Remember the fable of the hare and the tortoise? Well, it doesn’t seem like VC’s or investors do any more.
Many years ago, when I worked at a cloud-based ad-delivery startup called eBUS, we were trying to raise money to fund an expansion into China – a relatively small sum, under a million dollars. The company was already several years old at the time, we’d proven the business model and had a business in ANZ and India that was making a small profit which would clearly grow over time.
We met with all the big name VC funds and their feedback, pretty consistently, was that they wanted to invest in something that had the possibility of being a billion dollar company, not in a B2B with a high probability of success but perhaps a ceiling of 50 million a year in revenue. What became clear to me was that a business that had even a 1% probability of the billion dollar revenue (and hence multibillion dollar valuation) was a far more attractive proposition than our mid-sized, highly likely to succeed business.
Eventually, we did raise more money from existing investors, make the foray into China, build a business across Asia and sell it to IMD, so it all worked out. However, those interactions with VC’s left me puzzling about why they follow the model they do – of making several investments in low probability bets, most of which fail, in the hope that one will come good and make up for all the rest. I’ve tended to be involved with B2B startups, mostly, and I’ve always found raising money from the regular VC crowd quite difficult, whereas every day in the news you hear about some startup somewhere raising huge sums in the tens or hundreds of millions of dollars, but in the same breath look at them making massive losses that will clearly burn through the investment in a relatively short time.
Here’s the problem with that model – throwing huge sums of money at unproven businesses delays learning about the flaws in the model. If Fail Fast is an important element of building startups, giving them the money to not realize they’re failing is a huge mistake. Take all the bike-share companies or ride-hail app companies, for instance – I don’t think any of them has worked out the economics of making a profit in the real world. If they realized that in the first 6 months and were forced to tweak and modify their pricing and model, they’d eventually get to a place where, instead of trying to provide hundreds of millions of consumers with an unrealistically cheap solution, they’d price for profit, serve a smaller market more viably and actually have a business that made sense. Giving them huge sums of money takes away the incentive to arrive at a model that works, often for several years, during which these startups buy consumers with investor money. At the end of that time, the business still doesn’t make sense and implodes, taking all the investor money with it.
The investors were the one who exarcerbated the problem in the first place, so I don’t really care about them. However, that money could have done so much good if it was spent elsewhere. Failed over-funded startups cost a lot, it’s just not immediately apparent who’s paying the price.
This is why it makes sense to pursue disruption from within, somewhat slower and steadier, but with the intent always being to explore new, sensible, viable business models and then scale up, not the other way around.
The Change Manifesto 