What the next multibillion-dollar edtech company will look like

Education companies nationwide are raising funds, and eyebrows, as they receive more and more attention from the national media. In the past few months, more than $110 million has flooded startups like 2tor, Coursera, The Minerva Project and StraighterLine. In 2011, VCs invested nearly $430 million in edtech companies, and by 2015, the market size for U.S. education could reach $1.2 trillion, according to recent estimates.

We’re in something of an edtech “venture bubble” — investors are realizing that there’s a proliferation of education-focused companies for a reason. But that doesn’t mean all of these approaches are set to succeed. So, how can you assess which of these new companies will become the next Facebook or Google of education? Like any large, complex industry with an influx of capital, the company’s business model (and the investment pattern) will make all the difference.

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Right now, there are three major types of business models emerging within education technology companies: alternative institutions, new products, and services. Of these, alternative institutions and newer products may have larger presences right now, but ultimately, companies that serve existing college institutions are the ones that will be the most profitable, and have the most potential for long-term impact and growth.

Alternative Institutions

From the Minerva Project to UniversityNow (and even Devry, Apollo and KIPPS), there are many companies that are re-thinking institutions from the ground up. Their fundamental assumption is that current institutions are either broken, not competitive, or not sufficiently meeting market demand, leaving room to create entirely new educational institutions, both on and offline.

While this is a legitimate type of model that’s spreading in India, China, and other growth countries, it is capital-intensive and, in general, cannot gain enough traction to meet the growing demand for education, even in the U.S. In the past 10 years, the for-profit sector of higher education in the U.S. has still only serviced 10 percent of students.

New Products

New and better products for education – such as new educational content, software, games, widgets or tools – are certainly hot right now. Inkling, Kno, Piazza, Knewton, and DreamBox are just a few examples that come to mind; they’re building slick tools and applications for use in educational environments.

These businesses look and feel like typical Silicon Valley software startups; their first round of funding is usually small, and the first $5 million goes into product development and getting initial beta customers. However, their “go-to market” plan is often complicated, and in the current climate, it’s difficult to gain enough momentum to achieve mass adoption of new products in either K-12 or higher education.

So, these companies often find themselves in the limbo state of having a great product but no revenue. In that case, the most likely outcome is that major publishers like Pearson or McGraw-Hill have to finance their distribution and eventually end up buying them. A great example is Knewton – they’re now being distributed by Pearson and most likely will be bought by that company, as most of their revenue will be coming from that channel. This is not a bad venture investment, but it’s not a “home run.”