I wrote about the concept of scale that PMs sometimes get blinded by a little bit in a previous article. A couple of friends read it, and we started having a debate about what “scaling something” even means, why we feel so strongly about the way we see the world, etc. Then one of them said, “You should probably write about this,” so here I am.
I tend to have pretty critical views about “scale” now after having lived through a decade in the Bay Area. I’m of the firm belief that a lot of us were told to drink the Kool-Aid of “only businesses that scale to a billion (in valuation 😉 ) are the businesses worth doing or starting.” This narrative often originates from people who clearly stand to benefit from that speculative outcome even it that comes with some unsavory externalities.
Before we talk about the nuance, let’s get a few things out of the way, especially if this is the first post of mine that you’re reading. Yes, I know the standard VC model is to invest in things that have the potential for a blowout exit. It’s supposed to be high risk, high reward, yada yada. And sure, different VC models do exist now – pure plays, rollups, the de-SPAC trend that thankfully peaked in 2021, venture debt via hybrid funds, etc. Those are all fun and fine and we may even discuss them in a future post.
But I don’t think this dominant focus of scaling to a billion is primarily because large funds want consolidated control over different parts of commerce, though maybe some do. At the end of the day, they’re also subservient to their Limited Partners and investors too. Even the different General Partners at each fund don’t always have aligned incentives, which makes for some amazing drama.
::Engage Peanut Gallery Mode::
I think the root cause is a lot simpler than that. They’re just flawed, selfish humans like us, and they fall for the same crap we do.
Maximizing the easy win... or not?
There’s a meme going around Instagram and Tiktok (for which a link is quite hard to find right now) about a professor offering to adjust their students’ grades with extra credit. Students can request either 2 points or 6 points. If more than x% of students pick 6 points, then no one gets anything. There are a few variations, but I like this one because there isn’t a truly negative outcome, only a potentially decent positive-sum outcome that can be missed. It’s a great illustration of game theory and incentive alignment.
The simplest thing to do is coordinate and guarantee 2 points for everyone. But we all know that’s not how the game is usually played. Inevitably, some portion of the class, for a variety of motivations, will go for the 6 points because 2 points isn’t “good enough.” Maybe they bombed the test and need the highest return, or they did well and want the upside of pulling ahead...or the ones who did well just don’t want others to pull ahead and will consciously try to push past the % threshold so no one wins extra points. Often these types of common-pool resource experiments reveal a pretty honest (although sometimes shitty) view of humanity. These games play out in classrooms over a few rounds to see if there is a change in behavior.
Now, think about the VC world and the “billion or bust” mentality. The VC funding model sets up a similar game. The “6 points” is the billion-dollar exit – the outcome that delivers the necessary fund returns. The “2 points” might be building a profitable, sustainable, smaller business. The system incentivizes founders and teams to chase the high-risk “6 points,” knowing that while most players pursuing this path will end up with “0 points” (the startup fails), the few who hit “6 points” make the whole model work for the VCs and LPs. The VCs, as the architects of this game, profit from the system that encourages this behavior, often with less personal risk than the founders and teams playing the game.
But here’s the kicker, and it’s a big one. Even when a few companies do manage to get those 6 points – that shiny billion-dollar exit – it’s often not the fairytale ending you’d expect for the company itself. Look around: how many of those high-flying ‘unicorns’ truly thrive once they’re public or get tucked away inside a larger corporate parent? We talked about Zenefits last time and I’ll stay away from going deep into Lyft, Uber or WeWork that others often talk about. Think about companies like Box and Dropbox, which achieved huge valuations, but have faced ongoing questions about profitability, growth sustainability, or stock performance post-IPO. Or consider Slack, acquired for a huge sum by Salesforce, whose integration and continued independent innovation have been subjects of much discussion. And this pattern holds true for countless other B2B products acquired for huge sums only to see their roadmaps stifled, teams disbanded, or innovation slow dramatically as they’re forced into an acquiring company’s structure. The intense pressure to grow at all costs to achieve that exit valuation often builds companies optimized for that one single moment, not for much else. The “win” for the initial investors and founders doesn’t always translate to long-term health or continued product innovation.
The new Manifest Destiny
Marc Andreeson tends to represent this mindset quite well. “I can make multiple bets that have contradictory theses. This is the whole Peter Thiel thing of determinant optimism versus indeterminate optimism. A company founder CEO has to be a determinant optimist. They have to have a plan and they have to make the hard trade-offs to be able to succeed at that plan. A VC is an indeterminate optimist. We can fund a hundred different companies with 100 different plans with mutually conflicting assumptions.” - his words, not mine.
This neatly captures the portfolio approach that necessitates chasing those outlier outcomes. Obviously, we also have Private Equity with another angle that tries to go for fancy financial engineering magic as a way to generate returns regardless of the externalities.
Look, I could do the fun Bernie Sanders “It’s the Millionaires and Billionaires!” thing and call it a day. But I write about this world, not because these VCs/Founders/PE folks are the “other” group for me. They’re my friends and colleagues. These are all places where significant capital pools operate, where their careers are made and frankly, where many of them will be the leaders in the coming decade. But they aren’t the only or necessarily the best places to build lasting value or a fulfilling career.
Awesome Alternatives
What about the rest of us? Those who either don’t care to go to a BigTech/xTech firm, can’t get into one, or don’t even know much about them? I think being a part of a smaller business is quite underrated. Especially a business that doesn’t need to scale exponentially, or is in a niche unlikely to be the first target for consolidation. These companies offer compelling models for building sustainable value and careers outside the hyper-growth paradigm, potentially serving as a counterbalance to the trend of larger capital pools consolidating more parts of the economy.
From a Product perspective, there are companies like 37Signals, Automattic, Element84, Baremetrics, Kit, or Harvest that offer a great alternative to the big ones. My friend and colleague, Erad Fridman runs Fluxon, and they’re pretty great too! There’s also a giant list of consulting firms that focus on a niche like cybersecurity, systems integration/development, supply chain, product development, etc. Could these be opportunities for acquisition? Sure. Are they the first places to look for a blowout exit? Likely not, is my bet. They might either serve a limited market size, have lumpy revenue cycles, or don’t really have an enticing (aka 70%+) margin profile, nor do they explicitly follow the rule of 40.
I find these companies super fascinating; they represent smart, viable paths for building businesses and careers outside the traditional VC-funded model. The other thing that’s been very interesting to me is the “Micro” Private Equity space and its various flavors like Micro Permanent Equity, Micro Evergreen Fund, etc. They’re just the modern-day version of having a variety of small businesses conglomerated together the way many folks do in small towns. Think Dr. Lu Saperstein from Parks and Recreation! I want to explore a bit of this in a future post!
So, what are your thoughts on the “scale to a billion” mindset? Have you seen it impact how products are built or how careers are shaped? Do you know of other businesses thriving outside this model? I want to know :)