One of the biggest tensions I find in the venture capital business is the need to go big.
Many/most elite firms talk about needing to invest in companies that they can realistically see becoming transformative companies. From an exit standpoint, this means companies that could generates $100M+ in revenue and be worth over $1B in value.
This is motivated by a bunch of things. The first and most important, is probably fund math. But the second is more intangible. Call it personal satisfaction, legacy, etc. Many venture capitalists have been founders or investors in very big companies and have made lots of money themselves. The economics are a big driver, but probably just as big is the desire to continue to be a part of big big successes. Personally, one of the main reasons I co-founded a seed focused fund like NextView is because I saw it as the way I’d have the highest chance of being impactful to truly extraordinary companies. It’s not a financial incentive, it’s more about what I’d like my life’s work and contribution to be.
There are a few tensions, however, with the “go big” strategy. Two very particular ones:
1. The Tension of Reality: There are two counter-balancing realities at work in the go-big strategy. The first is the reality that most companies exit at much much less than $1B (usually much less than $100M). In addition, most companies are probably better off financing themselves in a way that maintains optionality for successful smaller exists along the way, vs. raising a huge round at a huge valuation very quickly. There is tons of data on this. Arguably, this means that one should actually target a strategy that does well in such a scenario. Indeed, we’ve been involved with companies like RentJuice that have generated an excellent multiple on our capital at an exit under $100M that is life changing for the founders involved. On the flip side, there is also the reality that excellent fund returns are driven by monster companies. Paul Graham wrote an excellent essay on this, where he noted that just 2 companies account for 75% of all of Y-Combinator’s portfolio value. Under that view, averages and base-hits are meaningless. The only way to create an extraordinary fund is to invest in a way that gives you the highest probability of catching a huge huge company. I think that both views of reality are right, and it’s a tension I think about on most days.
2. The Tension of Selection: One salient challenge of the go-big strategy is that evaluating whether an opportunity is “big enough” is quite hard at the seed stage. Some companies are going after opportunities in existing, quantifiable markets. In this case, figuring out if something is big enough is pretty do-able. You can figure out how many buyers of a product or service there are, you can figure out willingness to pay based on existing price points, you can assume some market share penetration, and you have some sort of an answer. But the very biggest companies are not playing in established markets. They also are often following hunches about where things are headed, but have no concrete way to show that there is a $1B+ opportunity on the horizon. Actually, it’s more likely that whatever analysis one can do will show that the quantifiable market opportunity is quite small.
The irony of that is that often, those companies that look like toys and have no obvious path to $1B, sometimes break out and end up being worth more than $10B. But there are doubters all along the way. Is FourSquare a transformative company, or a poor man’s Yelp? Is Dropbox destined to be crushed by Google, or is it destined to be the most valuable internet company since Facebook? Is TaskRabbit unlocking a huge huge category, or a tiny tiny niche? It’s not always obvious. But one thing I think is for sure – if you evaluate these opportunities using the lens used in quantifiable markets, you will miss them every time.