That's the most beautifully I've heard this thought articulated. I constantly hear people in SV talk publically talk about how they're living years in the future due to getting services from startups that haven't yet hit other markets. These people are very wealthy and very short on free time; they incorrectly assume the rest of the world is as well. The reason Uber became so successful was because it became cheaper than a cab in most major markets with world class service. You have to really dig deep to justify most other on demand startups having the ability to jump the shark and it's because they don't have a plebeian offering.
Uber certainly followed this growth curve - it started out as a service to call a black car to drive you around town, something that even the founders called a luxury for 1%ers. So did computers as a whole ("I think there is a world market for maybe five computers." - Thomas Watson, 1943), smartphones (at $600, the iPhone was considered a toy for luxury consumers when it came out), Facebook (initially only for Harvard University undergraduates), and LinkedIn (started with wealthy professionals who had lots of contacts).
It doesn't mean all startup ideas for wealthy, time-poor consumers will cross the chasm, but it seems to be a lot more feasible to go from wealthy consumers to poor ones than the reverse.
(Interestingly, it's the opposite story with B2B startups, where it's easier to add functionality than cut prices or improve ease of use. Hence the low end eating the high end, per Innovator's Dilemma. Actually, this effect in B2B markets may be behind the cost-reduction effect in B2C markets, as consumer firms start finding cheaper alternative suppliers that have recently moved up-market.)
This appears to be the crux of your comment, and it's an excellent point.
I’ve seen a few companies recently that seem to be getting strangled by the long tail. They have large numbers of low paying, price conscious customers draining resources. They can’t raise prices to a level that enterprises would be happy to pay since this would kill their established customers. Enterprises don’t want to pay a different higher price, why would they. The companies usually skimp on sales, especially field sales, so they have trouble competing in larger deals. And they can become arrogant that their niche solution, while better at one thing, can take on larger platforms that solve multiple problems.
Not saying your points are invalid, just that there seems to be a bit more at play and going from the long tail to the enterprise doesn’t seem trivial and shouldn’t be an after thought. In B2B it does seem like all the biggest winners have generally nailed the enterprise, but not necessarily the long tail.
Note that successful applications of this theory usually don't try to sell the same low-margin, self-service product to enterprises. Rather, they create a new "enterprise" product, priced according to what enterprises will pay. They get to leverage all the infrastructure, R&D costs, and ecosystem that's already gone into the mass-market product, but then apply that (with some additional features, and usually hardened security & reliability) to beat incumbent enterprise software on price.
Curious which companies you're thinking of - I can think of a few other mass market SaaS companies that have stumbled recently for the reasons you mentioned, but they have other things going on too.
If you can't convince an "enterprise" why they should pay more than a standard customer you're bad at sales. It's simple math.
it's not just that they are price insensitive, but you can use trigger words (auditing, apis, slas) to segment them into a higher tier since they have to have certain services provided.
One of the downsides of many startup types never having worked in a traditional enterprise place is they don't appreciate the features that will move you from the "small team in the company using" plan to the "whole department / company" custom plan where you're charging hundreds of dollars per user.
They would. The people buying products on behalf of enterprises aren't spending their own money, they're spending their company's. They'd happily spend an extra 10-30% (or more) if it means better support, easier setup and all-around less stress or headache for them.
Tesla Roadster -> Model S -> Model X -> Model 3
The point I'm trying to make is that many things of the current wave will pass into obscurity and perhaps ridicule, however some core concepts may emerge as foundational for the next wave. Further, experience with those concepts in the Bay Area may inform what is core and what isn't, and so launch better products.
We're not working together, we're letting investors decide what we make, and in the end what we produce is ephemeral.
Is our greed hijacking progress?
As for the question, greed always hijacks progress, that is the lesson of the Prisoner's Dilemma.
One lesson from 2001 is that Startups who Serve Startups tend to get hurt in the downturn as their customer are unable to pay them. Case in point Exodus.  This is especially relevant given the "Build something you want to use yourself" ethos.
The flip side is that if you make something that saves General Mills, Coca-Cola and P&G money, you'll always have a buyer.
Source: Credit Suisse: https://publications.credit-suisse.com/tasks/render/file/?fi...
OT but 10%? I'd've guessed at least twice that.
AWS, for example, was so expensive initially as to be ridiculous for most purposes unless you had a lot of money to waste. It was a 10% service. Now it's a 50% service. Tomorrow it'll be a 75-90% service.
The examples that don't follow this pattern, are usually riding on previous examples of the pattern that already became cheaper (such as mobile phones -> smart phones).
I'm not sure that "cheaper than a cab" had anything to do with it. You're the first person I've ever heard to cite pricing as a reason why people use Uber; everybody I've spoken to has cited the quality of service as the reason.
They achieved 2 things, the appearance of being cheaper(by putting a lower price, but making "surge pricing" look like a special thing), and eliminated price sensitivity from the customer.
In a cab you are constantly reminded how much its costing, so you suffer the price every second. In Uber/Lyft you dont even know until you left the car, so you are willing to pay more. I think this is an unfair advantage to UBER, in detriment of the consumer.
Yes, it will bring some concentrated pain to investors, CEOs, and employees of lots of companies. But how many people will be genuinely, life-alteringly affected by this? 1000? Maybe a few thousand? 1-2% of SF's population? By way of comparison Google has what, 50,000 employees?
I keep having to remind myself that the big companies are the elephants in the room compensation-, real estate- and traffic-wise. They employ hundreds of thousands of people and pay billions of dollars annually in wages. As much as I'd like an affordable place to live, none of this will move the needle that much for the average Bay Area resident.
I don't know reliable this  is, but it suggests that there are ~50,000 tech employees total in SF, and the top 50 companies employ about 30,000 of those. So the big players have a lot of people, but it's not as dramatically skewed as you're thinking -- maybe 40% of tech employees work at smaller companies. That passes the smell test for me.
Even assuming that the big players wouldn't lay anyone off (they would; they always do) That's more than enough to make an economic dent in a downturn.
Of course, you probably need that decent advice because you listened to your VCs' previous decent advice in better economic conditions - "don't worry about profit, just grow grow grow as fast as you can."
The cynical side of me thinks that it's this flip-flopping between two extremes that ends up disproportionately benefitting investors, and that entrepreneurs would be better served by always assuming economic conditions will change and preparing accordingly.
And yes, entrepreneurs are almost always better off ignoring everything an investor says and using their own data (which ought to be better than that of an investor's, otherwise why the hell are you founding a company?) to come to a conclusion.
The "Mr. Market" allegory was published in 1949, but it's never been more apropos. Pretty much all venture capital operates on this principle; use it to your advantage:
- The stock market is off 20%.
- Very few IPOs.
- Many hot IPOs are under the offering price.
- Most of the public market investors that have entered late in the game (Fidelity, etc) are marking down their positions, and holding off on new investments.
Every solid company should have a "What would we need to do to get cashflow positive?" scenario. It may damage longterm valuation (cutting growth does that) but at least it gives the existing investors an option: "We can enter survival mode and do X, or you can fund us with Y, and we can do Z"
I'm not really into conspiracy theories as a rule, but I will admit to having a similar thought. At the last, I find myself wondering if advice from VC's - especially regarding something like valuation - doesn't inherently tend to be self-serving on their part.
Remember, the objectives of a VC and the objectives of an entrepreneur aren't always aligned.
That said, you can't really argue with this part:
You know what kind of companies generally survive? Companies that make more money than they spend. I know, duh, right? If you make more than you spend, you get to stay alive for a long time.
1. It might. But it might not do so in the time-frame that VC's typically expect. Since funds tend to be time-boxed, VC's generally need to see not just a specific return, but they need to see it by a certain point in time. The older a given fund is, the more pressure to "do it now".
2. That said, nothing says growth has to be a smooth curve (whether it's linear, exponential, or whatever). You could be on an exponential growth path, slow down to flat, or even shrink, due to external macro-economic factors, or strategy, or whatever, then ramp back up again later and "go exponential" when things change.
and I'm kind of surprised that they would want to encourage their portfolio to transition into that kind of company
3. Well if the alternative is going out of business and resulting in a valuation of 0 for everybody involved, almost any alternative is better. I see it not as a call to give up on being a "home run" but as a call to batten down the hatches, hunker down, weather the storm, and then adapt as circumstances change.
VCs hate having "zombies" in their portfolio though, no? So I'd expect them to encourage companies to keep going for it, and may the strongest survive.
Though I agree with the substance of your comment, I don't think it's a 'conspiracy theory' to expect a VC to have her percentage in mind. That's just capitalism.
This throws a lot of people for a loop who want one source of objective truth for everything. But markets don't work that way: they're just deals between individual people, which may or may not become public. If somebody else makes a deal that you think is absolutely crazy, it is objective truth for them but absolutely irrelevant to you.
Personal finance works the same way. I know a few folks who were momentarily multi-millionaires during the dot-com boom; then valuations came crashing down and they were completely broke. We also tend to think of the value of a dollar (in cash) to be stable, but as anyone who lives in Zimbabwe can tell you, that's not a given.
Otherwise, we are left believing obvious absurdities: for example, somebody who bought Bear Stearns at $60 on March 13 2008 got just as good a deal as somebody who bought Bear at $3 on March 17; Bernie Madoff's fund management services were worth every penny until his arrest; etc. There is nothing 'subjective' about either Bear's hiding of the worthlessness of its subprime books or the fraudulence of Madoff's scheme.
I could drop the market cap of Google down to $3.4M right now. All I have to do is sell one of my shares for $0.01. The thing is, it would pop right back up again to $483B within a few milliseconds, and I'd just be out $690, so there's kinda no point to it.
(Pedantic note, since I know there's gonna be someone in the financial industry that corrects me: no, I couldn't, technically. When I put in a sell order, it goes into the order book, and buyers are required by law to take the best offer, which is probably more than mine. I'd have to place my order at a time when there are no outstanding limit offers. This has actually happened during flash crashes and technical glitches, but is not a normal occurrence.)
Privately traded companies are similar, but because there's less liquidity, the price doesn't necessarily correct on any reasonably time scale.
Good B-2-B biz most likely still get funded.
"The latest data from PitchBook show that VC investing in U.S. companies dipped to $9.3 billion in the first quarter of 2016, down from $17.6 billion in the fourth quarter. "There's significant uncertainty in the market right now and (we) would advise companies looking to raise capital to close quick and — while financing is available — maybe close on more capital than is necessary to be prudent in this environment," said PitchBook analyst Garrett Black. "
How is the first quarter of 2016 measured? We're only half way through it.
Contrarian takes aren't necessarily correct by the virtue of their contrarianism.
Yes, some companies are ‘moon shots’ (DFJ has a fair number of those in our portfolio) where this is simply not possible. But for the vast majority of startups, this should be possible.
What is the point of calling them start ups anymore. Remove the high risk/high reward aspect and new companies are simply small businesses that receive small business loans from banks. A lot of the "wow" factor of the startup ecosystem was the mind boggling user growth/high valuation/massive losses phenomenon that a few companies weathered through to IPO and monetization.
I think I saw someone advocating for better terminology on HN recently. I vote to call any close-to-profitable <2 yr old company a small business. Likewise, any portfolio that holds mostly safe small business loans and equity should simply be called a bank.
Leave the unicorn/VC/startup lingo in the past, or use it to describe actual risk profiles, and things will be a lot less confusing.
It's stupid, $2000/month in revenue shouldn't mean you are valued at less than if you had $0/month, but I can understand why some founders don't want to have any at all - in order to not have the more silly investors be distracted by looking at it.
There is a little truth to what he's saying - Once you have more than $0 in revenue, you have to make that number go up every month to keep investors happy and have nice numbers to bring in new ones, which makes it harder for the startup to invest in longer term projects that could bring much more revenue but with a slower buildup.
"I need you to start throwing off cash as quickly as possible."
"But you said generating revenue was exactly what we shouldn't be doing."
"But now that I'm spelling 'billion' with an 'm', I'm saying 'Do the exact opposite.'"
BBT makes fun of stereotypes, in the way only outsiders can make fun of stereotypes: The jokes don't make sense, the writing seems to have no real compassion for the group that they are lampooning at all, and I've never actually seen people behave like the characters do.
Instead, SV makes sense for people in startups: It doesn't really spend most of its time making fun of how maladjusted startup workers are, like BBT does, but instead makes fun of the theater we all are surrounded by. By just turning the tech into star trek style technobabble, the show can focus on things that are relatable and real.
Take, for instance, a conversation they have, in an early episode of this year, about the problems of high valuations and down rounds. There were articles written about it that hit the very top of HN, because the conversation was so very real. The craziness you see in the GPs video? It seems deranged, but it's said by a character more than loosely based on Mark Cuban, and it's reflecting the values of the time when Cuban made his money! And his story covers a huge issue in entrepreneurship: Does the fact that you managed to get an amazing exit in one company really mean you will be any good later as a venture capitalist? Were you lucky or good?
If you take away all the laughs, the series tackles realistic problems all the time. So the series is not about easy laughs at the expense of people: It's a story about a culture, that happens to have laughs to make sure people that aren't interested in the culture are still entertained by it. Just like The Wire, it's not a documentary, but it sure seems to rhyme with reality.
It might seem like cheap shots if you have only seen short clips of it though.
Startups are companies designed to grow fast.  Frequently, that means spending more than comes in but it's definitely not a prerequisite.
Likewise, there are plenty of small businesses which take years to reach profitability (some never do)—that doesn't magically make them a startup.
Aspiring towards profitability does not mean abandoning plans for growth (if anything, it often means doubling down on revenue growth). Small businesses don't double in size, startups do. Very little of what's relevant to my mom's small landscaping business is relevant to a technology startup, even if both are aiming to be profitable.
What benefit do derive from purposefully distorting terminology?
I would disagree with this terminology. I posit that a "startup" is a company designed to grow big. How fast it gets there is an implementation detail. Many startups aim for fast growth, but not all do. To me, the distinction between "the corner laundromat" and a slow-growing startup is that the startup still intends to be a Really Big Company.
Perfect example: YC funds startups only. YC funded a company working to cure HIV. That is going to take a decade probably. When they are ready they will be big in an instant.
Yeah, that's really exactly it. The way I've put it before is that you choose the model that fits where you are in your lifecycle. Or you grow slow, until you choose to (try to) grow fast. I'm not opposed to VC per-se or anything, but our mindset has always been "do it when the time is right". We get a handful of paying customers, real revenue and feel convinced that we've nailed the whole "product /market fit" thing, then we might decide it's time to turn on the afterburners or whatever. But right now, while more money would make some things easier, I wouldn't feel good about taking that on.
The actual measure of success is both size and revenue. Without the former it's a small company, without the latter it's going to get bankrupt unless it changes - with implosion proportional to size.
"An instant" is a huge hyperbole, let's start with verification, legislation, distribution, certification and all other kinds of legal nightmare to get a treatment on the market. Not to mention politics if it's (not) affordable.
> How fast it gets there is an implementation detail.
If you define "investors" as only VC's then I'd say that's a fair point. But just to paint a different scenario... for us, the only investors are the founders (so far). So why invest in building a company as opposed to putting that money in index funds? I can't speak for all the others, but besides still expecting a larger financial reward in the end, a lot of it is about the joy in the process of building something, and about having the opportunity to do things our own way. This way we get to build a company based on the principles we believe in and that will operate by our standards. And to top it all off, I would say that even if we fail and never make a dime, we'll all have benefited from the process itself simply in terms of learning and experience.
So yeah, sure, VC's want "fast" at all costs. No argument there. I guess what I'm saying is, the "take VC money and grow fast model isn't the only model."
Companies that are designed to grow fast by swapping profitability for free, user-attracting features will not do well in the current investing environment. That is the point of the article. The investor is looking for less risky, less high-growth oriented companies - aka slow startups.
While you may not agree with my call to revisit terminology, it is poor form to insinuate that I am an idiot whose goal is to derail conversations by torching old terms. The hostility is unnecessary.
Of course there are lots of nuances. I wouldn't say that Atlassian is an extreme pole though—it actually contradicts a lot of the narratives people tell about startups.
> What about a small, 5% gross margin software "startup" that takes on small investments with decent YoY growth that never makes TC news.
TC is absolutely not a prerequisite for being a startup (it's essentially a fashion show, which is relatively orthogonal to business). If this 5% margin software business has a realistic plan to grow into a large company and has strong growth then it absolutely is a startup, even if it's not fashionable.
> Or a chain of coffee shops that experiences huge growth and raises high-visibility funding rounds, such as Philz Coffee? What is Palantir?
Both are absolutely startups, their business model just isn't selling ads. They were both designed to grow big and used funding to get there.
> The investor is looking for less risky, less high-growth oriented companies - aka slow startups.
Yes, the investor is becoming more risk-adverse. That doesn't mean they're suddenly a bank looking to fund small businesses. I could walk up to her with a plan for opening a laundromat which was guaranteed to turn a profit in year 1, but I guaranteed she'd still be uninterested. Likewise, banks are generally uninterested in funding my tech endeavors even if they have a pretty reasonable path to profitability.
"Slow startups" is a much better term than small businesses. They still intend to be big some day, but aren't rushing as fast to get there.
> The hostility is unnecessary.
I apologize for coming off as overly hostile. I'm mostly just frustrated with people muddling terminology, and you certainly don't deserve the blame for that.
Maybe we can agree on "slow startups" as a good way to describe companies slogging through this new investment environment.
In general, I don't think most small business owners have any goal or aspiration to "make their companies as successful as possible" if that means turning them into a huge corporation. Most of my relatives own small businesses and none of them aspire to grow huge. In fact, my mother specifically sold her stake in her original landscaping company when it was getting too big (at 30 employees) to open a new, smaller one.
If you look at surveys of small business owners, most of them go into it from a desire to have more flexibility or to be their own boss—not necessarily to create a large and financially rewarding company. In fact, exponential growth is frequently at odds with the primary goals of small business owners.
In many real-world aspects I'd argue that Atlassian is more similar to the corner laundromat than it is to e.g. Snapchat. How would you evaluate them when considering making a business loan? How would you consider the prospect of working for them? How would you sell services to them? What do you think their HR plans look like? Their client relationships? Their regulatory situation?
Wherever you draw the line there will be companies that straddle it. But in my book there is a relatively clean distinction between companies that operate in a way that's sustainable in the short term and companies that operate at a high burn rate, and it is well worth reserving the term "startup" for the latter.
Edit: I'll also add that according to pg's "Startup = Growth" , profitability doesn't really come into the definition. Hence the existence of bootstrapped startups.
It absolutely does matter. Important terms need to be well-defined before you can have any sort of intelligent conversation about them. This is a rule in academic research for a reason, it clears up a lot of unnecessary confusion and vitriol.
Reframe this post as a bank talking to a small business owner about not taking on too much liability without proving a concept and it comes off as simple, sensible advice.
> in most cases profitability is not orthogonal to growth
It absolutely is. The longer you can offer a service for free, or for cost below margin, the more users you can attract to your business. It's pretty simple economics - build a nice free garden, let people play in it and invite their friends, get investments to pay your operating costs while improving the garden, keeping it open and free, then close it off and advertise once your ecosystem is strong enough to prevent substantial churn. This is not to say that all companies follow this path, but high growth companies certainly tend to, as it gives them a huge monopolistic advantage by putting profitability off into the future.
But the term "startup" isn't well-defined. Just go back through the history of the (many) debates on this very point here on HN. Sure, you could just declare pg the ultimate arbiter of all things startup, and use his definition; but there still isn't really industry-wide agreement on it.
I would argue that "startup" by itself just doesn't convey enough information and that it needs additional qualifiers to be useful. "VC funded startup" vs "bootstrapped startup" or "retail startup" vs. "tech startup", etc.
Words exist, let's not be scared to use as many as we need to be precise.
edit: I do realize (and hope) that the current financial environment helps to bring everyone back down to earth a bit.
The author's point seems to be - don't try to corner the market, the days of us investing in 5% success rate "moonshots" that do corner the market is over because that 5% is now down to 0.5%, and easy liquidity events such as IPOs and acquisitions are getting harder to come by. Just make a decent product and swim along with all the other little fishes because we don't want any risky market-cornering equity on our balance sheet given the current exit environment.
It's even arguable a startup is not really that close to cornering a market if there's no route to breakeven point without taking on further funding. That basically means they're either too tiny to enjoy any economies of scale, not competitive enough to be able to price their product at breakeven point or haven't opened the money valve enough to actually have a real market at all yet. Sure, any startup keen on cornering a market should have estimates of just how much additional CLV can be realised if they raise another $50m to scale up the sales team rather than continuing on their current growth path with the smaller team, but few of them should need that Series C to keep the lights on.
Granted, a lot of tech "startups" in SV are not innovating and should probably not be classified as true startups, nevertheless, that's the differentiating factor.
given that more and more startups go niche + traction first and often are ok w/ staying there there is also the need for a different finance model imo
First, The idea of risk-reward trade-off is stupid. (This is demonstrated in my footnote.)
Second: startups aren't startups because they have a high risk of failure. Simply because they expect to be much bigger in 24 months than they are today.
Someone making an app they want to sell on Android and iOS for $2 to all of the people who use smart phones is not a "small business", it's a startup. Why? Because there are 3 billion people on mobile phones.
At Internet-scale, there's really nothing between the two. There's no such thing as a mom and pop mobile game. Doesn't exist. If it's a mobile game, everyone can play it. Either you're in business around it or you aren't.
if you're in business on the world stage, you're not a small business, you're a startup. the only thing that matters is whether you would like to address the world's population or not.
i.e. whether you're "trying" (to hyper-grow.)
If you're trying to be much bigger later than you are now (by many orders of magnitude) then you're a startup. By the same token, anyone who has a plan to eventually make a million of anything is a startup. doesn't matter where you are today.
 You can show yourself that risk/reward is not true. Suppose that I transport from the future to today the entire faculty of MIT and Cal Tech, who know all of the major technology breakthroughs that have happened between our time and theirs. It stands to reason that they are worth more the farther from the future you transport them. 12 months is worth less than 24 months is less than 72 months is a lot less than 70 years.
Does it stand to reason that the more value they're bringing with themselves, the higher the risk of failure?
No, of course not. It's just objectively higher value. So stop talking about risk/reward, I've just proven that it doesn't exist. The only thing that matters is the value you're bringing to the table. You don't automatically run a higher risk of failure if you bring the world $1 billion of value versus bringing the world $100,000 of value. Doesn't exist. No law makes this the case. Zuckerberg didn't suddenly increase his risk by 1,000,000 when he decided to target a million times as many people (the world's population versus Harvard's student body). It's just false. You don't need to go through a million zuckerbergs to get another facebook. You don't even have to go through fifty thousand of them. You just need people targeting the world's population who know what they're doing. This is why VC works.
Since it is too late, I am happy to explain the thoughts in the above comment. I studied this area of economics from formal sources as well as having exposure to startups.
To summarize. One might think that if, say, a guy might be able to get a pizzeria off the ground, and it's 50/50, if it works he'll make a business with an enterprise value of $20,000 using his $5,000 investment, that's our assumption -- then if he wants to raise his sights and make the same investment, but this time is targeting $200,000 - his chances of success drop to 5%. And if he targets $2M then they drop to 0.5%. And if he targets $200M then they drop to $0.005%. If he targets $2B then they drop to $0.0005%. And if he targets $20B then it drops to $0.00005%. If he targtes $200B then it drops to 0.000005%
But 0.000005% is 1 in 20,000,000. There are 318 million people in America, so by those odds, the number of people in America who are capable of building a $200 billion business is exactly 15.
Yet there are more than 15 American companies that had those kinds of valuations in the past couple of years; Apple alone would account for 3 of them.
So with these kinds of large-scale successes, the risk-reward equation clearly doesn't actually work. And this ignores all of the home-run hits short of $200 billion. Clearly, risk does not increase at the same rate that reward does.
The risk-reward trade-off is just not a model that you can successfully employ when it comes to startups.
Secondly (this is not directly related to the above) the world is super-connected. There is 0 chance that if I find a pizzeria run by some guy in the city with 1 location as a small business, that 14 months from now it will have 50 locations that he personally operates. But if you find some guy with 2,000 downloads today from the Google Play store, there is no reason this same guy can't make something else and get 200,000 downloads. That is a factor of 100.
So the whole IDEA of a "small-business" just doesn't apply to online startup-like economies. The only question is whether the guy who made a niche app with 2,000 users is even interested in trying to use his same skills making something innovative and new, which he gets good press for, but which addresses the whole global smartphone audience.
The thing that makes it a startup is this hyper-growth component, like whether he's trying to roll out at that scale.
If someone doesn't understand either of the two (quite distinct) arguments above, or has any type of comments or rebuttal, I can follow up. Thanks for your time.
Risk is defined (in finance) as exposure to volatility.
Volatility is measured by calculating the standard deviation of annualized returns on an investment over a given period of time. The longer the time horizon of the investment, the more exposure to unknown and unaccountable variables you face.
Ultimately, this is because we do not have perfect information regarding the future. In fact, we have a very limited pool information that gets exponentially smaller the further out into the future we look.
In your example, the professor from 70 years in the future is much more valuable than the one from 2 years in the future precisely because the 70 professor has a much greater set of information about the future. Therefore he minimizes the risk that you will invest in the wrong technology because you already know what the world will need 10, 25, 50, 70 years down the line.
Reward is also very guessed or estimated or both.
So essentially the profile is made out of whole cloth as are valuations.
Let's further specify three groups, A, B, and a control C. A and B are asking you for $1 million to build their project. The control, C, is asking for $200K.
A is from 2 years in the future, B is from 70 years in the future, and C the control unlike A and B isn't a full cal tech + MIT faculty, it's just one guy with a youtube channel and no special knowledge, from our time. But they're all going to build their projects today if you give them funding.
A has proofs of concept and has just filed for patents but says they need funding to build prototypes, and for further patent filings. They say their patents and technology and the 2 years competitive advantage are worth $50M. But they will raise at $7M valuation, for a return of 7.14x over the investment timeframe between the current round ($7M valuation) and the next round in 2018 ($50M valuation).
B has nothing, but being from 70 years in the future, says they are presently worth $1 billion, but they understand it is difficult to raise money. So they are raising at a valuation of only $10M, selling 10% for $1M. They will use the money entirely on equipment and filing thousands of pages of patents, before their dazzling demonstrations allow them to raise their next round. It's the entire Cal Tech and MIT faculty from 2086! According to their story, after they show the dazzling new technology, they will proceed to raise a round in 2018 at a valuation of $1B ($10M valuation today, $1B valuation in 2018.)
C, the control, is some kid from today who is trying to raise some money so he can maybe raise at a valuation of $1.7M a year, or maybe 2 years, from now. Maybe. He already has some revenues from 5M youtube subscribers and he is raising a seed round to expand his channel into a whole media empire. His revenues are currently $5000 per month, or $60K per year, and he is trying to raise at a valuation of $600K or 10x earnings. He is only raising $200K. A year from now he hopes to raise a proper seed round at $1.7M, for 3x return. ($600K valuation today, $1.7M valuation in 1-2 years).
You are an investor. So, according to the traditional Risk-Reward profile, if A, B, and C are your possible investments, and A returns 7.14x (over 2 years), B returns 100x (over 2 years), and C returns 3x (over 1-2 years) and C already has an established product and established earnings, then the risk on B must be huge, whereas the risk on A is smaller and the risk on C is smallest of all.
But in fact, since 70 years is so far out, they have so much advanced knowledge, that the risk in that case is virtually 0 (there is no way that the entire faculty of both Cal Tech and MIT from 2086 with all their knowledge from them aren't worth $1B+ if they have $1M in financing and two years to spend on proofs of concepts, patent filings, etc! Yet they're raising at a valuation of only $10M. It's easy!)
Meanwhile, the group from only 2 years in the future is in a much riskier and more precarious position than the group from 70 years in the future. Their volatility is higher. This should be obvious.
While at the same time, even though the kid with the youtube followers already has a real product and real revenues, and is only trying to make a modest 3x return from a current valuation of $600k (10x earnings) to a valuation of just $1.7M -- in fact, his is the highest risk at all.
So this example shows that the least risk (essentially 0 risk) might be in a 100x return, the second-least risk might be in the 7x return. The control aiming for 3x return may be the highest risk of all.
I hope my thought experiments make it very clear to you that the risk/reward profile is flawed, and that there need be no particular risk associated with an outsize reward; likewise, the level of reward does not in any way need to match the exposure to volatility.
We are talking about the context of seed investments into startups, and I do not mean to generalize to other asset classes. The Risk/Reward profile is not an accurate statement of the situation investors are faced with in considering seed-stage startup investments.
Sorry about all the text, but it seems I didn't specify enough the first time around! Thanks for any thoughts and happy to hear your response.
Sort of reminds me of the conversation with a senior developer I had the first time I joined a startup and my first company lunch at my first job.
Me: "So, we just spend whatever money the company makes"
Me: "what if the company is burning all the money it makes to grow as fast as possible, and they can't raise money anymore?"
him: "that will never happen"
Me: (concerned) "so the company is constantly breaking even"
ME: (shocked) "so the company loses money some year, yet raises more money year after year so it can lose more money the following year than the last"
him: (annoyed) "you studied economics haven't you? you dont get it? everyone knows this is how you do startups what did they teach you in that shithole?"
(everyone else laughs)
That was 4 years ago. I checked the glassdoor comments and boy I didn't think a 2.1 rating was possible on glassdoor because that would pretty much scare off anyone in the job market....and yup the company is going under exactly for the reasons I asked 4 years ago but was ridiculed at my 'ignorance'
another one bites the dust for vancouver's brain drained tech scene. thank god I won't have to work here again in the near future.
Me: [Suggesting we should consider a couple things that would give us some revenue, and be mindful of spending]
Him: Listen, you're pushing it here. No offense to your economics degree but it's not like you've founded a business that's made more money than I have.
Me: Of course I have.
Him: When exactly did that happen?
Me: I ran a profitable lawn service business. I don't know the exact figure but we netted thousands of dollars over the lifetime of the business, which is about half a million dollars more than this business, as far as I can tell.
Him: [Grrk, change the subject...]
I know in start-ups making revenue is a bit of a dirty word but that's what the business is ultimately supposed to do anyway! Why the hell not build to support the revenue model(s) early so you can turn them on and test them as soon as possible? better to test your bets early before you're laying off hundreds of people because your guesses ended up being wrong.
I keep a note to myself positioned prominently nearby, titled "The Most Important Question". I wrote down something for "Question One" when I first put it up, but shortly after I went back and wrote in "Question Zero".
"What is the single most important thing I can be doing right now, to get us to revenue?"
(And no, "posting on HN" isn't a very good answer to that question, so shame on me). Hey, I won't claim to manage to adhere to 100% absolute razor-sharp focus on that point, but I keep coming back to it. When I find myself starting to bikeshed or work on some "cool but speculative" idea, I remind myself "work on what's going to bring dollars in the door first".
You could get funding for a portable neighborhood pony washing service if you built an iPhone app backed by an AWS service and called it Uber for Pony Washers (or some such)if you looked hard enough.
As the article points out, this is changing. The boom part of the boom-bust equation is starting to flatline with IPOs happening less frequently and for less money and the institutional investors who get in later in the game to buy out the initial VCs being more gun shy about investing.
Net result for the market? Startups need to focus on being a functioning business generating positive cash flow rather than a money pit that occasionally generates a lottery ticket. Not everyone will succeed, but the changing economic climate will push a lot of the fair weather pony washing app founders out and leave the more seriously business minded people which should result in a new wave of solid companies capable of handling more strenuous economic conditions.
A startup that's not cash flow positive right now but could be massively so in the future (or, atleast, the market expects it to be massively cash flow positive in the future) is significantly more valuable than a startup that is cash flow positive right now but with not a ton of room for growth.
In fact, placing the requirement of cash flow positivity right at the beginning of the startup would probably squash a lot of good (i.e. valuable in the long-er term) ideas.
Valuations are made out of belief (whole cloth).
The requirement is not a must, but you should take into account startup's burn rate over funding, which should eventually turn into burn rate over revenue. (without taking extra funding into account)
So, a startup that would have a huge burn rate should be much less valuable, as you're liable to lose money both short and long term. Same as with the bets, taking large bets with long timeframes is more liable to turn you bankrupt (both VC and startup owner) than taking small bets often, since you can back out at any given time.
(I'm not talking about motivation, that's a separate thing.)
However, markets are not rational, so startups with high burn rate are considered very valuable for some reason.
Companies can choose to not be profitable on purpose though, by re-investing revenues back into the business. Heck, Amazon's basically never turned a profit.
Companies should be built with revenue (and profit) in mind, and in most cases those are the ones that thrive and succeed.
During the "unicorn boom", I think we all had this belief that network externalities were very common in tech - a belief driven by the rise of facebook, google, and others. But now we're realizing that maybe strong network externalities are just as rare in tech as they are in other industries - and a business without network effects that's losing money for growth is just a business that loses a lot of money.
This NYT article from last week seemed to do a good job summing up the issue: http://www.nytimes.com/2016/02/13/business/dealbook/the-rise...
It now seems that we may have overvalued this effect. In fact, startups can grow quickly because new tech makes the first mover advantage tenuous; why should the effect that allowed us to climb the mountain now prevent others from doing the same?
The classic Metcalfe's law stuff means that a messaging service or marketplace with more people is more attractive to users than one with fewer, but not that those users will spend significantly more money or time on it. Certainly not linearly more.
How does the number of Uber cars in a city affect the frequency with which passengers use them?
And how many network externalities are there that don't rest on advertising dollars?
I've always perceived startups to be some kind of an extension of these (highly questionable) concepts and principles into the tech space. These days, it sems we're drawing closer to witness a clash of this weird, bubbly universe of its own with the real world as it were. The only real questions about it, I think, are: when _exactly_ will it happen, and what will the fallout look like?
It's not surprising to hear they plan to slow down investing. But that's not necessarily a reflection of the overall market.
Annual income twenty pounds, annual expenditure twenty pounds nought and six, result: misery."
The most valuable advice in this post reminds me of Marc A's awesome blog entry. Quote:
"Companies that have a retention problem usually have a winning problem. Or rather, a "not winning" problem."
In my opinion winning is, ultimately, measured by how much cash you can generate. We stopped thinking about an exit a long time ago while in the deepest darkest part of the valley of the shadow of startup death. We were forced to do it because we ran out of money and no one cared about us. Then we started focusing completely on our customers and our income statement. As soon as we did that, amazing things started happening.
Cash, in this case and in this climate, is king. Or net income to be specific. If you're able to generate large amounts of cash and keep a lot of it, not a heck of a lot else matters. From my perspective the only problems that really remain is giving your team a great quality of life and serving your customers.
Cash takes away issues like the board bugging you, investors breathing down your neck or (worst case) wanting to play CEO, hiring problems, retention problems, funding, what business are we in problems, product problems (you're obviously killing it, so do more of that!), exec hires, issues with rebellious execs (you're killing it, so you're implicitly right) etc.
When you "go for growth" (numbers growth, not revenue) you give up all of the above and put yourself as a CEO or exec in a precarious position. Your arguments are no longer that defendable because growth means jack shit unless it generates cash or will very clearly ultimately generate cash.
Think about the CEO of Giphy who just raised something like $50M at something like a $300M valuation. It's like my wife and co-founder says: Doing that you turn a cash problem into a much bigger cash problem. I'd add that you also now have less equity and less influence. For the investors it's awesome - the biz will likely bulk up on talent and worst case will exit as a talent acquisition at $2M per engineer and the investors (who get paid first) will recover perhaps everything that way with little left over.
If I was early stage in this environment I'd do the following:
Stop dreaming about a Deus ex Machina that will reach down and save your sorry ass. Stop fantasizing about acquisitions. If you don't you're going to inadvertently turn acquirers into your target market instead of your real customers. And humans aren't good at focusing on two goals at once.
Then do absolutely everything you can to generate sustainable cash. Usually this means (if you're early stage) discovering who your customers are and what business you're in or (if you're later stage) serving the heck out of your customers and making sure that what you provide is worth more than each dollar they spend to acquire it. Then do more of that. If you're successful doing this, rather than raising money, you'll notice that the really big scary problems simply go away.
What happens when you have competition with 10x or 50x the VC funding?
What happens to long-term product development when all you do is short term / small-scale improvements in order to 'better serve' your customers?
What happens to your core IP advantage that may be several years now but will have disappeared after doing long stretches of "feature" developments to chase after customers?
What happens when you have competition with
10x or 50x the VC funding?
What happens to long-term product development when all
you do is short term / small-scale improvements in order to
'better serve' your customers?
What happens to your core IP advantage that may be several
years now but will have disappeared after doing long
stretches of "feature" developments to chase after customers?
a) working on something that generates revenue in the short term (by adding features, improving the interface, improving your market reach or even doing some service work) and
b) something of more impact that generates revenue in the long-term (like investing in R&D, creating entire new products, etc..).
Note that b) most often does not include a), i.e. choosing b) explicitly means that you're foregoing some short term revenue opportunities for possibly larger revenue down the road.
This is precisely the case for VC (which you've argued against) so I was interested in how you'd solve this dilemma.
So really you absolutely need to generate revenue now or you won't be able to later. It's part of figuring out what business you're in and validating the model.
So just by going for revenue, you're absolutely not removing the ability to also do growth. You're just making sure that you can fund yourself and that the business you're in is a real business instead of just a fantasy one.
I should caveat this though. There are two strategies where revenue doesn't matter at all:
1. If you want to build a growth machine with no revenue purely in the hope of being a strategic threat to a big player so that they'll acquire you, then pure growth is a valid strategy. There are many success stories like that but I don't consider them real businesses.
2. If you want to be talent acquired, then you raise and make your core competency recruiting and your target market whoever is hiring engineers. You'll make some money and forever join the halls of those who have no idea how to run a real business that creates jobs.
I think the holy grail in entrepreneurship is creating a job creation machine that is self sustaining. That's what entrepreneurs were born to do and it's how we make the biggest contribution.
If you only consider Google (and there are so many more examples) - think about the effect that it has had on job creation, innovation, funding by the Google founders, the super angels it created, the angel investors, the funding projects that Google itself has and the quality of life it has created for tens of thousands of employees. That was just one success story that has had an enormous positive impact on the global economy.
When you talent acquire or strategic acquire a startup, you remove the possiblity of it ever becoming a Google or Facebook or Apple or Amazon and you remove all those positive benefits. So that's why I hate growth machines and talent shops.
I would love to read more about your experiences. I bet a lot of entrepreneurs can learn a thing or two from them.
The more I learn the more I realize I don't yet know - and hiring people smarter than I am tends to amplify that effect. So I still don't feel like I'm even close to being an expert - but I can share war stories, data and things that worked and did not. I'll try to get back on my blog and I might get my wife/co-founder involved. She's also been forged in the fires of startup hell and has a lot of wisdom to share I think.
Stop worrying about morale: Yes, you heard me right. I can’t tell you how many board meetings I’ve been in where the CEO is anguished over the impacts on morale that cost cutting or layoffs will bring about.
With these prospects, I wonder how will these CEOs keep all those underpaid and highly skilled young laborers working for him/her now?
That couldn't be farther from the truth, for a real startup with a real business. Maybe growth will not be as fast without VC funds, but I don't think real businesses will notice shrinking investments.
Correct me if I'm wrong.
These companies would struggle to operate with positive cashflows as their products/services and growth hasn't matured to allow for it yet. Perhaps they are building their product and/or are still in the early stages of iterating on their idea. Just because they have a decent business doesn't mean straight away they can consolidate right away on their business in terms of running a profit.
A lot of decent future businesses could die if startups are forced to consolidate. However in instances this may be a wake up call to keep them accountable to the financials of their business.
Then they would have to do like all of us, get creative and find alternative ways of getting cash.
But then, since it's irrelevant, bootstrappers have little incentive to comment here, other than a few folks for whom HN has become a habit. From where I sit the bootstrap startup world is actually significantly larger than the VC world, but the incentives are different: it is not to a bootstrapper's advantage to publish what they're doing to people other than their customers.
This is the most shallow statement I have read this year. The needs of the rich today would be needs of less rich tomorrow. The author clearly missed out on the whole American dream concept. I'm sure some people felt the same way about refrigerator and cars.
You'd almost never create a market segment starting with the bottom end. Almost every product you touch, including the very screen you're staring at, was once made for the 1%.
And almost always the version for the 1% is expensive, won't see a version 2, and is a one time sale. It doesn't matter if your initial rich/busy customers are going out of business. If you found a need you're fulfilling, you will with a fairly high probability will continue to find customers through the generation.
Dot com bust did not kill Network Solutions/Verisign. Very, very important.
However, following this piece advice sure makes it cheaper for other parties to acquire parts of those [companies] that do :)
That said, I agree with your overall point about not needing to raise millions of dollars to start a company. That's one way of doing things, but hardly the only way. Another choice would be to just take a regular job and start your company as a nights and weekends side project (deal with any potential IP issues, of course), or do consulting in your area of business and gradually transition from a service company to a product company. I'm sure there are others.
So, just like it is in most of the world, then?