A unified theory of VC suckage (2005)(paulgraham.com)
paulgraham.com
A unified theory of VC suckage (2005)
http://www.paulgraham.com/venturecapital.html
53 comments
Is it possible to take the money and just not do any of that?
Just increase your runway?
I’d guess it’s socially impossible even if it’d be legally allowed.
PG alludes to this idea with the treasury comment, but I really wonder about it. Maybe your investors would hate you, but it’d be a pretty comfortable move.
Just increase your runway?
I’d guess it’s socially impossible even if it’d be legally allowed.
PG alludes to this idea with the treasury comment, but I really wonder about it. Maybe your investors would hate you, but it’d be a pretty comfortable move.
I’ve never been a founder or a VC, so I don’t really know, but happy to speculate :)
I’d imagine it depends on the company, and “how are you going to spend the money” is something you’d discuss with VCs before the investment goes through.
I think the strong majority of the time, VCs want you to pump the money into the business to drive immediate hyper growth. They want to identify businesses that can soak up VC money and make good use of it … like Google, FB, etc. Most companies can’t, the money drives just moderate growth and a lot of inefficiency, but they want to do this test to see if they’ve struck gold. If you agree to do this, then don’t, new CEO time.
But I think there’s some companies that are clearly big, long term product bets. Where they know the runway has to be long, and years of product development has to happen before major growth. For example, I’m guessing if you’re a series A investor in something like CockroachDB, Tesla, SpaceX, you’re a bit more “yeah, take your time, spend this over 5+ years.” But that’s an anomaly, not the norm.
I’d imagine it depends on the company, and “how are you going to spend the money” is something you’d discuss with VCs before the investment goes through.
I think the strong majority of the time, VCs want you to pump the money into the business to drive immediate hyper growth. They want to identify businesses that can soak up VC money and make good use of it … like Google, FB, etc. Most companies can’t, the money drives just moderate growth and a lot of inefficiency, but they want to do this test to see if they’ve struck gold. If you agree to do this, then don’t, new CEO time.
But I think there’s some companies that are clearly big, long term product bets. Where they know the runway has to be long, and years of product development has to happen before major growth. For example, I’m guessing if you’re a series A investor in something like CockroachDB, Tesla, SpaceX, you’re a bit more “yeah, take your time, spend this over 5+ years.” But that’s an anomaly, not the norm.
The VCs control your board. If you don't spend the money the way they want, they can and will replace you. They might even find a creative way to dilute your stock to $0. Lots of stories like that.
Taking VC is like making a deal with the devil.
Taking VC is like making a deal with the devil.
I don't know the answer but I think investors at the very least expect you to invest the money they give you, not just keep it for a rainy day. I don't know how much leverage they will have to make you spend it.
I'm another poster completely devoid of actual knowledge (old Paul Graham posts are the fanfic corner of hn, right?)
I'd expect that to be part of the standard threat models that a fund would have prefab contract modules for. Founders still have 50+1? (otherwise it's clear what would happen) Include module "contingency stake transfer agreement" or something like that.
But it won't come to that, I'd expect GP's "socially impossible" to work well enough. Particularly when there actually is something in the contracts, that something will never be tested.
I'd expect that to be part of the standard threat models that a fund would have prefab contract modules for. Founders still have 50+1? (otherwise it's clear what would happen) Include module "contingency stake transfer agreement" or something like that.
But it won't come to that, I'd expect GP's "socially impossible" to work well enough. Particularly when there actually is something in the contracts, that something will never be tested.
> 1000 people got less done, with a lot less agility, than the 150.
too many chefs, not enough cooks.
too many chefs, not enough cooks.
Even if they are cooks, it's not easy to parallelize every problem. If the money is mostly used to pay for massive infrastructure - e.g. google, fb, etc buying lots of servers and other equipment investment or king/supercell spending on user acquisition (=advertisement) you can spend practically as much money as you can raise into it.
But if your costs are mostly salaries putting a lot more people to work is a hard problem to solve.
I'm currently running a startup with 6 employees (myself included) and if i get some extra money i can easily grow to 8 and immediately find plenty for the new people to do. But if you give me $Xm and i can/should suddenly grow to 30 people I'm going to have a hard time putting them all to use. I may eventually get to it but I can't start hiring them today because they will just idle or do unimportant work until I figure that out.
Beyond that, even if you do have a good use of 5x as many people productivity grows in sublinearly to the number of employees due to communication overhead. So even a well run company (which the above example was not) will probably get less per-person out of 1000 people than out of 150.
But if your costs are mostly salaries putting a lot more people to work is a hard problem to solve.
I'm currently running a startup with 6 employees (myself included) and if i get some extra money i can easily grow to 8 and immediately find plenty for the new people to do. But if you give me $Xm and i can/should suddenly grow to 30 people I'm going to have a hard time putting them all to use. I may eventually get to it but I can't start hiring them today because they will just idle or do unimportant work until I figure that out.
Beyond that, even if you do have a good use of 5x as many people productivity grows in sublinearly to the number of employees due to communication overhead. So even a well run company (which the above example was not) will probably get less per-person out of 1000 people than out of 150.
> Not out of laziness, just too many people for the size of the business problem
That sounds like a very common pattern: Got money so go on a hiring frenzy even if there isn't an actual and well-defined need for that.
One cause I think is that this is very good for careers: You hire below you, you expand your 'empire', and you become a much more senior and powerful employee as a consequence while projecting an image of impressive company growth.
That sounds like a very common pattern: Got money so go on a hiring frenzy even if there isn't an actual and well-defined need for that.
One cause I think is that this is very good for careers: You hire below you, you expand your 'empire', and you become a much more senior and powerful employee as a consequence while projecting an image of impressive company growth.
A major cause is just the nature of a big VC round, too. In my experience (and I think generally?), the funding comes with aggressive growth targets - you're expected to grow far faster after getting all the money injected than before. For a lot of businesses, there's no particularly good ideas for stimulating growth except "hire more" and "acquire other companies". The question becomes "how many people do you need to hire to hit X growth target", not "is X a reasonable growth target at all", or "are more people really necessary".
While this can work out for the right business, I think a lot of business are just naturally built around smaller problems, better tackled by a smaller, more agile team. With a huge problem you can effectively break it into a bunch of smaller problems, and still have tonnes of people working on it effectively without too much communication/coordination overhead. You're a huge company, but it's basically a bunch of loosely coupled small teams, each with a lot of autonomy, and few cross-team dependencies. That scales, but you need huge problem(s). If you have a smaller problem (like most startups), lots of people is just too many cooks in the kitchen, people's responsibilities overlap too much, every decision becomes a group decision, and there's lots of cross-team dependencies. This leads to massive planning cycles, everything locked down waterfall-style 3-6 months in advance, etc. Very inefficient, can no longer react quickly to change, all agility lost, and leaner startups eat your lunch.
While this can work out for the right business, I think a lot of business are just naturally built around smaller problems, better tackled by a smaller, more agile team. With a huge problem you can effectively break it into a bunch of smaller problems, and still have tonnes of people working on it effectively without too much communication/coordination overhead. You're a huge company, but it's basically a bunch of loosely coupled small teams, each with a lot of autonomy, and few cross-team dependencies. That scales, but you need huge problem(s). If you have a smaller problem (like most startups), lots of people is just too many cooks in the kitchen, people's responsibilities overlap too much, every decision becomes a group decision, and there's lots of cross-team dependencies. This leads to massive planning cycles, everything locked down waterfall-style 3-6 months in advance, etc. Very inefficient, can no longer react quickly to change, all agility lost, and leaner startups eat your lunch.
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500 of those hires sure as hell are MBAs
I'd think more in the range of ~10 MBA hires. Middle management definitely grew a lot, but most were not MBAs.
Lots of new positions were created that didn't really need to exist. In more "lean startup mode", if you have an idea for a creative way to grow, existing employee(s) just start trying it, and if it works really well but is making those employees too busy/overworked, then you hire for it. If it doesn't work, you stop doing it. But in "pumped full of VC $$$" mode, you never test the idea out, you just hire someone new to do it, which is often a mistake.
Also, on top of totally new roles, there was a lot of duplication of roles. Think multiple departments hiring email marketing teams, while before there was just a single email marketing person for the whole company, that sort of thing. Lots of things that used to be a single person, and were doing fine that way, became a team or multiple teams, each with their own manager.
Lots of new positions were created that didn't really need to exist. In more "lean startup mode", if you have an idea for a creative way to grow, existing employee(s) just start trying it, and if it works really well but is making those employees too busy/overworked, then you hire for it. If it doesn't work, you stop doing it. But in "pumped full of VC $$$" mode, you never test the idea out, you just hire someone new to do it, which is often a mistake.
Also, on top of totally new roles, there was a lot of duplication of roles. Think multiple departments hiring email marketing teams, while before there was just a single email marketing person for the whole company, that sort of thing. Lots of things that used to be a single person, and were doing fine that way, became a team or multiple teams, each with their own manager.
If I'm not being cynical--sales and marketing.
Building out a marketing organization is expensive in terms of manpower and money. Not everything can be bootstrapped. Enterprise sales, in particular, is expensive, slow, and annoying and needs a marketing organization dedicated to it.
It's rare that you can pour money to hyper-activate the technical side of things. However, normally you can do that on the sales and marketing side.
Building out a marketing organization is expensive in terms of manpower and money. Not everything can be bootstrapped. Enterprise sales, in particular, is expensive, slow, and annoying and needs a marketing organization dedicated to it.
It's rare that you can pour money to hyper-activate the technical side of things. However, normally you can do that on the sales and marketing side.
element.ai?
Hootsuite, though I’m sure many startups have similar stories.
I've worked in a bunch of companies that experienced similar (in %) growth & similar results.
Not sure if you still have shares but heard they are doing an IPO so you might get a small windfall?
:crossed_fingers:
>The huge investments themselves are something founders would dislike, if they realized how damaging they can be. VCs don't invest $x million because that's the amount you need, but because that's the amount the structure of their business requires them to invest.
It is a pity that the whole essay does not go a bit deeper and explain what are these business requirements here. Imho the main reason VCs (and angels too - if they are not from the 'family and friends' group) want bigger investments is to align the founder and the investor incentives. VCs want a binary option - big success or total failure and want to eliminate the third option of 'life style business' - that is a perpetual small business. In a 'life style business' there are too many avenues for continuously extracting small amounts of value from it so making it a fair game would require too much control from the investors.
It is a pity that the whole essay does not go a bit deeper and explain what are these business requirements here. Imho the main reason VCs (and angels too - if they are not from the 'family and friends' group) want bigger investments is to align the founder and the investor incentives. VCs want a binary option - big success or total failure and want to eliminate the third option of 'life style business' - that is a perpetual small business. In a 'life style business' there are too many avenues for continuously extracting small amounts of value from it so making it a fair game would require too much control from the investors.
The strongest argument in favor of VC would be the ability to deliver capital where otherwise none would be available, the ability to generate above-market returns (at least circumstantial evidence of offering value), and the experience/insights that emerge from experience with other startups.
The counter-argument would be, as PG alludes, the best VCs don't act like most of the others, the massive capital their business model requires them to invest causes misaligned incentives with respect to founders (e.g. the founder is happy to sell for $15M, but the VC folks are not), and there's a fair bit of IP security concern.
The bottom-line suggests a revisiting of incentives from both parties. Founders need some access to the VCs broader returns (possibly even offering their insight into OTHER businesses under the VC's flag) and VCs need to assess their returns over much larger temporal horizons than most funds will consider.
The counter-argument would be, as PG alludes, the best VCs don't act like most of the others, the massive capital their business model requires them to invest causes misaligned incentives with respect to founders (e.g. the founder is happy to sell for $15M, but the VC folks are not), and there's a fair bit of IP security concern.
The bottom-line suggests a revisiting of incentives from both parties. Founders need some access to the VCs broader returns (possibly even offering their insight into OTHER businesses under the VC's flag) and VCs need to assess their returns over much larger temporal horizons than most funds will consider.
> [1] After Greylock booted founder Philip Greenspun out of ArsDigita, he wrote a hilarious but also very informative essay about it.
Anyone have a link to this essay? I performed a few web searches but couldn't find it
Anyone have a link to this essay? I performed a few web searches but couldn't find it
> lately I've been learning more about how the VC world works
PG started YCombinator the same year this was written. Did he state somewhere how he planned to address the VC incentive issues pointed out here?
PG started YCombinator the same year this was written. Did he state somewhere how he planned to address the VC incentive issues pointed out here?
So why has PG allowed YC to become so VC focused and less about founders bootstrapping?
they make steep lines steeper
> In principle you could take a huge VC investment, put it in treasury bills, and continue to operate frugally. You just try it.
I’d really rather see this I think.
I’d really rather see this I think.
When we got our seed round check in 2016 my cofounder joked that we should put it in bitcoin, would have worked out way better for everyone involved if we did...
This is risky I think. First, you sold a business plan and a pro-forma for growth. I would bet that "investing in T-bills" was not in your business plan. Second, you need growth. If you don't deploy your capital to seek that growth, your VC will want to get out sooner rather than later. You dont want a down round...
I think the point of investing and continuing to be frugal is to not have another round.
It's not just in principle, I personally know some startups that do this. Crypto certainly helps them make this easy.
It is borderline scammy though.
It is borderline scammy though.
Everything PG says is true here. I would add: once you sell an iota of your company to a VC, your company is no longer yours. The VC will want to ensure they maintain control over every aspect of your business - and of course the valuation, how you sell and when you sell. There is no concept of building a sustainable long-lasting business: you need to build fast and grow fast.
This doesn't resonate as accurate at all to me. VC certainly would have an strong interest in protecting their investment and helping it grow. Unless you've given up a significant amount of your company they don't have ownership control and you also have a board (which I would assume you haven't handed over control of).
Again depends on the structure of your deal(s).
Again depends on the structure of your deal(s).
How many times have you raised venture capital?
> There is no concept of building a sustainable long-lasting business: you need to build fast and grow fast
This is actually incorrect. You're, more or less, in full control of your business until you give up control of the board.
Founder-controlled boards are common place after a series A and even series B (if you're in a strong negotiating position).
This is actually incorrect. You're, more or less, in full control of your business until you give up control of the board.
Founder-controlled boards are common place after a series A and even series B (if you're in a strong negotiating position).
Taking a peek into the VC world in China back in 2013~2016 gave me the same outlook of the industry. Of course I'm not close enough to give an accurate description as PG did, but the outlook is almost the same.
And for many times I think that modern funding is kinda broken. There is just too much $$ chasing around so few good companies and everyone is paranoid.
And for many times I think that modern funding is kinda broken. There is just too much $$ chasing around so few good companies and everyone is paranoid.
Do you still have contact with VC in China now? Is it still like this?
As a (funded) foreigner in China I'd say it's really difficult for outsiders. However, if you are a so-called "haigui" (海龟) or overseas returnee Chinese, then obtaining funding and government support appears to be much easier. The whole HK thing hasn't helped.
I'm actually surprised to see funded foreigner in China. Basically it depends on how many connections you have, the more the easier. But I remember after the year 2016/2017 the funding starts to die down quite a bit comparing to previous years.
I wonder if PG started YC after writing this and thinking, I can do better.
You can't. YC is a VC with a different coat.
Unfortunately when time and money is limited there will always be fat cats and starving dogs. There will always be worthy startups left behind and unworthy startups getting money.
The successful ones are only successful because of the immense money they get.
Unfortunately when time and money is limited there will always be fat cats and starving dogs. There will always be worthy startups left behind and unworthy startups getting money.
The successful ones are only successful because of the immense money they get.
> And of course giant investments mean giant valuations. They have to
This reads like satire these days because so many of YC's top companies are exactly that: companies losing hundreds of millions, or even billions of investor money every year, but all having insane valuations [1]
https://www.ycombinator.com/topcompanies/
This reads like satire these days because so many of YC's top companies are exactly that: companies losing hundreds of millions, or even billions of investor money every year, but all having insane valuations [1]
https://www.ycombinator.com/topcompanies/
You either die a hero, or live long enough to (join) the villains.
most VCs are soccer stars.
startups are basketball.
soccer and basketball are conceptually similar. both involve teams of players dribbling, passing, and shooting into goals. both require agility, teamwork, and endurance to succeed.
yet they differ in key dimensions to the point where no one assumes skill in one translates to the other.
similarly, investing and entrepreneurship share much in common but diverge in key areas. two cardinal rules of investing are: (1) diversify and (2) don't lose money. in entrepreneurship, these are cardinal sins. because of limited resources, startups fail when their bets aren't concentrated. startups also fail when prematurely optimizing costs because innovation is inherently wasteful.
to be clear, many VCs offer immense value and are instrumental to startup success. most are extremely intelligent and business savvy. the best ones adopt advisory roles, not managerial ones, providing insights and guidance that alter company trajectories, recognizing that it is your vision and drive, not their capital, that produces lucrative exits and world-changing companies.
if you have an opportunity to partner with talented and trustworthy VCs, strongly consider the option.
the simplest heuristic for evaluating VCs is this: if you removed capital from the equation, would you still hire them as your boss?
startups are basketball.
soccer and basketball are conceptually similar. both involve teams of players dribbling, passing, and shooting into goals. both require agility, teamwork, and endurance to succeed.
yet they differ in key dimensions to the point where no one assumes skill in one translates to the other.
similarly, investing and entrepreneurship share much in common but diverge in key areas. two cardinal rules of investing are: (1) diversify and (2) don't lose money. in entrepreneurship, these are cardinal sins. because of limited resources, startups fail when their bets aren't concentrated. startups also fail when prematurely optimizing costs because innovation is inherently wasteful.
to be clear, many VCs offer immense value and are instrumental to startup success. most are extremely intelligent and business savvy. the best ones adopt advisory roles, not managerial ones, providing insights and guidance that alter company trajectories, recognizing that it is your vision and drive, not their capital, that produces lucrative exits and world-changing companies.
if you have an opportunity to partner with talented and trustworthy VCs, strongly consider the option.
the simplest heuristic for evaluating VCs is this: if you removed capital from the equation, would you still hire them as your boss?
> In entrepreneurship, these are cardinal sins. because of limited resources, startups fail when their bets aren't concentrated. startups also fail when prematurely optimizing costs because innovation is inherently wasteful.
As a founder who strugglews with concentration, I found that your insight is gold.
As a founder who strugglews with concentration, I found that your insight is gold.
I personally have seen this, as a manager at a major company involved in obtaining certain data services from VC-backed startups (by now, medium-sized several-year-old companies).
I completely agree with the idea -- the VC-backed startup is completely incentivized to inflate deals to hit dumb revenue targets, regardless of how much it hurts (and they know it), really hurts them operationally to deliver. And when this happens at some point (usually quite soon), their priorities about the product take a back seat to simply pulling in as much revenue as possible.
At least we get to rake them over the coals and extract some ridiculously good prices for the product we buy while we do it, but man it's painful for both us and them at the same time. All for some valuation.
I see the CEO putting himself through a total hell to do this, and I ask "why are you doing this"? It's too late. They sold themselves to that world, and now have to live with the consequences.
edit to note: in the OP article, it points to a further essay written by Phil Greenspun in 2001 on his experience with VCs. It's funny and really interesting on its own. One small thing I noticed at the bottom is that the first comment is written by Aaron Swartz.
I completely agree with the idea -- the VC-backed startup is completely incentivized to inflate deals to hit dumb revenue targets, regardless of how much it hurts (and they know it), really hurts them operationally to deliver. And when this happens at some point (usually quite soon), their priorities about the product take a back seat to simply pulling in as much revenue as possible.
At least we get to rake them over the coals and extract some ridiculously good prices for the product we buy while we do it, but man it's painful for both us and them at the same time. All for some valuation.
I see the CEO putting himself through a total hell to do this, and I ask "why are you doing this"? It's too late. They sold themselves to that world, and now have to live with the consequences.
edit to note: in the OP article, it points to a further essay written by Phil Greenspun in 2001 on his experience with VCs. It's funny and really interesting on its own. One small thing I noticed at the bottom is that the first comment is written by Aaron Swartz.
Wow - he would have been 14 years old. Also, the second comment is from Dave Winer.
VC money can be incredibly damaging to a startup because it increases your options. In finance, optionality is good, in entrepreneurship it is a distraction. To achieve focus and speed, you want fewer options, not more. Even simply parking your money in treasury bills and focusing on your mission is not easy, because the option exists. Necessity is the mother of invention. As Steve Jobs said, you want to "stay hungry, stay foolish" [1], because nothing drives human beings like sheer pain and neediness.
[1] https://english.stackexchange.com/questions/44538/what-does-...
[1] https://english.stackexchange.com/questions/44538/what-does-...
VC $ decreases your options considerably in my experience. But perhaps we’re talking about different kinds of optionality
I really saw this at the first startup I worked at. We did a massive VC round (I think the largest in Canadian tech history?), hired like absolute crazy after it. The company got bureaucratic and bloated, lost the ability to move quickly and efficiently, and never got it back.
I still loved working there for the coworkers, management and interesting problems, but I don’t think the investment was good for the company long term. A company of ~150 people grew to ~1000 in a year, but I think the 1000 people got less done, with a lot less agility, than the 150. Not out of laziness, just too many people for the size of the business problem, which led to a lot of unnecessary communication/coordination overhead. Even disregarding the salary costs, I think had we stayed a lot smaller/leaner, we would have been able to move a lot faster, be more innovative, and ultimately become a larger/more successful company.