Quadrophenia

Who Loves You? | Who Fears You?

Entrepreneurship and schizophrenia have a lot in common.

Every entrepreneur lives the Stockdale Paradox — constantly toggling between the urgent daily realities of survival and their lofty dreams of massive success and cultural impact.

But entrepreneurs who take outside funding — and especially those who raise “institutional” money — have another dual life to live: one centered around customers and revenue, and another around competitors and incumbents in the industry they seek to disrupt.

If you raise venture capital you are signing up to a war on two fronts — one based on love, one based on fear.

Let me explain.

Like other very high risk investment strategies, venture capital is an asset class that puts a huge premium on deals with “asymmetric” return profiles — with limited potential losses but explosively large potential gains (i.e., where winners commonly return 1-2 orders of magnitude on invested capital).

In an exit environment dominated by M&A outcomes, the preferred liquidity path for venture capital investors is “strategic” M&A — which is code for overpayment relative to traditional financial benchmarks. Strategic acquirers overpay for deals for one of two reasons:

  • Fear — The target company threatens to disrupt the competitive landscape or destroy margins in a business segment core to the acquirer’s business and strategy.
  • Greed — The target company represents a new strategic opportunity for the acquirer to grow revenue / margin and improve competitiveness, thereby accelerating growth in enterprise value faster than normal / organic growth.
In this context, returns-maximizing investors who deploy capital with asymmetric returns expectations will tend to seek investments that meet (at least) two criteria:
  1. Business Viability — Can this combination of team and opportunity produce a business that generates positive cash flows with accelerating margins at scale?

  2. Disruptive Potential — If successful, can this team’s approach to the opportunity represent a sufficiently dangerous threat (or sufficiently attractive growth accelerant) to two or more large and acquisitive incumbent players to generate a significant exit price multiple as compared to an exit based on purely financial benchmarks?
In other words…
If your startup idea — implemented with quality + urgency — doesn’t scare the pants off one or more big and dangerous incumbents, most venture investors won’t give a shit about it.
So, not only do you have to build an amazing product, get customers to love you and pay you money for it, find a way to acquire customers for less than they’re worth to you, recruit great people, build a culture that keeps them happy, raise money, get press, pay taxes, etc. etc. (This is the “Love” part of the journey).
If you want to get professional investors involved, you also have to strike fear into the hearts of big, established companies that have (effectively) unlimited resources to throw at the same problem you care about. (This is the “Fear” part).
If you don’t like the idea of fighting on two fronts and think that building a solid, cash-generating business is all that should be asked of you, don’t be surprised when institutional investors don’t get out their checkbooks to support you.
But if you think this kind of two-front battle sounds like a hoot — and your team has the engineering, product and sales chops to back it up, please give me a call ;)