A unified theory of VC suckage (2005)
paulgraham.com
paulgraham.com
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.
too many chefs, not enough cooks.
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.
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'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 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.
Taking VC is like making a deal with the devil.
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.
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.
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.
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.
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.
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).
Again depends on the structure of your deal(s).
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]
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?
As a founder who strugglews with concentration, I found that your insight is gold.
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.
I’d really rather see this I think.
It is borderline scammy though.
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.
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] https://english.stackexchange.com/questions/44538/what-does-...
Anyone have a link to this essay? I performed a few web searches but couldn't find it
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?
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.