Why Now?
The most important question in venture capital
I used to think the most important question in venture capital was “is the entrepreneur exceptional?”
I now think the most important question is “Why now?”
Venture capital is an extremely expensive financial instrument: entrepreneurs give up massive chunks of equity for capital that is often meant to only last 18-24 months before the next round of financing.
Venture capital should be for land grabs, uncertain high-potential opportunities, and colossal risk-taking: hence the demand for lots of equity in exchange. Raising true VC for 5 years of runway makes no sense. The company should take its hypotheses, run them, and see if they're true. If they don’t, they go out of business. The risk of failure should be very high.
If the business has no monopoly characteristics or possibilities of capturing a market, VC $ doesn't make sense. Venture capital can also make sense for high-capex investments that should take a long time to J-curve into profitability. VCs are paid for that risk by the equity they get in the company.
VCs need explosive value creation across a limited fund cycle length. A company that is pure execution risk like the proverbial British restaurant in Palo Alto doesn't need VC $. It needs initial capital to get off the ground, prove the unit economics and operating model, then stamp out locations in places that make sense. Those locations should be funded by cheaper forms of capital like debt. There is no WTA dynamic, no true network effect, no risk-taking in the sense of "is there a market for this?" or "will demand explosively grow here?”
While that may be obvious for a restaurant, it’s also true for many software companies, D2C businesses, and other companies that were backed by VCs during the ZIRP era. Everyone largely agrees on things like D2C now, but even most software companies don’t have a ‘why now’ or enough differentiation that increases demand enough to justify VC $. Despite prevailing wisdom to the contrary, investing in a SaaS point solution makes less sense for VC $ than a nuclear microreactor.
‘Why now’ matters because tailwinds are the only thing that create massive demand spikes that alleviate market risk and offer the possibility of explosive value creation. Every truly great VC investment has some element of market risk (Uber, Airbnb, Facebook, Google, Snap, eBay, Amazon, etc.). It's truly uncertain how much total demand there is and if you did market analysis at the seed or A, you'd massively underestimate it. On the other hand, if you were right and there is a ‘why now’ that the company can harness, you have a big 1000x winner. Anything with market demand that can be accurately mapped out at the early stage is very unlikely to be a large winner or differentiated enough to dominate their industry without requiring massively dilutive amounts of capital in a knife-fight of perfect competition.
Tailwinds are often enabled by technology shifts, but technology alone is not enough for a “why now?” VR/AR, cleantech 1.0, scooters, etc. are all examples of this. Customer demand is the only thing that makes ‘why now’ real. “LLMs are here” is not enough for ‘why now’: consumers must actually demand what LLM applications offer.
True product-market fit in the venture capital sense is when the customer is pulling the product out of your hands, not needing to hire a thousand salespeople or spend a boatload on ads to push your product.1
To go back to the first point, there are many entrepreneurs who are building businesses that shouldn’t take venture capital money. Diluting yourself to a tiny percentage of the company only makes sense if the outcome is large enough to be worth it. Owning 4% of DoorDash a decade in is great when the company is worth $40B, not so much if it’s $40m.
Imagine building a software business that’s doing $10m ARR and growing 20% YoY. You’ve built something from nothing. You’re providing real value for customers. Yet to most VCs this company is DOA and not interesting. And they’re not wrong: for their model of investing, it actually doesn’t make sense to put money into this company.
But does that mean it shouldn’t exist? Or that you aren’t a great entrepreneur?
I don’t think so.
It just means it might not have been a company idea that should be funded by venture capital.
“We only back exceptional founders” is a tautology of venture capital. What differentiates a great venture capitalist from a good one is backing businesses that have the capacity for 1000x value creation in a compressed period of time, with a correspondingly high chance of going to zero during that same time period.
There is probably an opportunity for seed capital that invests in companies that don’t have these characteristics. The model for companies would be taking some seed capital, proving profitability or at least the operating unit economics, and then using less expensive forms of financing (or even their own profits, I daresay!) to continue to grow without diluting the shareholder base. Tech-enabled services and most software and consumer companies are examples of these.
However, traditional institutional seed generally won’t work for this model. Seed investors are in the business of high-risk/high-reward bets. Realistically, they also want markups from VCs that can help them raise new funds and an opportunity to exit via IPO or an acquisition in a decade. They don’t want you to churn out a small profit on a yearly basis and grind yourself to $30m ARR over a decade in a medium-growth market.
Maybe there’s an opportunity for a hybrid technology investor that could mix VC and PE characteristics, but it would require a different capital structure, fund cycle length, and investment team.
If you’re a founder, you should think long and hard about taking venture capital $. It’s a path you can’t really turn back from. It’s expensive, it’s dilutive, it puts you on a clock. Many companies have blown up unnecessarily because of the pressure and expectations that come from venture capital. And then people blame the entrepreneur and say he/she wasn’t exceptional. I reject that. I think many times the company simply should’ve been funded by a different form of capital and with different expectations of growth and value capture.
As a VC, the only thing that matters for me in a power-law game is finding the next Facebook or Google. I want to find companies where market risk is part of the bet, where there is unknown total demand, but there is a ‘why now’ that increases the potential for demand to go thermonuclear.
If that’s you, get in touch: pratyush@susaventures.com
And more pointedly, if that’s not you or maybe you’re just not sure2, you don’t necessarily need to throw your idea aside and look for an idea that’s ‘venture-backable.’ Getting funded by VC $ is not the prize. Making something people want and delivering value in the world is the prize. If you have an idea that you love and want to create in the world, go for it. Who cares if it’s backed by VCs or can land you on the front page of TechCrunch? You only have one life so go and do something you’re passionate about, regardless of what form of financial capital should back it.
To quote the ZIRP-iest founder of all time in a business that certainly shouldn’t have been funded by VC $:
“Do what you love.”
Thanks to Chris Paik and Jeremy Giffon whose ideas contributed to some of the thinking behind this piece.
As an experiment, I’m going to try to write a few shorter pieces like this over the next couple months. The idea is to publish more ideas that are percolating in my head and get feedback. And if they’re less than fully baked, contact with reality can help flesh them out. Let me know what you think!
People will point to Tik Tok as an exception to this. My rejoinder is yes, their ad spending worked, but their access to unlimited uneconomic capital was in part because it was strategically useful to the CCP.
There’s many amazing companies like Zapier or Atlassian who didn’t take venture capital until much later. The founders also owned much more of the business as a result.
Excellent post.