Before You Adopt the VC Playbook, Make Sure You’re Playing the Same Game

Venture capital can create opportunities that would be nearly impossible without it. But it also takes options off the table. It is important to consider whether objectives are aligned before assuming you need or want VC.

There is a very important difference between VCs and entrepreneurs that is the root of potential misalignment. VCs are optimizing the return on a portfolio of many, whereas entrepreneurs are optimizing the return on a portfolio of one.

VCs have converged around a model where a few companies with outsized returns cover the return of the fund as a whole. The implication is that most VCs are looking for investments with the potential for huge wins, even if the wins face long odds. They are concerned with odds across their portfolio, not a single investment.

As an entrepreneur, however, the odds facing your company are the only odds that matter.

Would you rather face (a) 50% odds of selling your company for $5M, or (b) 5% odds of selling your company for $100M?

The latter, right? But what if in the latter, your ownership dilutes in half, and the outcome takes 5 years longer to achieve? Now the former is more attractive. It is important to consider these dynamics before committing to the pursuit of a big outcome, because if the commitment involves investors, it might be impossible to unwind.

VC not only affects your definition of a good outcome, it also affects your operational strategy. The VC playbook is go big or go bust; get the unit economics right, then pour gas on sales and marketing to get your winners to scale as fast as possible. The problem with this approach is that oftentimes early signals are skewed. Unit economics can look promising as you sell to early adopters, then fall apart as you move into the broader market. If you run up a big tab to find this out, it can be very hard to recover.

On the other hand, if you grow your business in smaller incremental steps as you turn unknowns into knowns, it’s much easier to recover from missteps. You keep the option of something in-between go big and go bust.

It is understandable why the default approach is to pursue VC. Accelerator programs will coach you on your investor pitch, and advise you to create a narrative around massive potential. The press lavishes praise on companies when they raise big rounds of VC. Social proof points to VC as a necessary stop on your way to success.

But the VC playbook has a trade-off in that it eliminates the successful middle ground. Just make sure you’re comfortable with the trade-off before you adopt the playbook.