The Fail-Safe Startup by Tom Eisenmann

Author:Tom Eisenmann [Eisenmann, Tom]
Language: eng
Format: epub
ISBN: 9780241987780
Published: 2021-11-04T00:00:00+00:00

As Graham notes, many entrepreneurs who lead successful startups have the option to avoid raising more venture capital and could instead fund slower growth through internally generated cash flow. However, passing up more venture capital “on terms they’d be crazy to refuse” might forfeit the entrepreneur’s opportunity to become really rich. So, if a startup could scale rapidly but is not impelled to do so by competitors (more on this below), what might hold them back?

First, an entrepreneur faces a radically different risk-reward scenario than a venture capital investor. Assume that scaling rapidly—“swinging for the fences”—has a 1 in 20 chance of earning a huge payoff. With a few dozen companies in its portfolio—that is, with dozens of “at bats”—a venture capital firm can reasonably expect at least one home run, along with a few singles and doubles. Averaging across all of these outcomes, the VC should earn a good return on its investments, even with plenty of strikeouts. By contrast, entrepreneurs don’t deal with averages; they get just one turn at bat, and if swinging for the fences significantly boosts their odds of striking out, too, they might prefer a safer strategy.

As an example, if you, as a founder/CEO had one shot, would you rather have 1) a 10 percent equity stake in a startup that has a 5 percent chance of being worth $1 billion; or 2) a 25 percent equity stake in a startup that raised much less capital, grew more slowly, and has a 10 percent chance of being worth $200 million? In terms of personal wealth creation for the founder, both options have the same expected value: $5 million. But with the hypergrowth option, the founder has half the chance (5 percent vs. 10 percent) to earn twice as much ($100 million vs. $50 million).

Second, scaling at high speed puts tremendous personal pressure on a CEO. The hours can be brutal and filled with a constant stream of calamities. Everything happens faster: hiring mistakes, firings, service problems, customer defections. Of course, if things are going well, achievements come faster, too. Some leaders thrive under such pressure and derive great satisfaction from taming the chaos. Others, after skipping yet another child’s recital or one more friend’s wedding, may ask, “Is this really worth it?”

Finally, if a founder still holds the CEO role and chooses to scale her venture at a faster rate, she must accept the higher odds that she’ll be replaced. Faster growth means raising more rounds of venture capital, and each round typically adds a new investor to the board of directors. Investors will eventually control a majority of board votes and can dismiss the CEO if she’s struggling. A founder who relishes the power that comes with the CEO role, or who’d be distraught at being separated from a venture to which she’s passionately attached, should weigh this risk.

This final concern points to an underlying issue with being Willing to scale. “Fast or slow” isn’t solely up to the founder—it’s a board-level decision.

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