How much is enough? An acquaintance who is also a Chartered Accountant by profession asked me a pertinent question that is at the heart of Startup activity. How do Startup founders know that the investment made so far is enough, and that they shouldn’t invest any more? There is always the possibility that just a little more time or money could make the difference between success and failure.
Being an always learning Startup student, the theoretical answer is to reframe the problem with the help of Effectual Reasoning. All experienced entrepreneurs will know that while the breakout event is sudden, the journey getting to breakout requires that you have a clear notion of right direction. The guiding principle is then to know how much you can afford to risk before deciding whether or not to invest further. This is all great in theory and I’d like to know more about how it works in the real world.
The role of Principles. Principles will help you transform Vision into Goals and Actions that you can work on now. For instance, Startups may decide to operate frugally, or ignore Venture Capital and bootstrap themselves. Without a clear set of principles the resulting goals a startup pursues will simply be too far apart and any learning will be hard to decode.
A key distinction is that to simply state ‘Think Big’, or even assimilating ‘Think Big’ is not the same as assimilating a driving principle. We are not accountable to thoughts, but we can be accountable to principles in the sense that they are the verity for all our decisions, consciously and otherwise.
Returning to the principle of affordable loss, by first clearly identifying the risk you must and can take, you can then decide if you are indeed going in the right direction as Paul does ahead.
Principle of Big Successes. In an essay on the underlying principles that drive YCombinator’s investment philosophy, Paul Graham lays out these principles (Black Swan Farming),
… the huge scale of the successes means we can afford to spread our net very widely. The big winners could generate 10,000x returns. …
… We can afford to take at least 10x as much risk as Demo Day investors. And since risk is usually proportionate to reward, if you can afford to take more risk you should.
Hmm .. afford to take at least 10x as much risk as Demo Day investors. Afford to spread our net very widely. Sounds familiar? This is by design. YC invests very little time and money in their portfolio startups when compared to a Venture Capitalist. A mentor pointed this article out to me with these lines emphatically highlighted. This is not even the same as saying “Spread your bets” and is something else entirely. It gives YC the freedom to find and invest in companies that are real outliers. Driven by these principles, the learnings Paul gained from the performance of YC are,
The two most important things to understand about startup investing, as a business, are (1) that effectively all the returns are concentrated in a few big winners, and (2) that the best ideas look initially like bad ideas.
He goes on to show how this ought to translate into direction and goals,
We can afford to take at least 10x as much risk as Demo Day investors. And since risk is usually proportionate to reward, if you can afford to take more risk you should. What would it mean to take 10x more risk than Demo Day investors? We’d have to be willing to fund 10x more startups than they would. Which means that even if we’re generous to ourselves and assume that YC can on average triple a startup’s expected value, we’d be taking the right amount of risk if only 30% of the startups were able to raise significant funding after Demo Day.
… frankly the thought of a 30% success rate at fundraising makes my stomach clench. A Demo Day where only 30% of the startups were fundable would be a shambles. Everyone would agree that YC had jumped the shark. We ourselves would feel that YC had jumped the shark. And yet we’d all be wrong.
For better or worse that’s never going to be more than a thought experiment. We could never stand it. How about that for counterintuitive? I can lay out what I know to be the right thing to do, and still not do it.
Principle of Big Success. Thanks to his guiding principle, Paul is aware that adjustments to YC’s selection might be necessary. Unlike Paul, a founder gets to do just one startup. This is not to say you won’t do another Startup again in the future. It just means that you do one venture at a time. The idea you are working on right now is going to be the idea you are working on.
The question is, do you have the Principle of Big Success besides you all the time? Like Paul, use it to find and unlock areas where you will need to take risks.