People often look at the high valuations in early-stage venture capital and conclude there’s too much capital in the ecosystem, and that if there were less capital, valuations would come down.
However, another explanation for high valuations might just be that we need more founders.
How could this be? Typically, as explained in Econ 101, high prices imply low quantity — ie. scarcity. For example, high oil prices typically means there’s a scarcity of oil.
There’s a saying in commodities that the cure for high prices is, well … high prices. Because, usually, when prices increase, suppliers are willing to supply more of the goods they produce. This is also true if we think of employees as suppliers of labor — if we pay people more, they’ll likely work more. As prices continue to increase to levels no longer demanded by consumers, suppliers have to cut back to satiate the demand by consumers. Prices end up dropping again, but often drop too low, causing the cycle of increasing and decreasing prices to continue.
But with founders this is not the case. Higher valuations aren’t causing more people to start companies — ie. higher priced rounds are not causing increases in the supply of startups.
Why aren’t we seeing a surge of founders? Perhaps because people think that founding a company is too risky (even though I’ve already discussed why I think this isn’t so). Because of a few outlier successes, the average founder does OK, but the median founder flounders. Which is partially why so many people take executive jobs, or want to be VCs: those jobs will be there, but your startup might not. VCs have a portfolio; founders don't.
Indeed: There are lots of VCs who could make great founders — who would actually prefer to build a business than do a financial services job, but they just prefer the de-risked economic calculus of venture capital. Others, to be sure, are less interested (or less capable) of building a great business.
Given outliers, the average founder may have a good outcome, but we need to make the median founder have a better outcome. How? Diversification. While VC firms can give founders (and other operators) upside in their portfolio through scout programs and the like, founders (and their employees too, ideally) should engage in more founder pooling activities as well.
There’s a misalignment between founders and VCs: VCs take dozens and dozens of shots on goal, but founders only take one. Founders should band together and share upside, and VCs should facilitate this. Founders could get increased diversification by either scout investing or by pooling their equity with others. The infrastructure for this is still nascent but it’s something I’d like to see become commonplace.
To be sure, there are many bottlenecks to starting a company beyond risk-reward and other financial calculations — perceived career risk, fear of failure, and mental health to name a few. And if we’re just looking at things through a lens of economic risk, founder pooling is just a single solution to a single problem — we’re not taking into account the need for visas, health insurance, cheap housing, childcare and more. Which is why On Deck is trying to systematically remove all barriers to entry for entrepreneurship on step at a time.
Some critics would push back, claiming the tech ecosystem already has too much capital, too many founders, and too many failures. Why would we need more of each?
Well, according to Schramm's Law: "The single most important contributor to a nation’s economic growth is the number of start-ups that grow to a billion dollars in revenue within 20 years.”
Currently, we produce ~33 unicorns a year. If we wanted to maintain post-WWII growth rates, we’d need to see ~100 unicorns a year.
Which means to do this we need more founders—but also more investors too. To be clear, there is a lot of VC capital now, but it's concentrated within specific people at specific firms in specific geographies. It might be more effective if it were much more distributed.
Some VCs resist this sentiment partly because the more capital there is, the more competition — which is worse for them, but better for the ecosystem, as it relates to overall innovation.
Some VCs counter with the logic that some founders raise too much money and end up flaming out — which has some truth to it — but, net-net, more money enables more founders to pursue more companies, resulting in more winners. As I’ve said before, building a startup is about getting enough shots on goal to do something great; for the ecosystem at large, it’s a bit of a numbers game.
So with that premise in mind, I think we should be doing everything possible to unlock more great founders. How many people are out there who, if they started a company (or a few companies), could create the next $1B company? Hundreds? Thousands?
VCs smarter than I disagree here on several grounds:
First, they think bottlenecks to starting a company are a good thing, to separate the wheat from the chaff.
They think that economic "security" is inversely correlated with success. There is some truth to this, which is why founders often have low salaries in the early days, but there is probably something like a Laffer curve for economic security and one’s likelihood of success — but we're not close to the optimal point, it in my opinion.
They think founder diversification will result in less "all-in" founders. This thread best demonstrates the sentiment.
I'm sympathetic to critics, but still believe we can allow some diversification without sacrifice.
After all, VCs often let founders take some money off the table in later rounds, so they could go for the big swing. Facilitating some diversification might have the same effect.
Second, critics don't buy that there are great founders out there that are still held back.
Their thought process is that if a founder needs the support and encouragement to start a company, how will they maintain the motivation to keep pushing when things get hard? I'd equate it to the military: Many great soldiers "stumbled" into war and made it their mission once they got there — they just needed the first push.
In terms of their incentives, wouldn't you think that VCs would want more founders? Maybe not. After all, they’ll only invest in a handful of companies a year, and those same companies will need to hire thousands of people — the VCs want great talent to join their portfolio companies. Their advice to newcomers is often “join a breakout Series A or Series B company.”
Third, Founder Pooling has never worked, so why would it work now?
Fair enough! I'd suggest it hasn't really been tried. So maybe it won't work, but there are also other ways to diversify a founder’s risk — angel/scout investing hasn't seemed to hurt founders’ chances of success, as just one example.
We would benefit from more founders. Rising valuations aren’t leading to more founders.
We should systematically remove bottlenecks to starting companies.
We can incentivize more founders to take the leap by making the median founder outcome closer to the average.
We also should decrease the cultural friction to starting companies. We should celebrate starting companies as a thing for ambitious people to do globally. We should see startup failures on resumes as badges of honor instead of blemishes. And we should create communities to find co-founders and founder support.
Removing bottlenecks to starting companies is one of my core missions as a founder, operator, and investor. If this mission resonates with you, come build the future of entrepreneurial communities at On Deck, or pitch us for investment at Village Global.
Read of the week: Justin Murphy’s piece on Clubhouse.
I also enjoyed re-reading High Output Management. The On Deck team was 7 people in May and now we’re 30, so I’m enjoying revisiting one of the classics. I’m also wondering how Andy would adapt (or not adapt) to the changing climate today.
Listen of the week: Speaking of Max and Justin, their episode together on Justin’s podcast is a great look into Max’s story and what we’re trying to accomplish.
I also discovered Conservative Minds, which chronicles how conservatism has evolved over the last century. I’d like to listen to more podcasts that trace how a school of thought evolved over time, particularly in history, economics, and philosophy. Philosophize This is another great example.
Watch of the week: Oldie but goodie, Patrick Beverly and Lou Williams on Kevin Durant.
Speaking of basketball, I interviewed my old basketball coach and boss Dan Barto on the podcast. We discuss the evolution of the game and league, and we speculate over whether Lebron could start his own league.
Until next week,