You know what kind of companies generally survive? Companies that make more money than they spend. I know, duh, right? If you make more than you spend, you get to stay alive for a long time. If you don’t, you have to get money from someone else to keep going. And, as I just said, that’s going to be way harder now. I’m embarrassed writing this because it is so flipping simple, yet it is amazing to me how many entrepreneurs are still talking about their plans to the next round. What if there is no next round? Don’t you still want to survive?
Yes, some companies are ‘moon shots’ (DFJ has a fair number of those in our portfolio) where this is simply not possible. But for the vast majority of startups, this should be possible.
What is the point of calling them start ups anymore. Remove the high risk/high reward aspect and new companies are simply small businesses that receive small business loans from banks. A lot of the "wow" factor of the startup ecosystem was the mind boggling user growth/high valuation/massive losses phenomenon that a few companies weathered through to IPO and monetization.
I think I saw someone advocating for better terminology on HN recently. I vote to call any close-to-profitable <2 yr old company a small business. Likewise, any portfolio that holds mostly safe small business loans and equity should simply be called a bank.
Leave the unicorn/VC/startup lingo in the past, or use it to describe actual risk profiles, and things will be a lot less confusing.
"If you show revenue, people will ask 'HOW MUCH?' and it will never be enough. The company that was the 100xer, the 1000xer is suddenly the 2x dog. But if you have NO revenue, you can say you're pre-revenue! You're a potential pure play... It's not about how much you earn, it's about how much you're worth. And who is worth the most? Companies that lose money!"
Out of every scene in those two seasons, no sentiment captured what I've witnessed in startups as precisely as this one. Straight up perfect. I wonder who was the main advisor for that speech (this was pre-Dick Costolo, I believe).
It is a ridiculous sentiment, but my startup has had revenue from early on, and I've talked to investors who have wanted to value us on revenue multiples because of that - whereas without having any revenue they would have taken a guess at our potential. (They'd have had to, they can't apply a multiple to $0!)
It's stupid, $2000/month in revenue shouldn't mean you are valued at less than if you had $0/month, but I can understand why some founders don't want to have any at all - in order to not have the more silly investors be distracted by looking at it.
There is a little truth to what he's saying - Once you have more than $0 in revenue, you have to make that number go up every month to keep investors happy and have nice numbers to bring in new ones, which makes it harder for the startup to invest in longer term projects that could bring much more revenue but with a slower buildup.
Same thing is easy to see in established companies: management is more inclined to throw piles of cash at businesses that don't make money while at the same time cutting costs in the "cash cow" divisions to show better growth numbers on the balance sheet.
Huh, Gabe is on that show. How good is that tv show anyways? I've been meaning to binge watch it but it seems like its raison d'être is to take cheap shots at SV.
BBT makes fun of stereotypes, in the way only outsiders can make fun of stereotypes: The jokes don't make sense, the writing seems to have no real compassion for the group that they are lampooning at all, and I've never actually seen people behave like the characters do.
Instead, SV makes sense for people in startups: It doesn't really spend most of its time making fun of how maladjusted startup workers are, like BBT does, but instead makes fun of the theater we all are surrounded by. By just turning the tech into star trek style technobabble, the show can focus on things that are relatable and real.
Take, for instance, a conversation they have, in an early episode of this year, about the problems of high valuations and down rounds. There were articles written about it that hit the very top of HN, because the conversation was so very real. The craziness you see in the GPs video? It seems deranged, but it's said by a character more than loosely based on Mark Cuban, and it's reflecting the values of the time when Cuban made his money! And his story covers a huge issue in entrepreneurship: Does the fact that you managed to get an amazing exit in one company really mean you will be any good later as a venture capitalist? Were you lucky or good?
If you take away all the laughs, the series tackles realistic problems all the time. So the series is not about easy laughs at the expense of people: It's a story about a culture, that happens to have laughs to make sure people that aren't interested in the culture are still entertained by it. Just like The Wire, it's not a documentary, but it sure seems to rhyme with reality.
Office Space should be /required viewing/ in high school. That movie taught me more about what to expect in the typical American office than any other experience in my life.
There's a brief clip of pornography near the beginning. We watched it on the bus ride for a high school trip. The teachers quickly turned it off upon noticing.
I haven't heard any complaints, the humour is on point, the characters are great and it's even more amusing if you have some insight into how ridiculous certain things in real life SV are.
This bit is definitely my favorite:
https://www.youtube.com/watch?v=IJIAOosI6js
Can you really not tell the difference between the corner laundromat (a profitable small business) and Atlassian (a startup which was profitable for most of its history)?
Startups are companies designed to grow fast. [1] Frequently, that means spending more than comes in but it's definitely not a prerequisite.
Likewise, there are plenty of small businesses which take years to reach profitability (some never do)—that doesn't magically make them a startup.
Aspiring towards profitability does not mean abandoning plans for growth (if anything, it often means doubling down on revenue growth). Small businesses don't double in size, startups do. Very little of what's relevant to my mom's small landscaping business is relevant to a technology startup, even if both are aiming to be profitable.
What benefit do derive from purposefully distorting terminology?
I would disagree with this terminology. I posit that a "startup" is a company designed to grow big. How fast it gets there is an implementation detail. Many startups aim for fast growth, but not all do. To me, the distinction between "the corner laundromat" and a slow-growing startup is that the startup still intends to be a Really Big Company.
I agree. It's more about getting big than growing fast. A startup could spend years perfecting its model and technology before going full force.
Perfect example: YC funds startups only. YC funded a company working to cure HIV. That is going to take a decade probably. When they are ready they will be big in an instant.
A startup could spend years perfecting its model and technology before going full force.
Yeah, that's really exactly it. The way I've put it before is that you choose the model that fits where you are in your lifecycle. Or you grow slow, until you choose to (try to) grow fast. I'm not opposed to VC per-se or anything, but our mindset has always been "do it when the time is right". We get a handful of paying customers, real revenue and feel convinced that we've nailed the whole "product /market fit" thing, then we might decide it's time to turn on the afterburners or whatever. But right now, while more money would make some things easier, I wouldn't feel good about taking that on.
It's the thing about startups - everybody talks like they actually succeed. It should be "if", not "when".
The actual measure of success is both size and revenue. Without the former it's a small company, without the latter it's going to get bankrupt unless it changes - with implosion proportional to size.
"An instant" is a huge hyperbole, let's start with verification, legislation, distribution, certification and all other kinds of legal nightmare to get a treatment on the market. Not to mention politics if it's (not) affordable.
> How fast it gets there is an implementation detail.
Only if the investors aren't looking for a better than market average return on investment. And if they're only looking for an average return, why risk their money investing in an unproven company?
Only if the investors aren't looking for a better than market average return on investment. And if they're only looking for an average return, why risk their money investing in an unproven company?
If you define "investors" as only VC's then I'd say that's a fair point. But just to paint a different scenario... for us, the only investors are the founders (so far). So why invest in building a company as opposed to putting that money in index funds? I can't speak for all the others, but besides still expecting a larger financial reward in the end, a lot of it is about the joy in the process of building something, and about having the opportunity to do things our own way. This way we get to build a company based on the principles we believe in and that will operate by our standards. And to top it all off, I would say that even if we fail and never make a dime, we'll all have benefited from the process itself simply in terms of learning and experience.
So yeah, sure, VC's want "fast" at all costs. No argument there. I guess what I'm saying is, the "take VC money and grow fast model isn't the only model."
You're leaving out all of the companies between the two extreme poles that you just set down. What about a small, 5% gross margin software "startup" that takes on small investments with decent YoY growth that never makes TC news. Or a chain of coffee shops that experiences huge growth and raises high-visibility funding rounds, such as Philz Coffee? What is Palantir?
Companies that are designed to grow fast by swapping profitability for free, user-attracting features will not do well in the current investing environment. That is the point of the article. The investor is looking for less risky, less high-growth oriented companies - aka slow startups.
While you may not agree with my call to revisit terminology, it is poor form to insinuate that I am an idiot whose goal is to derail conversations by torching old terms. The hostility is unnecessary.
> You're leaving out all of the companies between the two extreme poles that you just set down.
Of course there are lots of nuances. I wouldn't say that Atlassian is an extreme pole though—it actually contradicts a lot of the narratives people tell about startups.
> What about a small, 5% gross margin software "startup" that takes on small investments with decent YoY growth that never makes TC news.
TC is absolutely not a prerequisite for being a startup (it's essentially a fashion show, which is relatively orthogonal to business). If this 5% margin software business has a realistic plan to grow into a large company and has strong growth then it absolutely is a startup, even if it's not fashionable.
> Or a chain of coffee shops that experiences huge growth and raises high-visibility funding rounds, such as Philz Coffee? What is Palantir?
Both are absolutely startups, their business model just isn't selling ads. They were both designed to grow big and used funding to get there.
> The investor is looking for less risky, less high-growth oriented companies - aka slow startups.
Yes, the investor is becoming more risk-adverse. That doesn't mean they're suddenly a bank looking to fund small businesses. I could walk up to her with a plan for opening a laundromat which was guaranteed to turn a profit in year 1, but I guaranteed she'd still be uninterested. Likewise, banks are generally uninterested in funding my tech endeavors even if they have a pretty reasonable path to profitability.
"Slow startups" is a much better term than small businesses. They still intend to be big some day, but aren't rushing as fast to get there.
> The hostility is unnecessary.
I apologize for coming off as overly hostile. I'm mostly just frustrated with people muddling terminology, and you certainly don't deserve the blame for that.
I see your thesis - that "startup" implies a desire to be big some day. I'd assume that most small business owners intend to do the best they can and make their companies as successful as possible. But who can really know these things.
Maybe we can agree on "slow startups" as a good way to describe companies slogging through this new investment environment.
In general, I don't think most small business owners have any goal or aspiration to "make their companies as successful as possible" if that means turning them into a huge corporation. Most of my relatives own small businesses and none of them aspire to grow huge. In fact, my mother specifically sold her stake in her original landscaping company when it was getting too big (at 30 employees) to open a new, smaller one.
If you look at surveys of small business owners, most of them go into it from a desire to have more flexibility or to be their own boss—not necessarily to create a large and financially rewarding company. In fact, exponential growth is frequently at odds with the primary goals of small business owners.
Words are tools for communication. A word will always be a simplification of reality (and will always have edge cases), but the best words are labels for clusters of similar things. When a word describes a group of things that really do form their own cluster then it's a good word; when it describes a group that really splits into two or more distinct groups, or describes part of a group but not other equally similar things, then it's a bard work.
In many real-world aspects I'd argue that Atlassian is more similar to the corner laundromat than it is to e.g. Snapchat. How would you evaluate them when considering making a business loan? How would you consider the prospect of working for them? How would you sell services to them? What do you think their HR plans look like? Their client relationships? Their regulatory situation?
Wherever you draw the line there will be companies that straddle it. But in my book there is a relatively clean distinction between companies that operate in a way that's sustainable in the short term and companies that operate at a high burn rate, and it is well worth reserving the term "startup" for the latter.
Doesn't matter what they're called. If you're running a startup right now and have the option to be profitable vs pursue expensive growth, OP says now is the time to choose profitability. The funding climate has changed and hence risk/reward ratio needs to be recalibrated. Whether this climate change is real or not is maybe up for debate but I'd guess that in most cases profitability is not orthogonal to growth. As a side note, getting profitable while maintaining growth would seem to put you in the best possible position to pursue more funding if you wanted it.
Edit: I'll also add that according to pg's "Startup = Growth" [0], profitability doesn't really come into the definition. Hence the existence of bootstrapped startups.
It absolutely does matter. Important terms need to be well-defined before you can have any sort of intelligent conversation about them. This is a rule in academic research for a reason, it clears up a lot of unnecessary confusion and vitriol.
Reframe this post as a bank talking to a small business owner about not taking on too much liability without proving a concept and it comes off as simple, sensible advice.
> in most cases profitability is not orthogonal to growth
It absolutely is. The longer you can offer a service for free, or for cost below margin, the more users you can attract to your business. It's pretty simple economics - build a nice free garden, let people play in it and invite their friends, get investments to pay your operating costs while improving the garden, keeping it open and free, then close it off and advertise once your ecosystem is strong enough to prevent substantial churn. This is not to say that all companies follow this path, but high growth companies certainly tend to, as it gives them a huge monopolistic advantage by putting profitability off into the future.
Important terms need to be well-defined before you can have any sort of intelligent conversation about them.
But the term "startup" isn't well-defined. Just go back through the history of the (many) debates on this very point here on HN. Sure, you could just declare pg the ultimate arbiter of all things startup, and use his definition; but there still isn't really industry-wide agreement on it.
I would argue that "startup" by itself just doesn't convey enough information and that it needs additional qualifiers to be useful. "VC funded startup" vs "bootstrapped startup" or "retail startup" vs. "tech startup", etc.
Words exist, let's not be scared to use as many as we need to be precise.
I started writing this then got distracted. Everyone not only needs to collectively define what a "startup" is, but more importantly, don't blow sunshine up my ass by telling me to act like an SMB. Because I don't run into many investors who get excited about my company's reasonable P&L. There's a significant difference between a company running like a small biz and a hyper-growth-at-all-costs one. It would be quite helpful to know which investors are interested in each, all the BS put to the side.
edit: I do realize (and hope) that the current financial environment helps to bring everyone back down to earth a bit.
A company that raises millions of dollars of equity funding to try to corner a market is not a "small business", and it's certainly not a smaller business for having non-trivial revenues so that any follow-on rounds are reinvested in expansion rather than survival.
The author's point seems to be - don't try to corner the market, the days of us investing in 5% success rate "moonshots" that do corner the market is over because that 5% is now down to 0.5%, and easy liquidity events such as IPOs and acquisitions are getting harder to come by. Just make a decent product and swim along with all the other little fishes because we don't want any risky market-cornering equity on our balance sheet given the current exit environment.
That is, to put it mildly, an uncharitable way of interpreting a statement that most well-funded startups ought to be able to find a route to profitability without further growth capital if it's not forthcoming. If there's one single reason why 5% moonshots are in danger of becoming 0.5% moonshots it's the palpable contempt for the concept of a route to profitability that you're displaying. Having enough revenue to be able to grow [more slowly] once the VC cash has all been spent is not a bad thing, and it doesn't make you a "little fish".
It's even arguable a startup is not really that close to cornering a market if there's no route to breakeven point without taking on further funding. That basically means they're either too tiny to enjoy any economies of scale, not competitive enough to be able to price their product at breakeven point or haven't opened the money valve enough to actually have a real market at all yet. Sure, any startup keen on cornering a market should have estimates of just how much additional CLV can be realised if they raise another $50m to scale up the sales team rather than continuing on their current growth path with the smaller team, but few of them should need that Series C to keep the lights on.
The difference between a startup and a new small business is novelty. A startup is innovating, a small business is not. More so if a startup is establishing or growing a market versus competing in an existing market.
Granted, a lot of tech "startups" in SV are not innovating and should probably not be classified as true startups, nevertheless, that's the differentiating factor.
First, The idea of risk-reward trade-off is stupid. (This is demonstrated in my footnote.)[1]
Second: startups aren't startups because they have a high risk of failure. Simply because they expect to be much bigger in 24 months than they are today.
Someone making an app they want to sell on Android and iOS for $2 to all of the people who use smart phones is not a "small business", it's a startup. Why? Because there are 3 billion people on mobile phones.
At Internet-scale, there's really nothing between the two. There's no such thing as a mom and pop mobile game. Doesn't exist. If it's a mobile game, everyone can play it. Either you're in business around it or you aren't.
if you're in business on the world stage, you're not a small business, you're a startup. the only thing that matters is whether you would like to address the world's population or not.
i.e. whether you're "trying" (to hyper-grow.)
If you're trying to be much bigger later than you are now (by many orders of magnitude) then you're a startup. By the same token, anyone who has a plan to eventually make a million of anything is a startup. doesn't matter where you are today.
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[1] You can show yourself that risk/reward is not true. Suppose that I transport from the future to today the entire faculty of MIT and Cal Tech, who know all of the major technology breakthroughs that have happened between our time and theirs. It stands to reason that they are worth more the farther from the future you transport them. 12 months is worth less than 24 months is less than 72 months is a lot less than 70 years.
Does it stand to reason that the more value they're bringing with themselves, the higher the risk of failure?
No, of course not. It's just objectively higher value. So stop talking about risk/reward, I've just proven that it doesn't exist. The only thing that matters is the value you're bringing to the table. You don't automatically run a higher risk of failure if you bring the world $1 billion of value versus bringing the world $100,000 of value. Doesn't exist. No law makes this the case. Zuckerberg didn't suddenly increase his risk by 1,000,000 when he decided to target a million times as many people (the world's population versus Harvard's student body). It's just false. You don't need to go through a million zuckerbergs to get another facebook. You don't even have to go through fifty thousand of them. You just need people targeting the world's population who know what they're doing. This is why VC works.
you may want to read my cousin comment (in response to roymurdock) in which I add rigor to the thought experiment to better explain my point. I add the time-frame that you asked for.
I was watching this comment carefully as I thought I might have to delete it (due to people not understanding the arguments therein). It started rising to +2 or +3, so I stopped watching it. Now that I've checked again, I see that a few downvoters got it down to -1.
Since it is too late, I am happy to explain the thoughts in the above comment. I studied this area of economics from formal sources as well as having exposure to startups.
To summarize. One might think that if, say, a guy might be able to get a pizzeria off the ground, and it's 50/50, if it works he'll make a business with an enterprise value of $20,000 using his $5,000 investment, that's our assumption -- then if he wants to raise his sights and make the same investment, but this time is targeting $200,000 - his chances of success drop to 5%. And if he targets $2M then they drop to 0.5%. And if he targets $200M then they drop to $0.005%. If he targets $2B then they drop to $0.0005%. And if he targets $20B then it drops to $0.00005%. If he targtes $200B then it drops to 0.000005%
But 0.000005% is 1 in 20,000,000. There are 318 million people in America, so by those odds, the number of people in America who are capable of building a $200 billion business is exactly 15.
Yet there are more than 15 American companies that had those kinds of valuations in the past couple of years; Apple alone would account for 3 of them.
So with these kinds of large-scale successes, the risk-reward equation clearly doesn't actually work. And this ignores all of the home-run hits short of $200 billion. Clearly, risk does not increase at the same rate that reward does.
The risk-reward trade-off is just not a model that you can successfully employ when it comes to startups.
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Secondly (this is not directly related to the above) the world is super-connected. There is 0 chance that if I find a pizzeria run by some guy in the city with 1 location as a small business, that 14 months from now it will have 50 locations that he personally operates. But if you find some guy with 2,000 downloads today from the Google Play store, there is no reason this same guy can't make something else and get 200,000 downloads. That is a factor of 100.
So the whole IDEA of a "small-business" just doesn't apply to online startup-like economies. The only question is whether the guy who made a niche app with 2,000 users is even interested in trying to use his same skills making something innovative and new, which he gets good press for, but which addresses the whole global smartphone audience.
The thing that makes it a startup is this hyper-growth component, like whether he's trying to roll out at that scale.
If someone doesn't understand either of the two (quite distinct) arguments above, or has any type of comments or rebuttal, I can follow up. Thanks for your time.
The risk/reward profile is the foundation of all of modern finance.
Risk is defined (in finance) as exposure to volatility.
Volatility is measured by calculating the standard deviation of annualized returns on an investment over a given period of time. The longer the time horizon of the investment, the more exposure to unknown and unaccountable variables you face.
Ultimately, this is because we do not have perfect information regarding the future. In fact, we have a very limited pool information that gets exponentially smaller the further out into the future we look.
In your example, the professor from 70 years in the future is much more valuable than the one from 2 years in the future precisely because the 70 professor has a much greater set of information about the future. Therefore he minimizes the risk that you will invest in the wrong technology because you already know what the world will need 10, 25, 50, 70 years down the line.
Without any kind of actual valuation (tied to revenue) you cannot gauge risk. This is why startups in "pre-revenue" stage are essentially infinite risk.
Reward is also very guessed or estimated or both.
So essentially the profile is made out of whole cloth as are valuations.
Obviously I didn't specify enough. The example considers current investment possibilities in possible startups. I asked you to imagine an entire faculty (actually two of them combined, Cal Tech and MIT) standing before you, asking for money. I then asked you to consider different versions of this same situation, corresponding to different levels of future-knowledge.
Let's further specify three groups, A, B, and a control C. A and B are asking you for $1 million to build their project. The control, C, is asking for $200K.
A is from 2 years in the future, B is from 70 years in the future, and C the control unlike A and B isn't a full cal tech + MIT faculty, it's just one guy with a youtube channel and no special knowledge, from our time. But they're all going to build their projects today if you give them funding.
A has proofs of concept and has just filed for patents but says they need funding to build prototypes, and for further patent filings. They say their patents and technology and the 2 years competitive advantage are worth $50M. But they will raise at $7M valuation, for a return of 7.14x over the investment timeframe between the current round ($7M valuation) and the next round in 2018 ($50M valuation).
B has nothing, but being from 70 years in the future, says they are presently worth $1 billion, but they understand it is difficult to raise money. So they are raising at a valuation of only $10M, selling 10% for $1M. They will use the money entirely on equipment and filing thousands of pages of patents, before their dazzling demonstrations allow them to raise their next round. It's the entire Cal Tech and MIT faculty from 2086! According to their story, after they show the dazzling new technology, they will proceed to raise a round in 2018 at a valuation of $1B ($10M valuation today, $1B valuation in 2018.)
C, the control, is some kid from today who is trying to raise some money so he can maybe raise at a valuation of $1.7M a year, or maybe 2 years, from now. Maybe. He already has some revenues from 5M youtube subscribers and he is raising a seed round to expand his channel into a whole media empire. His revenues are currently $5000 per month, or $60K per year, and he is trying to raise at a valuation of $600K or 10x earnings. He is only raising $200K. A year from now he hopes to raise a proper seed round at $1.7M, for 3x return. ($600K valuation today, $1.7M valuation in 1-2 years).
You are an investor. So, according to the traditional Risk-Reward profile, if A, B, and C are your possible investments, and A returns 7.14x (over 2 years), B returns 100x (over 2 years), and C returns 3x (over 1-2 years) and C already has an established product and established earnings, then the risk on B must be huge, whereas the risk on A is smaller and the risk on C is smallest of all.
But in fact, since 70 years is so far out, they have so much advanced knowledge, that the risk in that case is virtually 0 (there is no way that the entire faculty of both Cal Tech and MIT from 2086 with all their knowledge from them aren't worth $1B+ if they have $1M in financing and two years to spend on proofs of concepts, patent filings, etc! Yet they're raising at a valuation of only $10M. It's easy!)
Meanwhile, the group from only 2 years in the future is in a much riskier and more precarious position than the group from 70 years in the future. Their volatility is higher. This should be obvious.
While at the same time, even though the kid with the youtube followers already has a real product and real revenues, and is only trying to make a modest 3x return from a current valuation of $600k (10x earnings) to a valuation of just $1.7M -- in fact, his is the highest risk at all.
So this example shows that the least risk (essentially 0 risk) might be in a 100x return, the second-least risk might be in the 7x return. The control aiming for 3x return may be the highest risk of all.
I hope my thought experiments make it very clear to you that the risk/reward profile is flawed, and that there need be no particular risk associated with an outsize reward; likewise, the level of reward does not in any way need to match the exposure to volatility.
We are talking about the context of seed investments into startups, and I do not mean to generalize to other asset classes. The Risk/Reward profile is not an accurate statement of the situation investors are faced with in considering seed-stage startup investments.
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Sorry about all the text, but it seems I didn't specify enough the first time around! Thanks for any thoughts and happy to hear your response.
Yes, some companies are ‘moon shots’ (DFJ has a fair number of those in our portfolio) where this is simply not possible. But for the vast majority of startups, this should be possible.
What is the point of calling them start ups anymore. Remove the high risk/high reward aspect and new companies are simply small businesses that receive small business loans from banks. A lot of the "wow" factor of the startup ecosystem was the mind boggling user growth/high valuation/massive losses phenomenon that a few companies weathered through to IPO and monetization.
I think I saw someone advocating for better terminology on HN recently. I vote to call any close-to-profitable <2 yr old company a small business. Likewise, any portfolio that holds mostly safe small business loans and equity should simply be called a bank.
Leave the unicorn/VC/startup lingo in the past, or use it to describe actual risk profiles, and things will be a lot less confusing.