When we take something out of its natural rhythm and manipulate it to grow quickly, does this impact health and longevity?
A couple of years ago I read a fascinating book by Peter Wohlleben called The Hidden Life of Trees. My favorite chapter in the book is called Street Kids. And in it Wholleben compares the old-growth mechanics of the forest with those that occur in parks and urban areas.
Wholleben goes on to say:
The mechanics of planting [in urban areas] haunts trees for the rest of their lives; they are kept alive and handled in nurseries for years before being moved to their final locations.
All this is done not to improve the health of the tree but to make it easier to grow and handle. At first, the young trees stuff themselves with sugary treats because they can photosynthesize as much as they like in full sun. The problems are barely noticeable in the early years, and every young tree can do just as it likes.
So they go at it as though they were in a race, and every year, they put on a growth spurt. But after a certain height, the childhood bonus seems to run out. Irrigating the trees takes an enormous amount of water and time. The gardeners must spray many gallons of water out of their hoses — per tree. And so one day the care simply stops.
Can we draw parallels between trees and venture capital? When you intervene in and manipulate a system to drive a certain outcome, does this detrimentally throw the system out of balance?
As tremendous amounts of capital enter the venture industry, I wonder whether disadvantages are self-inflicted by an operating paradigm that demands size and speed.
Is there a downside to growth at all costs?
More is not better. In fact, more can be worse.
The Foie Gras effect refers to how force-feeding startups with capital can have negative effects on how they perform in the long run. In simple terms, too much funding is not necessarily a good thing.
In the pursuit of growth at all costs and “winner takes all”, the Foie Gras effect amplifies excessive and uncalibrated spending, causing costs to spiral out of control.
We’ve seen many of these examples, hot tech unicorns that grow but that continue to bleed cash. Some get lucky enough to be acquired, some fail, while others kick the can down the road to an IPO — but eventually, the public markets take their toll.
Interestingly, the CB Insights study “Does Raising More VC Lead to Bigger Outcomes?” shows that:
The most highly funded startups tended to underperform those that raised less
The startups that raised the most almost uniformly struggled to create long-term growth
The biggest exits, backed by the deepest-pocketed investors, are returning less and less as foie gras’ing becomes more common — and more extreme
There’s often also a huge survivorship bias at play. Success stories such as the Facebooks of the world receive the spotlight — setting the example — while those that saw arid fates are no longer in sight.
In my personal work with startups, I’ve repeated my conviction that capital and speed are imperative but that they shouldn’t come at the expense of a healthy and sustainable foundation.
Capital and valuation are a means, not an end. And purchased “growth” might not withstand the merciless conditions of a harsh market.
So, what do harsh markets test for?
A product that people actually use, and that retains its users/customers
Customers who are willing to pay your full price, a price that provides your business positive unit economics
Employees that stick with you because they believe in your mission and strategy
A fairly priced investment opportunity
Tying it back to the tree
Focusing on height, but not on the integrity of your foundation makes you fragile.
A tree that is fed more is able to grow faster, but without a strong underlying root system, it will eventually tilt out of balance.
The breaking point
Eventually, the breaking point comes when your foundation cannot support your height. Your growth is hollow, and the only solution is to keep taking lateral support (more funding) to keep you standing — something has to keep holding you up.
A healthy foundation is the best defense against the powerful headwinds a venture forest might see. Funding will buy time, but ultimately you will have to address the foundation. You might get lucky and get rescued, but unhealthy foundations are also less appealing to the forest’s acquirers.
My feeling on excessive funding is that it can erode some of the qualities that make startup conditions special: resourcefulness, constraint, and an underdog mentality. And sometimes, today’s startups can seem more like overdogs than underdogs.
Easy for me to say. So what might be causing this behavior?
As always, my intention is to uncover the context and perspectives. So let’s play devil’s advocate.
Maybe the next question is: but if this is the case, then why is all this happening? Maybe it’s the system — those influencing the forest; those who are making it rain.
Let’s take a look at the incentives that have been shaping the complex venture forest.
Low interest rate environments — and startup success stories — have attracted lots of capital to the industry over the last decade or so. And investors have wasted no time to deploy more money more quickly. This causes market prices [valuations] to go up.
The seeming gold rush and FOMO propel many would-be entrepreneurs to start companies, and more managers to start venture funds. The hottest fund managers are flush with capital: HNWI, institutions, governments and the likes are desperate to get a piece of the venture action.
It ends up trickling down from the top.
And so it trickles down from the top. A couple of major venture successes generate investor interest in the market. Fund managers compete for this capital. In the process of doing so, they pursue ambitious strategies that promise quicker and higher returns, placing higher growth pressure on their startups.
Quick “growth” allows the fund managers to record paper gains (markups), enabling them to raise more money for new funds. Yes, more venture capital 🥳.
The increasing valuations set a reference point. Startups can now point and command higher prices. “The market is speaking, look at how much company x is valued; we are the same.”
And so the cycle continues… more money. strong headline FOMO. more entrepreneurs. more markups.
As the whole “forest” in urban areas offers such perfect conditions, it’s no surprise that there are population explosions — but this means that trees have to fight for their lives.- Peter Wohlleben
It’s not over until it’s over
The question that’s been killing me is: is this some sort of new equilibrium, or have we completely thrown the system out of balance; has nature simply not reacted yet?
It’s not easy to decipher. But perhaps we can ask whether the venture forest can sustain itself when capital dries up? At such a point, startups that are too reliant on funding won’t be able to sustain their operations without more money. And this is when the trees start to wobble.
The market will look for healthy foundations. Valuations will be corrected, paper markups will take a hit, fund performance will not look as rosy, investors will lose excitement and appetite, capital will withdraw, and supply will dry up.
Around this point, the entire forest canopy takes a valuation trim.
As Warren Buffet says: It’s only when the tide goes out that you learn who’s been swimming naked.
Learning from nature, and evolving from growth myopia
At the end of Street Kids, Wohlleben states:
At the end of the day the stresses the trees must bear are so great that most of them die prematurely. Even though they can do whatever they want when they are young, this freedom is not enough to compensate for the disadvantages they face later in life.
So what if instead of myopic growth, we focused on vitality; and if instead of speed, we focused on resilience?
Evolving the way we do Venture
Despite the harsh realities, I write this from a place of passion for the venture industry: it is a treasured backbone for innovation. And treating it like a bubble-like theme park reduces it to something much smaller than what it has to give.
I’ve written before that what we measure derives from the questions we ask.
And so I think that one way forward, for both entrepreneurs and investors, is to ask:
If the end-goal is to have a sustainable business, where should we focus our attention, and what is conducive to long-term success?
Sequoia Capital has already taken the lead on this. Last year they announced their commitment to help startups and founders “build enduring companies and grow value over the long run.”
“Patience and long-term partnerships generate exceptional results. For Sequoia, the 10-year fund cycle has become obsolete.”
My points and arguments are far from perfect. There are lots of holes to be poked. But my broader objective — as always — is to ask a question:
Can we do venture in a better way for our startups?
I’ve always enjoyed learning about how you think about problems. A thought provoking piece and I loved the analogy to trees. I’ve missed having your insight. Decipher gives me a small window into your world again. Look forward to reading the next one too. Bravo!
Another great article with very useful information to help us ask the right questions and learn from our mistakes.
I love your style and content.
Thanks again Firas!