We’re Selling Entrepreneurship Short

Over the weekend I was invited to speak at the Thesis Festival, hosted by the team at Every. The event was filled with provocative ideas and I was grateful to be able to make a small contribution.

I based my talk off an essay I collaborated with Evan Armstrong on last year which he titled “Venture Capital Is Ripe For Disruption”.

In his essay, Evan observes that:

We have now reached a point in the startup ecosystem where for large VC funds, a startup achieving a billion-dollar outcome is meaningless. To hit a 3–5x return for a fund, a venture partnership is looking to partner with startups that can go public at north of $50B dollars. In the entire universe of public technology companies, there are only 48 public tech companies that are valued at over $50B. To hit this $50B hurdle, entrepreneurs take on more and more risk to try and achieve larger and larger outcomes. There is an entire generation of entrepreneurs who are ambitious and highly qualified who can’t receive venture dollars because they look or act a little differently. Even for those founders who are building a “world-changing” company, this push to enormous outcomes forces them to embrace an insane amount of risk.

This sets the stage for what would be described, in the parlance of disruption theory, as an opportunity for “low-end disruption” to occur.

Image source

Low-end disruption can be understood as:

Businesses that come in at the bottom of the market and serve customers in a way that is “good enough.” These are generally the lower profit markets for the incumbent and thus, when these new businesses enter, the incumbents move further “upstream.” In other words, they put their focus on where the greater profit margins are.

To understand what the bottom, or low-end, of the venture capital market looks like, we need to understand it from the top. And, in the case of the venture, the top continues to climb.

This year marks the ten year anniversary of Aileen Lee’s report that coined the term “unicorn” to describe businesses that achieved a public or private valuation of $1B or more. At the time she published her research, there were 39 unicorn companies representing about .07% of venture-backed software and consumer businesses. Up to that point, the venture business was averaging around four unicorns per year.

The fascination with these unicorn outcomes is obvious in the context of the venture business because it’s these outlier companies that drive the vast majority of the value created for the industry. Marc Andreessen famously broke down the math as follows:

The key characteristic of venture capital is that returns are a power-law distribution. So, the basic math component is that there are about 4,000 startups a year that are founded in the technology industry which would like to raise venture capital and we can invest in about 20.We see about 3,000 inbound referred opportunities per year. We narrow that down to a couple hundred that are taken particularly seriously. There are about 200 of these startups a year that are fundable by top VCs. About 15 of those will generate 95% of all the economic returns.

By this math, 15 companies, or roughly .004%, will drive 95% of the value for the entire venture industry.

Bill Gurley framed it even more succinctly:

Venture capital is not even a home-run business. It’s a grand slam business….

The objective, then, of venture capital quickly becomes not just finding and supporting great founders solving real problems but finding and funding as many of these 15 companies a year as possible.

With that context, the old VC trope of “too much money chasing few too few deals” has never rang more true

As venture has gone mainstream and fund sizes have increased, so too has the need for larger and larger outcomes. Where $1B outcomes were exceptional outliers a mere ten years ago, they’ve become rounding errors in the age of Mega Funds.

These larger and larger funds continue to consume the vast majority of capital allocated to VC as an asset class. The response by Stanford, one of the more prominent Limited Partners to VC funds, is not to widen the tent with new or innovative strategies but to concentrate their commitments into existing relationships with their large, and growing funds:

It’s more likely to double down on existing winners…than add funds to the mix. [At] Stanford seven years ago, the school had 300 investment funds in its portfolio. By 2020, [they] had nearly halved that number to 175, The Financial Times previously reported.

The high end of the market continues to climb and the math to reach the summit gets increasingly challenging.

After breaking down the math and the momentum of this growing need for these outlier outcomes within traditional venture, Evan concludes:

If you want to build anything less than a $50B company, this product is not meant for you. To be fair, this venture product does work for some! It is still a good way to make money if you’re building or funding enormous companies. But the product continues to move upmarket and is abandoning significant fiscal opportunity. What is more important is that it doesn’t work for most companies.

I love the venture industry and was an early participant in the creation of seed as a category. But it’s impossible to ignore the changes underway and the compelling case for a low-end disruption opportunity driven by smaller funds with more reasonable outcome expectations than $10B or bust. In fact, that was the promise of seed when it started!

But smaller funds and more reasonable outcome expectations are hard to make work when the companies you back continue to burn cash and are dependent on upstream capital for future financings. With each subsequent round, your portfolio companies, and by extension, your fund, adopts the return profile and business model of the new investor. This can often be rewarded by quick markups that LPs love to see, but it comes at the cost of optionality for early investors, early employees and founders.

For a firm to make low-end disruption work, every round they lead would need to function as an off ramp to the traditional VC track and make any subsequent funding entirely optional for the teams they back.

Of course, low-end is just one way to approach disruption.

The other, and I believe the more compelling opportunity is nested within the next, and largest, of the concentric circles above — the non-consumer.

This point seems fairly well understood, but visualizing it makes the magnitude that much more visceral.

Borrowing from Marc’s math above, roughly .05% of the tech companies founded each year attract venture capital. For those seeking it, the likelihood of closing a round of venture funding is incredibly slim, and the likelihood of a long term successful outcome even slimmer.

The gold dot was invisible at the correct scale so we had to stop at 1% to make it visible.

Of those that do raise, the likelihood of becoming one of those 15 companies a year that delivers 95% of the value for the industry is even slimmer.

As heretical as this may sound, the numbers tell the story better than the slides. We’ve oriented our startup funding model around an extremely high risk, high velocity, and high mortality model optimized for outlier outcomes — ideally within 5–7 years.

There is much good nested in a relationship between an investor and a founder such as access to industry networks, community support, expert advice, and access to capital. But, today most of that is bundled with the go big or go home business model of traditional venture capital.

A model that works for so few at the micro level yet creates so much value at the macro level begs the question of whether a different path for founders might yield a different set of results.

What planted the seeds for indie in the early days was not only seeing the soaring mortality rates in venture but seeing a wave of companies achieving venture scale without raising venture capital. The conversations I had with these founders were markedly different than the conventional wisdom of “always be raising”.

This advice was in stark contrast to what I was hearing from the founders who had built significantly scaled businesses with little to no outside funding:

If we’d have raised a seed round we would have been focused on the markets and milestones that investors needed to see and not on the needs of our customers. — Ryan Smith, Founder of Qualtrics

This focus on customers, revenue, and profitability early was not seen as a sacrifice, or a fallback plan in case funding dried up. It was a critical piece of the cultural foundation for companies like Atlassian, Calendly, Github, Mailchimp, Qualtrics, Zapier, and many more that set them up for success having raised little to no venture capital until they had scaled significantly.

We designed indie to offer the networks, community, accountability, and capital typically bundled with the VC business model of binary outcomes to the non-consumers of venture capital. Or, as one of the founders we work with quipped, “Just enough VC bullshit”.

These non-consumers tend to be a combination of founders who are actively looking to defer or avoid venture or building businesses that don’t map to the current trends, archetypes, or timelines VCs are looking to fund.

As for the former, this is a large and growing contingent of founders:

The article linked in Ryan’s tweet comes from Anu Atluru who wrote a piece on the rise of what she terms “Silicon Valley Small Businesses” or SV-SBs which she describes as:

Founding teams may look like that of a “traditional” Silicon Valley startup. They’re native to Silicon Valley ethos, skills, and playbooks.They value autonomy and flexibility. They envision a range of potentially good outcomes — not binary, all-or-nothing scenarios.

Teams stay small and run fast for as long as they can.
I define a Silicon Valley small business as having 20 or fewer employees (and often less than 10). In my experience, startup teams above this size are forced to operate very differently — much slower, with more bureaucracy, and less alignment. But below the threshold, a savvy team can create leverage and punch above its size.

They’re growth-oriented and going for efficient scale.
Unlike small businesses (and contrary to the common characterization of teams that bootstrap), SV-SBs aren’t just trying to build “lifestyle” businesses or modest passive income streams. They want to scale, as quickly and efficiently as possible. The desire and often the know-how to scale separates them from traditional small businesses, and their focus on doing it leaner and profitably can separate them from the traditional SV startup.

They try to bootstrap to profitability instead of relying on venture capital. They’re VC-literate yet aren’t charmed by the potential status, signal, or stability. Perhaps they raise the equivalent of a friends & family or pre-seed round but not much more. They look for capital-efficient businesses and prioritize profit alongside growth early on. With less money going in, there’s a lower bar for financial return. Moreover, “success” doesn’t require a billion dollar exit. Making millions is a win (and thousands keeps the team afloat).

Whether actively avoiding, or currently out of favor, at indie, we work to surround the founders we support with peers and advisors who’ve built and scaled real businesses. They share our ethos and values. They exemplify what is possible and present a road map for indie founders to follow.

The filters we use to determine who may, or may not, be a good fit for indie have evolved over time.

• First, we need to see that a founder can build and ship a product. This may have required some prior funding or may have been achieved by bootstrapping. This does not mean product-market fit it simply means their well positioned to take on risk capital to find it.
• This ties to the second filter; namely, that indie is best suited for companies building on existing or proven technologies that can be leveraged to get in the market quickly and cash efficiently vs. long R&D cycles or large technical lifts.
• Indie companies tend to focus on small niches that, on the surface, may not look like venture-scale opportunities. Often these small niches sit adjacent to very large markets. The best indie companies recognize this and see their small starting point as a large competitive advantage. In the case of the Qualtrics example, they started as a survey tool for professors to collect qualitative research. That niche led to the larger adjacent market of broad-based surveys and the introduction of Experience Management as a stand-alone category.
• The venture market can be a fickle one. One day everyone is chasing crypto then they’re hunting AI the next. It’s the nature of the industry to find these waves and ride them into an inevitable future. But the ride to those future states can often be bumpy and VCs’ attention can quickly turn and their corresponding funding dry up. At these times, a founder who is in control of their own destiny is best positioned to continue pressing toward that future while their peers who are reliant on outside funding struggle to stay afloat.
• Companies being built in geographies or by founder archetypes where VC dollars have been scarce have been conditioned by nature or necessity to build with cash efficiency and profitability in mind.
• The last, most potent, and most challenging to articulate, is the founder who truly wants to build this way. We struggle the most with founders who simply see indie as another fund or another round that will help them get to their next. Fully internalizing the indie ethos is critical to succeeding within the indie ecosystem.

6 years into indie we’re starting to see a fairly distinct departure in our return profile and results from the traditional venture model. Rather than a 60%+ mortality rate, we’re seeing 60% of indie-backed companies achieving $1M or more in revenue. An additional 25% have reached $5M+ in revenue. And 10% have crossed $10M+ in revenue. Most of these are cash-flow positive.

In the past year, we’ve seen indie companies lean into their profitability by repurchasing our equity, merging with VC-backed companies, getting acquired, or going on to raise growth capital from traditional VCs. There is a tremendous amount of optionality available to founders who control their own destiny.

The contrast extends beyond just the mortality rate.

Roughly 60% of indie companies are based outside the startup hubs that traditionally receive the lion’s share of venture capital dollars.

While female founders raise less than 1% of total venture dollars, indie sees a fairly equal split between genders in our portfolio. The appeal of indie for female founders was called out from our earliest days and we’ve seen it play out in the construction of our portfolio.

In a venture ecosystem where fewer than 1% of the dollars go towards Black and Latinx founders, indie’s portfolio is 20% with some of our fastest growing and most profitable businesses coming from these founders.

Despite the trope above that too much money is chasing too few deals in the venture business, consider a different spin on that idea. Perhaps, the more accurate assessment would be too many of the same dollars chasing the same deals and, naturally, seeing the same results. A natural consequence of this imbalance and the influx of capital into the venture asset class is that prices will skyrocket and ownership will shrink in these highly competitive companies. Or, as Doug Leone recently observed:

VC has gone from a high margin cottage industry to a low margin mainstream business. What we have right now is a sh*tshow.

Consider, for a moment, the impact on the entire entrepreneurial ecosystem if we were more expansive in our profile than our current archetypes. Or, more open to new funding models, such as indie, for investing in and supporting founders.

Take, for example, the recent $350M round raised for Adam Neuman’s latest venture. That’s a significant amount of capital concentrated behind one pre-product and pre-revenue company. Extreme risk, with the potential of unbounded upside. Very compelling.

But let’s apply that same amount of funding to the indie model. Instead of one business, with that amount of funding indie could back 700 (the average indie check is $500k).

Applying the same metrics we’re seeing in our portfolio 140 of those, roughly 20%, will go to zero.

Alternatively, 420 of those could go on to generate $1M+ in revenue, 175 of those could do $5M+ in revenue and 70 could be doing $10M+.

Imagine the impact that wave of entrepreneurship could have on individuals, families, companies, and communities. It may not elevate the world’s consciousness but it would certainly elevate opportunity for a much broader base of entrepreneurs and investors who are non-consumers today.

The beauty of non-consumer disruption is that it’s more of an opportunity for incumbents than a threat. We’re already seeing a wave of non-consumers crossing over into truly venture scale businesses within the ranks of indie. As we scale, we’ll continue to see that pool expand and raise future rounds. This is not just more of the same, this net-new dealflow for incumbent upstream capital partners.

It’s worth remembering that the venture model of blitzscaling businesses was not delivered from the mountain on stone tablets. We can change it, iterate it, and experiment with it.

The current binary model of blitzscaling works for many but still far too few. By continuing to double down on more of the same, we’ll continue to sell the impact and opportunity of entrepreneurship short. And, by extension, we’ll be leaving a world of potential returns untapped. If the venture model can unlock this much value created from less than 1% of companies, imagine what value we can create by developing models that can unlock another percentage point or two.

The indie product is one where everyone wins. LPs get access to an uncorrelated basket of early stage companies, entrepreneurs get more flexible capital that allows them to build the companies they want on their terms with a range of potential life changing outcomes, and incumbent investors get far more quality company supply to select from. That’s the opportunity we see with indie and the inevitable future we’re building towards.

If you’re a founder for whom this resonates or an LP who sees the same opportunity we do, please get in touch.