Signing Up

“This made venture capital a good match for companies in which there was a medium-sized upfront investment with unpredictable but potentially very large returns. For predictable but small capital investments (a barber shop), for predictable but large capital investments (a bridge), and for unpredictable but large capital investments(the internet itself) venture capital was not the right financing mechanism.” — Sam Gerstenzang, Venture Capital’s Goldilocks problem

“The minute you started giving stock to your employees — you’re in the game.” — Bill Gurley, recent Bloomberg interview

Venture capital has a specific design — portfolios of small bets with asymmetric payoffs that benefits from dislocations in markets or technology. Large asset allocators (endowments, pension funds, sovereign wealth funds) invest capital into the asset class not only because they’re expecting a certain return, but also because they are looking for a certain type of risk (borrowed from Harry Markowitz and modern portfolio theory). Given this structure, assets (startups) must grow and scale fast to test the distribution of possible returns. This is all to say: it’s the incentives, stupid.

In a post-Social Network era, it’s seemingly cool to start a company and raise lots of venture capital. I know why. There’s an allure to the pure form — a small, close-knit team writing code, building products, and saying fuck you to the man.

I see my peers and friends (many under 25 years old) who are starting or want to start venture-backed businesses often subscribe to false beliefs about what it means to do so. There needs to be more transparency on the cover — what are founders signing up for?

Some folks like Fred Wilson and Ali Rowghani have discussed this previously, but this point is worth hammering home, especially for younger entrepreneurs. Starting a startup is more often an exercise in organization building, rather than product building. This means spending an inordinate amount of time hiring executives, managing investors, and ultimately taking care of employees who expect a substantial prize at the finish line. It still takes roughly $50M - $100M+ of capital to generate the returns venture capitalists are looking for, and this doesn’t just appear out of thin air. The money has to be raised and resourced. There are rare exceptions (WhatsApp) where the pure form works out, but scaling into a large enterprise involves untangling people, not technology, problems.

And when it’s not working out, founders are questioned, but may have not known what they signed up for in the first place. Or, they had different expectations of what the outlay of their personal time and energy would mean. Venture, in its best construction, is value additive for all parties, but these investments require significant alignment and understanding.

If you have strong opinions on this topic, I’d love to hear from you. Feel free to reach out at aashay[at]haystack.vc.