When to use capital as a restraint vs as an accelerant
I’ve been working in venture investing for only 4 years, and already I’ve seen two seasons of the debate around growth v/s profitability. It consumes way too many people and way too much energy. In every bull market, it’s growth at all costs. In every bear market, it’s time to turn profitable as soon as possible.
So, I want to share some perspective on this topic that I think holds true across all stages of the market cycle.
First, it’s important to keep in mind that venture capital serves only two purposes:
(a) underwrite the cost of product development for new products and technology, and
(b) condense the timeframe of the market adoption from decades to years by spending heavily on customer acquisition.
Now, from a fundraising/investing perspective, this trade-off between growth and profitability is most pressing around the Series A/B stages, where the capital requirement is around $5-30mn. At pre-seed/seed, it’s more about figuring out if this thing actually works or not. From Series C onwards, it’s more about predictable (but still high) growth and steadily improving economics.
Empirically, seed to Series A is also the hardest because the startup has proven enough but still not enough – there’s potential and uncertainty in equal measure. In bull markets, investors focus more on the potential and are willing to write larger checks earlier. In bear markets, investors focus more on the uncertainty and want the business to be further along to write smaller checks (or ask for more equity).
So, how can founders navigate the ups and downs of capital markets while being true to their business?
One of the privileges of being a seed-stage investor is that we can clearly see the distinction between pre-product market fit and post-product market fit. Every single founder, in all honesty, knows whether they have PMF or not. As one of the wisest sayings goes, “if you have to think you have PMF, you don’t”.
There’s enough already written and talked about PMF, so I’ll only share my understanding of it briefly. PMF is 4 things – when the startups know who their customer is, what’s the best way to sell to them, what’s the right monetisation model/price point, and what the unit economics look like.
Aligning all 4 things requires a lot of iteration because changes in one impact the other three. The mistake founders make is thinking they have PMF when only one or two of these four is/are working. It has to be all four.
Grounding into product-market fit provides a logical way to calculate capital requirements and a structural framework to decide what to prioritise when.
Here’s what we’ve learnt from the best companies and what we suggest to our portfolio founders:
Before product-market fit, use capital as a restraint. Less amount. Small team. Razor-sharp focus. Resist all the temptations to grow. The pitfall startups could fall into here is scaling prematurely. When one of the four things works, they take it as PMF and try to scale it. The other risk here is that when investors are rushing to invest, they offer more capital than startups need at an earlier stage (again, when they don’t have PMF). This works for a while, but when market conditions change, it leaves the startup nowhere – they haven’t figured out the business model, and the valuation is already too high.
But once you have PMF, capital should be used as an accelerant, almost as a cheat code. Lots of founders here are okay to grow slowly (slow being relative to what’s expected of startups). When things are working, it’s important to double down – scale fast, create a new market, win market share. Every startup likely has a limited window of opportunity where it can grow quickly before they turn into a mature company. As long as your business economics are contribution-positive (or even slightly negative within range), growth should be the only north star.
One might think that growth conflicts with profitability, but we must keep in mind that as long as unit economics are working, scale is the biggest driver of profitability.
Now, of course, to keep fuelling the growth, the startup needs external capital. So founders might rightly argue - how can we grow if we don’t have capital? My argument here is that if you’re growing fast enough and have a clear plan of growth and targets, you should be able to get that capital.
To conclude: Capital markets will continue their cycles. Bull markets will reward growth. Bear markets will demand profitability. But the fundamentals of building remain constant: figure out what works, then pour fuel on the fire.
The biggest risk is not moving too fast or too slow. It's moving at the wrong speed for where you actually are.