Is Growth Bad for Startups?
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Alex Western's (Think3) SaaStr Europa 2018 presentation on whether growth is bad for startups.
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Is Growth Bad for Startups?
- 1. #SAASTREUROPA Is Growth Bad for Startups? Alex Western Managing Director | Think3 #SAASTREUROPA
- 2. Is Growth Bad for Startups? Alex Western Managing Director Think 3 and ESW Capital
- 3. Time 0x 1x 2x 3x 4x 5x 6x 7x 8x 9x 10x 11x 12x 13x 14x 15x Option 1: Without Growth Pressure 0x 1x 2x 3x 4x 5x 6x 7x 8x 9x 10x 11x 12x 13x 14x 15x Option 2: With Growth Pressure How venture capitalists see their portfolio companies Multiple of Invested Capital Multiple of Invested Capital Time
- 4. Rank of Companies Multiple of Invested Capital 0x 1x 2x 3x 4x 5x 6x 7x 8x 9x 10x 11x 12x 13x 14x 15x Breakeven Top-quartile Success A venture capitalist’s incentive: make every company try to be a unicorn
- 5. Global Institutional Capital Base •$36 Trillion •Has grown at a 10% CAGR since 1980 •Shifting more and more into “alternatives,” especially venture capital SOURCE: McKinsey Global Institute
- 6. 0% 2% 4% 6% 8% 10% 12% 14% 16% 10-Year Treasury Yield Yields at historic lows Valuations at historic highs Fixed income a less-compelling asset class Fixed income yields’ decline the last 40 years SOURCE: treasury.gov
- 7. -40% -30% -20% -10% 0% 10% 20% 30% 40% S&P 500 Total Shareholder Return, Annual Public equity returns’ decline the last 40 years SOURCE: Standard & Poor’s Capital IQ Capital influx has “bid-down” returns Valuations at historic highs Public equity a less-compelling asset class
- 8. Capital allocation has shifted towards alternatives to meet return thresholds Back In The Day 7.5%7.5% 7.5% 5.5% Since the ‘80s “Let’s find asset classes with higher returns” -Every Institutional Asset Manager in the World SOURCE (for average endowment returns profiles): Harvard Management Company HBS study
- 9. $0.0 $1.0 $2.0 $3.0 $4.0 $5.0 $6.0 $7.0 $8.0 $9.0 Private Equity Assets Under Management Invested Dry Powder T Meteoric private equity fundraising has left managers with $ trillions to invest PE firms: a record level of “dry powder” Companies: an amazing seller’s market SOURCES: Preqin, Bain & Company $Trillion
- 10. Institutional asset allocations have created a VCPE bubble Declining Returns in Legacy Asset Classes Constant Institutional Hurdle Rates 0% 5% 10% 15% 20% Fixed-Income Returns Previously Presently 7.5% 7.5% 5.5% 7.5% -40% 10% 60% Public Equity Returns + $0.0 $1.0 $2.0 $3.0 $4.0 $5.0 $6.0 $7.0 $8.0 Dry Powder Invested An Explosion in VCPE AUM, i.e. a Bubble Venture Capital and Private Equity Assets Under Management = SOURCES: Preqin, S&P Capital IQ, and Harvard Business School
- 11. (Over) growth is bad when startups: 1. Accumulate “tech debt” 2. Accumulate “management debt” 3. Neglect core customers 4. Scale before optimizing the economics 5. Rush into strategic missteps 6. Take exit options off the table
- 12. How to deal with the industry’s obsession with growth Which Entrepreneurial Path? One of Two Outcomes 3 Choose lifestyle, then: growth pressure is NA 2 Choose “big leagues and fail, then: sell quickly and try again 1 Choose “big leagues and succeed – even briefly – then: full steam ahead The Entrepreneur’s Decision Tree: Three States of the World
- 13. #SAASTREUROPA
Editor's Notes
- INTRO: “especially the kind of obsessive, unconstrained, at-all-costs growth the industry often espouses today” PowerDrive First thing: misalignment of incentives [..]; which pushes [..] too much, too fast; and [..] making the growth pressure worse Fundamentally, a founder [..]. But a VC […], “and that usually requires each individual company to assume more growth risk than if it were only maximizing it’s own value. What’s good for the group [..]”
- “Pretend you’re a VC, with one imaginary portfolio company, [..] fan of potential outcomes, as on the left [..]. The worst possible outcome [..] The best possible outcome [..] Entire portfolio. [..], “you know 1 or 2 or 3; 30% will plod along and deliver btw 1 and 2x, but you don’t care; and 2/3rds will lose money” Statistically, all that matters for your portfolio is finding those 2 or 3 grandslam homeruns to redeem all the other strikeouts. So rationally, [..] to be a grandslam homerun, [..] unicorn, [..] outlier. Volatility. [..] as on the right. Shaded region. Greater chance for outlier []. Worst, still Now, if you had only one [..] greater chance of total loss. But you have an entire portfolio of these ‘call options’ Asymmetric upside to introducing this volatility, to pushing companies to grow as much [..] even implicitly
- “So if you’re a smart VC, you’ll push your companies to grow at a breakneck pace, even if it wrecks every company but one, because one is all you need.” “No matter where you fall on this curve, the VCs would like you to solve for being at the top of this graph, no matter how improbable” Nothing pernicious [..] incentives are misaligned.
- Alright, brief audience check. Raise your hand if you think we’re in a bubble! OK raise your hand [..]
- “A logical objection to my supposed critique is, ‘incentives have always been misaligned.’ True.” Different today [..] how much the industry has grown, so this misalignment is having a larger effect. And the proliferation [..] too much, too few, creating a pyramidic, dangerous game of musical chairs. Exacerbating the incentives [..] “the only way for startups to escape their overcapitalization is to outgrow their excessive valuations” [..] “up the food chain” [..]. Pushing harder Self-reinforcing What concerns us, is we see this dynamic ruining great companies. Like PowerDrive. [..] 5,200 [..]. “Those companies are either being starved or over-extended by a venture industry too maniacally focused on growth. And we think that is a market failure.” Lady shrugging [..] theoretical
- “So let’s get granular: how exactly is growth bad for startups?” 60,000, 1,500 every quarter. Intimately. Metrics, progress, and challenges. [..] Developed “simple, consolidated list of the risks of over-emphasizing growth, based on that primary research” Numbers 1 and 2: metaphor. Large costs of cleanup tomorrow from shortcuts today. Number 3: “lose more in retention than they gain in growth.” Fan of outcomes, most won’t be exponential. OK, 4 and 5 are self-evident. But 6. “each time you fundraise, and bring on more investors at a higher [..], and establish [..] growth targets to justify [..] you take more and more exit options off the table.” Rocket launch into space You can build a hypergrowth trap for yourself that limits your options and forces you like a strait jacket to try harder for growth that deep down you know you can’t achieve So those are the 6 key risks to over-emphasizing growth [..]. But now, let’s get contructive! Talked about incentives misalignment, how over-emphasizes growth, how getting worse, and why dangerous. So what do you do with all this good news?
- Advice, actionable takeaway. Wake up now. We’ll walk through this decision tree as a framework for this advice. Oversimplify, 3 states of the world, depending. Soul-searching Embrace it. Don’t embarrassed, mkt is manic. Alternatively, if you choose big leagues, [..] 2 possible outcomes You pull it off. Escape velocity. Fundraise successively. 0.02%. No matter how generously [..] odds are slim, which implies more founders [..] [..] 34/90%, several tries. 90%/100%. Shouldn’t hang on 3rd pivot, 2nd bridge round, or growth inflection. Think3: permanent home Think3: hang on too long, underappreciate how precious, don’t maximize [..] greatness by treating time portfolio [..]. Shots on goals. Option value.
- most founders don’t realize the industry is obsessed with growth primarily but implicitly because there is an incentive misalignment between founders and their VCs. [..] over-emphasizing growth can be dangerous for their companies. [..] they can minimize the danger of overgrowth; judo; alternative, less-prestigious, more sober, selling their companies more quickly more often at lower [..] more shots, more value [..].