Why Do VC Funded Startups Love "Fake Growth?"

"What's the deal with all of these Venture Capital funded startups that raise tons of money, add tons of people, and then later flame out with almost zero revenue? How do the investors put up with this and how do the Founders ever think this is a good idea? This is bananas!"

February 8th, 2023   |    By: Wil Schroter

Venture-funded startups grow way beyond their means because they have to.

Time and time again we get asked by (typically bootstrapped) Founders about why in the hell venture-funded startups love that so-called "fake growth."

You've seen this before, when a new startup raises gobs of venture capital, hires hundreds of new people, burns through tens of millions of dollars (or more!), and then later on has to crash and burn the whole thing because it never actually made any money.

From the outside, it seems insane. What Founders don't realize is that this whole "fake growth strategy" isn't just some bizarre misstep - it's an actual playbook. We look at stories like WeWork and ask "How could anyone let that happen?" Well, it turns out, there's a pretty good explanation.

It's All About Momentum, Not Money

It all starts with understanding how the funding game works at the highest levels, particularly in later stage Series A, B, C, D rounds and beyond. In theory, we assume that startups raise money because they need capital to do a specific thing. But what if I were to tell you that raising money isn't about how much you need — it's about how much you can raise.

The startup investment game is all about momentum. A startup that looks like it's about to take off has momentum, which attracts a lot more investment dollars than one that doesn't. So if we co-found a startup, raise $20 million, hire hundreds of people, and spend millions in advertising - we have momentum. We're growing, we're scaling!

Startups with momentum look a lot more like they might be successful than startups that don't have any momentum. A startup chugging along hiring 10 people per year, and slowly growing revenue through profits doesn't feel like a rocket ship about to take off, and therefore doesn't attract tons of capital. You need the momentum to raise capital, and you need the capital to keep the momentum going.

"Yeah, but what about Revenue?!"

Everyone quickly points to the fact that many of these startups don't have nearly the revenue to support their fake growth — and of course, they are right. But it doesn't matter. That's not what investors are funding. They aren't funding existing revenue, they are funding the momentum that could create a massive amount of future revenue.

Think of it like this. If I open up one lemonade stand, take time to make a profit, and then open up a second, it's going to take a long time to have a national chain of lemonade stands - maybe decades!

But if I raise $100 million and open up 1,000 lemonade stands, they may not be profitable, but we look like we have way more momentum toward becoming the next big IPO in a short period of time. And that's what investors want — lots of momentum with a very short time frame.

"But. but... it's FAKE GROWTH!"

Yes, it's 100% fake growth. The VCs know it, the Founders know it. Oddly the people that actually work there often don't know it, which is a whole other thread. The big ad budgets, over-priced office leases, and legions of software engineers were never intended to support the present revenue or business model - they were there as a giant bet that the future model will require all of that when... and if... it works.

Frankly, it usually doesn't work. These are giant bets, and like all bets, they carry a ton of risk and a ton of cost. Investors are willing to bear those costs because the ones that do work pay for all the ones that don't — at least in theory.

But we have to stop comparing the path of a VC-funded startup and its "fake growth" to that of a typical business using profits to pay for growth. They aren't even remotely close.

Now that doesn't mean that VC-funded startups, or their Founders, are completely off the hook here. At some point, we're all required to make good decisions for the welfare of the business and those that we employ. But for most VC-funded startups, by the time they have to start making rational decisions, the money is typically gone anyway.

It's the ultimate fake it til you make it play. And 6% of the time — it works every time!

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About the Author

Wil Schroter

Wil Schroter is the Founder + CEO @ Startups.com, a startup platform that includes BizplanClarity, Fundable, Launchrock, and Zirtual. He started his first company at age 19 which grew to over $700 million in billings within 5 years (despite his involvement). After that he launched 8 more companies, the last 3 venture backed, to refine his learning of what not to do. He's a seasoned expert at starting companies and a total amateur at everything else.

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