What does a founder friendly investor actually do?
Is it…
- …the firm that is the most pleasant to work with?
- …the firm with the most capital to deploy?
- …the firm with the most powerful network?
Or is about alignment with a founder’s long-term succes?
The answer ought to be obvious, and yet the revealed preference of the industry is to broadcast founder friendly vibes structuring the market to undermine their future.
For example, a puzzling feature of venture capital that has appeared recently: investors telling (AI) founders that now is a good time to sell their companies.
They’re probably not wrong, but who is that advice for?
It’s not for any founder pursuing their life’s work. Nobody who wants to retain control, stay in “founder mode” and build a company of generational importance.
Instead, this attitude seems to be aimed at mercenaries; companies destined for a quick flip to an incumbent. Indeed, the majority of exit activity has shifted from IPOs to “BigTech acquisitions”, as larger VC firms have become more cowardly.
“In this paper, we argue that this focus on exit, particularly exit by acquisition, is pathological. It leads to concentration in the tech industry, reinforcing the power of dominant firms. It short-circuits the development of truly disruptive new technologies that have historically displaced incumbents in innovative industries. And because incumbents often buy startups only to shut them down, intentionally or not, it means that the public loses access to many of the most promising new technologies Silicon Valley has developed.”
Exit Strategy (2020)
What happened to finding founders who were on a mission to change the world?
Isn’t venture capital supposed to support the most important companies, driving progress, creating prosperity?
Where are they supposed to turn, otherwise?
It’s tragic that the dominant firms in venture capital have switched from financing creative destruction to the safer and easier role of serving incremental solutions to incumbents.
Of course, this is likely the natural consequence of venture capital firms themselves becoming bloated, risk-averse incumbents. The product they serve to LPs is stability and predictability, not risk-seeking alpha.
So, if a company does not choose to exit to an incumbent, or that option isn’t readily available, what then?
Increasingly, they are only funded into the later stages if they are a useful vessel for allocation — a vehicle by which VCs can justify fee income on ever-larger pools of capital. Private market sponges, with failing health and indefinitely postponed exits.
This also ends badly for the founder.
This is where the VC market is in a real pickle.
The case is crystal clear and yet nobody can admit to it, because it’s both extremely proifitable and hostile to founders.
“It is difficult to get a man to understand something, when his salary depends on his not understanding it.”
Upton Sinclair
Raising more private capital is correlated with worse long-term performance, and it gets increasingly worse with scale. Of the 12 companies who have raised >$3B and listed in the US, 11 have (dramatically) underperformed the index.
These were the darlings of venture capital, the companies which raised unprecedented amounts. Then they were dumped on public markets and left to struggle.
The reasoning is simple: Private and public markets have different goals, reflected by how they value companies.
- Private companies are valued on their fundraising momentum, which is a result of ARR and market narratives. Thus, companies are rocket ships with weak economics.
- Public companies are valued on a relatively thorough examination of their financial health. Narratives matter, but hype competes directly with pressure from short sellers.
As a result, the longer a company stays private, the more of a struggle it will be to adapt to public markets.
It even appears that giant growth-stage rounds don’t even perform particularly well for VCs, but the goal isn’t performance, it’s allocation. Capital at work. AUM. Fees. Rent-seeking. And then inventing new ways to dump these bags on others.
It’s great that we’ve moved on from the era of replacing founders and rushing companies to IPO for grandstanding purposes. But what has replaced it is arguably much worse.
Consider that tech is still dominated by the Mag-7; companies mostly founded in the 70s or 90s. Companies that are now worth trillions, who originally raised peanuts and went public in a median of less than six years.
So, founders appear to have two main choices if they take VC:
- Take a quick flip to an incumbent if your future looks dicey.
- Stay private and absorb capital until it becomes toxic.
The default used to be a sensible middle path: raise the capital you need to build a great business, take it public, and thrive.
Unfortunately, this outcome does not serve the platform firms whose main challenge is allocation at scale. So, liquidity has evaporated, smaller firms have suffered, and founders are more often stuck with these incentives.
Of course, founders have agency. They are able to determine their future, providing they are fully aware of the options and consequences.
Indeed, some founders may understand the importance of hitting an exit at the right time, and in the right shape, to maximise the future of their company. They have the potential to do exceptionally well.
However, their advisors on financing are usually venture capitalists, who are not incentivised to understand why too much private capital is bad for a company.
In fact, they are incentivsed to keep stuffing capital into attractive assets until they are no longer attractive assets.
So, the smart path isn’t easy or obvious, for the founder.
Getting an exit right requires nothing short of good timing, brilliant execution, and awareness that their future interests will eventually fall out of alignment with even the most “founder friendly” venture capital firm.
(top image: Michelangelo’s “The Torment of Saint Anthony” )
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