A Hypothetical List of Assumptions
Our perception of the state of venture funding.
Hey there! We’re Hypothetical Capital.
Hypothetical Capital is a firm that lets companies practice their pitch and give feedback as if it were an actual fund because they are an actual $0 fund.
This document expands on the assumptions that we proposed in our formal announcement document. For whatever reason you are here, we put a lot of thought into these insights and hopefully they speak to you in the same manner data speaks to Angelo.
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Assumption 1
We are validating the notion that start-ups deserve more than one opportunity to pitch. Usually when you pitch, no means no. Yet, this does not deter founders. Instead, we find that determined founders grow from rejection and won’t take no for an answer.
If you ask any VC, there is always the one that got away… generally because the company, at the time of pitch, wasn’t mature enough. Or, in the case of rejection post-pitch, is because founders lack experience through the deal-flow process (assuming the idea isn’t a lemming). In general, the pitching process is opaque and wildly different between different types of founders, companies, and venture capital firms.
There is value in opportunities to grow and learn from mistakes. There is even more value in opportunities to grow and learn from your own mistakes. We understand that in venture there is a large amount of optionalities and randomness. It was found that rulings on court cases were influenced by how much time had passed since the judge was on a break. (Note: this has been disputed) By that same logic, a under-caffeinated partner at a VC firm can have their decision making become suspect. We feel it’s unfair for founders to be punished for being at the right place at the wrong time.
In the same way a software engineer prepares for a coding interview by mock interviewing, a founder should practice their pitch to like minded peers in their field in order to receive the best practice and feedback as possible. This can be helped by setting up a safe environment to pitch. We can fight against prevailing false assumptions that founders should always stay in stealth until they have a product to prevent “idea theft”.
Our assumption is that companies who don’t pitch often are less likely to be prepared for success. We lack data on this assumption but we will be building this data-set as we go along. We believe great companies can be found anywhere and everywhere, but founders shouldn’t have to be in fear of burning opportunities with VC’s because their pitch may be under-cooked.
Assumption 2
Since we believe great companies can be found anywhere and everywhere, we feel it is just to connect the right dots for the right companies.
Venture is a connections based industry. For the uninformed, most VC’s don’t maintain a marketing presence and instead use word-of-mouth and blogs to gather deal flow. There are plenty of exceptions to this rule since Andreessen Horowitz’s founding in 2009, however much of the industry still works in this covert manner. Sometimes it comes down to being in the right place at the right time. The reason why we feel founders stay in San Francisco and other predominant tech hubs around the world, despite plenty of other lower cost metro areas, is because of the optionality. It affords founders access to talent pool and proximity to their investors, potential or current. As a result, many biases are weighted into the system of entrepreneurship and in some cases works against interesting companies that these firms might miss.
It’s near impossible to raise capital without said connections to capital. Your ability to raise capital in the middle of Missouri is not as likely to be successful as your chances in San Francisco. Objectively, this is true. To clarify — we hold nothing against the Bay Area and other hubs. (Ali holds San Francisco near and dear to her heart and Angelo sheds a lone tear of happiness whenever he lands at SJC)
Our assumption is your chances of success are tied to your network, as well as the opportunities to grow said network. Everyday in major cities, there are meet-ups, office hours, and gatherings dedicated to entrepreneurs. Although those cities may have rich start-up communities, if you aren’t located in the Valley your ability to attend quality events might impact your chances to expose yourself to a myriad of founder communities.
Those non-centrally located cities may have rich capital markets, but if you aren’t located near VC firms your opportunities and chances for success are hampered.
We also want to be clear that even folks in the Bay Area aren’t aware of how this capital system truly works, but we assume that people’s familiarity with venture in that area is higher than the norm.
Assumption 3
Since we believe that social capital is key to raising funds, we subsequently believe that if you have a lack of social capital it will be hard to get validation.
We assume that over time, the number of companies looking to raise capital through venture methods has been steadily increasing. New founders are finding it necessary to raise from venture capital as a result of private equity or bank loans not matching the time frames to reach profitability that these instruments assume.
The chart above demonstrates that the U.S. VC Market is slowing down. We can explain the drop because of the increasing strength of global investors, and a lack of good data regarding fund creation in those regions. We can also hypothesize that high cost of living in the Bay Area is hampering domestic start-up creation in said region as well as the maturity of start-up companies.
There is also a shift in the amount of funding raised in the rounds of start-ups. In data accumulated by Wing VC, it was found that at the time of seed raise in 2010, less than 10% of companies were generating revenue. Now, 50% of companies raising a seed round are generating revenue.
Given the data, we understand that the expectation of company maturity at the seed stage is significantly higher. We feel that this expectation can weigh negatively against truly daring start-ups that might not reach revenue generation as quickly as their peers. Thus many Type 1 errors (false positives) might occur when screening potential investments. Detractors might argue that companies now should look for pre-seed and grant funding for pre-revenue companies, however see Assumption 2. Many pre-revenue start-ups in non-core areas face inaccessibility to grants and pre-seed organizations.
As quoted from Khosla ventures:
Your seed… should validate your hunches about the market and help you decide what market segment you want to enter.
It is difficult to achieve validation when it takes money to accomplish validation.
Assumption 4
Companies should seek validation as early as possible, however we feel the methods to do so can be more efficient.
Early entrepreneurs tend to go through accelerators or start-up programs to get proper exposure and access to resources. We acquiesce that this is an effective way for people new to modern entrepreneurship to get involved in their local ecosystems.
It is expected that new founders will go through great lengths to get any advantage and to become as knowledgeable as possible. Most of their early exposure to the founding process is through theoretical knowledge — learned through online programs, books, and blog posts. Although the intent is proper, we feel many people fall into the trap of analyzing the future rather than building it.
We are firm believers in “learning by doing”. We think that there are a lack of firms that invest their time and resources into growing non-invested companies with the same capacity as if they were investors. This is expected because there is no immediate return from these grassroots operations. It takes a village but right now many founders are working as outlying nomads. We feel that there is a gap in firms reciprocating the investment and time needed to create businesses.
Assumption 5
In the United States, according to the census new business formation with planned wages (the ones that hire employees) did not recover from recession lows. This means that company creation has been increasing, meaningful companies that are revenue generating that spur economic activity are flat (see figure below). As a result, we feel that the venture ecosystem can do it’s part by being critical at an early stage to improve the quality of business formation. In sum, pitch early and often to incorporate continuous feedback while companies are discovering their product / sales / market fit.
The rate of income growth at the top levels of earning in the U.S. have far outpaced growth at the bottom segments. In the 1980s, it was the other way around according to research by Thomas Piketty, Emmanuel Saez and Gabriel Zucman.
As found in recent Federal Reserve data, the median family’s net worth had not recovered its pre-recession value by 2016, while the top 10% gained double digits.
It can be inferred from this data that more households are living paycheck to paycheck and the risk tolerance of these families has been decreased. Almost half of Fortune 500 companies were founded by American immigrants or their children. This was possible due to the economic elasticity that pre-recession America used to provide.
We argue that the trend is reversing because of cost-disease. Middle to low income founders are unable to de-risk their positions because of runway consumed by cost of living expenses. In addition, the businesses of today and tomorrow require more operator expertise because the table-stakes of founding a venture backed company are higher than what they were before. In sum, business is hard, living with no stable income while you spend your time and money on an idea is harder. Especially when the rent is too damn high.
Exposing entrepreneurs to the fundraising processes earlier is a possible way to address the above. Although we believe the skill gap is closing in entrepreneurship, people need money and those outside of the careers with golden handcuffs do not know about the raising process. Exposure to this process is growing, for example through Arlan at Backstage and their series of accelerators in underserved communities. Our time isn’t charity — we feel bad ideas (not the ones that appear bad) should be weeded out or revamped before founders make the jump to destabilizing their incomes and following their dreams. Capital and time is at a premium and its not to be squandered.
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If you’re a new founder and what we’ve said has resonated with you, checkout our website and apply to pitch.
