5. Global Institutional Capital Base
•$36 Trillion
•Has grown at a 10% CAGR since 1980
•Shifting more and more into “alternatives,”
especially venture capital
SOURCE: McKinsey Global Institute
7. -40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
S&P 500 Total Shareholder Return, Annual
Public equity returns’ decline the last 40 years
SOURCE: Standard & Poor’s Capital IQ
Capital influx has “bid-down” returns
Valuations at historic highs
Public equity a less-compelling asset class
8. Capital allocation has shifted towards
alternatives to meet return thresholds
Back In The Day
7.5%7.5% 7.5%
5.5%
Since the ‘80s
“Let’s find
asset classes
with higher
returns”
-Every Institutional Asset
Manager in the World
SOURCE (for average endowment returns profiles): Harvard Management Company HBS study
9. $0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
$7.0
$8.0
$9.0
Private Equity Assets Under Management
Invested Dry Powder
T
Meteoric private equity fundraising has left
managers with $ trillions to invest
PE firms: a record level of “dry powder”
Companies: an amazing seller’s market
SOURCES: Preqin, Bain & Company
$Trillion
10. Institutional asset allocations
have created a VCPE bubble
Declining Returns in Legacy Asset Classes
Constant Institutional Hurdle Rates
0%
5%
10%
15%
20%
Fixed-Income Returns
Previously Presently
7.5% 7.5%
5.5%
7.5%
-40%
10%
60%
Public Equity Returns
+
$0.0
$1.0
$2.0
$3.0
$4.0
$5.0
$6.0
$7.0
$8.0
Dry
Powder
Invested
An Explosion in VCPE AUM, i.e. a Bubble
Venture Capital and Private Equity Assets Under Management
=
SOURCES: Preqin, S&P Capital IQ, and Harvard Business School
11. (Over) growth is bad when startups:
1. Accumulate “tech debt”
2. Accumulate “management debt”
3. Neglect core customers
4. Scale before optimizing the economics
5. Rush into strategic missteps
6. Take exit options off the table
12. How to deal with the industry’s
obsession with growth
Which
Entrepreneurial
Path?
One of Two
Outcomes
3
Choose lifestyle, then:
growth pressure is NA
2
Choose “big leagues and
fail, then: sell quickly
and try again
1
Choose “big leagues and
succeed – even briefly –
then: full steam ahead
The Entrepreneur’s Decision Tree: Three States of the World
INTRO: “especially the kind of obsessive, unconstrained, at-all-costs growth the industry often espouses today”
PowerDrive
First thing: misalignment of incentives [..]; which pushes [..] too much, too fast; and [..] making the growth pressure worse
Fundamentally, a founder [..]. But a VC […], “and that usually requires each individual company to assume more growth risk than if it were only maximizing it’s own value. What’s good for the group [..]”
“Pretend you’re a VC, with one imaginary portfolio company, [..] fan of potential outcomes, as on the left [..].
The worst possible outcome [..]
The best possible outcome [..]
Entire portfolio. [..], “you know 1 or 2 or 3; 30% will plod along and deliver btw 1 and 2x, but you don’t care; and 2/3rds will lose money”
Statistically, all that matters for your portfolio is finding those 2 or 3 grandslam homeruns to redeem all the other strikeouts.
So rationally, [..] to be a grandslam homerun, [..] unicorn, [..] outlier.
Volatility. [..] as on the right.
Shaded region.
Greater chance for outlier [].
Worst, still
Now, if you had only one [..] greater chance of total loss.
But you have an entire portfolio of these ‘call options’
Asymmetric upside to introducing this volatility, to pushing companies to grow as much [..] even implicitly
“So if you’re a smart VC, you’ll push your companies to grow at a breakneck pace, even if it wrecks every company but one, because one is all you need.”
“No matter where you fall on this curve, the VCs would like you to solve for being at the top of this graph, no matter how improbable”
Nothing pernicious [..] incentives are misaligned.
Alright, brief audience check.
Raise your hand if you think we’re in a bubble!
OK raise your hand [..]
“A logical objection to my supposed critique is, ‘incentives have always been misaligned.’ True.”
Different today [..] how much the industry has grown, so this misalignment is having a larger effect.
And the proliferation [..] too much, too few, creating a pyramidic, dangerous game of musical chairs.
Exacerbating the incentives [..] “the only way for startups to escape their overcapitalization is to outgrow their excessive valuations” [..] “up the food chain” [..].
Pushing harder
Self-reinforcing
What concerns us, is we see this dynamic ruining great companies. Like PowerDrive. [..] 5,200 [..].
“Those companies are either being starved or over-extended by a venture industry too maniacally focused on growth. And we think that is a market failure.”
Lady shrugging [..] theoretical
“So let’s get granular: how exactly is growth bad for startups?”
60,000, 1,500 every quarter. Intimately. Metrics, progress, and challenges. [..]
Developed “simple, consolidated list of the risks of over-emphasizing growth, based on that primary research”
Numbers 1 and 2: metaphor. Large costs of cleanup tomorrow from shortcuts today.
Number 3: “lose more in retention than they gain in growth.” Fan of outcomes, most won’t be exponential.
OK, 4 and 5 are self-evident. But 6.
“each time you fundraise, and bring on more investors at a higher [..], and establish [..] growth targets to justify [..] you take more and more exit options off the table.”
Rocket launch into space
You can build a hypergrowth trap for yourself that limits your options and forces you like a strait jacket to try harder for growth that deep down you know you can’t achieve
So those are the 6 key risks to over-emphasizing growth [..]. But now, let’s get contructive! Talked about incentives misalignment, how over-emphasizes growth, how getting worse, and why dangerous.
So what do you do with all this good news?
Advice, actionable takeaway. Wake up now. We’ll walk through this decision tree as a framework for this advice.
Oversimplify, 3 states of the world, depending. Soul-searching
Embrace it. Don’t embarrassed, mkt is manic.
Alternatively, if you choose big leagues, [..] 2 possible outcomes
You pull it off. Escape velocity. Fundraise successively. 0.02%. No matter how generously [..] odds are slim, which implies more founders [..]
[..] 34/90%, several tries. 90%/100%. Shouldn’t hang on 3rd pivot, 2nd bridge round, or growth inflection.
Think3: permanent home
Think3: hang on too long, underappreciate how precious, don’t maximize [..] greatness by treating time portfolio [..]. Shots on goals. Option value.
most founders don’t realize the industry is obsessed with growth primarily but implicitly because there is an incentive misalignment between founders and their VCs.
[..] over-emphasizing growth can be dangerous for their companies.
[..] they can minimize the danger of overgrowth; judo; alternative, less-prestigious, more sober, selling their companies more quickly more often at lower [..] more shots, more value [..].