amazing technology)?
• Do I have competitors and if not, why? (more about it later)

The following argument is often brought to the conversation by the startup founders: 'When iphone appeared, it didn't solve any customer pains, it created the need from scratch. The users didn't know that all they needed was to scroll their fingers over telephone screens day in and day out'. Those who say this, are unaware of the market rule - a need from scratch can only be created by a market leader - say, Apple, Google or Amazon. Such companies are called strategists and they will be touched upon in other parts of the text. Strategists in the art market today are Sotheby’s, Christie’s, Art Basel, TEFAF, Larry Gagosian and other significant individuals and companies.

2. Wrong choice of the marketplace

Like we remember from the previous article, ArtTech startups who sprang to life after 2017 can be conditionally divided into four categories with the following size distribution: transactions (online auctions, e-galleries) — 64 %, information (databases, indices) — 12 %, research (online eduction, machine learning) — 12 %, collections management (logistics, storage, insurance) — 12 %. In other words, many young companies exist to sell art in any way possible. Therefore, the total size of the pie for such companies is $64.1 bln, out of which only 42% of total transactions are public (officially confirmed). To an institutional investor, sixty four billion is a small market, while 2/3 of all ArtTech companies trying to bite their share of it are either ignorant or downright insane. The remaining 1/3 of startups, willing to do gofer work for the market, play in a different field of a sizeable $3 trillion — that's the total worth of art in private hands that constantly needs to be researched, stored, insured and only rarely sold. Therefore, if you chose your niche right, you will no longer have to be crammed with the other startups in just one market segment, but you will enjoy a better position when talking to an investor.

3. I-can-do-it-myself attitude of the startup founders

A startup just can't go without socializing and mingling in a professional community. Hopping to events like project fairs, industry conferences, professional competitions and informal meetups must become an integral part of every startuper's tough schedule. Don't fall for the fallacy that too much communication and exchange will get your idea stolen. First, if your inventions are put to good use, congratulations — you were right. Second, stay assured, if you came up with an idea, then ten more heads were blessed with it somewhere else in this world. And someone, somewhere can be miles ahead of you in seeing it through. Several companies might cross the finish line and they will be cutting the market pie - try to get your fair share! For now, try to search for startups similar to yours, make friends and learn from their mistakes. If it turns out that your startup is truly unique, ask yourself: does the market really need the idea, if there is no one else doing it? Keep the answer to the question up in your sleeve, next time it will be the investor, asking you this.

4. Know your customer and build the customer network.

Many startups mix the two things - getting to know your customer and building the customer network. Both of them are needed when the founders of a starup have already painted the idea in powerpoints and now is the time to test it on a real customer. Usually, the idea is firstly presented to an easily available audience — friends, relatives, colleagues, and less often to a professional community. Close ones rarely give negative feedback and the founders often stop looking for more feedback, moving from proof of concept to money raising. Even if you are just checking your idea it is never enough to simply engage in a 'question and answer' exercise. Let's consider the following example: imagine you create a subscription-based system of remote collection management and you survey about 300 collectors, 70% support the idea and tell you they will use the service in the future. It's good for now, while you are checking your consumer. Now, try to levy prepayment for the subscription from them before the product has appeared, say offering a 50% discount. You will see right away how your 70% of collectors fade into darkness: the paying audience will shrink to just 10-15%. Meet you real users. However, after seeing how many of the inspired admirers turn into hardcore customers paying with cash, you will be able to appraise your future revenue streams properly (and the marketing costs).

5. Useless prototype

After getting the first money, a tech startup as a rule reinvests them into creating a prototype, a test software system, that can be used to once again prove the concept and do a feasibility assesment for your potential investor. The biggest mistake a startup can make at this stage is to try to fit all features of the future project into the prototype. The resulting product will most probably remind of an old abandoned construction site with metal bars sticking out: too expensive to complete and even more expensive to dismantle. Another extreme is when instead of a prototype, the entrepreneur hones just one element of the whole product which does not make any practical sense. Here is a good rule: if your final product is a luxury car - the prototype for it should not be a perfectly balanced wheel with blings but a skateboard. A skateboard, as opposed to the wheel, can ride by itself, while the wheel needs to be rolled. If you show the skateboard to investors, they are more likely to give money for your future car, recognizing your knowledge of mechanics and teamwork. If you show them the wheel, in the best case, they will buy the wheel and send you home.

6. The focus is on the investor, not the strategist

In other words, an investor is a private individual or a company, investing money expecting to make a return (in best case — profits, in base case — savings, considering inflation rates). A strategist is a large company, a market leader, who, if interested in your startup, buys it out for the purpose of either including its technologies into their core business or to wipe it from the market (when it has a competing spin-off). In recent years, the strategists eat up startups more because of the teams that run them: such teams will be vested with new projects and the original idea will be scrapped. Historically, for any startup, the best exit strategy is to be bought by a strategist. However, the majority of startups prefer to first approach the investors, whose number multiply the further the startuper moves along the axle of investment rounds (money raising stages). So, by the time a starup becomes lucrative for a strategist, it looks more like a spaghetti of various shareholders with a complex ownership structure. When such startups are bought, the founders get almost nothing in profits, which burn down in the attempt to satisfy initial investors claim to the proceeds of their investments, keeping promises made when the smell of hard cash made founders give away the shares frivolously. A more solid approach dictates that the starups first should knock on strategists doors and ask whether they are interested in the business idea, and whether they will buy it after a couple of trial years in the market. If the answer is yes - then one can start searching for investors, telling them about the interest that your idea has sparked in the strategists and proceed to rationally structure investor's share ownership. The risks that your idea will be stolen are minimal: for a big company like Sotheby’s it's cheaper to buy your startup when you have already learnt from mistakes spending your own time and money instead of doing it by themselves. This is proven by strategists' time and money.

7. Faulty financial model

Imagine you are an ArtTech startup that successfully ticked all the boxes above: chose the right niche, got its first customers, created an ecosystem of followers, partners and competitors, was blessed by a strategist to start and raised the seed funds. The investors' analysts have looked at your business plan and given it the 'green light' for money transfers and comissioned you to start working. It is when certain nuances may surface, that were overlooked by yourself and did not cause any concern of the investor. Analysts asses basic things: sales channels, sales funnel, unit economics, etc. If all of it matches a typical financial model, they endorse your project. But since they are usually unaware of the art market specifics, it means that you must be art savvy. Let's consider an example, imagine you build an art-shazam, an app that will recognize paintings in museums, initially raising $5 mln. From the outset your financial model might seem robust, but when you start developing the product, you realize, that in order to sign up all art museums in the world (ca. 15 thousand) your lawyer has to work due to to the local trade union standards a little more than 5 thousand working days, or 23 years. You start feverishly hiring external art layers who charge around $500 per hour and your cost estimate grows to $22,5 mln. as a result. And this is just the beginning for an ArtTech startup founder, there is more to come if you haven't considered the market specifics.

The next article will talk about the survival rates of ArtTech startups, optimistic figures and forecasts regarding young companies at the forefront of art and technologies. Stay tuned.

Denis Belkevich,
Founder, Fuelarts
telegram: @dbelkevich

This article was first published in Russian on ARTinvestment.RU