Growth Is The Only Way
Before understanding funding fundamentals, we must understand startup fundamentals.
And the most important thing to understand is this: startups = growth.
Very much has been said about that, and one of the best article might be the eponymous post “Growth” by Paul Graham in September 2012. You really should read that article if you are new in this environnement.
Let’s just look deeper in 5 principals from Paul Graham’s article, commented with my own view and great inputs of Christophe Janz, managing partner of Point9:
1. Growth could be the only metric
A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of “exit.” The only essential thing is growth. Everything else we associate with startups follows from growth. […] The good news is, if you get growth, everything else tends to fall into place. Which means you can use growth like a compass to make almost every decision you face.
Why is growth that important? Two words: talent and money.
A virtuous circle takes place with growth: (a) growth attracts (b) talents, who build (c) an incredible company, that attracts (d) money and (e) users, which is all the more attractive to (a) talents (hot startups, competitive compensation packages, etc.), etc.
2. Growth and big market are tightly linked
To grow rapidly, you need to make something you can sell to a big market. That’s the difference between Google and a barbershop. A barbershop doesn’t scale.
Big market is a requirement for growth and growth is a requirement in big market.
Because if you don’t grow fast, someone else will (high level of competition).
You can’t make a u-turn.
3. Growth is the only way in a high-risk environment
If you want to understand startups, understand growth. Growth drives everything in this world. […] Growth is why it’s a rational choice economically for so many founders to try starting a startup: growth makes the successful companies so valuable that the expected value is high even though the risk is too. […] Growth explains why the most successful startups take VC money even if they don’t need to: it lets them choose their growth rate. And growth explains why successful startups almost invariably get acquisition offers.
The expected value of a company is defined by a “risk of success” and a value in case of success. Since the risk of success is very low, you need to have a high target value for a sufficiently high expected value.
4. Growth is a race toward an uncertain solution to a certain problem
Starting a startup is very much like deciding to be a research scientist: you’re not committing to solve any specific problem; you don’t know for sure which problems are soluble; but you’re committing to try to discover something no one knew before. A startup founder is in effect an economic research scientist. Most don’t discover anything that remarkable, but some discover relativity.
There are three important ideas here:
- uncertainty: startups are built around searching. Searching a solution that fit a certain problem. Searching a fit between its product and the market. Searching a scalable model and a way to rebuild a whole industry.
- full commitment: as Christophe says: “Not so many founders have the stamina and patience to stick to their company for 10, 12, 15 years — after so many years, many people understandably need a change. And while a company can of course survive its founders, it’s still a loss that doesn’t make things easier in the future.”
Growth is neither short term race (burnouts are still not rare enough in the ecosystem) nor a lifetime walk. - winner-takes-all principle: most digital startups are built on network effects which lead to a race where the winner takes most of the pie. More about network effects and this race in one of my previous post about platform.
5. Continuous high growth leads to exponential growth
Small variations in growth rate produce qualitatively different outcomes. That’s why there’s a separate word for startups, and why startups do things that ordinary companies don’t, like raising money and getting acquired. And, strangely enough, it’s also why they fail so frequently. A company that grows at 1% a week will grow 1.7x a year, whereas a company that grows at 5% a week will grow 12.6x a year.
There is a very well documented bias in psychology and behavioural economy which is called the misperception of exponential growth: we tend to grossly underestimated exponential growth.
Growth of savings, economic growth or growth of populations are all following exponential paths. And when we ask people to extrapolate such exponentially growing process, they “use a repertoire of simple heuristic strategies” which lead to huge underestimations.
This is all the more problematic because “neither special instructions about the nature of exponential growth nor daily experience with growth processes enhanced the extrapolations. […] Professional decision makers do not show less underestimation than naive subjects.” (Wagenaar, 1975)
Growth matters all along because the growth path is very structuring. And as Christophe reminds us: “growth rates tend to go down, not up. So if your growth rate in year three is only, say, 50%, it’s unlikely that it will be 200% in the following year. It can happen and does happen, of course, but only if there’s a dramatic improvement in the business — a new product, a new distribution channel, a new business model or the like.”.
Bottom line: startups are designed to solve certain problem with uncertain solutions in big markets with a high risk of failure but an exponential growth if well done. So growth could be the only compass. Startups = growth.
But you’ll tell me that everyone is longing for growth. What is so special about startups?
In the next part, we will consider the tradeoff between growth and profitability. And startups have to make a radical choice.
Want to know more about startup funding? Read our other articles:
Want to know more about startup funding? Read our articles:
Part 1 — Startup Funding: Growth Is The Only Way
Part 2 — The Jedi Trick: You Have to Choose Between Growth And Profits
Part 3 — If Growth Was Easy To Forecast, There Would Be Only One VC fund: Nostradamus Partners
Part 4 — You Need to Lose Money, But Some Loss Are A Really Bad Idea
Part 5 — How To Have Growth AND Profits? (Part1: Transactional models)
Part 6 — How To Have Growth AND Profits? (Part2: Non-Transactional Models)
Part 7 — What About Valuation For Late Stage Startups?
Part 8 — Fail Often, Fail Fast. Investors Do Half of That
Part 9 — What daphni will not invest in
Reminder: daphni investment thesis
