Founders want money to grow. Here's why Investors want growth before funding

The founder's paradox: you "need" funding to drive growth and yet investors won't fund you unless you're already growing organically. If you have ever founded a company before or even considered starting one then chances are you can sympathize with that situation. There are few problems I've found that are as common as this one among both experienced founders and first-timers.

Before I dive into the solution here, I'd like to first address the logic behind this situation because I get so much pushback from entrepreneurs on it. Without any background context as to why this situation is so common, it would seem completely unreasonable to set such an expectation. "How am I supposed to build something, let alone something that will sell so fast I can't keep up, without any resources to help me do it?"

I suggest that the reason that seems so unreasonable is because you are looking at it from the entrepreneur's perspective and not the investor's.

So let's examine the investor's perspective. What is driving them to set what seem like such "unreasonable" expectations and push entrepreneurs into a corner like that? There are two primary reasons why this occurs and it has to do with: the venture capital market, and fund managers' incentive structure.

The first reason is that founders assume this is driven by an individual's perspective and not based on a broader market context. In other words, entrepreneurs are often quick to blame the individual investor as being "too greedy" or "unreasonable" because they only see that single investment interaction. They aren't really considering all of the other companies out there raising money and what they look like. You might find it unreasonable that the investors requires you to find traction without funding but of the 99 other companies that investor is looking at, a sizable portion of them have all figure out how to do just that. So now put yourself in their position. If you're looking at two opportunities, all else being equal, where one founder thinks they need money to get started and the other has already proven out a recipe for growth and how funding will accelerate that process, which would you invest in? Take Paul Singh's advice on this, "Founders should look at more deals."

The second reason is driven by the incentive structure for early stage funds (especially larger early-stage funds on the West Coast). Most of these guys are first and foremost looking for companies that are already growing organically at a tremendous rate. They're thinking is that any hiccups in tech, the business model, governance, customer support, etc. can be ironed out later. They just want to ride the biggest wave they can find.

What is creating this incentive structure? The answer is quite simply that big growth stories are what attract more high profile investors and drive higher and higher valuations, which in turn tends to create larger exits and more home run names for the fund's portfolio. Those last two items are what allow fund managers to make a bigger name for themselves and raise larger funds. (just look at the Twitter bio for many fund managers. They don't talk about their thesis they just list the names of the most famous companies they invested in) Unfortunately little of this story has much to do with whether the company in question is either sustainable or profitable, but that's nevertheless the incentive structure. Side note: This is also why 90% of the big tech IPO's you see have insane price to earnings ratios. They grew insanely fast but aren't necessarily generating the same level of cash flow.

So while you may be looking at funding as an insurmountable hurdle, the truth is on a macro level it's easier than ever to start a company. That also means that investors are looking at more deals than ever and a fair portion of those entrepreneurs have figured out how to start growing without funding. At the same time Fund managers are all on the lookout for the next Uber, Coinbbase, or Instagram to base their reputation on.

Alright so that's why founders are expected to start growing before getting funded but how exactly do you do that? Checkout FastThoughts again next week where I'll dive into that question head-on.

James Shomar
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