The False Dichotomy of Venture Capital
I’m currently fundraising for Outlaw. Having done this a couple of times before, I knew to expect a grueling process; it takes a lot of time and effort to raise money for an early stage business. You need to kiss a lot of frogs to find a prince.
What I wasn’t expecting, or perhaps what I’d forgotten, was how different VC incentives and priorities can be compared to the incentives and priorities of a startup. Different to the point of revealing major conflicts of interest. Different to the point of being potentially destructive to the organization which, on the surface at least, we’re all talking about building together.
How could this be?
It’s well documented that the underlying VC economic model requires huge exits, and that’s fine. It’s great to shoot for the stars. It’s exciting, sometimes even eye-opening, when someone encourages you to dream big. But the degree to which many VCs focus on “unicorns” (startups who achieve billion dollar valuations) leads many of them to marginalize or outright forget about the earlier steps that unicorns need to take in order to become unicorns in the first place. (OK, maybe the truly exceptional unicorns can skip the baby steps and “growth-hack” their way to scale — like Theranos.)
In an attempt to weed out founders with insufficient ambition, VCs have coopted and bastardized the term lifestyle business. Now, in reality, a lifestyle business is what the rest of the world calls a successful business. It’s a business that provides a valuable product or service to its customers, and has succeeded sufficiently in capturing that value in order to make a profit. This results in a desirable “lifestyle” for the owners of the business (in that they don’t need to kill themselves in order to make a living) and, in all likelihood, a thriving business that’s growing, employing more and more people, and serving more and more customers. In other words, a lifestyle business is the very manifestation of the the American Dream.
But in VC lingo, “lifestyle business” means, quite literally, “anything less than a billion dollars.”
And that’s a big problem.
In their dismissal of these so-called lifestyle businesses, VCs perpetuate an absurd notion that an entrepreneur must choose between one of two mutually exclusive paths: either shoot for a billion dollar exit, or create a viable business which, by definition, is a lot smaller and therefore not a viable venture investment. Even Kevin Kelly’s wonderfully inspiring True Fan Theory mistakenly reinforces this false dichotomy. At the end of his essay, he writes:
1,000 true fans is an alternative path to success other than stardom.
Kelly means to encourage creators and entrepreneurs to keep doing their thing, because a thousand is a way more reachable goal than a million or a billion. But garnering the first thousand customers is not an alternative path to larger success; it’s simply a first step, and in fact, it’s a much healthier and more robust path to getting there. If we start out by building a solid customer base, we’ll have many more possible growth trajectories open to us than if we’ve just been burning through VC money building a hype machine and crossing our fingers.
Here’s a small but representative sampling of the questions I got on the recent VC circuit:
“Once you’re doing ten million in annual revenue, what will your sales process look like?”
“Once you achieve massive scale, what will your competitive advantage be?”
And my personal favorite:
“How do you turn this into a billion dollar business?”
Aside from being so broad and generic that they render all answers meaningless, these questions are tantamount to asking the parents of a newborn,
“Which university will your daughter attend to complete her master’s degree?”
Do new parents sometimes daydream about their child’s potential life, decades into the future? Of course! But right now damn near 100% of their focus is (hopefully) on simply keeping this new human being alive. And that’s a good thing, because new parents who spent all their waking hours researching grad schools, instead of learning how to manage the non-stop flow of puke and shit, would turn out to be dangerously negligent parents. And that’s going to dramatically reduce this kid’s likelihood of ever reaching healthy adolescence, let alone grad school.
Do I have the moxie and delusions of grandeur necessary to genuinely believe and publicly exclaim that I’m aiming to create a unicorn? Hell yeah — you’re reading it now! And given the enormity of the space we’re in, with several unicorn-scale IPOs and acquisitions in recent years, that’s not actually an outlandish eventual goal. But it’s also utterly wasteful and even destructive to spend any significant amount of time right now fantasizing about unicorns.
First, we need to keep on hustling to grow our base of “true fans” (customers) and get to profitability. That’s where I’m devoting 100% of my energy, and that’s the sole use of the seed capital we’re raising in the first place. Anyone who disparagingly refers to that as a lifestyle strategy clearly has no clue what goes into creating a real business.
