Atoms vs Bits (Brick and Mortar Edition)

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Last week’s WeWork IPO filing had many folks in a tizzy about how much cash the business is hemorrhaging and what implications this has for its sustainability, especially if a recession strikes soon. This got me thinking about a topic that I’ve seen debated extensively in the VC ecosystem: Atoms vs Bits.

This historical debate centers around investing in companies that deal with physical goods and services (Atoms) vs pure-play software companies (Bits). Most investors, such as Fred Wilson, have historically preferred investing in Bits since they are generally less complex to create / execute on and are typically less expensive to bring to market. In his post, Wilson mentions that “the timelines will be longer and the road to adoption will be more challenging” for Atoms businesses and that to justify an investment into a company with these added challenges, it should be investable at a more attractive valuation (which is generally not the case). Indeed, a quick look at some of the biggest VC-backed outcomes this century reveals that most of the focus has been on Bits companies. Other VCs, such as Peter Thiel, have been very vocal about encouraging entrepreneurs to tackle problems that require an Atoms approach. While the level of difficulty goes up, Thiel says, the path toward solving the next set of complex problems will require this approach.

This brings me back to the specific set of opportunities I see a lot of entrepreneurs raising funding for – tech-enabled companies with brick and mortar locations as an integral part of the business model. At what point does a startup investment opportunity start looking like a real estate investment in terms of risk/reward profile and capital intensity? In WeWork’s example, why does it have a 15x+ revenue multiple valuation while its comp, IWG (operator of Regus), typically sits at 1-2x? Have investors gotten over-exuberant or is the valuation justified given how much of a land grab the company continues to make?

I think the truth is somewhere in the middle. Brick and mortar tech enabled startups are definitely a different animal compared to software pure-plays, which enjoy zero marginal costs and relatively quick iteration and deployment cycles. However, to solve some of the biggest problems tech has yet to transform, a more Atoms approach is required. Areas that are in entrepreneurs’ crosshairs include primary healthcare, dental care, therapy, dedicated common spaces for a certain demographic (such as for families with young children), pre- and post-natal workout facilities, co-working with childcare, and many more use cases.

Here’s a checklist I’m beginning to use for these types of investment opportunities to determine whether they are a fit with the VC model:

  • Founders must have venture scale ambitions (this is always an important consideration but especially so with these types of companies; Adam Neumann sure as heck checks this box off)
  • Is the founder committed to raising the required capital to scale? Do they have the ability to inspire confidence among investors in this way?
  • Ideally there is something in the business model that is very difficult to replicate (such as an operational hack that reduces complexity as the company scales)
  • What is the company’s potential to build a “sticky” community that maintains high engagement and keeps churn low? In an ideal case, there should be the possibility to develop a network effects moat.
  • How big of a step change improvement is the solution over the status quo? Incremental improvements won’t cut it for the VC model
  • What other revenue streams could be layered on to the core business model?

I get very hesitant when entrepreneurs want to solely rely on brand as their competitive moat, so ideally there has to be something very special about the founder as well as how they are thinking about the added complexity that comes with significant brick and mortar investment. In any case, I’m glad that entrepreneurs are taking on these complex problems – regardless of if their business is venture-backable or not.

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