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.

Get Out of the Basement Early, but Don’t Stray Too Far

In business school I had a new venture class in the school’s basement. During a group project, while we were devising overwrought strategies based on theory and not much else, the professor said, “I think it’s time for you to get out of the basement.”

Maybe he meant it literally, but I’ve used the expression figuratively many times since. “Get out of the basement” means go talk to some prospective customers, and do it as early as you can.

Where it gets complex is in balancing the need to talk to customers with not prematurely squandering resources on selling.

Let’s start with a few assumptions. I’m assuming that you are trying to build a product business that scales. I’m assuming your resources are thin; that you’re not working with a big team and a pile of capital that can be parsed to multiple pursuits at once.

The 3 main areas where an early stage company can focus resources: Product, Business Model, and Sales. How and when you shift focus between these areas is critical to maximizing your runway.

When a company gets stuck in the basement, they’re often iterating their product at the expense of time with potential customers. The product never manages to fit the market because the market is never understood. Product development is expensive, so this is a good way to burn through cash.

Alternatively, companies can get too far into the market too early, and the results can be just as dire. Oftentimes companies are putting way too much importance on hitting a growth or ARR figure they think they need to raise a Series A. They work the metric rather than the underlying business model that will fuel the metric.

Straying too far can create a couple of different outcomes. Outcome 1: in its desperation to close sales, a company will make ad hoc tweaks to the product to satisfy individual customers. It manages to sell and survive, but growth flattens. Without a product they can re-sell repeatedly, they have essentially created a services company. Outcome 2: they pour sales effort onto a flawed product, customers churn, and they continue to fill the leaky bucket until cash runs dry.

Ideally, you’ll get out of the basement early. You’ll spend the bulk of your early resources taking your MVP into the market and learning as much as you can about why it’s interesting to customers, how they are using it, how much it’s worth, and where it’s falling flat. 99.9% chance you had it wrong out of the gate, so you’ll be adjusting as you learn. Selling is a good exercise at this point, but in the interest of learning, not scaling revenue.

Once you’ve found the right business model, and have adjusted your product to address it, you can pour resources into sales and start significant product enhancement that keeps you ahead of customer needs.

By all means, get out of the basement as soon as you can. But make sure you’re doing it with the right objective in mind.

Your “Successful Exit” Might Be Harming Entrepreneurship

Another day, another announcement of a successful exit — terms not disclosed. Then a flurry of congratulatory messages. Then rumors that maybe the exit wasn’t as successful as people initially thought. It’s a pattern, and it’s not helpful to entrepreneurs.

Why does this happen?

No standard measure of “successful.” At its most generous, successful can just mean a deal got done. At the other end of the spectrum, some investors consider successful to mean a multiple of capital invested; enough to offset the losses of other portfolio holdings. Other investors might consider successful to mean invested capital plus an annualized return that exceeds that of a low-risk investment.

But at the very least, and at its simplest, success should return capital invested. I struggle to think of a situation where the goal includes losing capital.

Ego. Exits are public news. Successes are better than failures. Why go public with a failure when you can go public with a success?

Because failures matter. Track record is absolutely factored into the equation when you are being considered for investments. Future investors will want to find out about your failures, and that prospect encourages some entrepreneurs to spin a failure into a success. Bad idea. If investors have to peel back misleading statements to find your failures, your integrity is going to come into question.

Why is calling a failure a success a problem for entrepreneurship?

It misrepresents the real odds. I have written previously about the importance of assessing outcomes and probabilities. I think we’d have far more successful outcomes if entrepreneurs would capitalize their businesses according to what they think the business can become. When entrepreneurs see high odds of a big outcome, they take on investment, spend aggressively on growth, and swing for the fence. Miscalculation causes premature failure. When every attempt around you seems to result in a successful exit, you’re prone to miscalculation.

Calling your failure a success distorts the view for other entrepreneurs, and could cause problems with future endeavors. Own the L and move on.