Venture Capitalism Is Broken—Here’s How to Fix It
Myntexchange: a new way access capital for growing companies
Getting VC funding is usually the worst thing that can happen to a startup.
Like a lottery winner with no financial acumen, a startup with a sudden influx of cash is often doomed for bankruptcy.
Why?
Because of a fundamental misunderstanding of:
- What startups need
- How they use money
- How unicorns come to be
Harsh truth: having more money doesn’t suddenly make someone good with money. It only exposes the financial issues they already had.
So why do venture capitalists and entrepreneurs keep falling into the same traps?
And, more importantly, how can they be fixed?
Let’s dig in…
The Paradox of Venture Capitalism
A founder has a brilliant idea for a new product or service. They genuinely believe in changing the world. They might even have a passionate team, a prototype, and even some early customers.
But they have a problem.
They need more money to scale. Whether it’s marketing expenses, more team members, or an office space, they can’t grow without capital.
Where do they turn?
For most entrepreneurs, the answer is venture capital.
Venture capital has been instrumental in launching some of the most influential companies in history, such as Apple, Google, Facebook, Uber, and Airbnb. According to PitchBook, VC-backed companies accounted for nearly half of all U.S. IPOs in 2020, raising over $140 billion in total.
However, venture capital isn’t a magic bullet that guarantees success. In fact, it can sometimes have the opposite effect. There is a paradox at the heart of venture capitalism that nobody wants to address:
The more money a startup receives, the more likely it is to fail.
Sounds counterintuitive?
There’s actually a logical explanation for it. Most startup founders are:
- Passionate
- Creative
- Visionary
On the other hand, most startup founders are not:
- Skilled financial planners
- Great budgeters
- Accountants
They’ve cut their teeth by having crazy ideas and executing on them, logic and money be damned. That’s great for going from zero to 1. But going from 1 to 100? It’s usually a recipe for bankruptcy.
This can lead to a phenomenon known as “lottery winner syndrome”, where sudden wealth leads to worse financial outcomes than before. In fact, about a third of lottery winners go bankrupt. The same can happen to startups that receive too much money too soon.
When they receive a huge injection of capital from VC investors, those same entrepreneurs may feel pressured to spend quickly and aggressively, without considering the long-term consequences. They usually make the following mistakes:
- Hire too many people (big one)
- Expand too fast (in office space, tech, etc.)
- Invest in unnecessary features or products
- Lose focus on their core value proposition and customer needs
Venture capitalism has long been a driving force for start-ups. It provides necessary financial backing, giving entrepreneurs the opportunity to transform their vision into a tangible entity.
However, the conventional approach to venture capitalism clearly has pitfalls. So, how can VCs do better?
What Startups Really Need
Venture capital, while certainly useful, often comes with unrealistic timelines and mounting pressures to perform. Venture capitalists typically want to see fast growth and high returns on their investments. They may demand strict milestones and deadlines from startups, or interfere with their decisions and strategies.
This pressure-cooker environment can undermine a startup’s potential for success.
The other problem with venture capitalism is that it assumes money is the main thing startups need to succeed. However, this isn’t always the case. More often, startups need another, more valuable, resource beyond money:
Dedicated, talented, and passionate individuals.
In short, they need manpower.
One way to address this issue is to create a platform where startups can trade equity for work, instead of cash. This would allow them to attract passionate and skilled people who are willing to contribute their time and expertise in exchange for a stake in the company. This would also reduce the risk and cost of hiring employees or contractors.
Such a platform could also foster a community of like-minded individuals who can support each other and collaborate on projects. This could create a positive feedback loop where:
- More people join the platform
- More companies get funded
- More value is created for everyone involved
Nobody needs to do away with VC funding completely—there just needs to be a reimagining of the way venture capitalism works.
A Million Little Unicorns
Instead of investing large sums of money in a few select startups, why not invest small amounts of money in many startups? This could increase the chances of finding unicorns, as well as diversify the risk and reward for investors.
Because unicorns aren’t found—they’re created.
Don’t buy it? Look at Iceland, a tiny island nation with 360,000 people, which has created some amazing unicorns in recent years, such as CCP Games, Alvotech, Oculus, and others.
How did they do it?
One factor is that Iceland has a culture of experimentation and innovation, where people are encouraged to try new things and learn from failures. Another factor is that Iceland has a supportive ecosystem for startups, where they can get easier access to funding, talent, mentorship, and networks.
However, perhaps the most important factor is that Iceland has shown that startup success is unpredictable and hard to replicate. No one can tell which startup will become the next unicorn or when it will happen. Therefore, investing in many startups may be a better strategy than betting on a few.
Because, again: unicorns are created, not found.
A New Platform for Startup Financing
During a hurricane in Louisiana, a man found himself at the center of an impending flood. His little home, which he’d had for decades, was in a floodplain, and the state ordered him and his neighbors to evacuate.
He refused, saying “God will take care of me.”
As the tide rose, emergency responders in trucks appeared at his front door to save him. “No, thanks,” he said. “God will save me.”
The flood overtook his home, and he had to go to the roof. Thankfully, a good samaritan arrived on a rescue boat. But again the man refused. “God will take care of me,” he said.
Finally, the flood submerged everything he had, and he struggled in the water. To his surprise, a helicopter came to rescue him. But for a final time, the man refused. “God will take care of me.”
Eventually, the man drowned in the flood. In his final breath, he asked God why He’d failed to save him.
But God had sent him trucks, boats, and helicopters as lifelines.
Venture capitalism is entering a new wave of transformation. Like the man in Louisiana, so many are so caught up in old ways of thinking that they don’t recognize the lifelines available.
A fundamental shift to VC funding isn’t only possible. It’s necessary and more productive.
But there needs to be new ways of thinking and new platforms to make it happen.
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